This episode was originally published on October 3, 2018.
Many technology companies are sitting on an untapped resource that could add 5%, 10%, 20%, or more to their company’s value, says Dr. Elvir Causevic, managing director of Houlihan Lokey’s Tech and IP advisory department.
Problem is that if you wait until you have an M&A deal… all that value is lost to you – it automatically goes to the buyer.
Elvir and his colleagues have been innovating a new way to make sure companies, especially those in Silicon Valley, avoid that fate. And we go through that process, step-by-step. It’s actually pretty straightforward once you know the trick.
Check our discussion to find out…
Patrick Stroth: Hello there, I’m Patrick Stroth. Welcome to M & A Masters, where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here. That’s a clean exit for owners, founders and their investors. Today I’m joined by Dr. Elvir Causevic, managing director and co-head of Houlihan Lokey’s Tech and IP Advisory Practice. Elvir, welcome and thanks for joining me today.
Elvir Causevic: Thank you very much for having me.
Patrick Stroth: Yeah, Elvir is the co-author of what I believe is a groundbreaking article on intellectual property. It’s titled, Effectively Discharging Fiduciary Duties in IP-Rich M & A Transactions, and if I were to summarize this in a sentence or two, it’s very exciting. There are a lot of IP-rich tech companies out there that are literally sitting on a gold mine, in the form of non-core intellectual property and are literally giving it away for free without realizing it. The danger for them is that their shareholders and investors are realizing this give-away and they’re eventually going to have to answer for it if they don’t take action. Elvir, before we discuss this issue, tell me how you got to this point in your career.
Elvir Causevic: Through a number of steps. I started out as an engineer, electrical engineer, then got a doctorate in electrical engineering. Went to teach at Yale University for a number of years. From there I spun out a number of technologies at Yale and intellectual property into a series of medical device companies that I funded with venture capital. Two of those were sold to Fortune 500s and in that process I learned about the value of IP in building a company and in exiting a company. The third company’s still running, it’s financed by Steve Case from AOL and several other funds. It’s in DC, they were in brain monitoring business.
From there I got into the IP field and realized that intellectual property and technology transactions are a business for themselves. While I was building the last company, I also went to law school and got a degree, a JD with focus on M & A and IP and that’s where some of this interest came in to look at fiduciary duties. From that perspective, academically and at the same time seeing it in the field.
The last company I built, BSIP, was acquired by Houlihan Lokey just about a couple of years ago and that’s how the tech and IP group got created here.
Patrick Stroth: Well, the focus of your article, and we’ll link to the article in our show notes on our podcast, focuses on the lack of awareness or appreciation of the value of intellectual property by management, which hard to believe but even in an M & A situation, management is not aware of all their IP and I think you make a distinction between core and non-core IP. Let’s just start out, if you can distinguish what is core versus non-core IP for our audience and what led you to analyze that and the uses of it?
Elvir Causevic: Sure. The main distinction between core and non-core IP is, and by IP we primarily mean patents, is, pick a semi-conductor company that has a 1000 patents and has 15 different products across a few product lines. Odds are that much less than 50% of their patents are related to their products, are required to protect their actual products they are shipping. And the remaining 50% or more of the patents are really sitting on the company’s books, company is paying maintenance fees but these patents are not directly used or unlikely to be used in their future product.
So the company knows typically that there’s some value there, but it really doesn’t know how to extract that value in a way that doesn’t make them a patent troll. And the question is, where does this non-core patent value come from? It comes really from two different areas. One is that most of the middle market companies or even some of the smaller companies in Silicon Valley and generally in the technology field today have had a [inaudible 00:04:40] acquisition. Pick any company that’s been around 10 or 15 years or even 5 years, odds are, they’ve bought a few companies and when they acquire those companies, usually with those companies they acquire some intellectual property.
So over time, the first way this non-core IP accumulates is through acquisitions, through prior acquisitions. The second way the non-core IP accumulates is through R & D projects that were very valuable, that were early but for whatever reason, the company decided not to build a product there. Either because the company built a platform technology and could only leverage their resources in one little segment of that platform technology or because they really didn’t have a good market fit or didn’t have a way to go to market, but they still have the fundamental innovation in the business. So those are the two main ways that the non-core IP gets created in a company.
Patrick Stroth: And under this scenario, one of the ways, if you’re acquiring other companies, you’re taking whatever their IP is, lock, stock and barrel. You just grab all of it, whether you need it all or not. It just all comes as part of the deal when you buy that other company, correct?
Elvir Causevic: That’s right. Nine times out of ten, that’s the case. And this is what we published in the Berkeley paper you mentioned earlier. Showed up in the Berkeley Business Law Journal, is looking at the prior M & A transactions, a vast majority of them do not separate the IP. Now, how did we figure out this was a trend? We call it the lucky buyers club. What happens is we get calls from sophisticated buyers, who say, hey, we just bought this great company from these nice people and they were so nice they gifted us all of these patents that frankly they didn’t use and we’re not using, can you please go sell these for us?
So slowly, as we started working on more of these sell side assignments from the lucky buyers club, we started realizing the value for these patents really belongs to the shareholders of the original owner, of the seller. And at the end of the day, it’s the board’s job to really review all of the pockets of value that exist in a company before a transaction takes place. And especially, as a transaction takes place, the so-called Revlon duties kick in, which change the view of the board and the focus of the board from the long-term success of the company to what the courts in Delaware called, board members become short-term auctioneers to generate the best short-term value for the shareholders. So this is where that value of non-core IP becomes important to the board and the shareholders.
Patrick Stroth: What’s the potential, I didn’t even realize that you could separate it out, but if it’s non-core and somebody’s purchasing a company for their core asset, they don’t care about the non-core stuff, so the core, non-core IP can be segregated out. What’s the potential value of that non-core, those non-core assets?
Elvir Causevic: We looked at about 1000 IP, I’m sorry, 1000 M & A transactions involving technology companies. Hardware, software, medical devices, automotive technology and others, over the last several years, we got the data from a Price Waterhouse report and then we went back and looked at how many patents did the sellers have? All the patent data is public so this is relatively easy to figure out. We then looked at the sellers and how many of them did any patent transactions prior to the M & A deal, it turned out much less than 10%.
So certainly safe to say that 90% of the deals had non-core IP and did not trade it. We then looked at how much of this non-core IP that we could figure out by relatively simple patent analytics to figure out the IP that moved from the seller to the buyer and then the assignments get recorded, as the patents move from the seller to the buyer. We looked at which technology areas were these patents in, relative to the product set of the company. And by doing a fairly large sample, we realized that over 50% of the M & A deals, that had non-core IP, the non-core IP had at least 5-10% of the overall deal value, which is material by SEC standards or any other, Delaware court standard. Meaning more than half of the deals and the technology space has material non-core IP that was not traded separately. Basically was in some sense gifted to the buyer. This is consistent with our observations just tactically and day to day in our work, where this is the case.
Now, several times, we’ve seen the value of the IP exceed the value of the business. One good example, it happened several years ago with [MIPS 00:09:48] semi-conductors, those who are electrical engineers will know [MIPS 00:09:54] and it’s history, where it came from. It’s the original risk processor architecture and they had a number of patents in their core business, but they had also done a string of acquisitions over the years. And when it came time to sell, the company was trading at about $125 million enterprise value and the company had some bankers and they tried to sell the business with the patents or without the patents and no matter which way they split it, they couldn’t really generate any incremental value. Part of the reason is that traditional bankers are also not aware of this non-core asset. It’s just not been something that’s been talked about a lot. In this particular case, we worked hard with the board and I ended up getting hired by the board and the CEO to do the patent sale separate from the business sale.
[MIPS 00:10:51] business sold, JP Morgan was their banker, they sold the business to Imagination, a semi-conductor company in England for $100 million. I, with my team at the time, were successful in selling the patents, independent of that, and in a parallel process that ran at the same time, for $350 million to a consortium of 11, 12 buyers. So that’s one example that’s on the extreme. And there are a number of others where we were able to generate 10, 15, 20% of the value of the transaction, of the core M & A transaction, by doing a side deal on patents, either concurrently or ahead of time.
Patrick Stroth: That’s just a material, as you as said, it is a material difference and that’s just sitting there. They don’t have to develop anything, they don’t have to do anything extra. It’s just there collecting dust for the layman out there. And that’s striking. There’s the idea of monetizing, and your article talks about, numerous strategies, there’s more than one strategy for monetizing the non-core IP and those aren’t groundbreaking, new ideas or revolutionary new ideas. A lot companies have been doing it for a while. Why is it that management hasn’t glommed onto this or why hasn’t this lit up management where they’re doing it because the strategies are there already and they’re well understood?
Elvir Causevic: They are well understood, but by a small number of IP sophisticated companies. Companies like Intel, Microsoft, IBM, it’s not unusual for them to have literally hundreds of people in their IP department. As a matter of fact, a number of companies that we’re work with have a centralized IP department and then each business unit has its own IP department. They may have 20, 30, 50 people in it. And these strategies are well-known amongst the most sophisticated players. However, your traditional semi-conductor company or medical device company or automotive technology company, or software company might have one head of IP or director of IP, who reports to legal, and they may have one or two helpers. One that writes the patents and the other one that maintains the portfolio.
So there really is … the issue is more bandwidth. These people are already booked with their daily jobs and there’s a lot of requirements on their time. There just isn’t the mantel, the physical bandwidth, to undertake this process of separating the core versus non-core and then transact the patents. The list of buyers is very unusual, we’ve sold patents to all kinds of entities. So that’s one reason, is the bandwidth of the people who are there. They are really focused on just making money for the business and quarter by quarter delivering results, especially if they are public.
I was going to say, most boards are not aware of these strategies. And we know from talking to a number of boards, at most there may be one board member who understands IP. And what we’ve seen is a significant issue is the public narrative around patent trolls. So people have said to me, board directors at serious size, publicly traded companies have said, look, I really don’t want us to become a patent troll. And they basically describe the major misconception that exists in the market that the only way to make money from your patents is to be a patent troll. And that couldn’t be further from the truth.
Now, can somebody take their junk, old patents that are useless, and then go sue 25 of their competitors just to extract cost of defense like a patent troll does? Yes, they can. But we don’t do that and none of our clients do that. When our clients decide to sell their patents, they follow some industry best practices where there is a reputable way to sell patents. One, you don’t just set up other people to just go attack your competitors. You’re really just selling a complete set of patents. Two, you’re not selling bits and pieces of the same portfolio, of the same technology invention to five different people who are going to launch five different lawsuits each in the marketplace. We insist that our clients basically sell the portfolio, the entire portfolio relating to a particular technology. Three, a number of the buyers, as a matter of fact most of the buyers, by far most buyers of the patents that we sell are other large operating companies.
Just like I said earlier that there is excess, non-core patents, at the same time, those very same companies, they’re entering new fields. Some automotive company might be getting into internet of things or connected cars and they have no technology there and no patents there. A medical device company might be getting into some connected medical devices or might be picking up a new heart valve or a new whatever, expanding their product line and they really don’t have fundamental innovations there and they need to go buy some patents for the defensive purposes.
So about 50% of our business is buy side, 50 is sell side, when it comes to patents. There’s a healthy market out there where patents trade hands has nothing to do with patent trolls.
Patrick Stroth: Gotcha. Well, earlier you mentioned, you’ve got the board of directors where their bandwidth is stretched to the limit, which, unfortunately if you ever get into litigation or angry shareholders, that’s not a really good excuse for them. They should know everything, they should be on top of all this stuff, they’ve got a duty to the company to look out for it and everything. What could happen to management if they continue to underutilized this non-core IP? Some of the outcomes, they’re going to be held accountable. How do you see that happening?
Elvir Causevic: It really varies quite a bit by who the board is and how much scrutiny the company’s under. Where we’ve seen a lot of focus is from all of the activist shareholders. And we’ve been on the defense side with a number of companies as activist shareholders approached and then worked together with the company and the activist shareholders to affect some of these transactions. So for example, we’ve had an opportunity to work with Starboard Value and Elliott, Lion Point, Engage Capital, most of the large, activist shareholders are very savvy about IP. So that’s one avenue where management teams that are really not focused on IP can be a subject of a lot of scrutiny and a lot of pressure by activist shareholders.
The other one is, there may be board members who have experience in other companies that are monetizing. And that say, hey, I’m on the board of these two relatively similar medical device companies or semi-conductor, any of those software companies and how come in company A they make $100 million a year from their IP, of which 80 million is [inaudible 00:18:13] and in company B that has a similar set of patents, they make 0. Why does one management team get to post a donut, when the other management team is posting real dollars every quarter that goes straight to the EPS? So that pressure can come from boards or management and the pressure is on both boards and management, depending on the context in which a transaction happens.
Look, you can also turn this on the flip side and say, what about taking unnecessary risks? There was a company here in Silicon Valley that did the flip side of this and rather than having many patents, they were actually infringing somebody’s patent and then frankly ignored the scope of that infringement for a number of years and then when finally they were sued and lost, and then settled for $500 million, the court decision was the damages were over 900 million. What happened basically was the company lost a lot of cash and then, in a way, invited an activist shareholder, who came in and dismissed the founders, the board and the management team and brought in a brand new team that’s now running this business.
Patrick Stroth: Well, I would think there’s … and the tone of the article that you put out to inform board members is to say, essentially, here’s this opportunity that you need to start taking advantage of this or else something really bad will happen. You have a duty to protect the company and here’s the background and everything. As an optimist, I look at it as, hey guys, here is, as you said, 5, 10, 20% real value that’s just sitting there and it’s not going to cost you much to exploit and take advantage of and it’s just sitting there, get going. And so, what I want to ask is for our listeners out there that are either part of an organization or know of an organization or the VCs out there that are shareholders, what’s the first step they need to take to address this core, non-core issue and get a handle on to move forward?
Elvir Causevic: Sure, let me just start by saying that the purpose of the paper was to lay out a pathway for the boards to properly discharge its fiduciary duties and to raise this issue that we’ve seen some shareholder lawsuits, for example, AOL sold its patents for a billion dollars but didn’t tell its shareholders. So, it immediately had a lawsuits from the shareholders that had sold their stocks six month prior to the billion dollar patent sale, saying why didn’t you tell me you had this asset? I wouldn’t have sold my share. So the idea was to write the paper to lay out a pathway to say, here are the steps to take to … what’s the right thing to do here? Not just by Delaware law but also what’s the right thing to do generally.
The first step to do is to figure out, is there a non-core IP? If it’s a large company and they have 20 patents, maybe all 20 are used in the product and there’s really not much to do there. If it’s a large company and there’s 100s of patents or 1000s of patents, odds are there’s some non-core IP there. The second step is, this could be done through a management team or a competent outside advisors, to just figure out, is there non-core IP or not? Period. The second step is to figure out, how much is this non-core IP worth? So that’s typically done through an IP valuation to say, what can we get in the market for these patents? If we sold them to a restricted group of people, maybe we offer them first to friends and family, we offer them to our ecosystem or to our customers and then launch a broader process. What do we think is a right order of magnitude here? Are we going to get a million dollars, are we going to get a hundred million dollars, what’s the scope of this deal.
And then figure out, is the value in selling these non-core patents and non-core IP, is it material to the overall size of the company that we can sell? Should we launch a parallel process to sell the IP? MIPS decided to do that and launch a parallel process, Yahoo decided to do that and launch a parallel process, Broadcom did not. We worked with Broadcom for many years before they sold to Ivago. That purchase price was 37 billion dollars. You can imagine Broadcom has a lot of non-core patents, they’re worth quite a bit, but it’s really just not material to the overall value of the deal and anytime you’re doing two transactions, it obviously adds a small, incremental degree of complexity that’s unnecessary.
So these are the proper steps. Do we have the non-core IP? Yes or no. If we have it, how much is it worth, realistically, in the market? And given how much it’s worth, what’s the relative value of the percentage of the company. If it’s 5, 10, 15% or more, then yeah, you should probably take a look at that. If not, if it’s down in the sub-5%, it may not be worth the additional complexity in the process.
Patrick Stroth: And you’re leading Houlihan Lokey’s tech and IP advisory practice and you mentioned earlier that there are very few investment banks or other outside experts that have experience doing these types of diagnostics and valuations and so forth and help strategize. With what you guys are offering, give us an idea, just relative cost of doing a venture like this to look into it?
Elvir Causevic: Sure. It depends on the number of patents and the size of the company. We can get a projects started in the just really rough numbers, for a smaller portfolio, say 100 patents or something like that, oftentimes we’ll take a look at it just on our own. We can do the first pass analysis on what we call the friends and family basis, if we need to figure out what the value is, that [inaudible 00:24:34] and the patent analytics to actually split things into core and non-core, on smaller project it’s 50 to 100000 dollars on larger projects it could be several hundred thousandth. We’re not really consultants, we’re bankers so we don’t want to get paid for that work. We want to get paid on the success fee. So that’s typically where we get paid is, we’ll have some retainers up front, but if the company’s committed to doing the work and going through and executing the sale, then typically structured with some success fee so that when the company wins, we win at the same time.
Patrick Stroth: I just believe that’s a very nominal investment to make, not only to, worst case scenario, you are providing protection for your fellow board members and protection for the company, just to go through the exercise. And the upside is virtually a no brainer, I would think.
Elvir Causevic: Yeah. Look, nothing is without risk. Here, we have taken a look at portfolios where we just couldn’t find enough value there to take it to market because it was too old or too young or something like that. But we’ll know that before we start a project. We’ll do the preliminary analysis ourselves and we really want to work with clients where we think there’s real value in the marketplace at the end of the day. And we know enough about the market and have a team of nearly 30 people just on the tech and IP practice, engineers, patent attorneys, IP licensing attorneys and bankers so that we can quickly turn through a portfolio and have a good feeling of whether there’s something there or not.
So to get started, it’s really a matter of a phone to say, hey, look, we have this set of patents and this is the business that we’re in, and this is what we’re doing, we’ll come and take a look just to evaluate whether it’s worth moving forward.
Patrick Stroth: Well, that leads me to my last question, which for our audience members out there who are thinking just this very thing right now is thinking of those couple of questions. How can they reach out to you? How can they find you?
Elvir Causevic: Very easy. We’re the largest bank on Wall Street that has a group that deals with technology and IP transactions. Today we focused on IP, the same story applies to technologies that a company has developed. You can find us at HL.com, HoulihanLokey.com, or by phone. It’s 415-273-3616 and then of course all of our, we’re in the tech and IP practice. We have some case studies and other things on the HL website.
Patrick Stroth: Well great. Fantastic. And we’re also going to have a link to this piece in our show notes too so people can share the great insight that you have on this. Elvir, thank you very much. I think this is probably one of the most value-packed conversations I’ve had, just in terms of the potential value out there for our fellow companies out here in Silicon Valley, so thank you very much.
Elvir Causevic: Thank you very much for the opportunity. I think this is an important message to get out there and I really appreciate you investing the time in helping us get the message out. I agree with you. This could be very helpful to folks, engineers like me, or technologists who work hard and generate real value. It’s always nice to have that value recognized with a nice transaction.
Patrick Stroth: Absolutely. Well, thank you very much.
Elvir Causevic: Thank you.