The Under-Utilization of Technology as an IP Asset in the Private Equity Ecosystem

IP has already had its heyday – buzzwords like  patents, infringement, NPEs, prior art, patent trolls, and invalidity, - filled articles on the pages of the WSJ. I am writing about the days of Blackberry, of Lycos, of Intellectual Ventures, of Acacia. The significance and monetary potential of good IP is still very much part of a solid business strategy, and large monetary awards are still given in courts to patent owners, but the energy of it all has died out for a while.

However, the focus on IP created a season where licensing strategies were a field of creativity and even elegance (in a transaction structuring sense). Large companies had to find ways to work together while also competing, sharing some IP resources while leveraging and monetizing others. Broad cross-licensing agreements, for example, were used to stop or at least slow down “patent wars” within an industry. Patent pools were enacted by third parties to streamline the process of patent licensing in multiple industries while protecting large corporations from litigation threats by NPEs and patent owners.

Additionally, the scope of Intellectual Property as an asset evolved and expanded. Utility patents were considered within the large bundle of inventions that define a product in its entirety, and design patents became relevant in an environment where product iterations became more often. In terms of software, the emphasis has always been to have a system or method patent that describes the process instead of just the copyright to the source code. However, SaaS became more prevalent and a major defining revenue model for companies. Thus, licensing strategies around software developed as well.  With time, SaaS and PaaS licensing agreements became more complex and sophisticated, leveraging broad IP licensing practices such as Field of Use, Geography of Use, exclusivity, royalty models, sub-licensing and more. These strategies were not necessarily deployed for EULAs but for leveraging and monetizing software assets in corporate and transactional structures.

Additionally (we can probably have an entirely different conversation about this), tax treatment for IP assets and their monetization defined corporate structures. In order to extract maximum tax benefit from its IP assets, corporations like Microsoft and others, domiciled their IP assets in locations with favorable tax treatment for such assets, such as Luxembourg or Ireland, and then licensed out the assets to their other subsidiaries that actually sold the software out to end users. In other words, a common corporate structure for companies with valuable IP assets was, and still is, to have the IP assets in a separate subsidiary that then licenses to the operations or sales subsidiaries of the same corporation.

Private Equity firms can learn and “borrow” some of these licensing and IP practices from the corporate domain. The aim will be to hold an asset class, software, embedded within the PE firm’s ecosystem that can provide a channel for significantly increasing the valuation multiple of portfolio companies.

Further, over time, the expansive depository of technology and its various modules will create a decisive advantage for such PE firms in recruiting assets from its pipeline since the access to the technology stack will be just as valuable to the portfolio company as it will be the PE’s capital and scaling expertise.

Our thesis around Private Equity 3.0 is that the PE firm can (and should) pull tech stack assets from its portfolio companies and then utilize these for the ongoing development of other portfolio companies (current and future) and not dispose of the tech stack along with the portfolio company. Instead, the tech IP can be licensed to multiple portfolio companies through structures such as “fork licensing,” where the portfolio company (and eventually its acquirer) has full ownership of a copy of the source code and full freedom to operate and further develop the technology for its use and field – thus transforming the portfolio’s company technology assets base. All the while, the underlying technology stack still remains the property of the PE and is deployed again and again and again.

So, where corporations segregate their IP in a subsidiary and then licensing to its other subsidiary for tax considerations, in the environment of a Private Equity firm, the same structure can be deployed to provide value to various portfolio companies while maintaining (and growing) the technology asset.

Fork licensing is a structure that allows for a one-time copy of a software platform’s source code to the licensee where the licensee then is allowed to further develop and modify. Importantly, such a “fork” can (and most of the time is) be limited to scope and perhaps even geography.

I recently wrote a commentary on a study developed by PwC UK, where the analysts at PwC emphasized the need for Private Equity to embrace technology as the principal tool to create value and valuation for its portfolio within the time limitation of its IRR demands. The model and thoughts, which I am expanding upon here, provide a pathway for such strategic focus.

If anyone thinks that this is simply too far removed from the current practices of PE firms and their competency, then we only need to remember the shift that PE firms underwent in terms of operating talent – in essence, operating partners replaced outsourcing to expensive consulting firms and allowed for PE firms to differentiate themselves by having deep benches of operating partners that often excel in an area as the firm’s activities and portfolio grow.

Our thesis on technology and licensing is not different; it’s essentially the same. Though PE firms' role and purpose is to acquire and then sell portfolio assets, in effect these firms have a large and growing asset internally in the form of its operating partners that has allowed them to enhance the value of a portfolio company quicker and deploy less capital. Technology (and its internal modification and development) can do the same, only even quicker and definitely much cheaper.