Risks to Consider When Purchasing Technology-Based IP for Securitization

By Michael Sarlitto and Dan Roman | SummitPoint Management
Contact Michael Sarlitto and Dan Roman | Visit Website | About The Author

This article focuses on risks associated with technology-based intellectual property (“IP”). We provide transaction evaluators and originators with a working list of risk-influenced items to consider when reviewing opportunities involving the purchase of IP for securitization, specifically in cases where the source of the asset’s value is derived from commercialization, re-commercialization, and assertion. It is intended to assist practitioners identify and assess these risks, make better-informed investment decisions, and achieve their transaction goals.

Risk can be anything that threatens or limits the ability of a transaction to achieve its intended goals or objectives. Risk management, therefore, is the process of logically and systematically contemplating all possible undesirable outcomes before they occur, quantifying and pricing their effects, and establishing procedures to recognize, avoid, minimize, and/or cope with these or other outcomes and their eventual impacts. Three fundamental activities are associated with transactional risk management efforts: assessment, pricing, and control.

Risk assessment is the process of identifying modes of failure and their probability of occurrence.
Risk pricing builds upon this output to model the range of outcomes, their interactions, and potential economic impact so as to ensure that the transaction is valued correctly and that risk is offset through deal structuring or other means.
Risk control employs the first two activities to develop a combination of techniques and strategies designed to monitor, manage, and mitigate risks over time.

In general, large-scale transactions (as measured by value) tend to require more detailed risk planning due to the number and complexity of risks typically involved and the financial impact of undesirable outcomes. As a result, larger transactions will also include the development and analysis of alternative strategies and evaluation criteria. The ranking of risks and development of mitigation strategies in larger transactions often will demand greater sophistication in quantifying and qualifying the probability of occurrence and/or evaluation of impact. This article is not intended to provide an exhaustive list of risks and assessment criteria that a transaction team may observe. If exhaustive lists were possible, the modes of failure in transactions would be finite.

A RISK CHECKLIST FOR PRACTITIONERS

A simplified framework of transaction underperformance and failure, or what can go wrong, has three risk components:

Amount. It costs more and/or it yields less.
Volatility. The inflows are dispersed.
Duration. The inflows take longer to materialize, or the outflows happen earlier than planned.

To operationalize this basic framework of what can go wrong with a transaction, one must think of ways things can go wrong--this leads to categorizing risks. Categorization is most useful in unearthing specific risk factors that otherwise may not have been contemplated. It leads a transaction team to ask pertinent questions, identify relevant phenomena and parameters (that may need to be quantified), and examine unarticulated assumptions.

There are many market, commodity, financial, business, and asset-specific transactional risks for practitioners to consider when purchasing technology-based IP for securitization (see Exhibit 1). However, a review of past transaction experience yields the following categories of risk as most significant:

Macroeconomic and demand risk
Technology risk
Collateral risk
Illiquidity risk
Credit risk
Structural risk

E X H I B I T 1
General Transactional Risk Factors

It should be noted that risk categories are never mutually exclusive. As just one example, technology risks can quickly morph into structural risks,

About The Author

Michael Sarlitto and Dan Roman are Managing Partners at SummitPoint Management, a national professional services firm providing a full array of M&A due diligence and transaction advisory services to a wide range of publicly traded and privately held companies. They can be reached at 312-441-1400 or www.summitpointmanagement.com.