EN
ItalianoOne of the most challenging decisions to make in licensing or acquiring a patented or patent pending technology (herein referred to as intellectual property or IP), or by investing directly in the company that owns such IP, is its evaluation.
To determine the value generated by a technology that is not yet commercialized, and may be at any stage of development from just an idea to a fully developed prototype, requires a thorough analysis of such technology, from a technical, economical, and commercial point of view. The main benefit of this evaluation is to ensure that the money allocated for investing in, licensing in, or purchasing a technology and its IP is well spent. Such activity is called a due diligence.
In legal terms, due-diligence is defined as the investigation conducted by a party of a business transaction (usually the buyer) for the purpose of reviewing relevant information and documents of the counterparty (usually the seller) with regards to such transaction. The due diligence is always performed prior to the closing of a merger-and-acquisition (M&A) deal or investment process because it provides the buyer with an assurance of what is getting in the deal. While the M&A due diligence interests several aspects of a business including financials, taxes, employments and human resources, legal, marketing and sales, governance, regulatory, compliance, technology, etc., the investment in a startup or licensing due diligence focuses mainly on the last aspect—technology and the related IP.
Thus, before committing to licensing, purchasing, or investing in the IP, the licensee, the buyer, or the investor evaluates several aspects of a technology, namely:
Robustness of the IP
- Domestic and foreign ownership of patent(s) and patent application(s)
- Trade secrets and know-how, and actions taken to preserve their secrecy
- Protection of IP (e.g. confidentiality agreements, invention assignment agreements, etc.)
- Residual lifetime of the patent and possible ways to extend such lifetime
- When applicable, potential impact of regulatory data protection (RDP), an intellectual property right for approved drugs that prevents competitors from exploiting the safety and efficacy data generated during clinical trials, usually to make the generic version of the drug, for a certain period of time.
Freedom to operate (use) the IP
- Identification of third-party IP critical for the development of the product covered by the licensor/seller IP (Freedom-to-Operate or FTO analysis)
- Identification of possible infringement(s) on the IP rights of any third party
- Identification of possible third party infringement(s) on the licensor/seller’s IP rights
Presence of any IP litigation or disputes with other parties - Presence of exclusive license agreements and/or financial obligations to third parties (e.g. distributors)
- Indemnification clauses provided to or obtained from third parties related to possible IP disputes
Status of the technology
- Development stage of the technology (in vivo or in vitro data, proof of concept, prototyping, etc.)
Business model fit
- Internal knowledge and competences in practicing a technology to develop the product
- Fit of the product in the licensee/buyer business model and portfolio
- Competitive or complementary products or services that may limit or expand the sale of the product covered by the IP
Financial analysis
- Financial valuation of the IP to determine its appropriate price, based on the development stage of the technology and the value potentially generated by the derived product
- Forecast on development costs (including R&D investments), manufacturing costs, investment costs, distribution costs, royalty payments, and revenues generation to determine the return on the investment
- Break-even point, best and worst-case sales scenario
Although not exhaustive, as some of these factors may differ depending on the industry, this list covers what most investors, licensees, and buyers check during a due diligence to better understand the investment opportunity they are considering.
A due diligence can take from a few days to several months, depending on the complexity of the technology, the size of the company, the number of people involved, the number of potential licensees or investors interested in the technology, and the internal competencies and process flow of the licensee/investor.
For example, a small company, a venture capital (VC) firm, or a single inventor may not have the knowledge and the tools to determine the economic value of a technology or a patent, or how to perform the FTO analysis. In both cases, they may get help from professionals and IP law firms that can do such analysis.
Of course, large companies have more resources available to perform the due diligence process. In a recent conversation, the VP of External Innovation in a major US-based pharma company explained that the due diligence process duration may vary, ranging from a few days, with 24/7 engagement of 60 employees, up to three months, with a group of six to eight employees plus some lawyers.
The time allocated to perform a due diligence is always well spent. The consequences of not performing an effective due diligence can be catastrophic, as demonstrated in the Theranos case.
Theranos was a privately-held health technology company founded in 2003 by 19-year-old Stanford dropout Elizabeth Holmes. Theranos business goal was to use proprietary, groundbreaking technology to run several hundred blood tests using only a few drops of blood from a finger pinprick, for detecting serious medical conditions like cancer and high cholesterol. Elizabeth Holmes filed, and was granted, several patents on technologies to develop this revolutionary product that it was claimed would disrupt the $73 billion diagnostic lab industry [1].
In different rounds, the founder raised money from prominent investors: $150M from the Walton family owner of the retail chain Walmart, $125M from media mogul Rupert Murdoch, $100 from former Education Secretary Betsy DeVos and DeVos family, and undisclosed sums from Oracle founder Larry Ellison, high-worth entrepreneurs, angel investors, and a number of well-known VC firms. In addition, Theranos signed two partnerships, worth several millions of dollars, to offer in-store blood tests in 800 locations at supermarket chain Safeway and in more than 40 locations at pharmacy chain Walgreens in Arizona, with a plan to extend the blood tests to its 8,200 stores in 50 states [2].
In 2014, Theranos was worth $9 billion [1] and Elizabeth, owning 50% of the company, became the world’s youngest self-made female billionaire with a net worth of about $4.5 billion.
Interestingly, none of the VC firms that made an investment in Theranos were focused on life sciences or medical devices.
Indeed, when Theranos approached VC firms with expertise in diagnostics, they passed on the investment opportunity because they raised several red flags about the feasibility of the Theranos device that could not be addressed.
Eventually, the device that Elizabeth Holmes claimed she invented and used to run the blood tests was exposed as a hoax by The Wall Street Journal journalist John Carreyrou [3-5]: the machine never actually worked. In March 2018, she and the Theranos Chief Commercial Officer were sued for fraud and for false and misleading claims about Theranos operations and technology while soliciting money from investors. Overall, investors and VC firms lost more than $600 million. [4]
The hype about Theranos and its technology demonstrates the importance of an effective due diligence process, and the disastrous consequences of not doing a proper one, even in good faith situations.
Investments in a startup, a technology, or an IP are inherently risky, but such risk can be mitigated by a detailed and thorough due diligence process.
In case you or your company are not familiar with the technology, or you do not have the tools or the competence to assess some aspects of such technology, seeking external advice is critical, and investing appropriate financial resources to hire external experts in support of your due diligence is key to effectively mitigate the risk of your investment. Consultants, IP law firms, IP valuation firms, and key opinion leaders can provide expertise, advice, and perform analysis for a few thousand $$$ or €€€, that will allow you to save much larger amounts of money in the long run.
References
[1] https://web.archive.org/web/20191007102223/https://fortune.com/2014/06/12/theranos-blood-holmes/
[2] https://www.cnbc.com/2018/05/04/theranos-devos-other-investors-reportedly-lost-over-600-million.html
[3] https://www.wsj.com/articles/theranos-has-struggled-with-blood-tests-1444881901
[5] John Carreyrou “Bad Blood: Secrets and Lies in a Silicon Valley Startup” Knoft publishing, winner of the 2018 Financial Times and McKinsey Business Book of the Year Award