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Emerging technology M&A and associated IP challenges

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M&A activity is one indicator of underlying tech trends.  In particular, the level of M&A often tells us something about the stage of maturity of an emerging technology. We take a look at what the trends are telling us, how to manage issues relating to intellectual property in an M&A scenario and the use of strategic partnerships as an alternative to gaining access to IP and technology.

Naturally, Silicon Valley tends to lead, being home to many of the world’s biggest tech brands and the ecosystem that revolves around them.  European acquirers, which can be more circumspect, then follow on. 

Taking the Internet of Things (IoT) as an example, the first wave of significant consolidation took place in the US, with new entrants in the home security space being acquired by tech giants.  It is expected that the next wave of consolidation will take place in Europe in the industrial IoT space.

Established companies in industries such as automotive, healthcare and financial services are looking to acquire targets at the cutting-edge of new technologies.  Fin tech is a particular centre of activity, driven by investment in AI, chatbots and blockchain, with growing interest from corporate registrars, mobile operators, and financial investors in addition to banks.

A significant theme in recent years has been the rise of corporate venture capital, which is the investment by established companies in external start-up or scale-up companies.

Corporate buyers may be looking to achieve one or more objectives.  For example, they may be looking to buy in capability, technology or teams to build out what they already have, or they might be looking to allocate capital quickly to establish footholds into markets that will enable them to dominate in the future, particularly if customers in that sector are expected to be “sticky”. In addition, companies that are on the receiving end of disruption may be looking to shore-up a position or to safeguard their core businesses or, more dramatically, to deal with an existential threat (e.g. corporate registrars and blockchain).

Another sign of a maturing M&A market is where the emerging tech businesses themselves face a common challenge which scale will help them to overcome.  Such as slower than anticipated customer acquisitions and the cost of building out their IT infrastructure has led challenger banks in the UK to look to consolidate in order to compete with the traditional incumbents. 

Whilst internal R&D is not always the best way to foster innovation, buying in new teams or technologies is not without its challenges.  The conditions that go hand in hand with the start-up culture e.g. lack of failure stigma and ad hoc reporting practices may not sit well within an established acquirer’s business.

Talent

For buyers of an emerging technology company, intellectual property (IP) issues and people management are therefore critical and often go hand in hand.

IP rights arising out of work produced by employees usually belong to the employer as a matter of law.  However, this is not always the case.  For example, if there is little or no connection between the employee’s designated work duties and the code that has been created, ownership of the copyright in that code could vest in the employee. 

This may still be the case even if the IP was created using workplace resources. Well drafted employment contracts are therefore essential in order to ensure legal protection for employers.

Using freelancers is of course a popular way of accessing specialist skills on a flexible and cost-effective basis. Buyers should be particularly mindful that any IP created by a freelancer will typically vest in the contractor, unless agreed in advance in the contractual documentation.

As regards IP ownership generally, early stage companies tend to present particular challenges.  Sufficient time and resources may not have been devoted to protect the target's IP.  Problems may still be latent, with the seller simply unaware of potential problems and therefore unable to provide adequate disclosure to the buyer.

Where the purpose of a deal is to acquire the talent driving the target business this raises additional challenges.  A buyer will need the target to focus on minimising employee flight risk by offering retention bonuses or equity that aligns employee interests with the economic interests of the wider group going forward.

Strategic Partnerships

It is often said that the majority of M&A deals fail to achieve their strategic outcomes.  According to research by the Harvard Business Review, the failure rate may be as high as 70 per cent  . 

What is beyond doubt is that M&A involves material risks for management, and can take a toll in terms of cost, time and the distraction of skilled resource.  Where it is unsuccessful it is difficult, if not impossible, to unwind without resorting to further M&A.

An alternative structure for the development of new technology is strategic collaboration, partnership or alliance.  For the purposes of this article these terms are used interchangeably and refer to a binding agreement or joint venture between two or more companies to develop or exploit a particular technology but not involving an acquisition or disposal.

This is a model which is well understood in certain industries, the automotive industry being a good example.  It is also proving particularly popular in the IoT sector with large tech companies claiming to have thousands of IoT partners supporting their partner built IoT products.

There are significant advantages in strategic collaborations for strategic or trade players.    Whereas M&A is sometimes approached as if it were a zero-sum game, strategic collaborations involve parties working together where (if the arrangement is correctly structured) each party benefits from the other’s success. 

Collaborations are also more iterative in nature. They can be developed as technology unfolds.  Indeed, more than one partnership, alliance or agreement may be required to get from the R&D phase to the marketplace.  Unlike M&A, strategic alliances can be unwound if unsuccessful. 

New technologies such as IoT are formed from a number of underlying technological ingredients and so having specific partners for specific issues makes sense.  No one vendor will supply all the ingredients in the same way no one M&A could achieve all of the strategic objectives.    

For the smaller companies which have decided to partner with bigger companies, a collaboration is an indicator of proof of concept as well as maturity which can play well with potential investors.

It is critical that companies entering into strategic collaborations take time to protect their intellectual property rights.  Each such arrangement should clearly allocate the rights and responsibilities of the party concerned.  Particular emphasis needs to be given to ownership, obtaining and managing patents, prosecution of infringements and unwinding the arrangements on termination.  

As long as interest rates remain low and cash continues to pile up at both strategic and financial investors M&A is likely to be the first port of call.  That said, strategic alliances provide an attractive lower risk alternative for strategic buyers and a stepping stone to exit for the emerging technology companies.

Partners Nick Moore, Lee Harding and associate Jessica Rogers, Morgan Lewis
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