How to Improve the Performance of M&A: Determine Whether the Target Really Provides Durable Competitive Advantage

Most M&A transactions fail to meet expectations.  When IP is involved, ways exist to improve the odds.
Most M&A transactions fail to meet expectations. When IP is involved, ways exist to improve the odds.

Recently, I was asked to speak to a Georgia Tech MBA class about IP Strategy–specifically about the inter-play of IP in M&A.  A significant portion of my talk addressed how poorly existing due diligence and IP metric methodologies traditionally perform to predict the financial success of M&A transactions.  There is no question that improvements are needed in this regard.  For example, in 2006, reported that 60-70 % of acquisitions fail and more than 90 % of acquired businesses lose value. These somewhat dismal results leave no doubt that acquiring companies need better sources of information to properly vet and select acquisition targets.

Having been involved in M&A transactions as a legal and business advisor over the years, I have developed unique insights on the the due diligence and IP metric processes from both sides of deals.  In these deals, the highest (and presumably most expensive) advice of investment bankers and M&A attorneys directed the deal flow.  Significantly, however, much like a real estate transaction, these advisors took their money at the close of the deal and left my client with the property.  These advisors had no incentive to ensure the house was in good shape after they walked away with their compensation for effecting the deal.  Instead, these M&A advisors are incentivized to get the deal to close, not to ensure that the purchaser is buying a property that is poised to generate the value that drove the deal to completion in the first place.

As someone who has worked both sides of M&A deals for my clients as a day-to-day advisor, I now believe one of the major problems with M&A’s, at least those involving IP, is that the acquirer fails to properly assess whether and how the target’s products or technology provide a durable competitive advantage.  There is a big difference between a patent that covers the product that generates (or is predicted to generate) significant value after the acquisition and a patent that not only covers the valuable product and that is broad enough to prevent others from competing in the same product domain.  In my experience, the latter is what matters, but the due diligence process primarily focuses on the former.

The good news is that it is is not hard to develop a point of view about the competitive effect of a target’s IP, which includes patents, as well as other forms.  Those vetting the deal have to analyze not only the patent itself, but also the patents of others in the general area.  This is not an infringement analysis; such a review is done in traditional M&A due diligence.  Rather, this is more of a patent ecosystem-type approach to the patents relevant to the products supporting the business of the target company. The question then becomes:

Does it appear that other companies have worked or are actively working in areas identical to or similar enough to the products that are seen as important to defining a significant portion of the value of the target that is driving the decision to complete the deal?

If there are many companies with patent filings in the relevant areas, the potential acquirer should perceive a signal that other ways to solve the same consumer need e.g., other possible product designs.  Such alternatives should demonstrate that, without other factors, the product may not hold a durable competitive advantage, the absence of which could likely result in the competitive, non-infringing substitutes entering the market.  Of course, such substitutes will often lead to price erosion, a fact which will invariably result in a loss of profit margins for the seller of the product.  If those profit margins were the numbers that drove the M&A decision-making criteria in significant form, the expectations of the acquirer will not be met.  In this regard, it is not surprising that so many M&A transactions do not meet expectations.

I have written elsewhere about how to collect and analyze patent data appropriately, as well as having spoken on this subject to competitive intelligence professionals.  I will likely do so again.  The key is for business professionals to better understand what patents mean and the value they bring (or don’t bring) to a potential M&A target.  I look forward to continuing the conversation with business people.  Please feel free to contact me in this regard.

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