So you are thinking of buying into an IT company. What should you look out for? Atu Siwatibau, a solicitor with the Auckland Lawlink firm of Hesketh Henry, looks at some of the difficulties in protecting and valuing an IT company's intellectual property assets.
When buying into any company, the most common concern is the value of its assets and the extent of its liabilities. Depending on the performance of the company to date and how you envisage it will progress in future, you may also be interested in its management.
Things are not quite as straightforward in an IT ("information technology") company as in a more traditional company. The main difference lies in figuring out what the assets of the company are and how they may be used. Intellectual property rights are often the major assets of IT companies and all these rights are woven together to produce a product which the business then sells to the market.
Increasingly, the same questions can be asked of more traditional companies, as they now have extensive IT departments and systems integral to their businesses.
What sets an IT company, and indeed the whole IT industry, apart from more traditional businesses is that the industry is built on intellectual property rights. These include patents, trade marks, designs, copyright, systems and trade secrets. Properly owned and protected, intellectual property rights can offer tremendous commercial benefits and flexibility to the owner.
In most cases, the intellectual property held by a company is intangible. One cannot separate one intellectual property asset from another easily. Compare, for instance, the ease with which one can separate one physical asset from another (such as cars) to the difficulty of separating the contents of a database program from the program itself. The lines become even more blurred when the company adapts the programs or uses them in circumstances not envisaged at first.
Because of the nature of intellectual property, it is imperative that a company keep detailed records of exactly what intellectual property rights it has and on what basis it holds them (e.g. as outright owner, licensee, assignee, etc). Without this information, it will be very difficult to ascertain the intellectual property, and hence the value, of a company.
However, having the intellectual property rights alone is not the end of the story. One cannot necessarily use those rights as one pleases or for an indeterminate period. Many would be subject to stringent licences, copyright assignments, and other restrictions. Further, the uses to which the intellectual property rights are put may be subject to fashion and other changes in consumer demand, and may be capable of being achieved by the use of other competing intellectual property. These not only affect the current valuation and status of a business in the eyes of an investor, but will also affect any development or expansion plans that an investor may want to put in place.
Another consideration when buying into an IT company is how it protects its intellectual property rights. If they are not protected adequately, their value would be reduced significantly. In certain cases they would be worthless in terms of a commercial advantage in the market place. Things to keep in mind when enquiring into their protection include:
- how has the company used them?
- is anyone else using them?
- if so, on what terms?
- does anyone else have access to them?
When buying an IT company one should ask the following questions:
Ownership of Assets
- who owns the company's systems and programmes?
- were these assets developed by employees or independent contractors or bought from somewhere else?
- has there been any documentation of the ownership and use rights of the systems?
- if the systems were developed by employees or independent contractors, are there signed agreements assigning the ownership of, and rights to, those systems to the company?
Use of Assets
- if the systems were bought or hired, under what conditions did this occur?
- what is the status of any licences granted to or by the company?
- are the licences currently in force?
- has any party breached its obligations under the licences?
- have there been any claims that third parties' rights have been breached by the company's use of its intellectual property?
Protection of Assets
- what patents, trade marks, copyrights, confidential information, deeds etc are used to protect the company's intellectual property?
- has the company given enough notice of ownership of the intellectual property to allow its protection?
- has the company filed all required registrations for its intellectual property, are the registrations current, and have all filing fees been paid?
Once these questions can be answered, it will be possible to draw a fuller picture of the company's assets and their potential use and protection. This would then enable a prospective buyer to come to a better understanding of the company's value and its future potential. Assets alone are not totally determinable of a company's value; a prospective buyer needs to look at the sustainability of the income flow. This will involve analysing the market, and making an attempt to determine the protection the company has for the services it provides to its customers.
Not going into this process would make it extremely difficult to value an IT company properly.
Copyright The Lawlink Group Ltd 2001
Every effort has been made to ensure that this information is accurate. However, it is general introductory information only. It does not constitute legal advice and should not be relied on as such. Specialist legal advice should be sought in particular matters.
Atu Siwatibau is a Solicitor in the Lawlink firm of Hesketh Henry. He practises in the areas of e-commerce, mergers and acquisitions, and corporate law.
Web site: Hesketh Henry