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Article Written by Claudius du Plooy
www.claudiusduplooy.com 

Large acquisitions or mergers in exploration and production usually make the headlines and get considerable attention.  But acquisitions of innovation and technology companies often do not get the same level of attention.  Yet, the impact and importance of these businesses to the energy sector are undeniable—think of the new multi-billion dollar plays that the new technology of “fracking” has opened!


This rising importance can also be seen in the increase in new acquisition and investment transactions happening, at least, in the Canadian energy sector. The technology industry in Alberta has seen a significant increase in the investment and acquisition appetite of companies looking for an entry into the Canadian energy sector.

The Canadian government and the provincial government of Alberta are committed to making Canada into one of the leading technology economies of the world, by offering sizeable new incentives to encourage research and development. The total federal budget for the Scientific Research and Experimental Development (SR&ED) Program is now $3.6 billion, of which a large portion is applied to the energy sector.  According to the Alberta Enterprise Group, a non-profit organization, the Canadian energy sector is by far the largest sponsor and developer of innovation applications.

This article is the first in a series dealing with technology acquisitions.  In this edition, some unique points will be highlighted involving the due diligence process.  In the next edition, the transaction itself will be examined.

A technology target company often looks very different from other targeted companies.  Most, if not all, of its asset value is labeled Intellectual Property (IP), which includes copyrights, trademarks, trade secrets, industrial designs and patents.  In energy technology, the IP will often be a patent (or unregistered innovation) and, in the case of software applications, can also be copyrights. It naturally follows that an acquisition of such a company will also have very specific legal considerations to be aware of.

An acquisition can generally take two forms. The first form is an asset purchase where only the assets are bought, and not the shares of the company. This allows the buyer to choose the assets and liabilities that it wants to acquire. Also, the buyer avoids the risk of taking on the liabilities of the company. In the case of a technology acquisition, it may be more expensive if there are a number of IP assignments in multiple jurisdictions.  The other acquisition form is a share purchase, which is usually a simpler transaction because the buyer acquires the shares of the company, and all assets and licenses of the company become the property of the buyer.  The risk is that the buyer will also take over all liabilities of the company, even sometimes the unknown ones.  If there are multiple shareholders who will have to consent to the transaction, it may complicate the transaction, especially, if there is no shareholders’ agreement with a forced sale clause for minority shareholders.

In both an asset or share purchase, the due diligence for IP is often quite involved, detailed and expensive.  For example, if the IP is a patent, a patent lawyer should review the registration, jurisdictions of registration, validity, history of claims, which can often give an indication of whether the patent could be contested by competitors. This will also involve a competitor analysis to determine the risk. The last thing the buyer wants is infringement litigation by a competitor shortly after the purchase.  Patent litigation can be very expensive and, in some cases, will quickly wipe out any value in the acquired patent.  An alternative strategy is to acquire a registered patent by a simple aggressive market penetration and the first-mover advantage.  If the seller company’s strategy was to use industry relationships and contracts to protect its invention rather than a registering a patent, the review of material contracts such as customer licenses becomes very important, because the value of the innovation is intertwined with the company’s goodwill and market penetration.

If the buyer is a foreign company buying Canadian IP with the aim to apply the IP in its own jurisdiction or to roll it out internationally, the jurisdictions where the patent was registered move to the forefront.  If filed under the Paris Convention, the patent has a one-year priority window to file the application in other jurisdictions.  If not filed in the other jurisdiction and another competing patent is filed in that jurisdiction, the patent may be defeated for that country.

The actual ownership of IP can present challenges. When a patent is filed, the form requests an inventor. If the owner is not stated separately, the inventor is assumed to be the owner.  If the inventor then does not want to assign the IP, the buyer may have a problem.  Furthermore, it is common for IP to be held in a holding company in a different jurisdiction where it could receive preferential tax treatment for licensing and other IP income.  It would then license the IP to the operating company. The buyer should be very careful that it understands the relationship between the holding and operating/incubating entities.

There can be enabling or underlying IP, which is owned by someone else and is necessary for the proper functioning of the IP that the buyer is interested in.  Making sure that those licenses can be transferred or assigned, and that there is no infringement on another’s IP, is a vital part of the due diligence process.  Similarly, if the technology was developed with the help of government or university funding, there may often be rights of first refusals or other limitations to the sale.

Tip Sheet for IP Due Diligence

WHAT TO CONSIDER and WHY

  • Asset or Share Purchase - Different tax treatment, liability and restrictions in assignments of IP.
  • Patent Review - Jurisdiction, filing history, objection and claim against the patent, possible competing claims.
  • Competitor and Market Share - If IP is not registered, a large determinant of its value is how much of the market it has, and how aggressive the   competitors are.
  • Material Contract Review - Licensing agreements with customers, enabling IP licensing agreements, infringement from or on another’s IP.
  • Jurisdiction - Where does it have preferential rights or tax treatment of licensing revenue of the holding company?
  • Ownership - Holding or operating company, inventor and assignment considerations.
  • Holdbacks and Restrictions - Rights of first refusal or sale restrictions on IP transfers that they funded.