Buyout Firms Undervalue Intellectual Property –

When buyout firms first emerged in the late 1970s, several targeted companies that seemed valueless but owned land that could be sold separately. The sellers often would put little if any value on the real estate, and the buyout firm would come in, separate the assets and make a nice profit.

Later, in the early 1980s, several buyout firms used a similar strategy to acquire overfunded pensions. They, again, stripped the assets, sold them separately and managed to generate healthy returns.

Industry experts today say patents present a similar opportunity.

Buyout firms can acquire unremarkable companies that have warehoused unused patents with valuable applications to other industries-applications of which the seller may not be aware.

One of the first buyout groups to explore this area is newly formed Silver Lake Partners LLC, a firm backed by The Blackstone Group. The New York and Menlo Park, Calif.-based firm now is raising a $1 billion fund to invest in subsidiaries of publicly traded technology companies (BUYOUTS Feb. 8, p. 1). In its marketing pitch the firm says it is targeting underperforming divisions, but it is also looking at patents in those subsidiaries that could be worth a fortune if enforced, a source close to the firm said. Partners at Silver Lake declined comment.

A Niche Waiting to Be Tapped

Large public companies often have thousands of patents and fail to understand their worth, sources say.

Patent prospectors look at examples like Honeywell, which discovered in the mid-1990s that it owned the patent for the auto-focus technology feature on cameras. The company is now generating $350 million a year from camera companies that infringed on its patent.

Firms that are seeing dormant patents as a potential revenue source also include Patricof & Co. Ventures. The group routinely investigates the potential value of intellectual property in an investment as part of its due diligence. “You always love to find something in the vault that has value. We always do an IP review when we do a buyout,” said Salem Shuchman, a managing director, adding that he often takes patents to the venture professionals at his firm to see if the patents have untapped potential.

However, most buyout firms try to punch holes in acquisition targets instead of searching for undeveloped assets. Often, they do not thoroughly examine the patent issue when closing deals and fail to realize that patent nuggets exist in mid-tech and low-tech companies.

“Mid-tech is sort of an unexplored area for intellectual property. These are companies with one or two patents, some very good trademarks, and they don’t really look at IP seriously and don’t protect it, and there is a tremendous opportunity there for buyout firms to buy companies that have IP that’s underexploited,” says Bruce Berman, a partner at Brody Berman Associates, a New York consulting firm that works on intellectual property due diligence.

A Difficult Time Judging Value

When buying a company, firms have an easier time placing a value on hard assets than intellectual property.

“Many firms have the view that you’re not protected by patents but by market position. I think patents are important, but they are not guarantees,” says Lawrence Graev, a partner at O’Sullivan Graev & Karabell, LLP.

“What we want to know is the sustainability of recurring cash flows, and, if you have patents, whether they are defensible,” says Darryl Behrman, managing partner at Behrman Capital. Conducting due diligence on the defensability of a patent that a company depends on is a critical part of that process, he says.

Buyout pros often believe, however, that it is hard to put a quantifiable value on patents.

“Anyone who tells you they have a formula for pricing IP is guessing. It is based on risk assessment and a hell of a lot of experience,” Mr. Behrman says.

Some groups disagree: Aurigin Systems, has created IPAM systems, a software for integrating and visualizing information about IP assets. Additionally, BTG PLC and Competitive Technologies conduct due diligence on patents and assess their worth.

Some buyout firms eventually get around to investigating the value of unused patents held by portfolio companies, but only after the acquisition. “We identify problems and question the unused assets once we get under a company and stabilize its operations,” says Wallace Rueckel, a principal at Questor Partners. “I’d rather save up my positives for the deal after it closes and look for the negatives before.”

Questor often does acquire companies with patents they no longer use. The group recently realized unexpected value from one patent in an investment that Mr. Rueckel declined to name so he would not embarrass the seller.

“It was for a product that had never been commercialized by the prior owners, and it was in a product line that the prior owners had decided not to develop. We got some earnings right out of the box and focused our attention on it,” he says.

More often, firms do not conduct due diligence on unused patents before or after they close a deal, sources say.

“Firms need to look at their targets and examine the patents and review who in the marketplace is using products with those patents. Unless they pay attention to it, they do not realize they’re entitled to licensing fees,” says Stephen Willis, the chairman of Chicago-based Technology and Dispute Resolution Consulting.

“Patents being used for income is a relatively new development, and I guarantee buyout firms are not thinking about that,” Mr. Berman says.

Valuing Patents in a Buyout

The flip side of the patent question is the risk one runs when buying a company that does not have its technology properly patented or that might have difficulty creating a new generation of products without infringing on another’s patent.

“You have to spend time and money in order to satisfy that you are not buying a problem, and firms are shirking on conducting a complete intellectual property audit,” Mr. Graev says.

As several horror stories become better known in the buyout industry, more firms are conducting extensive due diligence on the defensability of patents to avoid surprises.

One tale is Jordan Co.’s 1992 investment in LePage’s, a maker of post-it-like products and adhesive tape. Minnesota Mining & Manufacturing used its patents to stop the company from developing and selling its products and the business now, which is still owned by the buyout firm, is mired in litigation. Partners at Jordan Co. declined comment.