INTERNAL – The patent holder may make use of the patent internally in an existing business (or firm). The patent may cover a specific aspect or an improvement of the manufacturing process use in the firm, or it might cover a specific feature of a product. In addition, the patent could be a method patent and claim a specific mode of operating the business, or implementing a procedure in software for example. Internal users typically supplement new patents with existing resources, trade secrets, and knowledge assets to put them in practical use. For example, Apple, Inc. regularly obtains patents on its own future product designs or for product features that it plans to incorporate into its products [See e.g. the Patently Apple Blog].LICENSING – The patent holder may focus on licensing the patent to third parties, with the goal of developing a royalty income stream by relying on the licensees to bring together any additional resources to practice the claimed invention. IBM has been granted more patents than any other US company during each year since 1993 [IBM Patent Licensing]. It maintains a broad portfolio of patents in the computer industry specializing in the areas of display, storage, network computing and software. Yet, IBM does not manufacture p0roducts in these areas anymore; it licenses its technologies to third parties that do engage in manufacturing. One technique increasingly used to establish a licensing program has been the threat of litigation. This strategy has been the choice for companies described as "non-practicing entities" or, less charitably, as "patent trolls."BLOCKING – The patent holder might not use the process, manufacture a product, or license third parties, but rather hold on to it in order to block competitors from developing specific products or benefiting from some innovations. This use is typically not publicized for obvious reasons, but imagine a car manufacturer had been the first to patent fuel injectors but did not use them in their vehicles nor licensed them. The competition would have to continue using carburetor-based engines as long as the threat of patent infringement was perceived as real, and the patent folding car company could buy a head start in developing a better fuel injection system for the future, thus staying two-steps away from the competition.MIXED LICENSING – A patentee could have a patent on, for example, a way of compressing and decompressing video to facilitate its transmission over the Internet. The main way in which it can profit from this is if the whole industry uses it and, specifically, if it licenses everyone to use it (even at very low royalties) along with its own internal use.CROSS-LICENSING – In many industries that are host to active patenting, such as telecommunications or pharmaceutical research, patent holders often use patents as bartering pieces to cancel out the threat of infringement litigation form competitors, by licensing some of their patents to the holders of patents it needs to compete, or is likely to be found infringing. A case in point is a recent agreement [Cross-Licensing Report] whereby Intel Corp. (the company famous for its microprocessors) received a license to Nvidia Corp.'s patents, while Nvidia (the company famous for its graphics processors) got a license to some of Intel's patents, thus resolving outstanding litigation between them. As part of the deal, Intel will pay Nvidia $1.5 Billion in royalties over the next five years.SLEEPING or SUBMARINE PATENTS – Sometimes, patent holders do not apply, license, cross license, or litigate their patents; they lie in wait until a suitable target appears, or they are simply shelved (sometimes forgotten) as a consequence of an overly active patenting drive or bad management.How the actual pool of patents is divided among these uses is hard to ascertain. Nevertheless, relatively recent survey data from the European Commission indicates that the most frequent use is Internal, at 51%, followed by blocking, at 19% (See Chart below) [2005 Patent Study Report].From the same European source, we have found that the distribution of the value of patents differs for its different uses (See next Chart). Relative to the value of the average patent surveyed, the most valuable uses by far are, not surprisingly, internal use and cross-licensing. Both of these uses allow patent holders to operate in a more profitable protected environment. Blocking, while popular and profitable, is a slightly inferior use of a patent because, one may expect, competitors invest in non-infringing alternatives and defeat the purpose of blocking. The other licensing uses are naturally less valuable than average because licensing involves sharing a portion of the incremental profits with the licensees. It is no surprise, finally, that Sleeping patents are the least valuable.In conclusion, from the perspective explored in this post, a follow-up question to correctly approach the valuation of new patent would be similar to: What is the intended strategic use of the patent?
Valuing IP in a Bankruptcy Context
Valuing IP in the Context of Bankruptcy a Webinar for Certified Patent Valuation Analysts Fernando Torres, MSc Chief Economist IPmetrics LLC email@example.com
Abstract A review of specific considerations and methodologies practiced valuing IP in thecontext of corporate restructuring through the bankruptcy process.
Agenda 1. IP and the Bankruptcy Context 2. Value Models by Properties 3. Practical Issues in Bankruptcy 4. Case Study
IP and the Bankruptcy Context A regulated process The need for valuation Creditors and claims Importance of IP
Bankruptcy: a regulated process• Chapter 11 Reorganization reflects the policy that “better to rehabilitate than to dissolve” (Ch. 7 Liquidation is last resort)• Bankruptcy is a set of laws providing for the regulated transfer of debtors‟ assets to creditors in order to settle claims• Until the business can be reorganized according to a “Plan,” a Trustee or Debtor-in-Possession (DIP) is authorized to manage the property of the estate and to continue operations• The DIP receives into the estate all “executory contracts” which include IP licenses and then can: 1. Assume beneficial contracts for the operation – assets 2. Assign not critical but valuable contracts – within limits 3. Reject not critical contracts – within limits
Bankruptcy: the need for valuation• For the most part, assets and liabilities must be valued to arrive at the appropriate transfer ratio between what the DIP owns and the creditors are owed• Per FASB, internally-generated IP is not reported in financial statements and must now be valued*• An administrative process, not negotiated in a market * GAAP does not recognize internally generated IP value, only acquisitions (since 2001, FASB 141-142)
Bankruptcy: IP & Intangible Assets Intangible Assets Intellectual Property Data & Customer Knowledge & Vendor TRADE Bases Relations MARKSPATENTS COPY RIGHTS Internet Proprietary COPY TRADE Software Assets RIGHTS SECRETS
Bankruptcy: creditors and claims• Some creditors have secured debts, such as mortgages, and title passes under contract• Most creditors are unsecured, pooled resources left over are distributed in either reorganization or liquidation
Bankruptcy: importance of IP• Increasingly, intellectual property (IP) represents a significant proportion of the aggregate value to be transferred, e.g.– • Trademarks: Tower Records (2004 & „06) Borders (2011) • Patents: Polaroid (2001) • Copyrights: Marvel Comics (1996)
IP value models by property Patents Trademarks Copyrights Trade Secrets
Value models: patents• A patent is only the temporary right to exclude others from a specific market delimited by a written description of an innovation• A patent has no intrinsic value independently of the value of a business, so the key questions to address are: • What is the value of the underlying business? And • How can this patent contribute to that business value?• A patents use is a key arbiter of its economic value, thus what are the past, current, and potential uses in terms of: • Internal application • External licensing, including cross- and mixed licensing • Competitive blocking • Sleeping or submarine patents
Value models: patents• In a going concern environment, the technology/product protected by a patent is typically clearly identified by the internal user or licensee.• In that case, conventional valuation models (cost, income, market) are applicable• In a bankruptcy context, additional analysis is necessary and different valuation techniques are often needed • Will the DIP continue to use the same technology covered by the patent at issue? i.e., is it a core technology or can it be licensed/sold? • Is there a market for the rights afforded by the patent, such as competitors (strategic buyers) or investors (financial buyers)? • Are there acceptable non-infringing alternatives available to potential joint venture, merger, or other bidders for the BK company assets?
Value models: patents• One concrete aspect to be considered in BK valuation is the “option” or “flexibility” value a patent gives.• A patent can be seen as the time-limited right, not the obligation, to exclude others from purchasing/selling the underlying asset (opportunity) at an uncertain price/profit. • Given the volatility of the industry, what is the "likely" range of variation for the value of the business in the future; and • What is the proper return on the amount invested buying the patent (even if it expires unused).• The patent‟s flexibility will have value to a buyer only to the extent that the "likely" price in the future exceeds the opportunity cost of earning just as much in a risk-less alternative.
Value models: patents• The Black-Scholes model gives a precise answer to the term "likely" by applying the statistical model of the Normal distribution to model the volatility of the specific business segment.• The BS option price (maximum expected profit) stands for the value of the patent. In this approach, a patent is valuable today to the extent the probability-adjusted potential net income from practicing it (or licensing) exceeds the probability-adjusted additional expense of maintaining its validity and developing the ancillary assets required to implement it.
Value models: patents• Key concept (BS): the higher the volatility of returns is, the higher the value of the patent and the license royalty rates Net Payoff from introducing product Patent Value NPV Cash Flow Implementation Cost
Value models: patents• In the BK context, the specific facts surrounding the company (DIP), the patented technology/product, the competitive environment, and the interest of financial buyers must be taken into account to properly value the patent by: • Establishing the ownership and statutory validity of the patent and its expiration date • Defining the most likely (or the alternative scenarios) of use: • Internally if key to operations • Licensing if continuing cash flow is more important than disposition • Outright sale if non-essential • The historical track record, accounting costs, and engineering appraisal of the merits of the technology are secondary to market realities
Value Models: Trademarks• Typically the most vulnerable intangible, and the most valuable of most B2C bankruptcy situations• Track record is important, because trademark rights are only earned through use in commerce, they deteriorate immediately and cannot be “parked” (more than 3 years) nor are they viable for a “non-practicing entity”• In TM valuation, the method most often applied is „Relief from Royalty‟ (Income Approach with optional input from Market)• Generally, we seek to explain trademark value as a function of the sales the TM supports, the context in which TM was acquired (liquidation or going concern), the scope of TM use, and other exogenous case-specific factors
Value Models: Trademarks• Must be based on the business model of potential acquirers to be FMV• Conceptually, the value of the trademark bundle is measured by the royalty avoided at market rate “r” on Sales “S” which grow at a rate “g” and are discounted to the present at the discount rate “k” and this relationship may be more or less than proportional (elastic at rate “ ”) depending on the existence of close substitutes/competitors. ( g k )t TM r S0 e dt
Value Models: Trademarks• The model can be reduced* to a simpler formula: r TM S (k g ) e 1• Typical values in a going concern and in bankruptcy are illustrated in the following tables, applying empirical estimates based on our econometric analytics of B2C industries: * Assuming trademark rights are maintained in perpetuity and perfect elasticity, =1 .
Value Models: Trademarks• Going Concern Slow Fast• Relative orders of magnitude TM Growth Growth of the TM/S ratio, for a 5% S (g=2%) (g=5%) royalty rate in scenarios combining high and low risk High (reflected in the cost of capital) and growth rates Risk 0.15 0.18 (k=30%)• Risk/volatility is relatively more important than the rate of growth in determining the Low ratio of the trademark asset Risk 0.48 0.69 as a proportion of (initial) (k=12%) annual sales * Assuming trademark rights are maintained in perpetuity and perfect elasticity, =1 .
Value Models: Trademarks Slow Fast• Bankruptcy TM Growth Growth• Relative orders of magnitude S of the TM/S ratio, for a 5% (g=2%) (g=5%) royalty rate in scenarios High combining high and low risk (reflected in the cost of Risk 0.02 0.02 capital) and growth rates (k=30%)• Generally, two-thirds of trademarks in bankruptcy Low sell at discounts between Risk 0.06 0.09 80% and 90% of GC value (k=12%) * Assuming trademark rights are maintained in perpetuity and perfect elasticity, =1 .
Value Models: Copyrights• Copyright arises automatically when a work is created, unlike other IP• Perfecting security interest requires state-UCC-1 filings and a filing with the Copyright Office if registered• Most enterprise copyrights are only valuable if transferred with the trademarks as they generally are ancillary marketing assets.• Exceptions are industries based on copyrighted works with intrinsic value: media, film, music, publishing• As with patents, the value of the copyright is commensurate with the profitability of the business opportunity these rights afford the owner• Modeling relies on defining the business plan over the (often long term) statutory life of the rights
Value Models: Trade Secrets• Trade secrets in bankruptcy are difficult to value if not properly institutionalized; most often they are human capital that does not travel with the bankrupt estate• Trade secrets may be most valuable if they are necessary to implement patented technology and bundled with the corresponding IP assets• The content of customer databases may be marketable and, therefore, valued if privacy is preserved and the partial or complete sales court-approved• Competitors are often the only likely market for the trade secrets, and the DIP may not have scheduled (identified) them and have a readily marketable asset at all.
IP Valuation Practical Issues in Bankruptcy Due Diligence Initial Assessment Alternative Scenarios
Practical Considerations• There may be a good reason why the entity is in bankruptcy• Perfection of title is key, particularly Copyrights• Not all IP / IA are created equal • Classify the assets as Core or Periphery• Analyze quality of IP • Relevance to current/future business • Relative strength analysis• Peripheral portfolios may be monetized • Vertical and horizontal • Out-licensing / Spin-off
Practical Considerations• Potential infringement assessment• Are the assets strategically separable from the core business?• Evaluation of credit bids for global asset portfolio versus individual asset buyers• IP assets to serve as collateral for either DIP and/or exit financing• Will need values for fairness opinions or court approval of 363 asset sales
Practical Considerations• Monetization Alternatives • Sale • License • Creditor Settlement • Sale & Leaseback • Securitization • Litigation• Securitization Alternatives • Line of Credit • Take-out or DIP • Interim • Long term
IP Valuation in Bankruptcy: Case Study Initial Assessment Identifying Value Outcomes
Retail Bankruptcy: Case Study• 2009 bankruptcy and liquidation of a prominent NY-based retailer of home, jewelry, and furniture stores, its second round under Chapter 11 since the start of the recession at the end of 2007.• After the real estate, both owned and leased, was relatively quickly liquidated, the merchandise inventory was sold to specialized liquidators.• However, as the IP consulting team was brought in at an early stage, at least some of the liquidation sales were conducted under a trademark license. The liquidators had to recognize, and pay for, the market power of the mark “[brand] Diamond Sale” vis-à-vis a generic “diamond liquidation.”
Retail Bankruptcy: Case Study• The trademark valuation model applied the statistical discount analysis and the approved transaction amount was on the high end of the range.• The sales forecast model took into account the loss of store space and the (statistical) damage to goodwill, and included the possibility of segmented segments emerging from the BK liquidation (a department store becoming a series of specialty stores• A few months after the final auction, the brand has been recast into a new, smaller, and more focused store, under new ownership.
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