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Brian Buss: Valuing IP Using an Apportionment Model BVR October 2015


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Valuing Intellectual Property Using an Apportionment Model - Brian Buss, Nevium IP Solutions

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Brian Buss: Valuing IP Using an Apportionment Model BVR October 2015

  1. 1. Valuing IP Using an Apportionment Model Brian Buss Nevium Intellectual Property Solutions Business Valuation Resources October 20, 2015 Today’s CE Codes: 1293, 4057, 7728
  2. 2. 2 © 2015 Business Valuation Resources, LLC Introduction / Contents To be discussed Why apportionment should be in the valuation professional’s “Tool-kit” when evaluating intellectual properties (IP) and intangible assets (IA) Review of the model we use to analyze, evaluate and value IP and IA in strategic valuation assignments Benefits and limitations of adding this model to your analysis tool kit
  3. 3. 3 © 2015 Business Valuation Resources, LLC IP Valuation IP Valuation & Analysis - common contexts  Contribution of an asset to the economic benefits achieved by a business involved in a dispute  Valuation of assets that would be transferred to, or used by, another business entity  Strategic understanding of the IP, IA, Assets and Resources being used by a business This presentation focuses on contribution of IP to the IP’s current user Definitions Intellectual Property (“IP”) Legally protected non-tangible properties: Patents, Trademarks, Copyrights Intangibles (“IA”) Non-physical assets owned by a business: relationships, trade secrets, processes & procedures, etc. Assets Tangible assets, IP and IA Resources The Assets and other capabilities or qualities that could contribute to a business Apportionment Process quantifying the portion of economic benefits derived from use of an Asset or Resource Allocation Process of assigning expenses incurred by the entire organization to a specific product or service
  4. 4. 4 © 2015 Business Valuation Resources, LLC IP Valuation Income Approach: Value of any asset or resource is based on the present value of future economic benefits that can be generated from ownership of that asset. Valuation Approaches & Apportionment Need to identify and quantify the specific contribution to Economic Benefits made by the IP or IA. The model shown in this presentation is an income approach, however . . . In both Cost and Market, need to focus on the Asset or Resource relative to other assets and resources used by the business. Cost Approach: Value is based on cost and effort to replace / replicate an Asset or Resource Valuation Context If asset isn’t providing a benefit, then there’s no value in its current context Market Approach: Value based on similar transactions
  5. 5. 5 © 2015 Business Valuation Resources, LLC IP Valuation & Apportionment Apportionment in Valuation Literature In determining the value that a patented technology contributes to end products, the analyst must apportion out value associated with contributions made by tangible assets as well as other intangibles. Some of the intangibles that would need to be apportioned out of the analysis include know-how, trade secrets, trademarks, and reputation. The Four Elements Used in Determining a Patent’s Value; June 30, 2011; NACVA 363 Search Results in BVLibrary Search for “Apportionment” 10/1/15 Guide to Intellectual Property Valuation BV Resources (p322, Chapter 11) The contributions that the licensor and licensee bring to the licensing transaction should have a material impact on the magnitude of any royalty rate determination. The licensor naturally owns the IP rights; however, the licensee brings value to the table, usually through execution prowess (e.g., manufacturing capability or expertise), sales and distribution channels, or working capital. Each of these components has value and is an important determinant in ultimate market success. If one party contributes more to the overall success, then that party should reap more of the rewards. Thus, the valuation analyst must identify what both the licensor and licensee bring to the transaction in order to apportion the contributions in an equitable manner. When prospective financial information is used to determine the fair value of a subject intangible asset it might include contributions from a number of different assets working together as a group. To arrive at the excess earnings solely attributable to the subject intangible asset, the valuation specialist needs to identify other assets that are contributing to the generation of the asset group’s earnings. Best Practices for Valuations in Financial Reporting: Intangible Asset Working Group – Contributory Assets The Appraisal Foundation, May 31, 2010
  6. 6. 6 © 2015 Business Valuation Resources, LLC Example from a Recent Analysis IP Valuation & Apportionment IP typically requires additional resources in order to generate profits. A patent owner requires physical assets such as machinery and manufacturing facilities, human capital, and other intangible assets in order to manufacture, distribute market and sell products that incorporate the patented innovation. A copyright protects the expression of an idea but not the actual product or process that is provided to customers. In other words, a copyright-protected marketing brochure is rarely the final product sold to customers, and therefore does not contribute 100% of the profits achieved from the sale of products featured in the brochure. Therefore a calculation based on 100% of the achieved profits would overestimate the contribution of IP to the product or service provided by the allegedly infringing user of the IP.
  7. 7. 7 © 2015 Business Valuation Resources, LLC Apportionment in Statute and Precedent In the Georgia-Pacific case, the district court identified a list of factors that may be relevant to determining a reasonable royalty for patent infringement damages, including factor 13, which provides that courts should consider “[t]he portion of the realizable profit that should be credited to the invention as distinguished from non-patented elements, the manufacturing process, business risks, or significant features or improvements added by the infringer” when apportioning damages. (Comment on the Georgia-Pacific case from: Geradin & Layne- Farrar, Patent Value Apportionment Rules for Complex, Multi-Patent Products; February 2011) IP Valuation & Apportionment There are many more similar comments . . . Apportionment must be considered – the challenge is how to do the calculations TILEC Discussion Paper Discussion of Georgia Pacific Factors Unless you find that a portion of the profit from the [use] [sale] of a [product] [work] containing or using the copyrighted work is attributable to factors other than use of the copyrighted work, all of the profit is to be attributed to the infringement. The defendant has the burden of proving the [portion] [percentage] of the profit, if any, attributable to factors other than [copying] [infringing] the copyrighted work. In establishing the infringer’s profits, the copyright owner is required to present proof only of the infringer’s gross revenue, and the infringer is required to prove his or her deductible expenses and the elements of profit attributable to factors other than the copyrighted work. 17 U.S.C. § 504(b)
  8. 8. 8 © 2015 Business Valuation Resources, LLC IP Valuation Business Value > Value of IP Assets owned by the Business Apportionment: Identify the portion of future benefits derived from use of the IP Assets Present Value of Expected Future Benefits Value of Business Intangible Assets Tangible Assets Copyrights Patents Intangible Assets Tangible Assets Trademark IP depends on other assets and resources in order to generate economic benefits
  9. 9. 9 © 2015 Business Valuation Resources, LLC IP Valuation The Model Described in this Presentation was built to isolate each product offered by the Business, and Assign Apportionment Rates based on the Product’s dependence on the Business’ Assets and Resources Same concept, different image Products generate profit through use of a Company’s IP and other Resources The Intellectual Property& Products Profits People Resources Tangible Assets / Natural Resources = Capital Resources Other IP & IA
  10. 10. 10 © 2015 Business Valuation Resources, LLC Questions? Review Looking for an analytical tool to help our strategic clients better understand the contribution of their IP to their own business Encountering the term “Apportionment” more and more How we use the term “Apportionment”: Identify the portion of future benefits derived from use of the IP Assets Key construct: IP depends on other assets and resources in order to generate economic benefits Today’s CE Codes: 1293, 4057, 7728
  11. 11. 11 © 2015 Business Valuation Resources, LLC The IP Valuation Model The Model is a procedure for . . . Identifying all assets used to generate economic benefit at a business Considers the value of all Assets & Resources used by the business Considers the different level of performance achieved by the Company’s different products Identifies and apportions benefits provided by the Assets & Resources, including benefits provided by IP Assets Values IP in the context of its use by the business
  12. 12. 12 © 2015 Business Valuation Resources, LLC IP Valuation Model & Process 1 Value total operations of the Business Perform a business valuation Forecast future economic benefits, discount to present value Value of the Business = value of 100% of assets and resources used by the Business 2 Forecast each source of revenue Most businesses are a portfolio of revenue and benefit-generating products and services Group and bundle similar revenue sources 3 Identify Key Assets and Resources What assets and resources are used by the Business? Identify and group: Tangibles, IP, IA and other Resources 4 Develop Apportionment Rates Which assets or resources are most important / least important to each revenue source Which products/services rely on each identified asset 5 Value the Forecast Apportion Rates Total the forecast period rents calculated for each Asset or Resource Discount each Assets’ total rents to a present value 6 Check results Apply the concept of equal values: Total value of Business = Total Value of all Revenue Sources = Total Value of Rents for all Assets and Resources
  13. 13. 13 © 2015 Business Valuation Resources, LLC IP Valuation Apportionment Model Business Valuation • Known valuation; or • DCF DCF would be based on “Build-up” product level forecasts Product Forecasts • Sales • Earnings • Invested Capital Cash Flows For each source of revenue at the Company Apportionment Rates • Analysis of how each Product depends on the Assets and Resources • Valuation is the Present Value of Apportionment Charges Concept of Equal Values Value of Business = Value of Products = Value of all Assets & Resources Also, weighted average rates of return are equal Assumptions Book Revenue growth (Product / Company) Earnings Margins Working Capital and Capital Expenditure Equal Value Dashboard Apportionment Rates: Each Product’s dependence on Assets and Resources Required Rates of Return: for each Product, and each Asset and Resource Model Framework One Model to Value the Business, Value each Product, and Value all Assets & Resources (including IP)
  14. 14. 14 © 2015 Business Valuation Resources, LLC Steps 1 & 2 Value of the Business Business Valuation Known valuation, or based on a DCF • Assumes a going concern • Forecast through the known business cycle / evolution to next generation of products • Include a perpetual value • Build-up forecast based on revenue and earnings forecast for each product Building the Model Build an assumptions book - 1 worksheet to drive forecast inputs, including: • Price • Unit Volume • COGS & margins • Operating Expenses & margins • Capital Expenditures • Working Capital ratios Reconcile the Business Valuation • Market and Cost Approaches • Comparable company performance ratios • Comparable company trading and acquisition multiples • Reasonableness tests Products don’t last forever, assume business will continue
  15. 15. 15 © 2015 Business Valuation Resources, LLC Steps 1 & 2 Identify and Forecast Each Source of Revenue Product Forecasts Most businesses generate revenue from a portfolio of products & services • Products • Services • Contracts / Licenses • Non-core activities Building the Model Different product types have different gross profit margins and different contributions to overall profitability Identifying & Grouping Revenue Sources • Financial reports • Discussions with Management • Promotional and marketing materials Often can group similar products: • Similar margins • Similar function / target market • Rely on the same assets & resources If possible, work with Management to develop . . . • List and grouping of products / services / revenue sources • Forecast for existing, in-development and future products • Isolating expenses (non-capitalized) related to IP and IA development, registration and maintenance • Length of product life cycle and use of perpetual values • Treatment of non-core activities Consider the typical product life cycle
  16. 16. 16 © 2015 Business Valuation Resources, LLC Steps 1 & 2 Sample: Business Valuation and Revenue Forecast Worksheets Business Valuation Y0 Y1 Y2 Y3 Y4 Y5 Perpetual Total Net Revenue 1,000.0 1,112.5 1,205.3 1,289.9 1,331.2 1,375.1 Gross Profit 795.5 904.0 967.4 931.9 962.6 Operating Expenses 508.9 555.4 602.3 626.6 652.2 IP & IA Expenses 20.0 20.4 20.8 21.2 21.6 22.1 Operating Income 266.2 327.8 343.9 283.6 288.2 Tax Expense 106.5 131.1 137.6 113.4 115.3 Net Income 159.7 196.7 206.4 170.2 172.9 Cash FlowAdjustments WC Balance 95.0 111.3 120.5 129.0 133.1 137.5 Change in WC (16.3) (9.3) (8.5) (4.1) (4.4) Capital Expenditure (55.6) (60.3) (64.5) (66.6) (68.8) Invested Capital Cash Flow 87.9 127.1 133.4 99.5 99.8 856.6 Discount Period 0.5 1.5 2.5 3.5 4.5 5.0 Discount Factor 15% 0.93 0.81 0.71 0.61 0.53 0.50 Discounted Forecast CF 81.9 103.1 94.1 61.0 53.2 425.9 Valuation 819.2 Product A Y0 Y1 Y2 Y3 Y4 Y5 Net Revenue 600.0 690.0 759.0 834.9 876.6 920.5 Gross Profit 552.0 569.3 626.2 613.7 644.3 Operating Expense 414.0 455.4 500.9 526.0 552.3 IP & IA Expenses 10.2 10.4 10.6 10.8 11.0 Operating Income 127.8 103.4 114.6 76.8 81.0 Tax Expense 51.1 41.4 45.8 30.7 32.4 Contribution to Operating Income 76.7 62.1 68.8 46.1 48.6 Working Capital Balance 42.8 50.1 54.2 58.0 59.9 61.9 Change in Working Capital (7.3) (4.2) (3.8) (1.9) (2.0) CapEx (38.9) (42.2) (45.1) (46.6) (48.1) Add: After-tax IP Expenses 6.1 6.2 6.4 6.5 6.6 Product Cash Flow 36.6 21.9 26.2 4.1 5.1
  17. 17. 17 © 2015 Business Valuation Resources, LLC Step 3 Identify Key Assets and Resources Building the Model Identifying & Grouping Key Assets & Resources • Discussions with Management • Company’s promotional and marketing materials • Comparison to peers: Competitive advantages; Points of differentiation; Margins & performance ratios Identify & Group Assets & Resources Technology: patents, trade secrets, designs, processes Marketing: TMs, logos, brands, signage, slogans, reputation, websites & domain names Physical: location, real estate, buildings, equipment, logistics Content: databases, customer lists, copyrights, manuals, publications, test results Relationship: suppliers, customers, distributors, work-force Working Capital: A/R, inventory, A/P Identifying & Grouping Key Assets & Resources • Company language analysis: Reliance on Service, Volume, Location • Customer surveys • Website traffic data
  18. 18. 18 © 2015 Business Valuation Resources, LLC Step 4 Develop & Apply Apportionment Rates Apportion the Forecast Cash Flow Calculated for Each Product • 100% of the Earnings / Cash Flow / Economic Benefits to one of the identified Assets & Resources • Apportionment Rate is the amount of Product earnings derived specifically from each Asset or Resource • Apply a consistent, qualitative analysis • Relies on analyst’s judgement and opinion – requiring clear communication of the support and rationale Building the Model Developing Apportionment Rates • Assess relative importance to each Product to estimate an apportionment rate • Use the Equal Value Dashboard to organize rates for each Asset type and Product Apportionment Math Each Revenue Source Relies the Organization’s Assets and Resources in a Unique Way Build a logic/rationale worksheet that . . . • Describes each Asset & Resource group • Lists observations about Asset’s use and importance to each Product • Cite source documents and reference materials
  19. 19. 19 © 2015 Business Valuation Resources, LLC Step 4 Sample: Apportionment Rate Support Worksheet Description, Observations & Opinions Description of Identified Asset Observations Source Doc 2d AdWords - Schedule XX Schedule __ and Schedule __ USPTO (Doc 6a) Apportionment Factors Revenue/Earnings Source Apportionment Observations Source Rate K&T MARCOM 15% CRO Cabinets 15% Cabinets (Home) Complementary products. Use other brand elements in addition to Subject Marks MARCOM 10% Anesthesia Cabinet Complementary products. Use other brand elements in addition to Subject Marks MARCOM 10% ADC Implants Dental Cabinet follow-on products. Use other brand elements Management 5% ADC Implants Hospital Cabinet follow-on products. Use other brand elements Management 5% Data Mining No relation: different branding and service-oriented marketing Management 0% Relative Risk Observation Implication Lower Lower Lower Required Rate of Return 17.5% Company's core products. Subject Marks are the brand name used with these products TM assets typically have similar or lower required rates of return compared to the corporation's WACC TM assets have the longest legal lives of IP assets No legal issues or disputes related to the names and marks The term and name related to the firm's line of ____________ products. These are the Company's core products. Design and word mark are registered at the USPTO Named used to identify ______ designed and manufactured by COMPANY 90 average monthly Google searches in the USA (higher than other brand assets at the Company) Loosly similar marks exist such as "_______Systems" Margin achieved by products using the Subject Marks > other products. Margins on Complementary products are higher
  20. 20. 20 © 2015 Business Valuation Resources, LLC Step 5 Value the Forecast Apportionment Rates To calculate a value for each Asset / Resource . . . • Sum the calculated Apportionment Charges • Deduct asset-specific expenses • Discount calculated Benefits to present value using the required rate of return for each asset Equal Valuations Require Equal Weighted Average Returns
  21. 21. 21 © 2015 Business Valuation Resources, LLC Steps 4 & 5 Sample: Apportionment Charges & Product Valuation Product B Y0 Y1 Y2 Y3 Y4 Y5 Perpetual Product Cash Flow 34.4 89.0 89.0 79.0 76.9 Apportionment Charges Working Capital 2% 0.7 1.7 1.7 1.6 1.5 PP&E 5% 1.7 4.5 4.4 3.9 3.8 Company Marks 12% 4.1 10.7 10.7 9.5 9.2 Patented Technologies 10% 3.4 8.9 8.9 7.9 7.7 Marketing Content 25% 8.6 22.3 22.2 19.7 19.2 Trade Secrets 5% 1.7 4.5 4.4 3.9 3.8 Relations with Customers 15% 5.2 13.4 13.3 11.8 11.5 Relations with Suppliers 10% 3.4 8.9 8.9 7.9 7.7 Workforce 16% 5.5 14.3 14.3 12.7 12.3 Total Charges 34.4 89.0 89.0 79.0 76.9 Less: After-tax IP/IA Expense 3.7 3.7 3.8 3.9 4.0 Cash Flow After IP Costs 30.7 85.3 85.1 75.1 72.9 683.0 0.5 1.5 2.5 3.5 4.5 5.0 Present Value Factor 14% 0.94 0.82 0.72 0.63 0.55 0.52 Discounted Future Value 28.8 70.1 61.4 47.5 40.4 354.7 Valuation 602.8
  22. 22. 22 © 2015 Business Valuation Resources, LLC Steps 4 & 5 Sample: Sample Asset / Resource Valuation Calculations Company Marks Y1 Y2 Y3 Y4 Y5 Perpetual Apportionment Charges from: Product A 2.9 1.8 2.1 0.3 0.4 Product B 4.1 10.7 10.7 9.5 9.2 Service C 8.8 8.6 9.3 8.8 9.3 Total Charges to Asset 15.8 21.0 22.1 18.6 18.9 Directly Related Expenses After-Tax 4.3 4.4 4.5 4.5 4.6 Economic Benefit 11.5 16.7 17.6 14.1 14.3 163.7 0.5 1.5 2.5 3.5 4.5 5.0 Present Value Factor 12% 0.9 0.8 0.8 0.7 0.6 0.6 Discounted Benefit 10.9 14.1 13.3 9.5 8.6 92.9 Valuation 149.1 Patented Technologies Y1 Y2 Y3 Y4 Y5 Perpetual Apportionment Charges from: Product A 9.1 5.5 6.5 1.0 1.3 Product B 3.4 8.9 8.9 7.9 7.7 Service C 8.8 8.6 9.3 8.8 9.3 Total Charges to Asset 21.3 23.0 24.7 17.7 18.3 Directly Related Expenses After-Tax 3.7 3.7 3.8 3.9 4.0 Economic Benefit 17.7 19.2 20.9 13.8 14.3 133.9 0.5 1.5 2.5 3.5 4.5 5.0 Present Value Factor 14% 0.9 0.8 0.7 0.6 0.6 0.5 Discounted Benefit 16.5 15.8 15.1 8.7 7.9 69.5 Valuation 133.6
  23. 23. 23 © 2015 Business Valuation Resources, LLC Step 6 Check Results Apply Concept of Equal Values • Value of Business = Value of All Revenue Sources = Value of All Assets & Resources • WACC = WARA = WARP (returns for Product valuations) • “Unidentified” is the value of the Business less sum of valuations of all identified assets & resources Check for 100% Allocations • Each revenue source must have 100% apportionment across assets • All expenses & charges must be allocated 100% across products Reasonableness Checks • Fit with Company Language Analysis and Key Competitive Advantages • Rationale for each required rate of return input • Would / Could an outside party purchase at the calculated price? • Specific Asset Valuation Approaches: • RfR • Workforce • Customer Relationships • Excess Earnings Value of Business Operations Value of Products Value of Assets & Resources Intangibles Tangibles Intellectual Properties = ==
  24. 24. 24 © 2015 Business Valuation Resources, LLC Step 6 Sample: Equal Value Dashboard Value of Business Value of Assets & Resources Value of Revenue Sources Asset / Resource Rate of Return Valuation Value Contribution Rate of Return Valuation Value Contribution Working Capital 5% 100 12% Product A 20% 46.7 6% PP&E 8% 105 13% Product B 14% 602.8 74% Company Marks 12% 149 18% Service C 19% 169.0 21% Patented Technologies 14% 134 16% Marketing Content 17% 74 9% Trade Secrets 20% 11 1% Relations with Customers 21% 100 12% Relations with Suppliers 20% 49 6% Workforce 23% 52 6% Unidentified / Synergies 29% 45 6% WACC 15% Weighted Return 15% Weighted Return 15% Business Value 819 Total Value 819 Total Value 819 Apportionment Rates IP Expense Allocation Asset / Resource Product A Product B Service C Asset / Resource IP Expense Working Capital 2% 2% 2% PP&E 5% 5% 5% Company Marks 8% 12% 30% Company Marks 35% Patented Technologies 25% 10% 30% Patented Technologies 30% Marketing Content 20% 25% 2% Marketing Content 10% Trade Secrets 10% 5% 2% Trade Secrets 25% Relations with Customers 10% 15% 20% Relations with Suppliers 5% 10% 2% Workforce 15% 16% 7% 100% 100% 100% 100%
  25. 25. 25 © 2015 Business Valuation Resources, LLC Using the Model Limitations • Multiple DCF calculations introduce many opportunities for mechanical error • Analyst must develop and support rationale for the Apportionment Rates • More difficult to employ without access to company’s Management Advantages • Yields an in depth analysis of Company’s operations • Identifies out-performing and under-performing product lines • Often identifies under utilized assets and resources • Valuations based on current use of the IP (rather than a transaction where the use may be somewhat similar)
  26. 26. 26 © 2015 Business Valuation Resources, LLC Review The model we’ve presented is best suited for use with strategic clients when addressing issues of business valuation, contribution of products and the Company’s IP assets The process of forecasting product performance and then apportioning the economic benefit yielded by each product to Assets and Resources helps managers and owners identify strengths, weaknesses and opportunities. The Model requires a qualitative assessment of the contribution of IP to each product group – this step relies on sound judgement and review of the available information The Model has helped our clients better understand their businesses, but has its limits and may not be appropriate in all valuation contexts. Questions?
  27. 27. 27 © 2015 Business Valuation Resources, LLC Nevium Intellectual Property Solutions Nevium provides solutions for managing and maximizing the value of intellectual properties and intangible assets. We work with entrepreneurs, corporations, legal counsel, for-profit and not-for-profit IP owners to value and maximize the value of trademarks, copyrights, patents, brands, domain names, endorsements, and other intangible assets. Nevium’s principals have worked with a diverse range of large and small organizations to build, identify and monetize their intellectual property assets. From brand licensing and endorsement programs, to infringement and mis-use disputes, to valuation and transaction negotiation; we enable organizations to achieve additional benefits from their proprietary assets. The Firm’s experience includes: • Valuation of businesses, brands, trademarks, copyrights, celebrity rights, patents, new technologies, endorsements, and other intangible and marketing assets • Valuation of IP and intangible assets for strategic decisions, transfer pricing, tax planning, litigation support, bankruptcy, due diligence, and acquisition advisory • Economic damages calculations and expert testimony in IP-related litigation and infringement disputes • Developing and executing IP licensing and management strategies • Revenue model and pricing strategies for IP-based businesses • Managing business and IP asset transactions for buyers, sellers, licensors and licensees Today’s CE Codes: 1293, 4057, 7728