Taking my instructions from the M & A attorney and investment banker leaders in the transaction, I conducted the patent aspects of the due diligence process according to their standard procedures. Everything checked out. CleanCo owned the patents and had kept the fees paid. CleanCo’s patent attorney had done a good job on the patents: the CleanCo product was covered well by the patents and there were no obvious legal errors made in obtaining the patents. So, I gave the transaction the thumbs up from the patent perspective. When everything else looked positive, my client became the proud owner of CleanCo and its product.
Fast forward several months . . . . I began to receive frequent calls from people on my client’s marketing team focused on the CleanCo product about competitive products that were being seen in the field. Given the fact that more than $150 million was spent on the CleanCo acquisition, these marketing professionals not surprisingly believed that the competitive products must be infringing the CleanCo patents. However, I found that each of these competitive products was a legitimate design-around of the patented CleanCo product. Because these knock-offs were not illegal, my client had no way of getting these competitive products removed from the marketplace using legal action.
As a result of this increasing competition for the CleanCo product, price erosion began to occur. The financial projections that formed the basis of my client’s acquisition of CleanCo began to break down. The CleanCo product still sells strongly, but with this unanticipated competition, my client’s expected margins are not being made and its investment in CleanCo will take much more time and expensive marketing to pay off. In short, to date, the $150 Million acquisition of CleanCo looks to be a bust.
In hindsight, the competition for the CleanCo product could have been anticipated during the M & A due diligence process. As we found out later, a search of the patent literature would have revealed that many other ways existed to address the consumer need addressed by the CleanCo product. CleanCo’s success in the marketplace now appears to be due to first mover advantage, as opposed to any actual technological or cost advantage provided by the product.
If I knew then what I know now, I would have counseled strongly against the expectation that the CleanCo product would command a premium price due to market exclusivity. Rather, I would demonstrate to the M & A team that competition in the CleanCo product was possible and, indeed, highly likely as revealed by the myriad of solutions to the same problem shown in the patent literature. The deal may still have go through, but I believe that the the financial models driving the acquisition would be more reality-based. As a result, my client could have formulated a marketing plan that was grounded in an understanding that competition was not only possible, but also likely. The marketing plan would then have been on the offense, rather than on the defense. And, I know that my client did not expect to be on the defense after spending more than $150 million on the CleanCo acquisition.