“While transactional insurance used to be only available for deals of $100 million or more, insurance carriers and brokers have filled the void in the middle market, and will now price policies in a range approximating 2% of the insured amount, and for premiums as small as $100,000 or more.”
As we emerge from a global pandemic in which many businesses are mothballed or operating at limited capacity, we know that a great number will not survive. They will have to pivot or sell, whether asset-by-asset or entirely. Some will face fire sales, assignment for the benefit of creditors, or Chapter 7 or 11 processes supervised by the bankruptcy courts, or otherwise. It has never been more important to be thoughtful as a buyer or seller of intellectual property and technology.
While many acquisitions are structured as whole entity transactions, with the buyer purchasing shares directly from each seller, or by forward- or reverse-triangular merger, acquisitions of intellectual property, technology and people can also be structured as asset purchases and recruitments. Other times, they can be structured as licenses, whether exclusive or not, with royalties that are one-time or recurring. Buyers will want to leave behind potential liabilities and be smart about not taking on latent or patent defective portfolios that could create havoc once integrated in a buyer’s business.
Sometimes, the buyer will require ongoing or transition services from the seller if the seller intends to continue as a going concern. The buyer may need to negotiate for a transition services agreement and may also want to recruit and retain talent to monetize the IP and technology post-closing.
Often, when the parties need to move quickly, a license can be a risk mitigation or transitionary tool to allow a buyer to obtain access to the IP and technology without the risk of ownership while it completes due diligence.
Speaking of due diligence, approaches differ according to deal structure and timing. Sometimes, there is very little time, which argues for structuring via license or asset purchase. Other times, the buyer can conduct due diligence, and if including software, will commission a Black Duck scan of the code. In a perfect world, sellers would do annual Black Duck scans of their own code to weed out any open source and ensure they were always ready for sale, much like one will want to commission the audit of one’s financial statements. Technology due diligence and the role of specialized vendors like Black Duck and their brethren are increasingly commonplace.
A definitive agreement for the purchase and sale of IP and technology, no matter if structured as an entity purchase of all of the shares, a merger of entities, a sale of assets, or simply a license, will likely include representations, warranties and an indemnity. While transactional insurance used to be only available for deals of $100 million or more, insurance carriers and brokers have filled the void in the middle market, and will now price policies in a range approximating 2% of the insured amount, and for premiums as small as $100,000 or more. Buyers will be looking to ensure they receive a representation that the IP is sufficient to operate the underlying business, along with other IP reps and warranties on a broad array of topics, including as to the patents, trademarks, copyrights, trade secrets, as well as representations regarding the security of the IP and associated data that has been collected. Cyber-policies for operating businesses have become ubiquitous, and they enable transactional insurance to layer on top.
As to whether the IP representations will be viewed as “fundamental,” with extended survival periods and greater caps for breach, or “basic,” with damages capped at the amount of escrow, holdback or transactional insurance available, or “quasi-fundamental,” with survival periods and caps landing somewhere in the middle, that will depend on the relative leverage of the parties. “Big Tech” companies will typically roll in and argue that their price reflects full value and requires bulletproof coverage, and sellers will look to get a clean exit with no possibility of the buyer coming back. Who wins is a question of relative leverage, which depends on market dynamics.
Atlassian, an enterprise SAAS company that went public and has become a serial acquirer, attempted to tackle this issue by “open-sourcing” its term sheet and attempting to standardize the terms for tech M&A deals. While Atlassian’s effort is a valiant one that is helping buyers and sellers get deals done faster, there will always be situations where the parties impose their will and make the terms more favorable to them.
Outsourcing the potential liability to insurers with the help of middle-market brokers like Rubicon can bridge the gap and allow buyers to externalize the conflictual process that would otherwise see them making post-closing claims against their own employees.
Red Flag Issues
Red flag issues relating to IP ownership include founders failing to effectively assign IP at formation or employees tainting seller IP with the IP of their prior employers, or because they failed to sign proprietary information and invention assignment agreements. Professors who invent technology that could be subject to claims of the universities that provided principal employment and consultants and contractors can also trigger red flags by failing to sign agreements that contain assignment of invention or work for hire clauses. While error rectification is possible, it often comes at a price, as the signatory can claim a ransom. Joint ownership can also be a red flag.
In a world where enterprise SAAS companies are flourishing, open source can be a huge problem. While Black Duck scans, as discussed above, can identify issues and pinpoint how to remediate them, they can be expensive and time consuming, particularly in smaller deals who depend on speed and price to get done.
To ferret out these issues, the parties should define materiality issues and use artificial intelligence engines like Kira Networks to quickly scan terabytes of contracts and search for anti-assignment or other potentially offending clauses. While these are imperfect tools that cannot yet be relied upon to replace human review, they can radically improve the speed and efficiency of due diligence.
Getting Deals Done
Buyers and sellers should select advisors who are expert in the space, have a deep knowledge of the technology, a broad network of players that could be potential buyers or sellers, and who understand the rules that will apply to the road to be traveled. In an age of remote “work from home” to “work from anywhere,” buyers must beware of insolvent sellers with unknown liabilities. Buyers should proceed armed with knowledge where possible, and should price in the unknown.
As we face the second half of 2020 and the “new normal” of remote deals, anticipating issues before they arise can only be done by experts. Transactional insurance can help sellers get cleaner exits, and products are now available in the lower middle market. Seek practical solutions to enable impatient business leaders to close new revenue streams, keeping the big picture in mind.