Conducting an IP audit is a way for a firm to assess the nature and value
of its intellectual property assets. Such assessments may be critical
and more commonplace in certain industries, such as IT and pharmaceuticals. However,
in the wake of legislative changes and the current economic downturn,
the potential value in conducting an IP audit may have become clearer
in other industries as well.
Generally speaking, IP audits are either externally
or internally driven. Externally driven IP audits are performed in
response to triggers such as infringement litigation, bankruptcies, funding
transactions, or transactions involving the sale of the business or certain
assets. Under
this circumstance, IP audits are often performed under time constraints
and are, by their nature, reactive.
Internally driven IP audits, on the other
hand, are initiated as a pro-active business practice by the holder
of the IP. Internally driven IP audits can be used to identify:
New revenue streams related to proprietary products and licensing;
Business risks and opportunities related to IP such as patent, copyright,
or trademark applications that should be filed, or securing certain IP
rights from employees;
Business process changes in R&D, Engineering, HR, or other areas;
and
Financial reporting disclosure items related to IP.
However, in the wake of the credit meltdown it may be hard to justify a “spend
money to make money” philosophy. How does a firm measure the potential
value of internally driven IP audits in relation to a tougher economy?
To find out, I spoke with Glenn Perdue, an IP
valuation expert. Perdue, who leads Kraft Analytics, LLC, a valuation
and litigation support consulting firm in Nashville, Tennessee, has
more than 20 years of experience in business strategy, technology strategy,
capital formation, valuation and litigation support.
Is performing
an IP audit a good move in today's business climate?
In any business
climate, it makes sense to identify and understand those assets that allow
a company to create economic value for customers and owners. In the industrial
age, value-enabling assets were largely physical in nature. Today, value-enabling
assets are more intangible. It’s a generally
accepted belief that the majority of public company market value is not value
identified on a company’s balance sheet. Instead, most value is attributed
to intangibles assets – often intellectual property – that may
not appear on the balance sheet at all. Therefore, companies that rely
on IP to create economic value should catalog and understand these intangible
assets so that their value can be better managed and optimized. An
IP audit is often a good starting point in this process. However, an IP audit
is one component of a more comprehensive IP management approach that may
include the following:
IP Audit – The assessment component, which informs management
as to the nature and value of their IP assets at a certain point
in time.
IP Planning and Policy Development – Based upon information
obtained through the IP audit, legal counsel, and business/industry
research, management develops IP plans and policies in an informed manner.
Execution – After developing plans and policies, managers
begin executing the plan through the implementation of business processes,
licensing, enforcement, and other activities identified to optimize
IP-related value creation.
Analysis and Reporting – This final step allows management
to assess results and refine the process. In addition to internal
reporting, the IP management process may also yield information needed
for disclosure in external financial reporting.
What advice would you offer an attorney who was presenting the idea
of conducting an IP audit to his client?
Making the case for conducting an IP audit is situational. Reasons might
include:
A prospective business purchase or sale that involves IP assets
IP sale or licensing transactions
Equity transactions in which investors, such as VCs, consider IP assets
to be a critical component of the deal
Debt and securitization transactions that rely upon IP as the underlying
collateral
Management insight and planning as related to marketing, finance, risk
assessment, and business strategy
Legal and regulatory compliance
Given this broad range of motivations, an attorney’s recommendation
to conduct an IP audit may be event-specific. In the case of transactions
involving IP, the due diligence process is similar to an audit in many
ways. If the audit is required, convincing the client may not be an issue.
However, if the audit is being suggested for planning or compliance purposes,
risk mitigation or profit optimization motives should be articulated to make
the business case.
What is the danger of not understanding one's IP holdings?
IP value is, first and foremost, contextual. The value of IP in the
hands of one enterprise may be different than the value of the same
IP in the hands of another enterprise. Access to the various means
of exploiting IP assets is an important factor. Consider a drug patent held
by a university. The university may hold the rights to an important piece
of IP but lack the means of producing and marketing a major pharmaceutical
product that embodies that patent and fully exploits its economic value.
Since universities are not in the business of making products, they
choose to license such inventions. Thus, the valuation issue faced by a university
relates more to up-front, milestone, and royalty payments for the use
of the IP by others. However, a pharmaceutical company that holds the same
patent faces a broader decision as to whether it should (i) make and market
the product itself, (ii) out-license the patent to another company that might
be better-suited to optimizing the patent’s value, or (iii) use the
patent in a more defensive manner. In this case, the pharmaceutical
company might consider a valuation analysis as a basis for making this determination.
Tell me about the relation between IP audits and the Sarbanes-Oxley
Act.
A broad view of Sarbanes-Oxley is that it requires corporate managers
and directors to be better stewards of company assets – including IP
assets – while
providing greater transparency and accountability with respect to financial
reporting. Given that IP assets are a predominant basis for value creation,
particularly in science and technology-based companies, the duty of
care imposed by Sarbanes-Oxley is
considered applicable to IP assets by many. In light of this - and
the fact that the value of these assets are typically not reflected in
GAAP-based financial statements - many believe that IP assets, their economic
value, and related risks must be accounted for elsewhere and disclosed
if material. Thus, companies with material IP assets may be advised by counsel
to conduct regular IP audits and valuations to maintain compliance with Sarbanes-Oxley.
Can you describe the need for IP audits in the non-profit sector?
I serve on several non-profit boards, including a research foundation
board that performs the technology transfer function for a major university.
I’ve
witnessed first-hand how large non-profits are increasingly aware of
accountability and transparency in their governance and financial reporting
functions. I’ve
also seen how this issue has affected non-profit hospitals. In the
case of universities and private research institutions that generate
IP, they may not be accountable to shareholders but they are certainly accountable
to trustees, boards of directors, donors, and other stakeholders that
place trust in them to be good stewards of the institution's assets, in this
case IP assets. Therefore, looking at it through this lens, such institutions
may not be public companies and subject to Sarbanes-Oxley directly,
but they may certainly be held to a similar standard of care and thus
must be diligent in protecting and optimizing the value of their IP while
also being mindful of the broader mission of their institution.
Sarbanes-Oxley regulates public companies. What about closely owned
companies? Do you see much activity among them in your valuation
practice?
Many
lawyers I’ve spoken to about this issue contend that small growth
companies considering an IPO or sale to a larger public company must
move towards Sarbanes-Oxley compliance early on. However, even if an
IPO or M&A
transaction is not on the horizon, some attorneys suggest that the
presence of outside investors in a private company can indirectly expose
a company to Sarbanes–Oxley, which may be invoked as the basis for
a standard of care that is owed the investors.
Is it wise for attorneys to suggest that experts be brought in
to determine possible new product development, potential competitor
infringement, etc.? If so, why?
In my work as an expert in IP-related litigation, I’m brought in by
attorneys regularly to assist in cases. My experience with the attorneys
I’ve worked with has been that they have a good sense of when and why
outside experts need to be engaged. One of the primary factors to consider
in this determination is the existence of internal expertise at the
client company. The need for outside experts may be due to a lack of
requisite expertise within the client company and/or the need to hire
an outsider for purposes of objectivity. In the case of litigation
or auditing, the objectivity of an outside expert is generally desired.
Note: This article first appeared in ipFrontline. Dawn Corrigan writes for IMS ExpertServices™, the leading global
expert witness search firm. Glenn Perdue is the Member-in-Charge at Kraft Analytics, an affiliate
of KraftCPAs Pllc.
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