Business Valuation Methods and IP Valuation

Business Valuation
PRESENTER: DAVID ABERCROMBIE, PHD, BCA
PRESENTED TO: CHEMPHARMA
EAC VALUATIONS LLC
1450 E BOOT RD, 500-B
WEST CHESTER, PA 19380
610-687-5855
EACVALUATIONS.COM
EAC Valuations LLC 19 December 2014

Objectives
 What is a Business Valuation?
 Who performs a valuation? Why would a valuation be needed?
 What methods are used to calculate value?
 Reconciliation of Values
 Valuation of Intellectual Property
 EAC Valuation Case Study
 Questions

What is a Business Valuation?
“The act or process of determining the
value of a business enterprise or ownership
interest therein.”
-- International Glossary of Business Valuation Terms

Who Performs a Business Valuation?
 Generally performed by certified valuator from the following organizations:
 National Association of Certified Valuation Analysts (CVA)
 American Institute of Certified Public Accountants (ABV)
 American Society of Appraisers (ASA)
 International Society of Business Appraisers (BCA)
 Proper valuations should follow organizational standards:
 AICPA issued SSVS-1 for Business Valuation Standards effective 6/1/2008
 NACVA Standards Equivalent to AICPA
 Uniform Standards of Professional Appraisal Practice
 FIRREA recognizes USPAP as the generally accepted appraisal standards

Why is a Business Valuation needed?
 Bank Financing
 Mergers and Acquisitions
 Ownership disputes
 Business Planning
 Estate and Gift Tax
 Marital/Business dissolution
 Family Limited Partnerships
 Purchase Price Allocation (ASC 805)
 Goodwill Impairment (ASC 360)
 Buy/Sell agreements
 Reorganization and bankruptcies
 Deferred/Incentive Compensation

Business Valuation Methods
The following methods can be used in conjunction or separately to
value an enterprise:
 Asset Approach
 Book value Method
 Adjusted Net Asset Method
 Income Approach
 Capitalization of Earnings
 Discounted Cash Flow
 Market Approach
 Direct Market Data Method
 Public Guideline Companies

Business Valuation Example
 Objective: Value 10% ownership in Steel Widget Inc as of 12/31/2013
 Define the Valuation Purpose:
 IRS Gift Tax
 The current state of the business defines the Premise of Value:
 Going Concern Value
 The purpose defines the Standard of Value:
 Fair Market Value
 Steel Widget’s shareholder agreement, the standard and premise of value,
and professional experience indicates the reported value will be:
 Non-Control, Non-Marketable, Voting

Asset Approach
 Under going concern premise of value, this approach typically
provides a ‘floor’ value
 Assets and liabilities are assigned fair market values as of the
valuation date (12/31/2013)
 Best for businesses with large tangible asset base or generate losses
 For profitable operations this method does not address earnings
 Equipment appraisal may be needed to ensure accuracy
 Yields a “Control, Non-Marketable” value

Income Approach
 In the simplest terms the income approach calculates value as:
 Benefit Stream divided by Risk
 Benefit Stream defined as:
 Net Cash Flow to Equity or Net Cash Flow to Invested Capital
 Risk Defined as:
 Cost of Equity or Weighted Average Cost of Capital (WACC)
 Two approaches:
 Capitalization of Earnings – Linear earnings
 Discounted Cash Flow – Non-linear earnings
 Can yield a “Control” or “Non-Control” value
 Yields a “Marketable” value

Weighted Average Cost of Capital
 Includes company’s
cost of debt
 Provides weighted required
return to equity and debt holders
Cost of Debt 5.00%
Tax Rate 35.00%
After-tax Cost of Debt 3.25%
Risk-Free Rate 3.50%
Equity Risk Premium 6.70%
x Beta 1.30
+ Industry Adjusted Premium 8.71%
+ Size Premium 6.03%
+ Company Specific Risk 1.00%
= Cost of Equity 19.24%
Capitalization Structure
Debt (Market Value) 25%
Equity (Market Value) 75%
WACC 15.24%

Capitalization of Earnings Example
 Determine benefit stream
 Weighted Average, Average or Last Fiscal Year
12/31/2009 12/31/2010 12/31/2011 12/31/2012 12/31/2013
$200,000 $25,000 $150,000 ($20,000) $180,000
7% (1/15) 13% (2/15) 20% (3/15) 27% (4/15) 33% (5/15)
Straight Average $107,000
Weighted Average $101,333 No Trend
 Define risk, utilize proper discount rate
 Convert discount rate to capitalization rate by subtracting long term growth rate
Discount Rate 19.24% Average $107,000
Less: LTG 3.00% x LTG 3.00%
= Cap Rate 16.24% = NCFE $110,210
Multiplier x 6.16
100% Equity Value $678,633

Discounted Cash Flow Example
 Calculate future cash flows based upon detailed projections
12/31/2014 12/31/2015 12/31/2016 12/31/2017 12/31/2018
Projected $80,000 $120,000 $100,000 $140,000 $130,000
Present Value 0.916 0.768 0.644 0.540 0.453
@ 19.24% $73,262 $92,161 $64,409 $75,623 $58,890
Residual Value: $133,900
Capitalization Rate: 16.24% Sum of Present Value: $ 364,345
Future Value: $824,507 Terminal Value: $ 373,504
Present Value Factor: 0.453 100% Equity Value: $ 737,849
Terminal Value: $373,504 Rounded: $ 740,000

Market Approach
 Similar concept as Income Approach
 Benefit (Revenue, EBITDA, EBIT, Cash Flow)
 Risk (P/Rev, P/EBITA, P/EBIT, P/CF)
 Two approaches:
 Direct Market Data Method
 Use past private company transactions as a multiple, which defines risk
 Yields a “Control, Non-Marketable” value
 Public Guideline Company Method
 Use public guideline companies multiples, which defines risk
 Can yield a “Control” or “Non-Control” value
 Yields a “Marketable” value

Reconciliation of Methods
 Review results from applied methods
 Often a valuator will give weightings to various methods
Method Value DLOM Value Weighting
Adjusted Net Assets $355,000 N/A $355,000 0%
Capitalization of Earnings $678,633 30% $475,043 100%
Discounted Cash Flow $737,849 30% $516,495 0%
Direct Market Data $559,982 N/A $559,982 0%
Public Guideline $4,250,000 30% $2,975,000 0%
100% Equity Value Conclusion: $475,043
10% Equity Value (Rounded) $47,500 Non-Control, Non-Marketable

WHAT COMPRISES A BUSINESS
VALUATION? (HOW DOES IP FIT?)
 When valuing a business we generally value it as a whole
 This value reflects the value of all the assets which the business owns
 This value can then be allocated into three classes of assets
Net Tangibles Assets
(Inclusive of all liabilities)

IDENTIFYING INTELLECTUAL
PROPERTY

WHY VALUE IP?
• M&A transactions; when disposing of business or acquiring a
business asset - understand the value of specific intellectual
property to ensure the best result in that transaction
• Required that intellectual property in acquisitions be valued and
amortized over their assessed useful life
• Tax consolidation for corporate groups
• Restructuring Transactions; Intellectual Property Valuations are
important in certain restructuring transactions
• Litigation Proceedings; often when intellectual property
protection is breached it is important to understand the value
prior to seeking compensation under litigation

VALUATION METHODOLOGIES
 There are three generally accepted valuation methods
utilized to value Intellectual Property:
 Market based – comparable market transactions
 Cost based – historic costs or replacement cost devoted to
the intangible asset overtime
 Future earnings based – expected future economic
benefits; relief of royalty savings

Valuation Case Study
EAC Valuations LLC 28 October 2014
 A case study that demonstrates valuation of an
early-stage pharma company that is pre-
revenue, with purchased assets that is looking for
partners to share drug development costs

EAC Valuation Case Study
 Small start-up pharma company acquired assets from major
pharmaceutical company that sold these assets for strategic
reasons
 Assets included patents, inventory, documentation, know-
how, and assigned contracts
 Purchase agreement called for an upfront payment and
remainder to be paid to seller upon meeting milestone of
dosing first patient in Phase 3 clinical trial
 Additional royalties were to be paid dependent upon level of
products sold worldwide

 Valuation assignment for EAC Valuations involved
providing the total enterprise value and the value of
assets of the business including 5 patents and 2
patent applications (at time of valuation)
 Valuation was intended to be used as a basis for
further negotiation with other pharma companies
desired as partners to complete development
through commercialization

 Appraisal assignment started with valuation of
financial information from sales and earnings
forecasts for multiple pipeline products that were
based upon the acquired assets
 The second part of the assignment was to value the
patents that were part of the transaction

 Determination of value was based upon an income
approach
 Valuation used projections of the total monetary
benefits expected to accrue from sales over
projected period
 Monetary benefits were discounted to net present
value over the projection period
 Initial discount rate (WACC) developed based upon
corporate risk and capital structure compared to
reference companies

Weighted Average Cost of Capital
 Includes company’s
cost of debt
 Provides weighted required
return to equity and debt holders
Cost of Debt 4.39%
Tax Rate 40.00%
After-tax Cost of Debt 2.63%
Risk-Free Rate 3.13%
Equity Risk Premium 6.70%
x Beta 0.56
+ Industry Adjusted Premium 3.75%
+ Size Premium 0.50%
+ Company Specific Risk 2.00%
= Cost of Equity 9.38%
Capitalization Structure
Debt (Market Value) 12.6%
Equity (Market Value) 87.4%
WACC 8.53%

 Biotech/pharma early-stage companies have challenging features for
entrepreneurs/investors
 Very long time to market (typically 10 years or more)
 Very high levels of risk (fewer than 1% of drug candidates will make it to market)
 Large amounts of capital continually needed to move most technologies
forward
 Compared to many other assets, investors need to take on more risk, hold
illiquid investments, and wait longer for a return – therefore require a higher
rate of return
High risk = a high Cost of Capital
► Evidence shows that the Cost of Capital for venture backed early-stage
companies in Life Sciences is 20% or higher

 A revised discount rate was calculated based upon
the WACC and based upon additional risk factors
(“project development delay” factors)
 Additional discounting of the income stream was
based upon a probability analysis in which probable
product development time delays were estimated
 Time delay in development = loss of revenue=
increased risk to the company and investors
 The increased risk is captured in the cost of capital
(discount rate)

Cost of Capital = 8.53% (base-line, build-up calculation; previous slide)
Cost of capital = 24.4%
Additional risk factors considered due to
project development delays

 The new discount rate was applied to projected cash
flows to calculate the present value of all pipeline
projects
 The value of the projects was summed to provide a
total enterprise value

 The next part of the valuation assignment was to
determine the contribution from the acquired
patents to the total enterprise value
 The indicated value for the group of patents is based
upon royalty savings (relief from royalty); the royalty
rate is estimated at 33% of sales revenue

Patents
0.0% Future
Total Attributable Royalty Adjusted Mid-Year* Present
Projected Revenues Savings for Taxes PWF Value
Growth FYE Months Period* Revenues 100.00% 33.0% 40.0% 24.4% Indication
- 12/31/12 12.0 1.0 0.0$ 0.0 - - - -
- 12/31/13 24.0 2.0 0.0$ 0.0 - - - -
- 12/31/14 36.0 3.0 0.0$ 0.0 - - - -
nmf 12/31/15 48.0 4.0 83.1$ 83.1 27.0 16.0 0.4657 7.0
3.00 12/31/16 60.0 5.0 249.2$ 249.2 82.0 49.0 0.3744 18.0
2.23 12/31/17 72.0 6.0 555.6$ 555.6 183.0 110.0 0.3009 33.0
1.76 12/31/18 84.0 7.0 976.3$ 976.3 322.0 193.0 0.2419 47.0
1.58 12/31/19 96.0 8.0 1,539.8$ 1,539.8 508.0 305.0 0.1945 59.0
1.40 12/31/20 108.0 9.0 2,160.4$ 2,160.4 713.0 428.0 0.1563 67.0
1.32 12/31/21 120.0 10.0 2,852.5$ 2,852.5 941.0 565.0 0.1257 71.0
1.21 12/31/22 132.0 11.0 3,461.5$ 3,461.5 1,142.0 685.0 0.1010 69.0
1.13 12/31/23 144.0 12.0 3,925.8$ 3,925.8 1,296.0 778.0 0.0812 63.0
1.12 12/31/24 156.0 13.0 4,390.1$ 4,390.1 1,449.0 869.0 0.0653 57.0
1.11 12/31/25 168.0 14.0 4,861.5$ 4,861.5 1,604.0 962.0 0.0525 51.0
1.10 12/31/26 180.0 15.0 5,333.0$ 5,333.0 1,760.0 1,056.0 0.0422 45.0
1.64 12/31/27 192.0 16.0 5,690.1$ 5,690.1 1,878.0 1,127.0 0.0339 38.0
1.03 12/31/28 204.0 17.0 5,847.2$ 5,847.2 1,930.0 1,158.0 0.0273 32.0
1.02 12/31/29 216.0 18.0 5,947.2$ 5,947.2 1,963.0 1,178.0 0.0219 26.0
1.00 12/31/30 228.0 19.0 5,947.2$ 5,947.2 1,963.0 1,178.0 0.0176 21.0
0.28 12/31/31 240.0 20.0 1,486.8$ 1,486.8 491.0 295.0 0.0142 4.0
Sum of Present Values 708
Tax Amortization Benefit Factor 0.1174
Indicated Fair Value 802$
Rounded: 800$
Intangible Asset Premium
Cumulative

 Patent valuation procedure -
 Assumed revenue stream is 100% attributable to acquired patent-related
products
 The projected sales were adjusted down annually by the percentage of
patents expiring in a given year
 The modified revenue streams were multiplied by the percentage royalties to
calculate the pre-tax royalty savings
 These values are adjusted by the reciprocal of the tax rate and further by the
present value factor to arrive at the annual royalty savings
 The sum of annual savings, with application of the tax amortization benefit
factor calculation, provided a value for the patents

 Summary of Fair Market Value Conclusions
 XYZ Company Patents & Applications for Composition of Matter .................. $800 Million
 Patent/App Number File Date
 US Application 1111 (Aug XX, 20XX)
 US Application 1112 (July XX, 20XX)
 US Patent 8,113,XXX (Dec XX, 20XX)
 XYZ Company Patents for Manufacturing Methods & Formulation ................ $300 Million
 US Patent 8,115,XXX (Aug XX, 20XX)
 US Patent 8,116,XXX (June XX, 20XX)
 API & XYZ Company Inventory ..................................................................... $5.0 Million
 Intangible Business Value ............................................................................. $1,400 Million
 Total Value.................................................................................................... $2,500 Million

Conclusion
 Business Valuation is the process of determining the value of a business
enterprise or ownership interest therein (definition)
 There are 3 approaches possible –
 Income approach – value = cash flow/risk (discounted cash flow
method)
 Asset Approach – book value (w/ adjustments) of company assets
 Market Approach – value based upon comparable private and/or
public companies
 Intellectual property is an intangible asset that can be valued and
contribute to the overall enterprise value of a company
 Discount rates are a measure of the risk of a company = cost of capital =
what an investor would expect to earn from an investment in the company

Questions?
EAC VALUATIONS LLC
1450 E BOOT RD, 500-B
WEST CHESTER, PA 19380
DABERCROMBIE@EACVALUATIONS.COM
610-687-5855 X104

About EAC Valuations LLC
EAC Valuations has provided in-depth and trusted appraisals
and valuation reports since 1971. Located 20 miles northwest
of Philadelphia, near Valley Forge, our assignments have
taken us around the world, and next-door. We have
completed more than 10,000 appraisals for clients ranging
from multi-national, multi-billion dollar Fortune 100 companies
and financial institutions, to privately held local manufacturing
and services companies.
Our highly qualified, certified and experienced appraisers can
exceed expectations for a wide range of appraisal needs
meeting IRS, FASB, IFRS, USPAP, and FIRREA requirements,
encompassing appraisals of industrial and commercial real
estate, machinery & equipment, intangible assets, and
complete business enterprise valuations.
Contact Info:
David Abercrombie, BCA
EAC Valuations LLC
1450 E Boot Road, Suite 500-B
West Chester, PA 19380
610-687-5855 x104
dabercrombie@eacvaluations.
com
www.eacvaluations.com

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