How IP Ownership Can Jeopardize a Transaction

smallpic_Nashman

Mark Nashman
President & CTO
Clarity Systems

A few years ago, I went through a comprehensive due diligence process with two potential acquirers before ultimately selling my company to a large strategic buyer. Here are a few of the key lessons that I learned regarding intellectual property (IP) ownership.

Identify all Open Source Software:

Make sure that you fully understand what open source software you have in your code. All open source software comes with some type of license agreement. You need to fully understand these licenses to ensure that you are in compliance. You should also carefully consider whether the potential acquirers will be pleased or concerned about the open source licenses that you choose to imbed in your code. In my experience, many of the “GPL” type of open source licenses cause more concern to potential acquirers, as compared to the more permissive licenses.

Prepare your code for the due diligence process.

Prior to selling our company, we did a series of automated scans of our application to identify any open source software in our code. For all open source components that we found, we documented the license type and the reason for using that open source software. Following this review, we decided to remove some open source components that had “GPL” type licenses, to make the code “cleaner” for a prospective acquirer. Note that this process can take time, so start early. Or, even better, ensure that you have clear procedures to review and approve any open source software prior to letting your developers add these components into your code.

Remove unwanted open source components.

During the due diligence process, both strategic buyers required that we have our application scanned with 3rd party tools to identify all open source components. It seemed as if the acquirer would have chosen to walk away if they didn’t like what they found – even though they really wanted to buy our company. We ended up passing these open source scans with “flying colors” because of our careful preparation. But, the company that did end up buying us required that we remove one specific open source component that had a “LGPL” license – before they would let us sell our solution under their brand name. This reinforced my belief in the importance of ensuring that you fully understand your open source situation before you enter into an M&A process.

Retain Legal Ownership of IP

In my experience, potential buyers also want strong IP language in employment and contractor agreements. They want to make sure that the company has clear and unambiguous rights to the IP that was developed by the employees and/or contractors. For example, during our due diligence process, we were told to revise our employment and contractor agreements to include stronger IP language. We then had to get all of our employees and all of our contractors to sign new agreements. We even had to track down some contractors that hadn’t worked for us for quite some time, and get them to sign as well. And, all of this had to happen prior to closing.

Clear ownership of IP matters. As I now look to coach and invest in early stage companies, clear IP ownership is one of the first things I look for in a potential opportunity.