Well-known and respected business consulting and advisory firm Ocean Tomo reports that within the last quarter century, intellectual capital has emerged as the leading asset class for businesses comprising the S&P500. Between 1995 and 2015, the share of intangible asset market value increased from 68% to 84%. In July 2020, Ocean Tomo found that COVID-19 had accelerated the trend of increasing value share, with intangible assets now commanding 90% of the S&P500 market value. And although Ocean Tomo was focused on changes in the S&P500, there’s no reason to believe that the same trends were not impacting small to middle market companies.
So, what is encompassed by this “intellectual capital” asset? The term is generally used to refer to traditional intellectual property (IP) assets – patents, trademarks, copyrights, and trade secrets - together with certain contract rights.
Take the value of your company as a going concern and subtract from this number the fair market value of the hard assets. What’s left is a fair approximation of the value of your company’s intellectual capital. For most businesses, but particularly those in technology, information/ communication, consulting, or consumer products, it will be a soberingly large number. That’s good – it’s part of what separates you from your competitors.
Now, take a look at what you spend to insure your hard assets, in contrast to what you spend to protect your intellectual capital, and in particular that portion of the intellectual capital comprised of intellectual property. Does what you discover suggest that your company should be paying more attention to perfecting and preserving these assets? If you haven’t already taken care of this, as the time approaches for you to sell your business, it is especially important to take steps to ensure that these assets, which probably comprise a large part of the value of your business, are in good form and ready for the buyer’s due diligence review. What follows is a brief explanation of each of the components of intellectual capital together with a list of steps you will want to take in preparation for sale.
Patents
A patent is a government grant to an “inventor” of a temporary monopoly to prevent others from producing, using, selling, or importing his/her invention offered in exchange for disclosing the invention to the public. Patents cover devices, compositions of matter, or processes (utility patents) and also non-functional designs (design patents). In order to be patentable, the invention must be useful, novel, and not obvious to one skilled in relevant art.
The patent right is a “national” right and must be sought and secured on a country-by-country basis. In the U.S., patent protection now lasts a maximum of 20 years from the initial filing date. The process of obtaining a patent can take from one to three years or more.
In any business where technology can provide a competitive edge, the monopoly rights granted by patents can help you preserve your lead, provided you act appropriately. It is important to recognize your potentially patentable improvements or inventions, to identify the inventor (so that appropriate rights can be secured), and to file your application in a timely fashion. Once publicly disclosed, inventions are no longer eligible for protection. (However, in the U.S., there is a one-year grace period from the date of disclosure or first offer for sale.)
Sale Preparation Steps:
- Ensure that all employees hired to invent have signed invention assignment agreements
- Review the invention disclosure process and documents
- Ensure that adequate steps have been taken to guard the confidentiality of work-in-process until such time as patent applications have been filed
- Review inventions for patent eligibility and document the basis for your decision to pursue application or rely on trade secret protection
- Docket due dates for filings and maintenance
- Review and maintain freedom to practice opinions
- If you have pledged any of these patent rights as security for a credit arrangement, check to ensure that if the debt has been satisfied or refinanced, that a formal release has been recorded in the appropriate offices
Trade Secrets
The law of trade secrets covers general information, things like proprietary processes, financial information, and customer lists, provided that the information is indeed secret, that it has commercial value, and that the owner has taken reasonable steps to preserve its confidentiality. Unlike patents, trade secrets can be protected indefinitely. This form of protection is, however, more tenuous since it lasts only as long as the secret is preserved – once the cat is out of the bag it cannot be put back in. There is no government application process involved. Instead, the owner’s efforts should be focused on ensuring that employees and contractors enter carefully crafted confidentiality agreements before being provided with access to proprietary information. The strength of your protection is entirely dependent upon the enforceability of these agreements.
Sale Preparation Steps:
- Ensure that all employees hired to invent have signed invention assignment agreements
- Ensure that you have a formal trade secret policy
- Check that you have non-disclosure agreements with all employees and contractors who are exposed to trade secret information
- Curate and archive key documents
- If you have granted a general security interest in intellectual property and intangibles, check to ensure that, if the debt has been satisfied or refinanced, a formal release has been recorded, in the appropriate state office
- Conduct exit interviews with departing employees to remind them of their continuing obligations to respect and maintain your trade secrets and maintain a written record of those exit interviews
Trademarks/Service Marks
A trademark or service mark consists of a word, name, symbol, or device (including, under certain circumstances, color, sound, and even smell) used to identify the source of goods (trademarks) or services (service marks). Marks must be nonfunctional and must serve as a distinctive source indicator. Once rights in a mark are established, others may not adopt similar ones.
The trademark right is a common law right acquired by use of the mark on or in connection with goods or services in the geographic region where used (augmented by federal protection for registered marks). Thus, federal registration is not essential to a trademark claim, though it offers some substantial benefits, including: nationwide rights; the right to recover profits, damages, and costs from an infringer (and possibly up to treble damages and attorney fees as well); establishment of constructive notice of ownership of the mark; a presumption of validity (and in some cases, incontestability); the right to use the registration mark symbol; access to enhanced remedies for counterfeiting; certain advantages in domain name disputes; and the right to stop importation of goods bearing an infringing mark.
Trademark protection is potentially perpetual, although registrations require periodic updating or renewal. In many cases, a search for existing or potential conflicts is advisable prior to investing in registration or tooling up to use the mark.
Sale Preparation Steps:
- Identify and document common law marks
- Keep record and documentary evidence of the date of first use
- Archive clearance opinions
- Register appropriate marks in countries of interest
- If you have pledged any of these trademark/service mark rights as security for a credit arrangement, check to ensure that if the debt has been satisfied or refinanced, that a formal release has been recorded in the appropriate offices
- Docket due dates
Copyrights
Copyright is a form of protection provided to the authors of original works of expression, including literary works, computer programs, dramatic works, musical works, artistic works and architectural works. Material not eligible for copyright protection includes titles and short phrases, ideas and facts, blank forms and standard tables (though patent, trademark, trade secret, and unfair competition laws may provide protection).
Copyright protection is available to both published and unpublished works and, unlike patent and trademark rights, is not territorial (a copyright granted in one country will generally be respected in other countries by virtue of several international conventions and treaties).
U.S. copyright law generally gives the owner of copyright the exclusive right to reproduce the copyrighted work, prepare derivative works, distribute copies of the work, and publicly perform or display the work. It is illegal for anyone to infringe any of these rights (subject to certain exceptions, including fair use and compulsory licensing). Remedies include seizure and destruction of the offending goods, damages of up to $150,000 per infringement and recovery of costs and attorney’s fees.
Copyright protection is automatic from the moment the work is created in fixed form – neither registration nor notice are required for protection (though there are substantial benefits to both). The copyrights in a work immediately become the property of the author who created it; although, in the case of works made for hire, the employer and not the employee is presumptively considered the author. There are, however, many traps for the unwary in the “work for hire” doctrine and, particularly when creative work is outsourced, caution should be the watch word. Protection lasts for the life of the author plus 70 years (or 95-120 years for works made for hire).
Sale Preparation Steps:
- Maintain an archive of who created what, when they did it, and a list of any reference works consulted in the course of development
- Identify works with commercial value or significance
- File applications within three months of publication when possible
- Archive certificates of registration
- If you have pledged any of these copyrights as security for a credit arrangement, check to ensure that if the debt has been satisfied or refinanced, that a formal release has been recorded in the appropriate offices
- Archive copies of any clearance opinions or grants of permission/licenses
Contracts
The contractual arrangements that you enter into with your suppliers, business associates, and customers are another source of value, and in some cases, risk. To the extent that you have been able to lock in favorable relationships or terms that may no longer be available, a purchaser would assign value to the opportunity to step into your place. On the other hand, certain types of agreements carry obligations and risk – e.g., licenses in general and open-source licenses in particular. You can expect that a significant portion of any purchaser due diligence will be directed to understanding the value and risk in your contractual arrangements.
Sale Preparation Steps:
- Keep an archive of licenses-in, licenses-out, open-source licenses, non-disclosure agreements, and non-compete agreements
- Docket expiration and renewal dates
- Archive no-assignment and change of control restrictions
In summary, a calculated mix of IP protection and thoughtfully crafted IP policies can help you safeguard your intellectual assets, avoid infringement problems, increase the value of your company, and ease or expedite the due diligence process if and when you are ready to sell (or seek additional investment or credit financing, for that matter). This process need not be a budget buster; you don’t have to take advantage of every possibility for protection. But it makes sense to be disciplined and systematic in your approach, and to spend to protect what you have where in makes economic sense to do so.
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