What Is Due Diligence?

At its heart, a due diligence project has a goal of obtaining information to make educated business decisions and mitigate risk. In the world of intellectual property, this includes freedom-to-operate searches, validity and enforceability investigations, ownership and transferability assessments, patentability assessments, and the like. Due diligence is often—and should ideally be—conducted before a company decides to invest a significant amount of resources, such as time, employee efforts, or money. Due diligence frequently is conducted before developing a new product; bringing a product to market; selling, licensing, or acquiring a company or an IP portfolio; initiating litigation; and entering into a collaboration agreement with a third party.

Because of the many different scenarios that can trigger due diligence investigation, there is no one “right” way to conduct the investigation. In general, successful projects start with understanding the business objectives, defining the project and its scope, recognizing the key deciding factors underlying the project, identifying the steps needed to determine those key factors, and allocating those steps between outside counsel, in-house counsel, and other parties, as needed. With multiple separate groups involved, one critical aspect of successful due diligence is establishing regular modes of communication between each other up front so that information is shared as it develops. Almost inevitably, due diligence projects change over time, and setting the groundwork for sharing information among each of the groups will allow everyone to change course more nimbly, saving precious time and money.

Step One: Define the Project, Scope, Timing, and Key Factors

Gone are the days of large budgets. In the new days of fast-paced technology, time is increasingly constrained. But that’s not always bad. Due diligence projects are not academic endeavors. While interesting legal and technical questions may be uncovered along the way, ultimately, due diligence investigations are performed in order to answer specific business questions so that a company can decide whether to go through with an allocation of resources, avoid unmanageable or undesirable amounts of risk, and maintain its industry reputation.

With that in mind, it is critical to identify why the due diligence is being performed and what drives the decision. Knowing this information up front enables the team to identify what main questions need to be answered. That understanding will then allow the team to decide what assessments need to be performed in order to answer those questions, which patents or technologies to assess, an order to perform each task, and the time and money to allocate to each task, all in line with the company’s priorities. As a corollary, this information also informs the due diligence team when they should pause and notify one another when a main question is answered or when they find something that impacts a critical aspect. Indeed, answering an important question or uncovering a major flaw with a key aspect sometimes can end the entire due diligence, making it unnecessary to investigate further. As a result, noting these key factors and questions up front can save time, money, and frustration as the due diligence investigation progresses.

So, when the marketing team asks whether a product eventually could be launched, you might first identify the important technical aspects of the product (often the distinguishing features that will drive sales), and ask where the product will be sold or manufactured. This information will help to define the geographic scope of the freedom-to-operate assessment and to determine what features of the product to clear. When the business team asks whether a patent portfolio is worth purchasing, determine the value they see for the company in the portfolio’s acquisition. Value can be assessed very differently depending on the ultimate business goals for the portfolio. For example, does the company need patent coverage for a certain product for a set number of years in order to recoup the investment costs? Does the company want key patents to potentially leverage against a different company in a looming infringement litigation? Does the company want to shelve the acquired portfolio to stop the seller from bringing a product to market, and necessarily ensure that the acquired patents prevent the selling company from creating a design-around? Does the company want to use the portfolio to expand its own holdings and, more broadly, to keep specific competitors from entering the field? Is the company looking to create synergy by complementing patents of its own? Asking these questions up front will help to identify the critical patents and technologies, how they will be integrated into the company, and what the company is looking to get out of the investment.

It is hard to be efficient conducting due diligence when in-house and outside counsel are both left in the dark as to the larger business purpose of the project. An overall portfolio might be assessed on a high level rather than taking a deeper dive into a handful of key patents. If a valid, enforceable set of patents is needed to cover a specific product for the next six years, but that is not communicated as being the value of the portfolio, then the due diligence team may investigate other issues long after that question has been answered. Or, the due diligence team might interpret the “value” of the portfolio to the company as being the value of the portfolio touted by the selling company, even though the potential acquiring company may want to utilize the portfolio in an entirely different way.

In another example, if the important technologies or patents are not highlighted up front, when a more complex issue is discovered down the line, it may be difficult to assess on the fly whether to devote further resources to resolving that issue. Yet, if the purpose and scope of the project have been identified and priorities highlighted, the team might more quickly make that assessment. If it is an issue with a key patent, the decision may be to go ahead and investigate or resolve the potential problem. If not, the problem may be noted but not explored further.

Last, but perhaps most important, the available budget and timeline should be clearly known and communicated, as these can be the biggest factors when determining the scope of a due diligence project.

Step Two: Allocate Tasks and Establish Communication

Many factors affect how a due diligence investigation is allocated between departments of a company and between inside and outside counsel. In some instances, the business team or marketing team may want to be more or less involved, depending on the importance of the deal to the company. In other instances, while employee time may be less costly than hiring outside counsel, employee time may be better spent on other projects, or employees may not have enough bandwidth to run a larger due diligence project. Or, depending on the technology or type of deal, a company may be more or less inclined to involve its employees or engineers in the due diligence. For example, while the technical people may have the most relevant knowledge, a company may not want to taint its own employees with sensitive technical information from a potential acquisition, reducing the risk of allegations of misappropriation if the deal does not go through. Or, a company may not want word of a deal reaching its employees prior to its occurrence, especially in deals involving large public companies.

For many reasons, due diligence projects often involve multiple groups of people, each with their own costs, time constraints, perspectives, and expertise. With these in mind, the due diligence project can be broken down into tasks, which are then allocated to each group.

One common way to divide up a due diligence project is according to technology, with certain aspects kept in-house, and other aspects sent to outside counsel. In other instances, it may make sense to divide up tasks by the type of investigation that needs to be performed (i.e., freedom-to-operate, validity, transferability) or the specific business question to be answered.

Once the due diligence project is allocated among groups, it is helpful to establish a point of contact for each group. Protocols and timelines for sharing information should be established. In some cases, it may make sense to schedule brief weekly or biweekly phone calls with certain team members, with updates provided in the interim for important developments. While such logistics and scheduling may sound mundane or trivial, establishing roles and protocols for the diligence at the outset can lead to better working relationships and more efficient execution by all parties as the information quickly multiplies. If in-house or outside counsel expect a weekly phone call to share updates, this may avoid interim calls that could be perceived by the receiving party as annoying or repetitive. Regular updates may reveal information that one group thought was insignificant but that another group finds more important because of its different perspective; keep everyone substantively on point and on schedule, as deadlines provide an impetus to complete a task; and help to promote communication about the status of the budget and how evolving issues may affect it.

Finally, identifying points of contact and having regular reminders about the other groups working on a due diligence may itself promote valuable information sharing. When each group is focused on its own tasks and is busily checking off items on a long to-do list, it can become easy to forget that something one group is doing may impact another group in ways the first group did not anticipate. One group may desperately be searching for a missing puzzle piece, while another group is looking at that isolated puzzle piece trying to figure out what it means and where it came from. Or, something that one group considers general knowledge may not have been as widely shared as that group thought. For example, an analysis by regulatory counsel or an FDA decision on one technology may have major consequences on the importance of a particular product or technology to the diligence investigation as a whole. But if this information is not communicated to IP counsel in a timely manner, IP counsel may continue to spend time and money looking into a no-longer-important product. Fortunately, many companies assign an in-house project lead, who is often an experienced business person. Being close to the company and employees puts this person in the best position to facilitate the various interactions and discussions between teams. Priorities set in the beginning of the diligence should be regularly updated according to new developments in order to keep the project on track.

From the Outside In

After working on a number of due diligence projects, patterns of what works and what does not work start to appear. While there is no one-size-fits-all template for outside counsel to apply to every due diligence investigation, there are general themes to embrace. Here is a sampling of “dos and don’ts” and warning signs to look for as outside counsel.

Be Careful Not to Steer the Initial Conversations Too Much

When preparing for a new due diligence project, a company has so much background knowledge that it can be difficult for outside counsel to make sure they are getting enough information to understand both the big picture and the specific details of the due diligence investigation. This information can be helpful to understanding the issues from the company’s perspective and to understanding the business questions that the due diligence is trying to inform. Ultimately, it is the job of outside counsel to gather information to inform these business decisions, so framing the questions according to the company’s perspective is crucial. Listening and asking the right questions is key.

Ask Questions That Invite Information

Questions embedded with your own preconceived notions of the answer may fail to reveal important information. A “yes” or “no” question tends to elicit a one-word answer, leaving potentially helpful information on the table. Instead, ask open-ended questions. When timelines are tight, it is tempting to guide the conversation and to “cut to the chase,” but very useful information can emerge when the conversation is more free-flowing. While an answer may not initially appear on point, the large-picture background information could be valuable in framing the due diligence project and its importance to the company.

Words Can Be Better Said Than Written

While communication is important and should be encouraged, it should also be controlled. When possible, communication should be conducted via phone calls, not e-mails. When writing an e-mail, ask yourself: “What would happen if the e-mail landed on the desk of the worst-possible person to see it?” Impress this rule upon attorneys and clients. During due diligence, you do not know whether the deal will go through, so there are many opportunities for writings to have unintended consequences. And, if the deal does go through, the company will not want unnecessary negative characterizations about its new portfolio. So, information should be shared over regular calls whenever possible. Regular calls can reduce unnecessary written communications because there is already a planned forum for sharing marked on the calendar.

Companies May Have Good Reasons for Not Sharing Information

In those cases, the due diligence can be structured with minimal communication, tailored to include only specific points of contact, or shared on a need-to-know basis. Even when there is regular communication, it is always important to evaluate with whom it is being shared—or potentially reshared—and to make sure that the communication is frequent enough for everyone to keep abreast of relevant developments, but not too often so as to be disruptive or annoying. And, it is wise to consider that, despite proper efforts and notices, communications can leak beyond a diligence team. In very confidential diligence projects, it may be beneficial to have internal teams sign confidentiality agreements to reinforce the importance of a deal. Finding the appropriate balance of risk and resources depends, among other things, on company culture, the importance of the deal, and timelines.

Know When to Stop

The issues that can arise during due diligence investigation may be intellectually fascinating and can raise nuanced legal questions. It can be tempting to resolve those issues or grapple with the complexities and possible effects of those issues on the analysis of the portfolio. But, ultimately, only the issues that really matter to the larger project should be analyzed in order to efficiently answer the larger business questions. While the issues can and should be raised, they should be investigated only if they ultimately align with the business priorities.

From the Inside Out

Being inside a corporation presents opportunities and challenges, including many unrecognizable from the outside. Furthermore, the nature of outside counsel work is to provide a focused, reasonable legal assessment of specific issues in response to a request. The nature of in-house counsel work is to provide assurances to management that the most meaningful and efficient legal (and often common-sense) analysis is underway and that risks involved in the particular business activity will be identified and hopefully mitigated by this analysis. In a very real way, in-house counsel are partners, team members, and often friends of their business colleagues. Their personal influence and reputation are intertwined with the work and communication of such work. Effort should be made to provide relevant, truthful information in a clear, concise manner tailored to the audience.

In-house counsel need to know who to talk to, what to ask, and what to divulge. It is important to avoid tainting internal programs with external information. Further, employees may not always be as confidential as an attorney would like. Deals, litigation, agreements, and the like peak employees’ interests because they can have a noticeable impact on a company. So it is often the case that during fact investigations, questions need to be asked in a vacuum—e.g., without specific reference to a patent, a company, or a deal. As alluded to above, in-house counsel also need to be sensitive to politics and personalities. Employees are represented by their work and decisions in a company. They do not want to be told no; they want to know how to navigate risk. Any given project may represent an employee’s opportunity to shine or may carry the risk of creating a negative impression. Finally, it is paramount to be sensitive to others’ time, resources, and commitments. In-house counsel need to make their clients feel confident that a proper due diligence investigation was performed.

For in-house counsel, one component of providing stellar due diligence work to coworkers is to learn their business goals, their frame of knowledge, and the systems used to provide the facts. Information provided to attorneys may not always be relevant, complete, accurate, or up to date. In-house counsel should understand and evaluate the source of the information, such as a file drawer or validated design history file, stored on a controlled server. Even if the source is generally reliable, the accuracy of the information should not be taken for granted. For example, product drawings may be incomplete and/or specify early versions of a product rather than a commercialized product. Counsel need to know enough to ask for the right details, which comes from being closely involved with a team. Further, it is useful to have access to databases and files and to be trained in how to use such resources and read the documents properly.

Counsel, in-house or outside, can benefit by creating a list to ensure that a diligence strategy is complete, yet calibrated appropriately. A list can allow for prioritization of efforts as well as provide flexibility if something changes. A diligence list can make evident to a business the amount and type of work that needs to be pursued, thereby allowing the business to participate in the overall legal strategy and accept responsibility for outcomes. The list also will help to determine scheduling and budgeting. And, it can be a living document and act as a useful guide for later due diligence projects.

Due diligence lists can help identify the type of diligence needed for a given business activity. With intellectual property, as with any discipline, there are unique types of information to pursue—e.g., a patent portfolio overview, priority dates, filing dates, expiration dates, foreign equivalents, family members, and so forth. Some categories of IP diligence need deep investigation. Inventorship and ownership, for example, require an understanding of participation in an invention, employee assignment obligations, country of invention, and potential royalty payments, among others. Technology and related intellectual property may be subject to agreements with outside parties, including licenses, assignments, development agreements, acquisitions, and divestitures.

Finally, outside counsel are your partners. Outside counsel will work hard to maintain attorney-client privilege, and their skills and interests are aligned with inside counsel. Outside counsel likely will have performed more varied types of diligence work than in-house counsel. This relationship creates an air of freedom for counsel to discuss and explore strategies and look at facts. Outside counsel will have useful knowledge, techniques, and tools (as a result of various attorneys at a given firm performing diligence work over the years) that may not be adequately developed in-house. Take advantage of this! Furthermore, when outside counsel are experts or have performed specific due diligence projects, let them speak directly to the business team from time to time rather than acting as intermediaries. But, also remember that it is in-house counsel’s responsibility to control outside counsel’s efforts in light of company resources, risk aversion, and urgency. Outside counsel can investigate as broadly or deeply as needed, but it is up to in-house counsel to set limits.

Conclusion

Knowing how to organize tasks and communicate between in-house and outside counsel can promote an efficient and successful collaboration. Excitement and stress can run high at the beginning of due diligence, but it is worth fighting the instinct to immediately dole out tasks and jump right in. Instead, pausing a moment to define the project, understand the key deciding factors, and divide the labor between in-house and outside counsel can save much more time down the road.