Money in the shadows: directors and intellectual property

Last week I sat down with a director of a well-known company. “There’s good news and bad news. First, the bad news. You have very high infringement risk around two core products. Together they represent 40% of your revenue and 60% of your margin. The good news: you have some very innovative intellectual property inside another business unit.” 

“Well that’s positive about the new innovation” he responded. Then cautiously, “what is the relevance of the infringement risk?” I explained. He paused for a long time. “How was this allowed to happen?”  

Directors’ duties today are greater and encompass more aspects of business than ever before. Risks need to be managed and assets need to be sweated. 

Despite our economy being increasingly built on technology and innovation – areas fundamentally underpinned by intellectual property – intellectual property still doesn’t feature on most board agendas. Boards still tend to see intellectual property as purely about patents and trademarks – a quasi-legal or administrative issue that variously belongs to the chief financial officer, chief technical officer, head of R&D or general counsel. Often effective responsibility for intellectual property is essentially farmed out to external patent attorneys with little understanding of the business or its strategic drivers. This seriously misjudges the critical importance intellectual property has now assumed in modern business.

In the US and UK intellectual property (which includes data, content, code, brand, knowhow, confidential information, design) is increasingly regarded as the single most important asset of a company. Intangible assets now represent 80% of the value ($US15.8 trillion) of the S&P500. It is one of the major risks many companies face. Yet it is still not properly understood by many New Zealand boards. This is true of both private and public companies.

So what are some of the key intellectual property issues boards need to be aware of? 

Scenario one: imagine the police arrive one day and confiscate a small but important machine producing a key product. It transpires a staff member stole the machine from a competitor. Presumably the inability to manufacture an important product would be considered a significant risk. Being sued for intellectual property infringement is not only more probable but also has the potential to be even more serious. Every day we see companies where intentionally, recklessly or naively staff use intellectual property they have no rights to. This varies from poor choice of open source code licenses to inadvertently replicating other products to deliberate copying and theft. The consequences are serious and include injunctions, product recalls, expensive litigation and damages awards. In the US litigation costs start at approximately $US1.5 millijn and the median cost to first judgment is $US4.8M.

Ensuring you have freedom to operate (FTO) – that is, the ability to run your business without infringing someone else’s intellectual property rights is vital for any business exporting or founded on development and innovation. 

The first step in avoiding these issues is an independent infringement risk analysis, preferably before you start major R&D or product development projects. The costs of trying to change tack after you’ve committed to a technology path or are in the market are enormous. Best practice is to ensure infringement risk analysis is undertaken by someone independent, not the same people who are filing patents and trademarks on the technology you are now checking. A rigorous infringement analysis will focus on more than patents. Any form of intellectual property can be infringed: copyright, trademarks, design rights or confidential information such as data or processes. Offshore intellectual property should be the primary focus, since the most serious infringement threats are likely to come from overseas. 

Scenario two: imagine the CIO reports that bank accounts containing 25% of the company’s cash assets are at high risk of being hacked due to lax security. This is a risk no director should ignore. But leaving a critical element of your company’s intellectual property unprotected could have an equivalent or even worse impact.

We recently worked with a New Zealand company which contracted an offshore software developer to deliver the final stages of a key product. The company’s engineering team did not understand the true value of the intellectual property they were developing and took few steps to adequately protect or manage the asset, either contractually or through protection of the code itself. The offshore developers, however, quickly realized the value of what they had been sent. After completing the product they shut down their company, restarted afresh and developed a rival – far more successful – product. The product subsequently stole a market share position worth hundreds of millions. The Kiwi company had no recourse. Neither the board, the R&D manager nor the general counsel had identified the intellectual property risk.

On the flip side is the potential reward for companies who understand that intellectual property can be an extraordinary growth lever and ensure they have a robust intellectual property strategy. 

Scenario three: imagine finding the company owns a previously unrecorded warehouse, filled with product that, with some minor modifications, will deliver a 25% increase in revenue for the next five years. 

It may sound fanciful but this is more common than you might think. For example in the early 1970s Xerox identified 32 projects from its famous PARC facility. None were believed to have any value to Xerox and royalty-free licenses were given to various startups. Eleven of the 32 succeeded. The combined value of these cast off companies? Three times that of Xerox. 

There are many such examples of companies allowing ideas or intellectual property to pass to third parties, who proceed to turn these overlooked scraps into successful products or services. Ironically, while most companies will have a fixed asset register listing desks, vehicles and equipment, few have records of vastly more valuable intellectual property assets. These can include brand, copyright in content, data or code and confidential information such as systems and processes, know-how and trade secrets. An expert audit can help identify these nuggets of potential gold and turn them into revenue streams or strategic advantage before they are lost.

Recognising intellectual property is an asset and managing it accordingly is the first step to realising its value. Boards need (and have a duty) to understand that companies today operate in a very different landscape, and take their intellectual property as seriously as machinery, products or a bank account full of cash.

Paul Adams is chief executive of EverEdge IP.