IP Due Diligence Seals the Deal
Last year’s flurry of mergers and acquisitions looks set to continue at a steady clip, according to an annual M&A outlook survey by KPMG, which canvassed 550 deal-making executives.
Seventy percent of those executives said that technology companies would be most actively involved in M&As in 2016, driven by innovations and constant market disruption.
In this sector, perhaps more than any other, intellectual property drives the value of a deal. Thirty-four percent of surveyed executives said enhancing intellectual property or gaining access to new technologies would be a primary reason for acquisitions in 2016.
Yet buyers and sellers frequently push IP due diligence too late in the negotiation process, or fail to properly evaluate its value altogether.
Sixty-three percent of survey respondents said valuation disparity between buyer and seller would be a key challenge in the tech industry, and over half identified valuation disparity as a challenge in every sector. Thirty-one percent said correct valuation was the most important factor in a successful acquisition.
The risks of undervaluing IP or failing to protect it during negotiations threaten both buyers and sellers.
Misjudging the monetary value and revenue-generating potential of a piece of registered IP — like a patent or trademark — could mean that the seller misses an opportunity to cash in.
“For smaller, more high-tech companies such as medical device or semiconductor producers, the IP patents are an important driver of value,” said David Wanetick, an IP valuation consultant for Warren Averett CPAs and Advisors. “If the value of the patents isn’t articulated in the context of a negotiation, the buyer won’t make note of their value and the seller leaves a lot of money on the table.”
Of course, buyers also face the risk of paying too much.
“The inventor is usually enamored of their patent because it may reflect 20 years of hard work, and a lot of ego is built into it, so they may be overly aggressive in their asking price,” Wanetick said.
Patent valuation specialists can generate reports to show both parties what a patent is really worth.
These specialists have to know the potential market for a patent-protected product and what the patent may be able to pull in from licensing fees. Financial modeling can forecast expected revenue by comparing a patent to comparable products.
They would also look for past infringement, which “would actually be a good thing, because it’s proof that somebody is using the patent and selling the product, so the patented technology works,” Wanetick said.
A buyer could then reach out to those infringing on the patent and offer them the opportunity to license it. Most infringers are likely to choose licensing over the alternative — litigation.
“If we see that a buyer has not engaged third-party consultants in addition to its IP lawyers, it raises the question: Why didn’t you dig a little further into that exposure?” — Jeff Anderson, Allied World’s senior vice president, mergers & acquisitions, North America.
“There are multiple definitions of value,” said Robert Surrette, shareholder and firm president at McAndrews, Held & Malloy. “There’s monetary value, of course, but there’s also competitive value. A patent could have competitive value depending on the scope of its claims.”
In addition to financial worth, patent valuation reports indicate how much risk a patent carries in its assignment and litigation history.
“The biggest fear in the IP space is when there are larger buyers. When the buyer makes the announcement publicly, you tend to have a situation where someone in their garage says, ‘I invented that,’ or an independent contractor claims they had a role in it, so they should have a role in the sale,” said Jeff Anderson, Allied World’s senior vice president, mergers & acquisitions, North America.
“It all comes back to the assignments and releases.”
Problems arise when there are multiple co-authors on a piece of IP, which often happens in the case of research conducted by a team of professionals. Buyers should make sure that their target company had procedures in place whereby any patents generated by employees belong to the company, which is usually established in employee agreements.
“If you don’t have that in place and the company gets acquired, the buyer may not have rights to the patents that it thinks it now owns,” Wanetick said.
The waters become muddier when trade secrets and “know-how” come into play. Companies don’t patent this information because that would require public disclosure, but the lack of a patent means one less layer of legal protection. Sellers must establish confidentiality agreements to ensure any information shared during the negotiation process doesn’t leave the room.
“Over the last several years, I’ve noticed non-registered IP becoming a more critical piece,” Surrette said. If a deal falls through, sellers can fall back on their confidentiality agreements to file a trade secret appropriation claim if their potential buyer furtively worked the seller’s IP into its own products.
Prioritizing Due Diligence
Unfortunately, companies tend to leave IP due diligence until the end, focusing instead on legal, environmental, real estate, cultural and financial risks first.
“That’s because patent due diligence is expensive, and companies don’t want to invest in that unless they’re almost certain a deal is going to go through,” Wanetick said. Delaying the process though, could mean skeletons in the closet regarding patent history stay hidden for too long. Buyers should not underestimate the ability of intellectual property disputes to bring a deal to a grinding halt.
“There was a lot of talk about Foxconn acquiring Sharp in Japan, which was supposed to be a $6 billion deal, but it was derailed at the last minute by potential liabilities associated with IP lawsuits and damages from patent infringement,” Wanetick said. “That’s an example of how a deal can go awry if due diligence with patents isn’t conducted earlier on.”
“For smaller, more high-tech companies such as medical device or semiconductor producers, the IP patents are an important driver of value.” — David Wanetick, an IP valuation consultant for Warren Averett CPAs and Advisors
One way to streamline IP due diligence is to establish early what patents are on the table, and what are not. Knowing the structure of the deal allows a buyer to prioritize due diligence and adjust its offer accordingly.
Bringing in third-party consultants to dig deeper into patent history also saves the buyer time while providing a more thorough understanding of the target’s IP.
“If we see that a buyer has not engaged third-party consultants in addition to its IP lawyers, it raises the question: Why didn’t you dig a little further into that exposure?” Anderson of Allied World said.
From the seller’s perspective, establishing ownership and proper assignments of its intellectual property is also critical to avoiding future disputes. Contracting a specialist to build a valuation report not only protects the seller’s interests in a sale, but expedites a buyer’s due diligence to move a deal forward.
In addition to thorough due diligence and confidentiality agreements, both buyers and sellers can protect themselves through reps and warranties insurance.
The buyer is covered in the event of a breach of the seller’s representations of the value and ownership of its IP. The seller is protected if a third party makes a claim on its IP once a large buyer announces its plans to acquire it.
“When a large buyer comes in and demands a certain representation and indemnity package from the seller, the seller can procure its own R&W coverage to backstop that indemnity,” Anderson said.
Innovations in mobile tech tend to be the most difficult forms of IP to underwrite, given the lack of history surrounding them and a higher likelihood of third parties making claims on the technology. But with tech sector mergers and acquisitions set to rise, IP protection will prove a valuable investment.
Changing the Game
If the market is so competitive, why are there more challenging renewals this year? The reason is that global volatility of risk is increasing.
Volatility arises from multiple factors: insurer challenges, re-underwriting, exposures, products or coverage placements that are newly considered difficult, financial and collateral challenges.
Best negotiating practices help, especially during turbulent times. When the renewal game gets difficult, change the game by knowing your options, managing the timetable, preparing harder, communicating and then over-communicating.
Several years ago, I worked with a large client for the first time. High costs of collateral were a strain on the company and the risk manager felt trapped.
In listening harder, we found that what the risk manager and his bosses wanted was to be able to understand and quantify their options at all times.
They wanted expansive and unconventional options for consideration. Once we could quantify both the nominal costs and opportunity costs of different options, then we could consider trade offs.
The change of mindset from trapped to having options completely changed the game with the insurer, who then came to the table and negotiated a better win-win result that saved the client both costs and collateral.
I’m fanatical about preparation. Listening harder to understand concerns, using analytics to establish the counterparty’s negotiating position, anticipating questions, and articulating your story are more important than ever.
I’ve seen risk managers work through successful coverage renewals on difficult products many times. Many times, the insurers’ starting positions in the negotiation were to exclude coverage for a specific product that had caused significant known losses.
In listening harder, we found that what the risk manager and his bosses wanted was to be able to understand and quantify their options at all times.
By explaining the product and any difficult aspects in a very deep and technical way, the risk managers were often able to negotiate a reasonable result.
Having options matters here too — is there an opportunity to carve out a portion of the risk to a specialty market or an opportunity to change retention without increasing total cost of risk?
Managing the timetable to allow maximum optionality and stakeholder communications is one of the most effective tools any risk manager can deploy.
Many risk managers ask for guidance into what to build into budgets way in advance and then hold counterparties accountable for the budgetary goals. This doesn’t mean “settling” if you could achieve a better result than budget but certainly means preparing management and stakeholders for the best and worst case options.
Risk managers can also facilitate an effective timetable by providing renewal underwriting information as early as possible. By providing a timely and accurate submission, you can often hold insurers accountable for a timely quote.
Early quotes afford you more optionality with ample time to negotiate improvements, follow up on new or increased data needs or underwriting questions, or negotiate with alternative solution providers.
Recently, a wise risk manager was facing a difficult renewal. By knowing the options, preparing for the most effective negotiation and managing an effective renewal timetable, he was recommending a change to achieve substantial cost savings and more program sustainability. He had already talked to his boss, the Chief Financial Officer but he needed more time to get in touch with other stakeholders.
“Communicating and over-communicating” turned out to be essential given the fast-paced, global nature of the organization.
In a well-managed organization, surprises, even “good” ones, are often unwelcome. By communicating early and often, we can avoid surprises.
Changing the game can be unsettling for insurers who may be accustomed to a traditional renewal dance where they are holding the cards. But changing the game may result in a home run without sacrificing strong relationships.
Compounding: Is it Coming of Age?
The WC managed care market has generally viewed the treatment method of Rx compounding through the lens of its negative impact to cost for treating chronic pain without examining fully the opportunity to utilize “best practice” prescription compounds to help combat the opioid epidemic this nation faces. IPS stands on the front lines of this opioid battle every day making a difference for its clients.
After a shaky start cost-wise, prescription drug compounding is turning the corner in managing chronic pain without the risk of opioid addiction. A push from forward-thinking states and workers’ compensation PBMs who have the networks and resources to manage it is helping, too.
Prescription drug compounding has been around for more than a decade, but after a rocky start (primarily in terms of cost), compounding is finally coming into its own as an effective chronic pain management strategy – and a worthy alternative for costly and dangerous opioids – in workers’ compensation.
According to Greg Todd, CEO and founder of Integrated Prescription Solutions Inc. (IPS), a Costa Mesa, Calif.-based pharmacy benefit manager (PBM) for the workers’ compensation and disability market, one reason compounding is beginning to hit its stride is because some states have enacted laws to manage it more effectively. Another is PBMs like IPS have stepped up and are now managing compound drugs in a much more proactive manner from an oversight perspective.
By definition, compounding is a practice through which a licensed pharmacist or physician (or, in the case of an outsourcing facility, a person under the supervision of a licensed pharmacist) combines, mixes, or alters ingredients of a drug to create a medication tailored to the needs of an individual patient.
During that decade, Todd explains, opioids have filled the chronic pain management needs gap, bringing with them an enormous amount of problems as the ensuing addiction epidemic sweeping the nation resulted in the proliferation and over-consumption of opioids – at a staggering cost to both the bottom line and society at large.
As an alternative, compounded topical cream formulations also offer strong chronic pain management but have limited side effects and require much reduced dosage amounts to achieve effective tissue level penetration. In fact, they have a very low systemic absorption rate.
Bottom line, compounding provides prescribers with an excellent alternative treatment modality for chronic pain patients, both early and late stage, Todd says.
Time for Compounding Consideration
That scenario sets up the perfect argument for compounding, because for one thing, doctors are seeking a new solution, with all the pressure and scrutiny they’re receiving when trying to solve people’s chronic pain problems using opioids.
Todd explains the best news about neuropathic pain treatment using compounded topical analgesic creams is the results are outstanding, both in terms of patient satisfaction in VAS pain reduction but also in reduction potentially dangerous side effects of opioids.
The main issue with some of the early topical creams created via compounding was their high costs. In the early years, compounding, which does not require FDA approval, had little oversight or controls in place. But in the past few years, the workers compensation industry began to take notice of the solid science. At the same time, medical providers also were seeing the same science and began writing more prescriptions for compounding – which also offers them a revenue stream.
This is where oversight and rigor on the part of a PBM can make a difference, Todd says.
“You don’t let that compounded drug get dispensed when you’re going to pay for it without having a chance to approve it,” Todd says.
Education is Critical
At the same time, there is the growing, and genuine, need to start educating the doctors, helping them understand how they can really deliver quality pain management to a patient without gouging the system. A good compounding specialty pharmacy network offering tight, strict rules is fundamental, Todd says. And that means one that really reaches out to work with the doctors that are writing the prescriptions. The idea is to ensure that the active ingredients being chosen aren’t the most expensive sub-components because that unnecessarily will drive the cost of overall compound “through the ceiling.”
IPS has been able to mitigate costs in the last couple years just by having good common sense approach and a lot of physician outreach. Working with DermaTran Health Solutions and its national network of compounding pharmacies, IPS has been successfully impacting the cost while not reducing the effectiveness of a compounded prescription.
In Colorado, which has cracked down on compounding profiteering, Legislative change demanded no compound could be more than $350.00 period. What is notable, in an 18-month window for one client in Colorado, IPS had 38 compound prescriptions come through the door and each had between 4 and 7 active ingredients. Through its physician education efforts, IPS brought all 38 prescriptions down 3 active ingredients or less. IPS also helped patients achieve therapeutic success (and with medical community acceptance). In that case, the cost of compound prescriptions was down to an average of $350, versus the industry average of $788. Nationwide IPS has reduced the average cost of a compound prescription to $478.00.
Todd says. “We’ve still got a way to go, but we’ve made amazing progress in just the past couple of years on the cost and effective use of compound prescriptions.”
For more information on how you can better manage your costs for compound prescriptions, please call IPS at 866-846-9279.
This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with IPS. The editorial staff of Risk & Insurance had no role in its preparation.