When does a reasonably straightforward divestiture become dauntingly complex? When it turns out to involve intellectual property that is central to the seller's core business. This holds true in almost any industry, but it is particularly true in technology, where products and processes are often underpinned by multiple licensing agreements, joint ventures are common and multiple business units may use certain IP assets. A central question that sellers need to consider when determining deal structure is which IP to keep and which to sell or license.
"Divestitures are in many ways a lot more complicated than deals where one company acquires another,'' says Eric Reifschneider, a partner at Cooley Godward LLP in Palo Alto, Calif. "Often, it's more complicated to figure out how to unscramble the egg than how to buy the egg."
Consider the case of semiconductor chipmaker LSI Logic Corp., which sold off its last remaining fabrication plant (where microchips are manufactured out of silicon wafers) earlier this year to ON Semiconductor Corp. LSI wouldn't comment on the deal, but Reifschneider, who served as outside counsel, says the company had to confront some tricky IP problems.
While the Oregon plant was LSI's only remaining fab, it was important to the company to retain much of the manufacturing IP because it would continue to design and sell integrated circuits in wafer form. "The IP being licensed was and is considered by LSI to be very valuable to its ongoing business," says Reifschneider, whose other clients include Applied Materials Inc., Conexant Systems Inc. and Cadence Design Systems Inc. In the end, LSI opted to sell the physical assets but to license the relevant IP.
Deciding which patents, copyrights, trade secrets and other intellectual assets are included in the sale of a business unit is a complex process in which each answer often raises an entirely new set of questions. It also requires sellers to think through multiple scenarios that could arise after the sale, such as the possibility that a competitor could gain access to IP transferred in the sale by acquiring the buyer.
Just getting an accurate inventory of the intellectual assets associated with the business can be difficult. Companies must determine what other business units use the IP and whether it is licensed outside the company. If so, are the licenses transferable in a sale? Then it's on to deal structure. Should the IP be included in the sale, or would a licensing agreement make more sense? Should licensing agreements be exclusive with geographic limitations, or is a broader agreement warranted?
Not thoroughly thinking through these issues on the front end can have serious consequences down the line, from alienating managers of business units that use the IP to losing potential revenue by undervaluing the assets. Jim Tully, a vice president at Gartner Dataquest in London, remembers one semiconductor manufacturer that sold off IP related to computer networking only to learn later that the IP was worth far more than the sale price.
Before a company can sell off a piece of its business, it must have a thorough understanding of the IP and any existing licenses associated with the unit. Much depends on the size of the patent portfolio. This can be a relatively straightforward exercise if the unit being sold is a standalone business. It gets considerably more complicated, though, if the unit -- and its IP -- are intertwined with other parts of the corporation.
In-house patent lawyers usually conduct the initial IP analysis, says Reifschneider, but business unit leaders and other executives should also be consulted. Keep in mind, though, that it's not uncommon for managers who will be going with the business being sold to start looking at IP from the buyer's perspective. "You have to make sure you're dealing with people in the seller's organization who will look at these issues with the seller's best interests in mind," says Reif- schneider.
Of course, making an inventory of IP is an exercise that should be done regardless of whether a sale is imminent, says Laury Sorensen, in-house counsel for the tech storage provider EMC Corp. "It should be an ongoing obligation of the company, not something that gets done when you decide to sell. It's important to know what's in your IP arsenal."
A thorough grasp of the licenses associated with the IP assets for sale is critical for both the seller and the buyer. Joint ventures are common in technology development, particularly in the semiconductor industry, says Reifschneider, so it's important for a seller to be sure it is the sole owner of the IP in question.
Reading the master license agreement is the best defense, adds Jenny Blank, director of enforcement at the Business Software Alliance, a nonprofit trade association of leading software manufacturers. "Sometimes you divest part of a company, and you may or may not be allowed to spin off software as part of the deal. The acquiring company may get a nasty shock, because [the seller] didn't do their homework ... in spinning off a division and the [third-party] software with it."
Once the inventory is complete, the parties can begin exploring possible deal structures. According to Reifschneider, there are essentially three ways a sale can be structured: The seller retains ownership of the IP and licenses it to the buyer, the IP is included in the sale but is licensed back to the seller or the IP is jointly owned. The last approach is the least common one, says Reifschneider, because "you're joined at the hip in all sorts of complicated ways."
If a licensing agreement -- in or out -- is part of the deal, the companies must agree upon how narrow or broad the agreement should be. Will the license be for use only in association with a specific product or process, only in North America (say) over a 10-year period, or will a much broader license be granted? As is typically the case, much depends on the industry. In the semiconductor industry, licenses involving manufacturing processes and chip design most commonly come into play. The two are often tightly interwoven, which creates a fuzzy line, says Reif- schneider.
In the LSI Logic deal, the company opted to sell the physical assets of its Oregon fab to ON Semiconductor but chose to license its manufacturing and much of its design process. Under terms of the deal, ON Semiconductor can use LSI's process technology at its other fabs and can also use it to make wafers for itself and for sale to its customers, including LSI. The two companies entered into a wafer supply agreement in which LSI will purchase roughly $200 million worth of wafers from ON Semiconductor over the next two years, according to Reifschneider.
The trick is to transfer enough IP so that the buyer can do its job, but not so much that you lose control of fundamental processes. "You want to tailor the licensing provisions broadly enough so that the company can perform its obligations," says EMC's Sorensen, "but narrowly enough so that they cannot walk off with your technology."
If business units within the parent company also use the IP, there are several creative options for structuring the deal. Variables to consider, says Reifschneider, include how closely related the businesses are, the nature of the IP and the relative bargaining power of the parties involved. "The licenses could be exclusive or nonexclusive, could be limited to particular fields of use, could be perpetual and irrevocable or subject to termination in certain scenarios."
The best licensing scenario for the seller is to obtain a broad, irrevocable license back to all the patents being assigned to the buyer. This can help the seller avoid being accused of infringing on a patent it used to own should it acquire a business that uses the technology. There's nothing worse for a seller than to find itself infringing on a patent that it developed or used to own. It's a "nightmare scenario," says Reifschneider, one "that could cause someone to lose his job."
A broad license can also protect the seller should the patents eventually end up under the control of a competitor that picked them up through an acquisition. Licensing contracts may be written in good faith to allow the buyer access to intellectual property after a sale, but "if the IP is in the hands of a deadly competitor ... there would always be a suspicion that the competitor is slowing down certain processes or restricting access, so at the end of the day, it's a concern," says Gartner's Tully.
No doubt there is plenty to consider when it comes to the intellectual assets associated with a business unit on the block. But it's worth investing the time for a thorough inventory and vetting, because a company that makes the wrong decision about which intellectual property to keep, which to sell and which to license could find itself at the mercy of a competitor or, worse still, out of business. - Esther Shein
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IP questions to consider in a divestiture |
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• How is the IP used throughout the company?
• Is the IP being licensed outside the company?
• Are those licenses transferable?
• Are you the sole owner of the IP? |
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Source: Corporate Dealmaker |
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