Companies that seek to enter a new product or technology area through acquisition are invariably at a disadvantage because, by definition, they do not possess insider knowledge about the category. This lack of familiarity hit home when a large consumer goods company (let’s call it “CleanCo”) sought to acquire a small company with an innovative cleaning product, specifically a highly effective cleaning product with a new spray bottle that augmented its effectiveness. CleanCo operated in an adjacent product line, but had no direct familiarity with the specific market to which the cleaning product belonged.
Seeking to jump-start its ability to generate elevated profits from the proprietary differentiated cleaning product, CleanCo participated in an asset purchase transaction to acquire the resource-constrained entrepreneurial company along with the several patents covering the innovative product. The more than $100 MM purchase price was calculated as acceptable based upon the exclusive nature of the product as demonstrated by the apparently solid patent coverage–which covered both the product itself and the bottle from which it was dispensed–as well as the growing popularity of the cleaning product with the relevant market. Significantly, most of the more than $100 MM purchase price was attributable to the exclusive nature of the innovative product and its proprietary dispenser. The purchase of the company was seemingly validated by the fact that several of CleanCo’s competitors were actively bidding on the company and its IP (which, of course, pushed the final purchase price up substantially).
Shortly after the deal closed, several products similar in appearance and identical in usage began to be seen in the market. Almost immediately, price erosion began to occur in the market, a fact that motivated CleanCo to find out why their pre-closing financial projections now appeared to miss the mark so substantially.
A “post-mortem” revealed that none of CleanCo’s advisors had advocated a review of the competitive patent landscape during the due diligence phase of the deal. This post-deal review of the relevant patents revealed that, although the cleaning product and its dispenser were unique, there were many other methods to achieve the same innovation. Moreover, because these alternatives did not infringe any of the numerous patents acquired by CleanCo, there was no legal way to keep these competitive products from the market. CleanCo thus paid a premium for the innovative product, but was not able to recoup its investment by obtaining higher margins from the consumer.
Put simply, CleanCo purchased a specific cleaning product invention that served as only one innovative solution to an unmet consumer need. However, the IP owned by the target company did not fully cover the innovation, and there were several other unpatented ways to solve the same consumer need. The other market entrants were actually in a better position than CleanCo because they did not invest more than $100 MM to gain entry into the market. As a result of CleanCo’s failure to ensure that that it was acquiring an innovation and not just an invention, it now appears that the payback estimates for the $100 MM acquisition were wildly off the mark and that CleanCo will be required to write down a considerable portion of the acquisition.