We have previously discussed goodwill as a distinct asset in purchase agreements. In this post, we explore the growing value of goodwill and other intangible assets in mergers and acquisitions (M&A) and the legal issues parties should consider when seeking to value, protect and exploit these assets.
Intangible assets are often the most significant portion of a target company’s value and goodwill alone can be a very significant portion of a target’s purchase price. For example, in Amazon’s acquisition of Whole Foods, approximately 70% of the purchase price was allocated to goodwill. Although goodwill and intangible assets each refer to significantly different concepts, they are often (confusingly) used interchangeably. Intangible assets are a broad category of non-monetary, non-physical assets (which may include goodwill) such as trade secrets, proprietary technologies, trademarks, patents, and copyrights. Goodwill is a specific type of intangible asset, and in accounting is generally considered to be the amount paid for a business over its fair market value or its identified assets. Practically speaking, goodwill can include brand reputation, brand value and customer loyalty.
From the very beginning of a proposed transaction, both buyers and targets must consider which covenants should be added to protect the target’s goodwill and its other intangible assets. Covenants that can protect intangible assets include:
- Non-Competition: During and after the transaction, the target and key personnel should be prevented from maintaining or creating any assets that would be in direct competition with the acquired business or of poaching key employees and customers. However, these clauses can be difficult to enforce and care should be taken to limit the length of time, geography, and scope of business to which they apply in order to maximize the chances that these covenants will be enforceable.
- Confidentiality: Parties should specifically and consistently refer to a target’s known intangible assets, for example customer lists or brand strategy, in the definition of confidential information in all documents related to the transaction. Targets should ensure that any proprietary information that is shared with potential buyers relating to intangible assets before and during the due diligence process is protected by non-disclosure obligations before it is disclosed and cannot be used for competitive purposes.
- Non-Solicitation: Both the buyer (both during the transaction, as well as after the transaction if the transaction is not successful) and the target (if the transaction is completed) should be limited in their access to a target’s employees, vendors, suppliers and client. Non-solicitation provisions have similar enforceability issues to non-competition agreements and should be similarly limited.
For buyers, proper due diligence of intangible assets and goodwill is essential to determine the true value of intangible assets. Considerations may include the following:
- Classification: identifying and classifying the different types of intangible assets – i.e., those arising from contractual rights (e.g., licensed technology, key customer contracts, key employees) and those arising from non-contractual avenues (e.g., trademarks, trade secrets, patents, etc.).
- Risks and Safeguards: Identifying risks and evaluating the safeguards for each intangible asset – e.g., whether the target’s patents could expose the buyer to infringement lawsuits, whether proprietary software contains open source code that may make it non-proprietary, or whether the target’s trade secrets are adequately protected by legal and operational safeguards such as non-disclosure agreements and password protections.
- Contractual Obligations: Evaluating the limitations placed on intangible assets, such as exclusive licensing agreements, dependence on third party intellectual property and software, liens and other encumbrances on a party’s rights to its intangible assets.
- Future Considerations: Whether an intangible asset is separable from the business and can be separately monetized, synergies with buyer’s business, and the sustainability of goodwill and relationships once the transaction is complete.
Both buyers and targets must protect their goodwill and intangibles from the earliest stages of a transaction. These are often the most valuable assets in a transaction and their value can be quickly lost if adequate protections are not put in place. These protections will entail thorough due diligence and mitigation of risks that arise from that due diligence. It is also often helpful to perform these analyses with an international perspective given the increasingly international nature of intangible assets such as patents, goodwill and data.
The author would like to thank Vahini Sathiamoorthy, Articling Student, for her contribution to this legal update.