Leveraging The Intellectual Capital of Your Portfolio Companies

In the recent era of down rounds, portfolio company shutdowns and declining tech budgets, the bright spot for increasing the value of your portfolio companies may rest in the mining and harvesting of intellectual capital. From 1977 to 2001, billions of dollars went into the venture capital and private equity markets, and the primary use of proceeds by portfolio companies was the creation of intellectual property and other intangible assets. In many cases, however, those companies have failed to leverage this intellectual capital into new revenue streams, profit centers and market opportunities . Sometimes this is the result of a "laser-like" focus on the company’s core business but often it is the result of a lack of strategic vision or expertise to uncover or identify other applications for distribution channels. Investors and tech executives may also lack the proper tools to understand and analyze the value of the company’s intellectual assets. In a recent study by Professor Baruch Lev at NYU, only 15 % of the "true value" of the S&P 500 was found to be captured in their financial statements. This gap points out the critical need for a legal and strategic analysis of a portfolio company’s intellectual property portfolio.

To begin uncovering hidden value, venture capitalists should strongly urge their existing portfolio companies to go through the process of an intellectual property audit. Venture capitalists should also consider incorporating some elements of an intellectual property audit into their diligence for potential investments. The intellectual property audit will examine the company’s intellectual asset management (IAM) system (if any), ensure that the intangible assets of the company have been properly protected, and most importantly, will serve as the starting point for the strategic planning exercise; an exercise focused on identifying ancillary applications and markets for the company’s intangible assets, in order to create new income streams and profit centers for the company via licensing, joint ventures, strategic alliances and even business format franchising. The intellectual property audit and strategic planning process based upon the audit results will increase shareholder value by ensuring that the highest and best uses of the company’s intangible assets are pursued – which could also be part of the turnaround or restructuring plan of a troubled portfolio company or which could serve at the core of the value proposition in positioning a portfolio company for sale.

As an entry point into the strategy of leveraging IP assets, an appreciation of the different types of assets and their licensing characteristics is useful. The corporate intangible asset inventory may include trade secrets and know-how, trademarks and trade names, patents and patent applications, and copyrights. In situations involving semiconductor chip companies, a type of federally registered right known as "mask work" protection may also be involved. The range of intangibles that may be included under each of these broad categories encompasses almost anything of worth a company knows, writes, makes or does.

While trade secrets, considered collectively, often comprise the prime IP asset a company owns, the protection regime for trade secrets—unlike patents, trademarks or copyrights—is not based on a federal statute. Trade secrets are unpatented bodies of information that lay outside the public domain. For example, products, or the way they are made, may be (or at least include) trade secrets. Formulations, such as the concentrate for Coca-Cola®, may be immensely valuable trade secrets. The processes used by an enterprise to make products or to man-age itself may qualify as trade secrets. For example, material sources, marketing plans, distribution techniques, customer information, product specification/tolerances, best methods and practices, and franchise management protocols all qualify as trade secrets. Tweaks and modifications to improve equipment—even off-the- shelf equipment purchased on the open market—may qualify, as do the fruits of R&D operations: blue prints, test results (even unsuccessful test results are protectable), designs, databases, etc. Know-how is a first cousin of trade secrets but far more difficult to inventory as a discrete IP asset; it is an accumulation of information, knowledge and experience (some of which may qualify as trade secrets, some not) that enables its possessor to achieve practical results which can not be obtained by one not possessing it. Know-how is the essence of what makes a company’s most valuable employees valuable. Trade secrets and know-how, unlike patents, may be licensed in perpetuity. The quid pro quo for the licensee’s payment is initial disclosure and access to the technology.

The most basic definition of a trademark (or servicemark) is any word or symbol (or combination) that distinguishes the goods (or services) of one business from its competitors. While rights in trademarks are acquired by use, registration makes it easier to enforce those rights. Valuable trademark rights can be easily lost; all that needs happen is that the proprietor allows the mark to lose its ability to distinguish its goods from competitors goods. Witness one time valuable marks such as "aspirin", "nylon", "zipper", "cellophane", and "escalator". Most businesses only use their marks in connection with specific goods and/or services. For truly famous or recognizable marks, this opens very attractive collateral marketing opportunities, often referred to as "merchandise licensing" or "character licensing." Trademark proprietors must be careful when licensing to avoid killing the goose that lays the golden egg. Any loss of control by the proprietor over use of the mark could be fatal.

We will assume basic familiarity with patents as a federal statutory scheme that confers upon inventors (or their assignees) the exclusive right, for a limited period of time, to make, have made, use, sell, offer for sale, or import anything that falls within the scope of the claims issued by the U.S. Patent & Trademark Office. Patent license agreements come in many flavors. Some are paid up when signed, some require an annual payment, and some a running royalty based on activity. Some licenses are exclusive, some not. Some licenses permit sublicensing; some do not. One of the most interesting aspects of patent licenses in terms of their value as a revenue stream generator is how the exclusive right can be divided into discrete in fields of use or into geographic territories. For example, a patent owner can reserve for itself the exclusive right to use its patented technology against direct competitors (or in its geographic area of operation) while licensing others in fields in which it does not compete or operate. Patent licenses are often part of a "technology" license, which includes technology exchange, technical assistance, and transfers of know-how. Patent licenses can also be used to gain access to valuable technology of others through cross licensing, especially where the licensor has a dominant patent position which can be used to leverage valuable rights to improvement technologies developed by others. Companies should, however, be careful that their efforts to exploit their patent positions with respect to certain markets or products to gain a position in other markets or products does not cross the line into impermissible "patent-tying."

Copyrights are a frequently overlooked IP asset that is of obvious importance when dealing with computer software companies and content providers (such as publishers of music, movies, books, etc.). However, because one of the exclusive rights of the copyright owner is the right to prepare derivative works, copyright is often a valuable adjunct to technology or know-how licenses where the recipient will often want to develop materials (forms, letters, protocols, best practices manuals, etc.) based on those of licensor.

By making a company’s intellectual assets the focus of its strategic planning, new opportunities are likely to be identified. The company’s technology might be licensed into non-core, non-competing applications or industries; its distribution channels might be used for new products and services which are co-developed with others such as by in-licensing transactions; its internal software management tools might be licensed to others within the industry (provided that competitive advantage is not lost); its employee training programs might have applicability or uses to third parties; its geo-graphic expansion plans might utilize a business format franchising approach in order to preserve working capital, etc. In summary, there are many different ways to approach exploitation of intellectual capital.