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Intellectual Property Valuation & Damages Analysis   Boris J. Steffen, CPA, ASA, ABV, CDBV   Principal & DirectorPage 1
Overview  »      Intellectual property characteristics  »      Reasons to value intellectual property  »      Valuation co...
Intellectual Property CharacteristicsPage 3
Intellectual property is a unique class of intangible asset different from      other intangibles in how it is created, de...
The value of intellectual property is a function of the property rights and      economic benefits associated with its exi...
Intellectual properties can be grouped by category and type based on         similarities in development, use, features an...
Reasons to Value Intellectual PropertyPage 7
The demand for intellectual property valuation is driven by a variety of         legal, financial, regulatory and commerci...
Under ASC 350, acquired intellectual property must be recognized based    on fair value separately from goodwill and amort...
Valuation ConsiderationsPage 10
The value of intellectual property will vary based on the standard of value    applied» Fair market—the value at which a b...
The value of intellectual property will vary based on the assumptionsunderlying the premise of value employed  Valuation  ...
Intellectual property incorporates legal rights that are distinct, separable, transferable, and of varying economic value ...
As the value of intellectual property changes over time, valuations should  be qualified “as of”, and relied on only for, ...
The value of intellectual property is in part a function of the time periodover which it is expected to contribute to futu...
The risk inherent to an intellectual property is measured by the cost of    capital used to discount economic income gener...
Methods of Valuing Intellectual PropertyPage 17
The Uniform Standards of Professional Appraisal Practice recognizesthree basic approaches to valuation                    ...
Theory of Patent DamagesPage 19
The owner of a patent may recover damages equal to lost profits    attributable to infringement, but never less than a rea...
Analysis of Intellectual Property DamagesPage 21
Intellectual property damages can be valued by the “before and after,”    “but-for,” and “actual/opportunity cost” techniq...
Comparison of intellectual property damages method calculations       Before and after               But-for          Actu...
Valuation Case StudyPage 24
Acquisition of technology use rights»   Situation    ›   A large international conglomerate acquired rights, formerly lice...
Acquisition of technology use rights    (cont)»   Valuation    ›   Relief from royalty—qualifies as both income and market...
Relief from royalty valuation                                                                     In-The-M oney C orporati...
Avoidable cost valuation                                                                                I n -T h e -M o n ...
Reproduction cost valuation                                           IP Technology                                Current...
Expert profilePage 30
Boris J. Steffen, CPA, ASA, ABV, CDBV      (202) 538 – 5037      boris.steffen@naviganteconomics.com  »       Boris Steffe...
Intellectual Property Valuation & Damages Analysis   Boris J. Steffen, CPA, ASA, ABV, CDBV   Principal & DirectorPage 32
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IP Valuation And Damages

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IP Valuation And Damages

  1. 1. Intellectual Property Valuation & Damages Analysis Boris J. Steffen, CPA, ASA, ABV, CDBV Principal & DirectorPage 1
  2. 2. Overview » Intellectual property characteristics » Reasons to value intellectual property » Valuation considerations » Methods of valuing intellectual property » Theory of patent damages » Analysis of intellectual property damages » Valuation case study » Expert profilePage 2
  3. 3. Intellectual Property CharacteristicsPage 3
  4. 4. Intellectual property is a unique class of intangible asset different from other intangibles in how it is created, developed and protected » Intangible assets are economic resources, often created in the normal course of business, that lack physical presence, but have value due to the rights, benefits, and privileges they convey to their owner › Brand names › Customer lists › Non-compete agreements » Intellectual properties comprise a subset of intangible assets that are created consciously through the intellectual effort of specifically identifiable individuals, and are registered and legally protected by federal and state statute › Patents › Copyrights › Trademarks › Trade secrets › Know-howPage 4
  5. 5. The value of intellectual property is a function of the property rights and economic benefits associated with its existence » Property rights associated with intellectual property include it being subject to › Private ownership and legal transfer › Specific identification and description › Legal existence and protection › Tangible manifestation › Coming into, and going out of, existence at a specific time or due to a specific event » Economic benefits associated with intellectual property ownership, and that are required to quantify value, include: › Incremental income › Decremental costs › Contributory value enhancement » Economic phenomena lacking these attributes may not qualify as discrete intellectual property or intangible assetsPage 5
  6. 6. Intellectual properties can be grouped by category and type based on similarities in development, use, features and legal protection Marketing Technology Artistic Data processing Engineering works Creative • Trademarks • Literary • Computer software • Trade names • Musical • Integrated circuit • Service • Dramatic masks and Marks masters • Artistic • Logos • Proprietary • Film databases Innovative • Product patents • Trade secrets • Process patents • Designs • Patent • Drawings applications • BlueprintsPage 6
  7. 7. Reasons to Value Intellectual PropertyPage 7
  8. 8. The demand for intellectual property valuation is driven by a variety of legal, financial, regulatory and commercial needs Category Reason Damages for infringement, breach of contract, Litigation business interruption, fraud, property settlements Enterprise purchase price allocation, IP purchase, Accounting, and financing collateral value, reorganization, licensing, transactions alliances, SFAS 141 and 142 Resource allocation, evaluation of returns, Corporate planning management strategy, development, protection, commercialization, monetization Transfer pricing, transfer of IP to investment Taxes holding company, estate/gift tax, ad valorem property taxPage 8
  9. 9. Under ASC 350, acquired intellectual property must be recognized based on fair value separately from goodwill and amortized over its useful life» Recognizable intangibles are assets that lack physical presence, have a finite life, and › Have an underlying contractual or legal basis, or › Can be separately sold, transferred, licensed, rented, or exchanged» Recognizable intangibles with finite useful lives are accounted for based on fair value, amortized, and tested annually for impairment» Recognizable intangibles are amortized over their useful lives, no longer limited to 40 years, but subject to any residual value» Identifiable intangibles with indefinite lives (trademarks and brand names) are not amortized, but must be tested for impairment
  10. 10. Valuation ConsiderationsPage 10
  11. 11. The value of intellectual property will vary based on the standard of value applied» Fair market—the value at which a buyer and seller would transact, neither being compelled to do so and both having reasonable knowledge of relevant facts» Fair—the value to fairly compensate an owner for being involuntarily deprived of the economic benefits of an asset for which there is neither a willing buyer nor seller» Investment—the value to an individual investor based on investment expectations and requirements» Acquisition—the price a specific buyer would pay based on the unique benefits to that buyer» Use—the value of an asset given a specific, defined use» Owner—the value given the current owner’s field of use application and ability to develop the asset commercially» Insurable—the amount required to replace an asset with one of comparable utility, function, and income-generating ability» Collateral—the amount a creditor would loan with the asset serving as collateral» Ad valorem—the value of an asset for property tax purposes under jurisdictional statutory standards
  12. 12. The value of intellectual property will vary based on the assumptionsunderlying the premise of value employed Valuation Valuation Highest and Premise of purpose objective best use valueWhy performed •Deal pricing •Consistent with •Continued use and structure applicable laws as part of goingIntended use and regulations concern •FinancingAudience •Physically, •In place, but not •Tax planning functionally, in current use technologically •Strategic possible •In exchange in planning an orderly •Financially disposition •Reorganization viable •In exchange in a •Litigation •Results in the forced highest value liquidation
  13. 13. Intellectual property incorporates legal rights that are distinct, separable, transferable, and of varying economic value Interest Summary termsFee simple Total and absolute ownership of all legal rightsLife or estate Rights to ownership of IP for the life of the owner, or the rights to income from IP for the life of the tenantTerm Ownership rights to IP for a specified term or number of yearsLicense/franchise Rights retained by the licenser/franchiser, or granted to the licensee/franchisee, for specific term, use, market area, etc.Reversionary Rights to future ownership of IP owned by another partyDevelopment Rights to develop and commercialize subject IP for transferee benefitExploitation Rights to make use of subject IP (natural resources, mining, forest)Use Rights to derive some manner of benefit from the use of an IP (often related to specific areas, industries, products and/or services)
  14. 14. As the value of intellectual property changes over time, valuations should be qualified “as of”, and relied on only for, a specified date Historical Contemporaneous Prospective•Prior to date of •At date of valuation •At a date subsequent to valuation valuation •Requires disclosure• The appropriate valuation date is often tied to the intended use of the valuation Decision making Information• May be a function of statutory or regulatory ruling Date of asset transfer, merger, lien, reorganization• Should be agreed to by analyst and user, together with valuation purpose and objective
  15. 15. The value of intellectual property is in part a function of the time periodover which it is expected to contribute to future cash flows Expected Expected use useful life of related assets Maintenance The useful expenditures life of an asset Legal required to is a function limitations obtain future of cash flows Obsolescence, competition, demand, Regulation technology
  16. 16. The risk inherent to an intellectual property is measured by the cost of capital used to discount economic income generated by the asset» The cost of capital is the expected rate of return required to compensate for the time value of money (real rate of return plus inflation) and risk of an investment» Several options are available for estimation purposes › Buildup, CAPM, MCAPM, WACC, P/E, VC» In practice, the appropriate cost of capital depends on whether the IP will be valued as part of a going concern or on a standalone basis › Under going concern assumption, rate is a function of business enterprise ‒ Results in estimate of value in continued use as an integral component of going concern entity › With stand-alone basis, rate is tied to risks of specific asset ‒ Results in higher rate than going-concern assumption and value of IP as independent asset» Ultimately, the choice between capitalization scenarios will rest on the › Valuation objective › Highest and best use of the IP › Actual use of the IP
  17. 17. Methods of Valuing Intellectual PropertyPage 17
  18. 18. The Uniform Standards of Professional Appraisal Practice recognizesthree basic approaches to valuation IP valuation methodologies Income Market CostValue is equal to the Value is inferred from Value is equal topresent value of future comparable asset accumulated costseconomic benefits market transactions — Discounted cash flow — Comparable asset — Reproduction sales — Direct capitalization — Replacement — Relief from royalty — Relief from royalty — Profit split — Excess earnings — Loss of income
  19. 19. Theory of Patent DamagesPage 19
  20. 20. The owner of a patent may recover damages equal to lost profits attributable to infringement, but never less than a reasonable royalty» Lost, “but-for” profits damages are equal to the difference between expected and actual profits absent the infringement › Assumes infringer not licensed to use patent › Requires showing of causation per the reasonable probability standard of Panduit ‒ Existence of demand ‒ Absence of acceptable non-infringing substitutes ‒ Manufacturing and marketing capacity ‒ Supportable estimate of lost profits» Reasonable royalty damages are equal to the amount that would have been paid by the infringer in an arms-length transaction for the right to use the patent › Assumes infringer licensed to use patent › Sufficient to show infringing sales actually occurred › Reasonable royalty based on hypothetical licensing agreement approach and Georgia- Pacific factor analysis» Statute and case law permit damages of lost profits and reasonable royalties combined along with prejudgment interest; also trebling and attorney’s fees
  21. 21. Analysis of Intellectual Property DamagesPage 21
  22. 22. Intellectual property damages can be valued by the “before and after,” “but-for,” and “actual/opportunity cost” techniques» Under these methods, damages are assessed as the: › Decrease in IP or enterprise value, or › Value of the damaging event» Each method can be applied across a variety of situations › Fraud, infringement, lender liability, breach of contract, business interruption, etc.,» Further, damages under each method can be measured by changes in › Unit volume, price, revenue, market share › Costs of production, operations, and research and development › Capital investment and financing costs» Conceptually and in execution, each method is analogous to one of the three approaches to valuing intellectual property › Before and after » market approach › But-for » income approach › Actual/opportunity cost » cost approach
  23. 23. Comparison of intellectual property damages method calculations Before and after But-for Actual/opportunity cost Value of IP/Enterprise Value of past but-for Restated past cost of before start of damage income from start of developing IP period damage period Plus: Restated past Less: Plus: opportunity cost of not developing IP Value of IP/Enterprise Value of future but-for after end of damage income to end of Plus: period damage period Future opportunity cost Equals: Equals: of not commercializing IP IP/Enterprise value Value of lost profits diminution Equals: Value of damages
  24. 24. Valuation Case StudyPage 24
  25. 25. Acquisition of technology use rights» Situation › A large international conglomerate acquired rights, formerly licensed, to technology developed in Europe and Asia together with a joint-venture partner» Considerations › Purpose and objective—to value acquired assets for financial and tax reporting purposes › Premise and standard of value—fair market value in continued use and as part of a going concern › Highest and best use—continued use as part of going concern yielded highest valuation › Rights subject to appraisal—ownership and use rights to background and foreground technology used in developing and manufacturing products › Useful life—equal to amortization period › Cost of capital—WACC based on premise and contributory nature of IP › Valuation date—beginning of calendar year to conform with fiscal period
  26. 26. Acquisition of technology use rights (cont)» Valuation › Relief from royalty—qualifies as both income and market approach ‒ Historical royalty rates for licenses for the subject IP ◦ Comparability established ◦ Clear “but-for” standard ‒ Arms-length royalty rates from licenses of comparable IPR ◦ Based on analysis of ownership rights, financing, industry, geographic market, transaction duration, terms, and secondary market conditions › Reproduction cost ‒ Current costs of research, development, and design services required to exactly duplicate IP › Avoided cost ‒ Research, development, and design services costs not incurred due to the benefits of ownership
  27. 27. Relief from royalty valuation In-The-M oney C orporation IP T echnology (1) R elief from R oyalty M ethod (U .S.$000s) A s of January 1, 2003 2003 2004 2005 2006 2010 (2)R evenues $ 811,720 $ 893,250 $ 888,000 $ 1,036,800 $ 1,130,220G row th From Prior Y ear 16.8% 10.0% -0.6% 16.8% 0.0%R oyalty R ate (3) 4.0% 4.0% 4.0% 4.0% 4.0%G ross R oyalty Savings 32,469 35,730 35,520 41,472 45,209 L ess:A m ortization 7,398 7,398 7,398 7,398 7,398M aintenance expense 16,300 16,300 16,300 16,300 16,300 N et R oyalty Savings 8,771 12,032 11,822 17,774 21,511T axes (3,184) (4,368) (4,291) (6,452) (7,808)A fter-T ax R oyalty Saving s 5,587 7,664 7,531 11,322 13,702 Plus:A m ortization 7,398 7,398 7,398 7,398 7,398A fter-T ax C ash Flow 12,985 15,062 14,929 18,720 21,100 T im e Factor 0.5 1.5 2.5 3.5 7.5Present Value F actor 0.9678 0.9064 0.8489 0.7951 0.6118Present Value of R oyalty Savings $ 12,567 $ 13,653 $ 12,673 $ 14,884 $ 12,910C um ulative Present Value of R oyalty Savings @ 1/01/03 $ 110,970V alue (R ounded) $ 111,000 Sensitivity analysis based on varying gross royalty rates:A ssum ptions: R oyalty R ate V alue 2.00% $ 18,000W eighted Average C ost of C apital 6.77% 3.00% $ 64,000R oyalty R ate 4.00% 4.00% $ 111,000T ax R ate 36.30% 5.00% $ 158,000Y ears am ortized 15 6.00% $ 204,000
  28. 28. Avoidable cost valuation I n -T h e -M o n e y C o rp o ra tio n I P T e c h n o lo g y A v o id e d P u rc h a s in g C o s t V a lu a tio n (U .S . $ 0 0 0 s ) A s o f J a n u a ry 1 , 2 0 0 3 2003 2004 2005 2006 2010E n g in e U n its 1 4 0 ,0 0 0 1 5 0 ,0 0 0 1 5 0 ,0 0 0 1 8 0 ,0 0 0 1 8 0 ,0 0 0P r ic e R e d u c tio n fo r I P R T r a n s a c tio n $ 79 $ 79 $ 79 $ 79 $ 79P r ic e R e d u c tio n fo r O n g o in g E n g in e e r in g 1 1 6 .4 3 1 0 8 .6 7 1 0 8 .6 7 9 0 .5 6 9 0 .5 6 B e n e fit F r o m P r ic e R e d u c tio n 2 7 ,3 2 5 .0 0 2 8 ,1 1 2 .5 0 2 8 ,1 1 2 .5 0 3 0 ,4 7 5 .0 0 3 0 ,4 7 5 .0 0 O n g o in g E n g in e e r in g E x p e n s e (1 6 ,3 0 0 .0 0 ) (1 6 ,3 0 0 .0 0 ) (1 6 ,3 0 0 .0 0 ) (1 6 ,3 0 0 .0 0 ) (1 6 ,3 0 0 .0 0 )T o ta l o f A v o id e d C o s t 1 1 ,0 2 5 .0 0 1 1 ,8 1 2 .5 0 1 1 ,8 1 2 .5 0 1 4 ,1 7 5 .0 0 1 4 ,1 7 5 .0 0 L ess:A m o r tiz a tio n 4 ,0 6 6 .6 7 4 ,0 6 6 .6 7 4 ,0 6 6 .6 7 4 ,0 6 6 .6 7 4 ,0 6 6 .6 7N e t A v o id e d C o s t 6 ,9 5 8 .3 3 7 ,7 4 5 .8 3 7 ,7 4 5 .8 3 1 0 ,1 0 8 .3 3 1 0 ,1 0 8 .3 3T axes (2 ,5 2 5 .8 8 ) (2 ,8 1 1 .7 4 ) (2 ,8 1 1 .7 4 ) (3 ,6 6 9 .3 3 ) (3 ,6 6 9 .3 3 )A fte r -T a x C o s t S a v in g s 4 ,4 3 2 .4 6 4 ,9 3 4 .1 0 4 ,9 3 4 .1 0 6 ,4 3 9 .0 1 6 ,4 3 9 .0 1 P lu s :A m o r tiz a tio n 4 ,0 6 6 .6 7 4 ,0 6 6 .6 7 4 ,0 6 6 .6 7 4 ,0 6 6 .6 7 4 ,0 6 6 .6 7A fte r -T a x C a s h F lo w $ 8 ,4 9 9 $ 9 ,0 0 1 $ 9 ,0 0 1 $ 1 0 ,5 0 6 $ 1 0 ,5 0 6T im e F a c to r 0 .5 1 .5 2 .5 3 .5 7 .5P r e s e n t V a lu e F a c to r 0 .9 6 7 8 0 .9 0 6 4 0 .8 4 8 9 0 .7 9 5 1 0 .6 1 1 8P r e s e n t V a lu e o f A v o id e d L ic e n s in g C o s t $ 8 ,2 2 5 $ 8 ,1 5 8 $ 7 ,6 4 1 $ 8 ,3 5 3 $ 6 ,4 2 8C u m u la tiv e P r e s e n t V a lu e o f A v o id e d L ic e n s in g C o s t @ 1 / 0 1 / 0 3 $ 6 0 ,8 1 9F a ir M a r k e t V a lu e @ 1 / 0 1 / 0 3 $ 6 0 ,8 1 9V a lu e (R o u n d e d ) $ 6 1 ,0 0 0W e ig h te d A v e r a g e C o s t o f C a p ita l 6 .7 7 %T a x R a te 3 6 .3 %Y e a r s a m o r tiz e d 15
  29. 29. Reproduction cost valuation IP Technology Current Dollar Conversion Valuation($ million) Historical Dollar Costs 1996 1997 1998 1999 2000 2001 2002 TotalsIP Technology $ - $ - $ - $ - $ 63.1 $ 5.2 $ 24.6 $ 92.9Current Cost ConversionFactor 100 = January 2003 0.9405 0.9560 0.9784 0.9849 0.9971 0.97936 0.96399 Current Dollar Costs 1996 1997 1998 1999 2000 2001 2002 TotalsIP Technology $ - $ - $ - $ - $ 62.9 $ 5.1 $ 23.7 $ 91.7
  30. 30. Expert profilePage 30
  31. 31. Boris J. Steffen, CPA, ASA, ABV, CDBV (202) 538 – 5037 boris.steffen@naviganteconomics.com » Boris Steffen is an expert in financial and managerial accounting, corporate finance and valuation with significant multi-industry, multi-company and cross-border experience in operations, finance, strategy and litigation. As an advisor in financing, investment and restructuring transactions and claims, matters in which he has consulted or testified include antitrust and competition policy, bankruptcy, restructuring and solvency, contracts, intellectual property, international trade and arbitration, mergers and acquisitions, business valuation, pricing, costs and profitability, securities and taxes. » As a corporate development executive and consultant, Mr. Steffen has advised in transactions and claims valued in excess of $100 billion. Sectors in which he has consulted include the aerospace, automotive, beef processing, biotechnology, business services, cable network, chemical, consumer product, defense, document management, electronic imaging, financial services & banking, food & beverage, healthcare, independent power, information technology, insurance, internet, newspaper, magazine, pharmaceutical, oil & gas, printing, pumps & controls, retail, satellite, semiconductor, software, steel, telecom, tobacco and electric utility industries. » Mr. Steffen has held positions in finance, public policy, corporate development and consulting with Inland Steel Industries, the FTC, Bureau of Competition, U.S. Generating, and LECG. He holds a Master of Management degree with specializations in accounting and finance from the Kellogg School of Management of Northwestern University, and a Bachelor of Science degree in Finance and Bachelor of Music degree in Applied Music from DePaul University. He is an Accredited Senior Appraiser, Certified Public Accountant, Accredited in Business Valuation, Certified Distressed Business Valuation Analyst, and member of the AICPA, ABA, ABI, Insol International, AIRA, ASA and American Finance Association.Page 31
  32. 32. Intellectual Property Valuation & Damages Analysis Boris J. Steffen, CPA, ASA, ABV, CDBV Principal & DirectorPage 32

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