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Your company's intellectual property -- assets and risks

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Every company should make regular assessment of the value (legal and financial) of its intellectual property and the risk of infringement of other companies' IP. The assessment should also evaluate the effectiveness of the existing program to identify assets and risks and make recommendations for improvements. Time constraints apply to all forms of IP. The assessment will identify time critical filings and the systems in place to assure that dates are met.

Today, IP comprises a much higher percentage of the value of a company's total assets. In the knowledge age, every company produces IP as it creates in-house systems, develops new products or improves the efficiency in how services are delivered. In high-tech companies, an average of 80 percent of a company's capitalization is in intangible property (mostly IP). This includes goodwill, trade secrets, copyrights and patents. Patents can protect software and unique machine implemented business models, so most companies are creating potentially patentable inventions in addition to trade secrets, copyrights and trademarks.

Who, when, how much?

An IP assessment should be made by an IP attorney (a patent attorney, if any of the assets are likely to be inventions). The first step in assessing the value of IP is to determine the scope of protection enjoyed by the company's IP and the strength of the IP to withstand assaults on its validity.

The assessment attorney should not be affiliated with the company's regular IP firm or practice group, and, by contract, should disclaim any attempt to seek to represent the company in the future. Why? It's not reasonable to expect existing IP counsel to criticize their own work. A realistic assessment of IP protection can only come from a disinterested third-party patent attorney. The goal of the assessment is not to embarrass existing counsel but to show the ways to improved protection and increased valuations.

Candidate IP assessment attorneys should have filed and prosecuted many patent and trademark applications themselves, and should have had IP litigation experience. An attorney with this background will have practical experience in how the scope of protection for the company's patents and other IP translates into increased profitability to each aspect of the company's business. Only an experienced attorney will have the credibility to have the IP assessment accepted by evaluators, such as venture capitalists and other investors, merger candidates and IPO underwriters. An experienced IP evaluator will also be able to determine early on what financial and/or marketing expertise will be needed to translate the "legal value" into financial asset value.

All existing companies that have developed a competitive advantage through the use of knowledge or information should have an IP assessment at the earliest possible date. An immediate assessment stands the greatest chance of identifying IP rights that may be otherwise lost by delay.

An early assessment also serves to create a baseline value so that subsequent assessments that show a higher evaluation can be demonstrated to have resulted from a series of incremental improvements to the company's IP position, rather than a single, arguably inflated assessment. Privately held companies have found this information invaluable in obtaining the highest possible valuation for their stock or assets when engaging in merger or acquisition negotiations, or when raising capital.

How much will such an assessment cost? Well that depends. But a specific safeguard against a nasty cost surprise also happens to be the best way to get a good result.

Initial, baseline reports

The first phase of the assessment should involve the fewest people possible. A cap on the cost of this initial report should be negotiated. Typically, the IP attorney and one company designee who has access to the upper levels of management should suffice as the initial IP assessment team. Their initial report should provide a preliminary inventory of the company's IP and a preliminary analysis of these assets. The report should also detail the scope of work for a proposed complete assessment, and provide an estimated cost for the complete assessment.

The initial report should incorporate a recommendation for the company team that should be assembled to ferret out all the information needed for the complete report. A feature of the initial report should be the apparent range of values for the IP under current programs, and the increase in value if new comprehensive IP policies are implemented. If the estimated cost of the complete report can't be justified, the work can be stopped immediately. The complete report will normally be justified if it will identify IP that hasn't been protected, and that when protected will exceed the cost of the report by an order of magnitude. The complete report may also be justified if it will increase the credibility of the company's search for angel investors, venture capital or private equity capital, or improve the company's leverage for a merger or acquisition.

The second phase consists of the complete baseline report. If the company elects to move on to a complete report, it should include recommendations of how to most efficiently sustain the gains that will be achieved after the recommendations of the report are implemented. The report will include a complete catalogue of all existing IP and all IP on which the company should seek protection. The IP assessment counsel and company designee can direct the creation of all the legal and business systems to run a long-term program and make evaluations of existing IP protection, agreements (internal, e.g., employee invention agreements; and external, e.g., license agreements) and infringement risks.

All identified IP should be valued. That is, each piece of IP should be analyzed for the legal value (the scope and validity of the protection) and the dollar value. The dollar value will be determined using a creditable method that achieves the highest valuation. This will require a valuation approach different from what would ordinarily be used by an accountant. Book value, discounted cash flow and similar valuation approaches are not suitable to valuing intangible property. In appropriate cases, the company might employ a financial adviser with market savvy, an expert with credentials for determining a "reasonable royalty" as that measure has been developed in patent damage cases. This individual can translate the subjective valuation into capital value, taking into consideration the market direction of the company and industry, and the extent to which the IP will penetrate the applicable market.

All identified IP should be evaluated for importance, and a determination made whether a complete due diligence report on the validity and breadth of protection should be included as part of the complete report.

Additionally, the report should address the creation and maintenance of a database of existing IP, and establish the process of determining whether to seek formal protection for newly identified IP.

On a continuing basis, the company will want to establish a regular process of ferreting out the IP being developed. Traditionally, this has been accomplished by an IP committee that meets regularly to determine for which items IP protection should be sought. Today this function may be more effectively accomplished by a single IP czar.

The IP czar must have clear authority to commit department heads and others to spend time on the IP assessment, and to inform department heads of newly identified IP and the czar's preliminary decision on whether or not to pursue protection. Without opposition, the IP selected for patent protection should immediately be drawn to IP counsel's attention so that critical dates can be determined and met. Since costs are minimal, the czar should have complete discretion on which copyrightable materials to seek protection. An assistant should be trained to make copyright filings. The primary focus on copyright assessment is whether all copyrightable materials are regularly drawn to the czar's attention. Copyrightable materials include virtually all promotional material, proposals, business plans and software.

The initial baseline and later updated reports should indicate the status of all IP, including whether the IP is currently, or will prospectively, be used on company products or services. A database should be maintained listing at minimum:

a) owner and any necessary actions to get title in the company's name;

b) inventor or authors;

c) whether the IP is licensed or cross-licensed;

d) status (pending, etc.);

e) critical dates (publication, registration, renewal etc.);

f) new action items, the person responsible for completing the action and the target date (e.g., the date for filing a patent application); and

g) products or services on which the IP will be used.

Agreements: The report should list all the necessary agreements and whether they are believed to be adequate (employee invention agreements, trade secret policy and agreements, copyright employee/consultant authors "work for hire" and assignment agreements), acquisition of domain names and e-mail policy.

Licensing: IP assets that are, or potentially could be, licensed to third-party companies should be evaluated for financial performance (e.g., the value of the royalty vs. the loss of competitive advantage, if any).

Trademarks: Trademarks should be evaluated based upon the value of the goodwill associated with the mark. The protection program must create the necessary mandate for trademark adopters (marketing groups) to have all new trademarks searched for availability and protectability.

Value of the baseline report: As noted, an immediate baseline comprehensive report gives an immediate increase in perceived valuation to the company's assets and makes subsequent increases in valuation more credible to investors.

The analysis of ownership as presented in the baseline report should include whether the IP has been properly assigned, or otherwise owned by the company, and whether title is properly documented and recorded with the Patent and Trademark Office, or the Copyright Office as appropriate.

Unauthorized third-party use (infringement) of the company's IP: After identification of the individual items of IP, a survey should be done to determine whether that IP is being improperly used without license by a third party.

Infringement avoidance: The company should adopt a policy requiring all new product and service introductions to first be reported to the IP czar for a determination of the risk of infringing IP belonging to a third party. This risk assessment may be as simple as a survey of industry representatives to determine if IP has been asserted against similar products. The IP czar should be given the tools to make an initial determination on what level infringement assessment is justified.

Value: Companies that have effective IP asset evaluations have found they are able to add significantly to the actual and perceived value of the company.

The process of assessing value is parallel in many cases to the processes used by federal courts in patent infringement cases where damages are assessed. These damages are constrained by the patent statute to be "not less than a reasonable royalty." Case authority has established a 14-point test for making this determination. There is a proposed federal statute that would replace that test and the methodology of the proposed statute is also of some guidance. The assessment should make a recommendation of which tests are the most applicable and creditable for the IP in question. Where appropriate, the IP could be found to be responsible for the entire profit on the company's product or service, especially where larger companies could easily undercut pricing but for the IP protection. Of course, where the company exploits its IP by licensing, the IP is virtually always the sole basis for the income stream.

IP assets are frequently overlooked or undervalued in business transactions. An early IP assessment will not only provide an immediate snapshot of the IP value and risk, but create a lasting awareness of IP's potential importance in future transactions.

Martin is a partner emeritus with Gordon & Rees' Intellectual Property Group, based in the firm's San Diego office. He has experience in business model patents and the technologies of Internet systems, fiber optics, communications technologies and complex mechanical devices.

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