Unveiling the Value: Conducting Intangible Assets and Intellectual Property Audits (Due Diligence) in the Startup Ecosystem

Investing in proper due diligence, risk assessments, compliance frameworks, and robust contractual agreements is critical to reducing post-transaction costs and avoiding legal disputes. While high transaction costs may be a lawyer’s bread and butter, it is ultimately in the best interest of businesses and investors to prioritise these measures, rather than risk with costly and time-consuming post-transaction problems. Taking a preventive approach saves time and money in the long run.

It is true that in the early stages of a startup, the investment is not so much in the product/service, but in the team. However, the team’s capability is indicated by how the startup manages its intangible assets, which are crucial for maintaining a competitive edge through the protection of valuable information. It is important to note that in this development stage, intangible assets constitute the main value. If this information falls into the hands of competitors, or is used against the company’s interests (e.g. by former shareholders/employees), the investments made will become worthless.

However, traditional legal due diligence typically does not cover a startup’s know-how, trade secrets and related matters (e.g. know-how and trade secrets are not included in the Startup Estonia Due Diligence Checklist, see https://startupestonia.ee/resources). Moreover, the special audit is often not substantial and does not go beyond checking items off a list. For example, with regard to intellectual property, an investor may be satisfied with a tick in the “IP” box on the checklist, indicating the existence of a particular IP instrument such as a patent. However, it is not verified whether the patent is actually being used in production, and if so, in what capacity. If not used, what solutions are being used instead, whether they are describable, and if so, whether there are corresponding manuals, and who physically possesses the know-how, what confidentiality provisions have been agreed with these individuals, and so on. It is not uncommon for investors to overlook who owns the IP instrument, or not to delve into the terms and current state of compliance of the purchase agreement (which may contain, for example, a reservation of ownership) or license agreement being used in production.

To ensure the reliability and security of investments made in startups, it is important to clarify how the startup’s gradually accumulated and developed skills and knowledge, including data, are protected in addition to the existence of specific technical solutions. A meaningful legal audit must not only cover relevant documents, but also analyze the actual situation. For example, the technical process is often so complex that documenting it is impossible or impractical. Nevertheless, achieving legal protection and analyzing its existence is possible and necessary even in such situations.