Is IP due diligence the answer for investors?
It has been hard to avoid the recent headlines following a spate of high-profile tech startup scandals, fooling even some of the most well-regarded venture capitalists (VCs).
The Financial Times recently published ‘Doesn’t anyone do due diligence any more’ – an opinion piece on the apparent failure of investors to ask the right questions before handing over their money. Whilst the article primarily focused on financial and governance due diligence, the same is equally true of IP due diligence. A quick look into the IP portfolios of a number of recent high-profile VC failures speak for themselves.
A simple search into Theranos, the disgraced med-tech startup, retrieves a substantial portfolio of hundreds of patent applications. However, investors seemingly did not look much beyond this, as the substance of the patent applications themselves lacks technical detail. Only six months before the Wall Street Journal article that brought about the company’s downfall, the Business Insider published an article responding to scepticism by scientists, commenting that, if Theranos had come up with a “killer application” for microfluidics, “that may explain its reluctance to show the patented details that make its technology unique, even though that rubs researchers the wrong way.” However, this sentiment directly conflicts with established patentability requirements to sufficiently disclose the invention to allow it to be put into effect. This should have raised alarm bells amongst the investor community, but instead, Theranos reportedly raised around $724 million from VCs and private investors before its demise.
To take another example, Nikola became renowned as a battery electric and hydrogen fuel cell vehicle company to rival Tesla, their hero product being a hydrogen fuel cell truck. Less than a week after General Motors (GM) announced a $2 billion deal to acquire an equity stake in the company, a whistleblowing report was published accusing the company of lying to investors. The founder was later found guilty of securities fraud, with GM later backing out of the deal. However, this again raises questions about the quality of due diligence being performed. In 2016, the year the Nikola One truck rose to prominence, the majority of Nikola’s patent filings were directed to aerodynamic fenders, doors, and windows, with a distinct absence of hydrogen technology alleged central to its success.
This is certainly not just a US problem. Once touted as a rare British ‘unicorn’, Powa Technologies later collapsed into administration. A search for their patent portfolio reveals 19 patent families. However, on closer inspection, only two of these achieved grant, and neither covered their core e-commerce technologies. For comparison, PayPal has over a thousand granted patents in the US alone.
When conducted properly, IP due diligence can provide investors with key insights into early-stage venture management. Comparing what founders pitch about their venture, its technology and its business model against their IP strategy and portfolio can provide clear and early warning signs when things do not align.
Similarly, conducting internal IP due diligence can be extremely important for founders. During investment, founders may be required to sign a number of IP warranties and indemnities, often guaranteeing to investors that the relevant IP is owned by the company. As a result, in cases where IP ownership issues subsequently arise, the founders themselves may be personally liable for the associated legal costs. Unfortunately, IP ownership issues are far too common. For example, many are unaware that in the UK contractors own all IP created by default, unless the IP is expressly assigned to the commissioning party. It is therefore essential that founders have a clear understanding of any issues surrounding the business’ core IP.
As an intellectual property specialist firm, our team at Mathys & Squire have extensive experience in IP due diligence. We are also partnered with the UK Business Angels Association (UKBAA), and offer regular ‘IP health checks’ for UKBAA members.
An IP audit can be a helpful way for a business to take stock of its current IP position, particularly ahead of important investment rounds. If this may be of interest to your business, please contact a member of our Scaleup Quarter team at Mathys & Squire.
Written by: Jessie Harrison and Andrew White