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Due diligence is a critical step in an initial public offering (IPO) to ensure compliance with laws, investor expectations and stock exchange requirements. A company¡¯s intellectual property (IP) status significantly impacts its valuation, market competitiveness and legal compliance, making it a key focus of due diligence.

Invalidated core IP or involvement in infringement disputes during the IPO stage could jeopardise the listing process.

For instance, during the 2023 IPO process of Visight Advanced Material, Changzhou Tiansheng New Materials filed a patent infringement lawsuit and patent invalidation request, prompting Visight to withdraw its IPO application.

Uniqueness

An IP due diligence investigation stands out from general legal due diligence with distinct characteristics. First, the selection of approaches to IP due diligence relies on specialised IP databases, requiring skilled professionals with extensive search experience to provide informed opinions based on retrieved data.

Second, the scope of IP due diligence varies for each case, necessitating tailored analysis to address specific circumstances.

For example, assessing the stability of a company¡¯s patents or conducting a freedom-to-operate (FTO) analysis for key products, along with defining their scope, requires specialist due diligence investigation lawyers to clarify the background, objectives and scope of the report.

This process involves understanding the company¡¯s IP portfolio and consulting with relevant parties.

In practice, a due diligence investigation is often constrained by budget limitations. These tasks demand a high level of expertise from due diligence investigation lawyers, often requiring the involvement of patent attorneys and sometimes supported by patent search professionals.

Due diligence opinions are essentially expert assessments and may vary widely, much like medical examinations, where different doctors may adopt distinct approaches and produce differing results.

Scope

IP due diligence in IPOs covers patents, trademarks, copyright and other IP, reflecting a company¡¯s technological strengths, brand value and creative capabilities. The investigation primarily focuses on the ownership, legal validity, licensing and pledging status, along with the potential legal risks of the IP owned or utilised by the company.

Ownership. This is a key focus in IPO investigations, with regulators placing particular emphasis on whether a company holds undisputed and well-defined rights. This is crucial as it directly impacts the company¡¯s core competitiveness and future profitability.

An ownership investigation typically covers: (1) whether the target company is the sole rights holder, or whether there are multiple co-owners; (2) whether the rights were acquired originally or through transfer; and (3) whether any ownership risks exist.

IP ownership risks primarily arise in patent ownership, such as issues with service invention-creations, ownership disputes in collaborative R&D, and patent conflicts caused by employee turnover.

For instance, MEMSensing Microsystems responded to an inquiry from the China Securities Regulatory Commission regarding a patent ownership lawsuit filed by GoerTek Microelectronics (Goermicro).

In the lawsuit, GoerTek claimed that a MEMSensing patent invented by the individual, Mei Jiaxin, and filed within one year of Mei leaving GoerTek, was related to his previous duties or assigned tasks at the company and should therefore belong to GoerTek. The Supreme People¡¯s Court ultimately ruled in favour of GoerTek.

Licensing and pledging status. Due diligence investigations also involve examining whether a company has licensed or pledged its IP, as this affects its control over the IP and future revenue potential.

Licensing reviews include scrutinising agreements to verify the licensee, scope, duration and fees, ensuring consistency with disclosed information. Such assessments typically require the expertise of seasoned IP lawyers.

Validity and stability. In IPO due diligence investigations, the unique nature of patent rights often necessitates stability analysis of key patents, marking a clear distinction from standard legal due diligence.

Infringement lawsuits. IP infringement lawsuits or disputes are key areas of focus in IPO due diligence investigations. Reviewing these cases offers investors insight into a company¡¯s IP management and helps the company identify and address potential risks early.

Quality. A distinctive feature of IP due diligence investigations is the need for proper evaluation of IP quality, focusing on two key aspects: (1) patent quality; and (2) alignment between patents, products and technology.

Patent quality assesses whether the protection scope effectively covers the invention, its vulnerability to circumvention, and ease of evidence collection in infringement cases. The alignment review ensures that a company¡¯s products and technology are adequately protected by patents.

From a budgetary and pragmatic perspective, the evaluation typically focuses on the quality of critical patents and the consistency between core products, technologies and patents.

Zhang Hanguo is a partner and Qiao Chuanlin is an associate at Grandway Law Offices