For investment professionals, understanding the ins and outs of trade secrets is not just about compliance — it’s about business.
Whether researching a startup, doing due diligence on an acquisition, or dealing with a portfolio of businesses based on intellectual property, trade secrets expertise can safeguard your clients and facilitate better decision-making.
If you’re an investment professional, here are five things you must know about trade secrets.
1. What is a Trade Secret
A trade secret isn’t merely anything a business wishes to keep private. Under U.S. law, specifically the Defend Trade Secrets Act (DTSA) and the Uniform Trade Secrets Act (UTSA), a trade secret must have the following three characteristics:
- It must have economic value in and of itself and not be something that’s public knowledge or readily determinable by others.
- It must be maintained under reasonable safeguards to ensure secrecy.
- It must not be in the public domain and not publicly known.
Some examples of trade secrets include customer lists, steps in a manufacturing process, and algorithms. For investment managers investing in tech or biotech firms, it’s important to know whether a firm’s most precious assets are protectable trade secrets. If not protected, the assets will depreciate over time.
2. Trade Secret Misappropriation Can Kill Deals or Lead to Litigation
Abuse of a trade secret by current or former employees, competitors, or outside suppliers has long-term implications. Misappropriation lawsuits for illicitly stolen trade secrets result in litigation, injunctions, contract loss, and reputational harm.
Investment managers must be due diligence vigilantes. If the target firm is guilty of stealing another firm’s trade secrets, or if it is overly reliant on information it has learned from the former employees of its rivals, warning lights should flash.
And if the firm hasn’t taken any measures to safeguard its own trade secrets — such as by insisting on NDAs or limiting access to confidential information) — its intellectual property is compromised.
Knowing the legal framework for protecting trade secrets discourages investment in companies that are susceptible to suits or loss of IP. It might be worth your while to speak to a trade secret expert who can answer specific questions and offer advice.
3. Trade Secrets Must Be Protected Actively
Trade secrets are not patented the way patents are with the government. They are simply guarded by a company’s effort to keep them a secret. The courts will not recognize something as a trade secret unless the owner made reasonable efforts to protect it.
For investment professionals, this means ensuring that a company has a good confidentiality system in place.
Non-disclosure agreements with employees, contractors, and partners; data access controls and data encryption; and proper employee exit procedures to prevent data pilferage are some ways companies can safeguard trade secrets.
An enterprise that fails to institute these measures risks losing its trade secrets — and with them, a substantial percentage of its value. Institutional investors look at things like the strength of trade secret protection during due diligence.
4. Employee Mobility Is a Trade Secret Risk
One of the common ways trade secrets are disclosed is when employees move on. An employee who quits to join a competitor can unwittingly or intentionally take with them confidential information. This is particularly so in knowledge-based companies such as those in software programming, engineering, or the pharmaceutical business.
5. Trade Secrets Have Strategic and Legal Advantages Over Patents
While patents are open to the public and provide limited protection, trade secrets can provide permanent protection — if not divulged. This makes them extremely suitable for secret recipes), internal techniques, and company operations that are not patentable.
Being aware of the fact that a company has opted to safeguard its innovation as a trade secret instead of through patent, and why, can shed light on long-term IP value.
Trade secrets law is not something investment professionals need to think about every waking moment, but ignoring it is a chance no serious investor can afford. As the economy becomes more knowledge-driven, intangible assets will increasingly play a larger role.
Understanding trade secrets can help investment professionals assess good IP portfolios, measure legal and operating risk, and steer clear of costly mistakes.
