Michael D. Moberly   July 23, 2010

What do I mean by designing and executing monitoring covenant’s in merger and acquisition representations and warranties?   It’s somewhat akin to the the statement routinely misattributed to Peter Drucker, i.e., if it can’t be measured, it can’t be managed. 

So, similar to Druckers’ perspective, in M&A’s, if control, use, ownership, and value of about-to-be-acquired/purchased (intangible) assets of a targeted company are not monitored and found to be sustainable (pre and post transaction) then there’s a reasonable probability the desired outcomes and/or projected returns, synergies, and efficiencies, etc., will be significantly impaired, diminished, or left unrealized altogether.

It’s not that intangibles are particularly unstable in comparison to tangible or other types of assets.  Rather, it’s due to the fact that the contributory value and competitive advantages intangible assets can bring to a deal have become essential to its success.  But, in today’s globally competitive and highly predatorial business (transaction) environment, intangible asset value and competitive advantages can be rapidly undermined, erode, or irrevocably lost, if there are no monitoring (representation, warranty) covenants in place for oversight.

Conservatively, when 65+% of most company’s value, sources of revenue, and foundations for future wealth creation today lie in - evolve directly from intangible assets; it seems a ‘no brainer’ that in a majority of instances, the essence of an M&A, i.e., what’s really being merged or acquired, are intangible assets!

An effective way for M&A professionals then to increase the probability that the desired - projected returns will be achieved is to ensure that M&A planning and due diligence not be focused solely on a company’s balance sheet that tends to roll up intangibles into a single heading of goodwill.  Rather, decisions to merge-acquire or don’t merge-acquire should include the question, how fragile and sustainable are the intangible assets under consideration?  In other words, is asset value and materiality vulnerable to erosion or undermining prior to, or immediately following, deal closure which, in either instance, will adversely affect projected returns?

Again, in today’s M&A environment, a seller’s or acquisition target’s intangible assets carry a readily exploitable liquidity that outpaces and utterly disregards conventional intellectual property enforcements. This of course, elevates asset vulnerability to many different forms of internal-external compromise that serve as preludes to (asset) value erosion which can literally sabotage deals. 

If either occurs prior to M&A finalization, the value of the about-to-purchased or acquired (intangible) assets can quickly hemorrhage and sometimes ’got to zero’.   At that point, M&A terms will certainly necessitate change based on a determination (assessment) of the extent of asset deterioration or whether the intangibles can rejuvenate to sustain the buyer’s original objectives.

To effectively mitigate such vulnerabilities-risks, its important for buyers and equity sources to have in place, a highly proactive ‘deal impact analysis’ process (capability), e.g., monitoring covenants.  Such (negotiated) covenants are intended to permit monitoring of key intangibles so that the parties can be alerted, in a timely manner, to any acts and/or events that adversely affect changes in the assets’ value or materiality.

If impairments or discrepancies arise, the terms may be re-negotiated as warranted without necessarily losing deal momentum, timing, or resorting to costly and time consuming dispute resolution options.  Most traditional forms of M&A due diligence still constitute ’snap shots in time’.  That is, they do not provide buyers-sellers with the level of on-going monitoring that’s necessary to address the easily exploitable and nanosecond liquidity (value erosion vulnerabilities) now common in transactions in which intangibles are in play.

The ‘Business IP and Intangible Asset Blog’ is researched, written, and produced by Mr. Moberly to provide insights and additional and sometimes alternative views for company management teams, boards, and employees to aid in identifying, assessing, valuing, protecting, and profiting from their intangible assets.  I welcome and respect your comments and perspectives at m.moberly@kpstrat.com.

Michael D. Moberly   February 22, 2010

In every business transaction today, whether its across the street or around the globe, but particularly acquisitions in knowledge-intellectual capital intensive sectors, growing percentages of the deal will inevitably consist of intangible assets. 

For acquisition management teams, the prospect of acquiring (intangible) assets that are (a.) complimentary, readily transferable and exploitable, and (b.) quickly facilitate/enable execution of strategy, should be key drivers for acqusition proposals.  This is especially relevant given the economic fact that 65+% of most company’s value, sources of revenue, building blocks for future wealth creation, and sustainability lie in and/or are directly related to intangible assets!  In other words, intangible assets will be integral to the deal’s value and outcomes, e.g., achieving the near term and strategic objectives which the acquisition team presumably foresaw.  

For the acquiring firm, not-to-be-overlooked factors that underly - add to the probability that the acquisition will be as successful, contributory, and profitable as intended, requires the acquisition team:

1. to recognize that its not solely about asset acquisition, rather it’s about their effective integration and utilization which is an exercise quite different from the acquisition of purely physical/tangible assets, because intangibles (a.) lack physicaliy, and (b.) evolve from - are embedded in intellectual,  relational, and structural capital, therefore,

2. acquisition due diligence and management should be designed and conducted to include pre and post contexts (components), e.g.,

     a. to unravel and assess the assets’ status, stability (fragility), (legal) defensibility, and transferability - integratability factors, and

   b. ensure the assets’ control, use, ownership, value, and materiality are sustainable and monitorable, particulary in post acquisition contexts.

Any acquisition today, or business transaction for that matter, in which the pre and post perspective is not considered or poorly executed, the probability that costly and morale deteriating post-deal challenges will evolve that adversely affect shareholder-stakeholder attitudes and undermine the deals’ success, are almost inevitable!

in today’s extraordinarily predatorial and winner-take-all transaction environment, these (pre-post) perspectives cannot be overstated insofar as the role and contribution of the acquisition management/due diligence team.  Why?, because (intangible) asset contributions and value are sometimes quite fragile, that is, they can rapidly erode, be undermined, and/or their potential benefits literally unravel in hours, not days or weeks. 

Michael D. Moberly   January 5, 2009

When negotiating - executing any business transaction, its increasingly likely intangible assets and intellectual property (IP) will be in play, if not, they should be!

Merger and acquision due diligence that focuses specifically on intangible assets and IP is particularly relevant today because 65+% of M&A value - pricing are embedded in intangible assets and IP!  Presumably, its in the interest of the ‘acquiring’ party’s due diligence to fully assess the status, stability, fragility, and defensibility of those assets to determine if control, use, ownership, and value can be sustained (practically and legally) pre and post transaction.

In addition, its equally prudent for M&A due diligence teams to examine the assets to:

1. identify and assess the existance of any ’me too’ aspects in which the value of the assets will diffuse or erode due to (a.) the breadth of the current field of those assets’ underlying technologies, or (b.) being readily superseded (undermined) if competitors - economic adversaries were able to acquire - launch new technologies that would render those assets’ commerically obsolete, i.e., significantly shorten their projected life-value-functional cycle…

2. determine if (a.) any component will be subject to export, and, if so, (b.) proper/current legal protections are in place in the U.S. and internationally, otherwise, additional legal - regulatory compliance events could be triggered along with significant costs attached…

3. fully unravel - verify their origins and identify/assess if any (problematic) legal restrictions and/or liabilities exist that could inhibit their (a.) complete and unrestricted utilization and/or commercialization, (b.) undemine its value, (c.) erode its competitive advantages and market position, or (d.) add substantial (post transaction) costs for litigation and/or remedies (fixes)…

4.  determine if significant asset (IP) infringement, counterfeiting, piracy, misappropriation, theft, and/or compromises (above normal business risk thresholds) have - are occurring either before or as a reaction to the M&A transaction…

5. determine if key intellectual-human capital ‘drivers’ (i.e., personnel) are leaving the company in advance of the M&A (e.g., going to competitors, etc.) that could adversely impact projections/assessments for near term viability of the transaction and strategic sustainability, efficiencies, value, defensibility, and revenue generating capability of the assets, post transaction…    

                             (Mr. Moberly adapted this post from the excellent work of L. Burke Files.)

Michael D. Moberly    September 18, 2009

Due diligence management teams must be fully cognizant of the reality that the control, use, ownership, value, and materiality of the targeted (intangible) assets do not remain static assets during the (due diligence) process.  They are subject (vulnerable) to being compromised, misappropriated, competitive advantages undermined, and/or value eroded if not properly monitored in both pre and post transaction contexts.  In fact, there’s good evidence to suggest asset vulnerability actually elevates during this time.

What’s more, any of those adverse events (outcomes) can occur in rapid-fire order and cascade throughout the transaction and change its entire structure, e.g., adversely impact the projected (sought after) economic and competitive advantage benefits initially envisioned for the transaction.

Another reason why its important to continually monitor intangible assets throughout a due diligence process is because the time frame when buyers and/or sellers of the intangibles can leverage - extract - realize the most value is continually being compressed.  This is due, in no small part, to the globally predatorial business intelligence and data mining operations, among other things, that can rapidly ’get out front’ of deals and/or transactions to adversely affect (undermine, erode) an assets’ (strategic) value and thereby render the transaction less attractive or severely hamper its (envisioned) viability.

The considerations described below represent additional factors that should be taken into account when management teams ’frame and structure’ a due diligence strategy, any one of which can constitute either a ‘red flag’ or signal a probability that the transaction will be effective, i.e., is there evidence of:

1. a broad company culture that genuinely recognizes the value of the core (revenue - value producing intangible) assets?

2. consistent stewardship, oversight, and management of those assets?

3. consistency in the representation of those assets, ala Sarbanes-Oxley, FASB, etc., in which risks, value, materiality, and financial performance are accounted for and measured?

4. business continuity-contingency planning that includes the core intangible assets?

5. strategic planning intended to achieve fuller utilization (monetize, extract value) from the intangible assets?

Michael D. Moberly    September 17, 2009

When conducting ’due diligence’, there are multiple objectives.  Three key ones are to (1.) recognize that 65+% of most deal - transaction value lies in the targets’ intangible assets, (2.) provide superior knowledge and insight to principals about the status of about-to-be-purchased assets relative to a deals’ terms, objectives, projected returns, and exit strategies, and (3.) examine any circumstances that may adversely affect the target and/or transaction to ensure control, use, ownership, and value of those assets under consideration (about-to-be-purchased) are sustainable in both pre and post transaction contexts.

In other words, due diligence must account for the reality that the control, use, ownership, value, and materiality of those assets can be rapidly compromised, undermined, misappropriated, eroded, and/or fluctuate to adversely impact the projected (sought after) economic and competitive advantage benefits of a transaction.

It’s essential therefore, that due diligence represent/serve a clients’ interests better by being much more than a cursory or confirmatory review of the presence, absence, and/or position of a target’s intangible assets or merely provide decision makers with subjective, snap-shot-in-time estimates.  Instead, in today’s increasingly predatorial and ‘wired’ business transaction environment in which data mining and business/competitor intelligence are routinely applied, due diligence must bring strategic clarity (certainty) to management teams decision making process, particularly regarding the status, fragility, stability, sustainability, defensibility, and strategic value of the targeted assets.

Understanding the strategic value of intangible assets starts by recognizing that the dominant value drivers of most targeted company’s assets no longer lie in tangible-physical assets, i.e., plants, equipment, inventory, etc.  Rather, today, and for the (irreversible) foreeable future, intangible assets will continue to be the overwhelmingly dominant source of most company’s value, revenue, sustainability, and foundations for future growth, expansion, and wealth. 

There are many forms - types of intangible assets, e.g., intellectual property, intellectual capital, brand, reputation, image, goodwill, etc., which is why those critical insights that due diligence should provide to decision makers cannot be correctly/properly articulated solely by using conventional templates and snap-shots-in-time techniques.  It’s also because, in today’s hyper-aggressive and globally competitive transaction environment, asset value and materiality can fluctuate rapidly especially if adverse circumstances exist which includes, among other things, the assets being subject to compromise, misappropriation, infringement, erosion, or undermining prior to or immediately following deal closure.

Michael D. Moberly   August 27, 2009

Designing and implementing (representation, warranty) ’convenants’ for mergers and/or acquisitions (as well as other types of business transactions) to monitor about-to-be-purchased (merged) intangible assets is a prudent and forward looking exercise that is increasingly likely to represent the difference between a successful and something less than successful outcome.  (For a comprehensive list of intangible assets see http://kpstrat.com/brochure.) 

Its well documented that a significant percentage of M&A’s do not bear the anticipated/projected fruit as the deal was initially and often enthusiastically conceived and negotiated.  In no small part, the underliers to M&A’s less than stellar track record:

1. are the various challenges associated with actually and effectively integrating-meshing the key intangible assets in the post deal environment, and 

2.  is the probability that the status, stability, value, and/or materiality of those key intangibles have been undermined, eroded, or otherwise adversely changed in the interim.  

Therefore, the rationale for introducing ‘intangible asset monitoring convenants’ in mergers and acquisitions is on two levels:

1. today, its an economic fact that 65+% of most company’s value, sources of revenue, sustainability, and foundations for future growth lie in - are directly related to intangible assets.  If the control, use, ownership, value, and stability of those about-to-be acquired/purchased intangibles are neither verified nor monitored pre, and post deal, this represents significant risks that could be mitigated and decision makers could be made aware, if effective monitoring convenants had been negotiated ‘up front’ and were being executed.

2. recognition that intangible assets’ integral to a deal’s (projected) profitability and success are vulnerable to an ever growing milieu of risks, challenges, disputes, and changes, anyone of which can adversely affect the outcome.  For example, in an acquisition, the will and ability of the target company to sustain the know how, competitive advantages, reputation, market position, goodwill, image, etc., that are integral to the deals’ value and critical to the deal’s success should be monitorable.  In so doing, decision makers can have ‘early warning’ alerts to these risks so they can be properly addressed, prevented, and/or mitigated by, among other things, renogitating deal terms.

Michael D. Moberly    July 27, 2009      

Today, when negotiating, performing due diligence for, and/or executing business transactions it’s important for management teams to not be dismissive about the role that ’secure’ intangible assets play in the outcome.  The more familiar (alert) management teams are to intangible assets and their management, e.g., their role - contribution to transaction value, future company growth, and overall sustainability, the more likely a favorable outcome will be in the offing.

Whether its the buy or sell side of a transaction, the objectives are similar, which is to ensure management teams fully recognize and assess intangibles that are so essential to transaction (near term, long term) profitability and success.  That’s because factors such as (asset) status, fragility, stability, control, usability, and ownership will, with increasing frequency, affect transactions and their outcomes. 

In many instances, transaction team reluctance to duly recognize the relevance of intangibles is attributed to a mistaken assumption that intangible assets are synonymous with intellectual property, thus, conventional IP protections, e.g., patents especially, are sufficient safeguards for the assets in play and will deter would-be infringers, thieves, fraudsters, and misappropriators.  A counter view however, and one more reflective of todays aggressive, predatorial, and winner-take-all transaction environment, is that conventional IP protections are more akin to reactive swords, rather than proactive shields, and carry little, if any deterrent affect.  In other words, the real value and benefits that well protected and preserved intangible assets bring to a transaction can be significantly diluted, undermined, or even irrevocably lost when management teams overlook and/or don’t factor those realities.

A positive, perhaps first, step management teams should consider to consistently and favorably affect a transactions’ outcome, is to recognize the importance of conducting an inventory and/or assessment of the assets, applying a ’business impact analysis’ methodology in both pre and post transaction contexts.  An intangible asset assessment is a thorough, systematic, and circumstance-company specific procedure that objectively describes the (a.) status, (b.) stability, (c.) fragility, (d.) sustainability, and (e.) vulnerability of the assets in play.

Further, its important to test those assets insofar as their ability to sustain the transactions’ projected (a.) objectives, (b.) returns, and (c.) exit strategy under various circumstances, e.g., embellished respresentations, fraud, misappropriation, business intelligence, and infringement, etc., anyone of which, should they occur, will, most assuredly, adversely affect a transactions outcome.  The objective here is to enable/facilitate a more secure and profitable transaction to go forward, not impede it! 

Finally, it’s important that management teams’ recognize that intangible assets will almost always be part of any transaction, especially in light of the economic fact that 65+% of most company’s value, sources of revenue, sustainability, and foundations for future wealth creation consistently lie in - are directly linked to intangible assets!

Michael D. Moberly    May 19, 2009

Audits - assessments of company intangible assets, i.e., intellectual property, proprietary know how, competitive advantages, etc., should be considered on-going necessities and fiduciary responsibilities rather than ‘quadrenial’ expenses or exercises engaged only after problems are suspected or lawsuits filed.  Why, because today, 65+% of most company’s value, sources of revenue, sustainability, and future wealth creation are embedded in intangible assets.

Today’s intangible asset audit and assessment must be much more than a mere confirmatory review of IP status using generic checklists or templates developed decades ago.  Instead, today’s audit and assessment must provide business decision makers with:

1.  an objective sense of the assets’ status, i.e., its fragility, stability, defensibiliity, sustainability, and value.

2. actionable and practical recommendations for (a.) maximizing, positioning, leveraging, and extracting value from the assets, and (b.) sustaining control, use, ownership, and value of those assets through effective stewardship, oversight, and management.

The primary responsibility of the entity conducting assessments/audits is to fully understand ‘how the company works’, i.e., how its knowledge-based assets (intangibles, IP, etc.) are produced, inter-connected, and utilized insofar as their contribution to revenue, value, competitive advantages, market position, etc. 

This insight will enable and facilitate management teams to engage - conduct more secure and profitable transactions by (a.) sifting through and unraveling a company’s operational complexities and nuances that have a bearing on utilizing and sustaining control, use, ownership and value of relevant assets, and (b.) bring operational and economic clarity to a company’s intangible assets, intellectual properties, and other knowledge-based assets.

Michael D. Moberly    May 15, 2009

Intangible assets (intellectual property, proprietary know how, reputation, image, goodwill, etc.) can advance a company economically and competitively, in deals and transactions, only so long as their control, use, ownership, and value are consistently monitored and sustained!

It’s important to recognize, once again, that growing percentages (65+%) of most company’s value, sources of revenue, sustainability, and future wealth creation are attributed to - directly linked to intangible assets.  The relevance and value assigned to those assets can fluctuate which requires methodologies for monitoring and assessing that value fully reflect the life and functionality cycles of the assets in play - part of a deal.

Similarly, a company’s portfolio of proprietary (sensitive) information and trade secrets evolve over time, in part due to various practices company’s employ for internal classification (re-classification) of information.  While some information is considered sensitive and fall into trade secrecy status, those classifications will vary with some information becoming outdated, and may ultimately bear little or no relationship to the types of information a  company ultimately must, and should be safeguarded.  The effectiveness of information security and classification policies and procedures diminish rapidly if such fluctuations go un-recognized, un-monitored, or un-reported.

Some information can literally become obsolete because, among other things, it no longer possesses commerical or competitive value, while new information is constantly being produced (generated) and can rapidly escalate in value, but, again, if un-recognized as such, its vulnerability to compromise or inadvertently entering the public domain rise, and, once there, value will quickly go to zero!  Therefore, recognizing that the production of information assets is a dymanic, not a static process, and is an important and necessary first step in ensuring business transactions, in which intangibles and IP are in play, are as successful as the parties’ intended and demand!

Today, most business transactions are extraordinarily competitive, predatorial, globally intertwined, and ‘winner-take-all’ oriented, for which there is no single, stand alone information protection platform that is adequate.  Absent a thorough appreciation that the end game for most any transaction is to sustain control, use, ownership, and value of those (information-based) assets in both pre and post transaction contexts, then favorable transaction outcomes will surely be in jeopardy before the ink dries!

More succinctly, when engaging in any type of transaction in which (information-based assets) IP and intangibles are being bought, sold, transferred, or licensed, its essential to ensure that (a.) due diligence is as good on the front end (pre-transaction) as it is on the back end (post transaction), (b.) due diligence does not succumb to faux sense of urgency, i.e., an entire deal must be fully vetted in 48 hours, and (c.) conventional templates for conducting due diligence are challenged, that is, when 65+% of a transactions’ value lie in intangible assets and IP, presumably, the ability of the parties to sustain control, use, ownership, and value of those assets and conduct thorough on-site interviews and assessments become necessities with little or no room for negotiation!

Michael D. Moberly    May 23, 2008    Part III of Three Part Post

The approach to intangible asset due diligence espoused in this and the previous two posts (May 21, May 22) can deliver necessary target specific analysis to acquisition - due diligence teams by, (a.) revealing and unraveling under-the-radar risks to the targets’ strategic value embeddedd in its intangible assets, IP, proprietary know how, competitive advantages, brand integrity, etc., and (b.) where - when feasible, identify considerations for (value, risk) remediation.

Should significant risks, value fluctuations and/or asset entanglements ‘come to light’ as a product of this approach to due diligence, acquisition teams could propose (design) special ‘monitoring’ covenants be attached to the transaction that reflect (address) the revelations of risks to the key assets. 

Such covenants, developed through the findings of this specialized due diligence, can serve as an additional hedge against a common affliction of acquisitions, i.e., post transaction surprises wherein its found that targeted assets have been significantly compromised, value diluted, and/or there’s been an over/mis-representation of a targeted assets’ origins and/or value which are often preludes to time consuming and costly remediation, disputes, and challenges.

Perhaps Alan Weber described it best, ‘the first rule of life is also the first rule of business…adapt or die’.  Its important that merger and acquisition due diligence, as well as due diligence in most every other business context, adapt, that is, fully recognize that the value of what’s being bought or merged lies increasingly in intangible assets.  Unfortunately, studies have found that companies that engage in mergers and/or acquisitions to try to improve (their) market position (for example) may devote as little as 10% of their due diligence to ‘intellectual capital’ (intangible asset) issues such as retaining sales and marketing.

Again, respecting the fact that today, 75+% of most companies’ value, sources of revenue and future wealth creation lie in intangible assets, it seems only prudent that due diligence should and will be much more reflective of this economic fact - business reality!