Merger – Acquisition Due Diligence for Intangible Assets

Conventional (snap-shot-in-time) approaches to conducting intangible asset due diligence…for a merger – acquisition, etc., that utilize a one-size-fits-all model, checklist, or mere confirmatory review are unlikely to provide decision makers (M&A teams) with the necessary insights and analyses that are so necessary today to…

  • avoid costly – undesirable surprises, miscues, less-than-expected returns, key asset devaluations, and/or an escalating chain of other (potential) challenges.

Experience indicates either of the latter is substantially more likely to occur when decision makers are operationally unfamiliar with the…

  • key intangible assets in play, and
  • economic fact that 80+% of most M&A targets’ (company’s) value, sources of revenue, competitive advantages, and future wealth creation capabilities today lie in – emerge directly from intangible (non-physical) assets, not tangible (physical) assets.

So, when contemplating, proposing, or becoming engaged in a M&A activity, its essential to…acknowledge, at the outset, there will be valuable and competitive advantage intangible assets in play, otherwise, why would one initiate the M&A?  In point of fact, M&A target’s intangible assets are likely to be a primary driver for pursuing the transaction.

As for the (targeted) intangible assets in playthose unfamiliar with intangibles, often assume the motivating prize are the registered intellectual properties, not necessarily the proprietary know how, and other forms of intellectual, structural, and relationship capital, competitive advantages, brand, and reputation, ala intangible assets.  Through my lens, this makes M&A due diligence, specific to intangible assets, an essential, not-to-be overlooked or  dismissed, component!

Again, respecting the consistent – elevated relevance of intangible assets to any transaction…a primary objective of M&A due diligence should be to provide acquisition teams – decision makers with objective and strategic insights and analysis relative to the (intangible) assets being sought and in play.

So, when valuable – competitive advantage intangible assets are in playand, the targets of an acquisition, due diligence should deliver intangible asset specific analysis to acquisition teams regarding…

  • Fragility – have the assets already been compromised or diluted in ways that adversely affect value, brand integrity and/or business processes, procedures, or practices.
  • Stability and Sustainability – can the assets produce/deliver the projected revenues, efficiencies, and/or collaborations.
  • Defensibility – the effectiveness of legal, monitoring, continuity/contingency and awareness measures to aggressively pursue violations, compromises and/or recover from adverse events.
  • Remediation and Forensics – requirements (costs) to sustain control, use, ownership, and value of the targeted assets and employ measures to counter (mitigate) economic-competitive advantage hemorrhaging that may materialize (pre-post transaction).
  • Control – targeted assets subject to gray markets, challenges to brand integrity.
  • Asset Origins and Development – identify, unravel, verify, and assess the targeted assets’ history, contributors, and ownership to ensure the assets are free from encumbrances, challenges, and disputes.
  • Value – ability of the targeted assets to continue to perform (a.) the intended functions, and (b.) generate (economic) revenue.

In other words, M&A due diligence should produce – deliver target specific analyses…for acquisition teams, relative to determining whether the about-to-be-acquired intangible assets can sustain the deals’ near term as well as strategic objectives.

The due diligence product should also reveal and unravel…any – all under-the-radar liabilities and risks to the assets and identify remedies (if feasible) to mitigate, shift, and/or leverage the risks to negotiate better deal terms, i.e., special covenants.

This approach to transaction due diligence…can also identify circumstances, objectively known to serve as preludes to costly and time consuming disputes and/or challenges over control, use, ownership, and value of the assets in play, anyone of which, if left unchecked, can undermine (erode) the deals’ projected strategic competitiveness and/or projected profitability.

Up-front negotiated agreements to ensure sufficient accessibility to the targets’ intangible assets…of course, are necessary to conduct this level of (in-depth) due diligence. Admittedly, this level of accessibility – analysis of a target’s intangible assets has not been the norm.  Too, transaction analysis has often been restricted to ‘sterile war rooms’ where unwieldly time constraints have been imposed.

Again, the rationale for conducting M&A due diligence in this manner…is because most targets’ value is directly linked to its intangible assets which must be identified, unraveled, and assessed.  Too, unlike patents, trademarks, and copyrights, there are no certificates issued by the government that describe (a.) your intangible assets, proprietary know how, and competitive advantages, or (b.) this is how a company should safeguard, preserve, and monitor the asset’s value and materiality.

Too often, acquisition due diligence has been an exercise…focused primarily on verifying a targets’ financials. Today, acquisition due diligence should provide decision makers and acquisition teams with much more!

The approach to intangible asset due diligence espoused in this post…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 intangible asset focused 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 also serve as an additional hedge against a common affliction of acquisitions, i.e., post transaction surprises, wherein its found that targeted assets have been (a.) significantly compromised, (b.) value diluted, and/or (c.) there’s been a mis-representation of a targeted assets’ origins and/or value. Again, anyone or other challenges revealed can often materialize as 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.

Interestingly, studies have found that companies that engage in mergers and/or acquisitions…as an effort to try to improve (their) market position, may devote as little as 10% of their due diligence to ‘intellectual capital’ (intangible asset) issues such as retaining sales and marketing.

It is prudent therefore…in light of the economic fact that 80+% of most company’s value, sources of revenue, and competitive advantage lie – emerge directly from intangible assets, that all due diligence activities reflect this irreversible business reality!

Michael D. Moberly June 11, 2018 St. Louis [email protected] ‘The Business Intangible Asset Blog’ where one’s attention span, business intangible assets, and solutions converge!

Readers are invited to explore other relevant resources, i.e., papers, books, blog posts I have produced-published at  particularly a paper titled ‘Moneyball and Intangible Assets’.

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