Intellectual Property Issues for Venture Capital and Private Equity Firms: A Comprehensive Guide
November 9th, 2023
Everything you need to know about the different IP issues you may come across—and what you can do to prevent them.
In the past few decades, both private equity and venture capital firms faced waves of developments and industry-wide evolutions that shaped the way they work today.
Compared to the olden days, VC and PE firms operate with a higher level of intricacy that encompasses anything and everything that affects their profit margins and financial statements. From vetting potential investments to managing returns, the range of details that both of these company types need to deal with widens yearly—with some growing more impactful than ever.
One such example of a detail that’s come to light recently but has become exponentially more important over time for venture capital and private equity firms is Intellectual Property (IP).
As it stands, IP is one of the most valuable assets businesses across all industries can invest in—VC and PE firms, included. Some estimates, as a matter of fact, suggest that nearly 80 percent of the value of S&P 500 companies comes from intangible assets such as patents, trademarks, and trade secrets.
With all of this in consideration, it’s clear that both venture capital and private equity firms need to pay more attention to the importance of protecting IP. This is an especially irrefutable fact since investors are more observant of a company's IP portfolio since it can be a critical indicator of a company's long-term success and potential for growth nowadays.
By having a strong IP portfolio, any company can maintain a competitive advantage, minimize the risk of competitors copying or stealing their ideas, and generate revenue through licensing. This also, however, brings up one question that many VC and PE firms looking to capitalize on the Intellectual Property train end up asking themselves:
“What are the different IP issues we should look out for—and how can we protect ourselves from them?”
Fortunately, managing to do the latter all boils down to exercising due diligence (more of which will be talked about later on in this article).
An Introduction to the 4 Types of IP VC and PE Firms Will Come Across
Before any VC or PE firm starts protecting themselves from IP issues, they’ll need to familiarize themselves with the different types of intellectual property they may deal with. Currently, there are four main types of IP that businesses may capitalize on and invest in:
These standard forms of IP are geared to protect inventions and give patent holders exclusive rights to make, use, and sell their inventions for a specified period.
Generally, patents are critical for companies developing innovative new products or technologies, as they provide legal protection against competitors who might try to copy or replicate their inventions. Apple, for example, protects its iPhone line of products with numerous patents—all of which prevent competitors from copying its design or technology while helping it boost its sales.
With this form of IP, companies can protect brand names, logos, and other distinctive marks used to identify their products or services.
Trademarks are essential for building brand recognition and loyalty among customers—all while protecting the sense of uniqueness brands have. Nike’s "swoosh" logo is a prime example of this form of IP in play that’s helped a company make it instantly recognizable worldwide (and ensure it stays that way for decades to come).
These types of IP are primarily aimed at companies and players in the creative field since they protect original works of authorship, such as books, music, and movies.
With copyrights, owners gain the exclusive rights to reproduce, distribute, and perform their work—as well as create derivative works based on the original. One of the most illustrative examples of this IP type’s capabilities in action is seen in Prince’s decades-long control on the distribution of his music, which prevented streaming sites and video platforms (like YouTube) from hosting or sharing his music for several years.
- Trade Secrets
Through the help of this IP type, companies can protect their secrets or confidential business information—such as customer lists, recipes, and manufacturing processes.
Compared to other patents, trademarks, and copyrights, trade secrets aren’t publicly registered or disclosed—and their protection relies on maintaining secrecy. Trade secrets (like Colonel Sanders’ chicken recipe) can be precious for businesses that have unique technologies or other confidential pieces of information that give them competitive advantages.
By understanding the different types of IP and how to protect them, any business can leverage its intellectual property for long-term success. It’s crucial to remember, however, that thriving with the creative use of intellectual property goes beyond merely understanding what forms of it are available to use.
3 Common IP Issues Private Equity and Venture Capital Firms Run Into
Nowadays, PE and VC firms face many potential intellectual property (IP) issues while investing. Here are three of the most common hurdles that can come up during an acquisition or purchase:
- Infringement Lawsuits
Infringement lawsuits are one of the most significant risks investors face when investing in companies with a substantial IP portfolio.
Although a company may have a valuable patent or trademark, its value as an investment could freefall if it’s eventually found to infringe on another company's IP rights. One such example of an issue like this is the historic Star Wars vs. Battlestar Galactica copyright infringement lawsuit.
With infringement lawsuit cases becoming more common, investors are urged to carefully evaluate the potential infringement risks of a company's IP portfolio during the due diligence process. Doing so can make a significant difference in avoiding these costly legal battles by either remedying such issues early on (or abandoning the potential acquisition entirely).
- Ownership Disputes
Another common form of IP issue that VC and PE firms can run into is ownership disputes.
These situations arise whenever there are questions or uncertainties about who owns a company's IP. Ownership disputes commonly happen if a founder creates a startup and develops any form of intellectual property related to the company's products or services but eventually leaves the company.
One example of a famous ownership dispute involves Facebook—particularly founder Mark Zuckerberg being sued by his former partners, the Winklevoss twins. After years of battling in court over who created the social media giant, Cameron and Tyler Winklevoss and Divya Narendra eventually agreed to a $65 million settlement.
To avoid running into ownership disputes, VC and PE firms must ensure that a company has a clear and valid ownership structure for its IP. This can be done with a thorough check of legal records and filed IPs to ensure that all ends of the “who owns it?” question are fully and factually answered.
- Licensing Agreements
Licensing agreements are another common intellectual property issue that can pose a significant challenge to PE and VC investors—especially if agreements are not well-drafted (or have disputes over their terms).
Generally, venture capital and private equity firms must be mindful of this issue if a company they’re investing in relies heavily on licensing its IP to generate revenue. To best ensure that no licensing agreement issues arise down the line, investors need to evaluate the strength and enforceability of these agreements thoroughly.
Recently, investors in VC and PE firms have had to pay extra attention to licensing agreement disputes in the wake of news surrounding Moderna and Pfizer. The current situation involving both pharmaceutical manufacturers sheds light on the importance of running checks and balances on the validity and strength of a company’s licenses before investing.
These three issues can have a significant impact on the value of the investment—and investors have to take steps to mitigate these risks long before they sign contracts. This reality means that both PE and VC investors need to be aware of the most common IP issues that can affect their investments to ensure that their decisions are as correct and as profitable as possible.
Discussing Due Diligence in the Context of IP
Whenever a private equity or venture capital firm considers investing in a company, it must exercise due diligence—part of which typically entails evaluating the company's intellectual property (IP) portfolio.
Well, this helps firms ensure two things:
- Their investment is equipped to thrive in the future, and
- The company they’re investing in has a well-protected IP portfolio.
The due diligence usually involves a detailed analysis of a company's IP assets.
With the help of a thorough patent portfolio analysis, for instance, VC or PE firms can determine if a company's patents are strong, valid, and enforceable—or if there are any potential infringement risks or challenges from competitors.
If a firm doesn’t follow through with a due diligence process, however, it may find itself in a costly predicament.
One instance of a company falling short in IP due diligence was seen in Microsoft’s purchase of Nokia for $7.2 billion in 2014. While the acquiring company’s executives felt the acquisition would turn out to be a worthwhile investment, their lack of IP due diligence proved otherwise:
Microsoft eventually discovered that many of Nokia's patents were insufficient or had already been licensed to other companies—limiting the potential value they expected to receive.
Cases like this only further cement the point that conducting thorough IP due diligence is a non-negotiable requirement for both investors and businesses. This also means that it pays to enlist the services of a skilled patent attorney who can help businesses ensure that their IP portfolio is well-protected and that they comply with all relevant laws and regulations.
Learn More About IP and Use It to Elevate Your VC or PE Firm
As the concept of ownership in the context of investments continues to grow more critical, venture capital and private equity firms need to familiarize themselves with intellectual property. The issues that arise due to this crucial facet of business, in particular, post greater importance for firms to exercise precaution and due diligence before signing contracts and finalizing acquisitions.
By familiarizing yourself with the different IP issues that may arise in any of your current—and future—investments, you’ll be able to steer clear of financially challenging issues and help your VC or PE firm grow!