MONETISINGINTELLECTUAL PROPERTYASPECTS OF VALUATION OF IP Chumphol Mahattanakul
Outlines• IP System• IP Embodiment• IP Valuation• IP Strategy• IP Audit
IP System• IP system is a set of activities to encourage and protect persons or parties of concerns in relation to invention, innovation and creation along the social and economic development path• IPRs which are intangible assets as derived from IPs are systematically governed by competent functioning bodies e.g. WIPO, WTO (via TRIPs) and NPOs in - Administration - Codification - Regulation - Enforcement - Dispute Resolution - Marketplace Regulation
• IP embodiment comprises IP business partners and their respective IP actions/functions or interactions.IP Embodiment • IP business partners cover the following players whose activities or functions are interrelated or mutually made or strategically overlapped with each others such as IP/technology development companies, licensing agents, patent licensing and enforcement companies, privateers, institutional IP aggregators/IP acquisition funds, litigation finance/investment firms, IP brokers, IP-based merger & acquisition advisory firms, IP auction houses, IP-backed lending firms, online IP/technology exchanges, royalty stream securitization firms, IP transaction exchanges, etc. • IP functions are engaged in variety of arrangements for monetization or securitization of IP from which IP business models are structured for the sake of industrial and economic development, and for benefits to all concerned parties.
IP Business PartnersIP/Technology Development Licensing Agents - entities functioningCompanies – Entities engaged in R&D as intermediaries by helping IP ownersactivities and produce IP often not find licensees. Also called IP advisory,used for manufacturing themselves but IP consulting, IP management orlicensed to one or more operating technology transfer firms. They maycompanies for their further activities in merely act as consultants where thebringing physical products or services patent owner gets involved in theto marketplace. In case the IP creators licensing process, or function more likeprovide consulting services to the IT companies where the patent ownerlicensees to integrate the technology outsources patent monetization andinto the licensee’s products or sets aside day-to-day licensingprocesses, they are considered beyond operations, but collects a major part ofthe scope of intermediaries between revenue from licensing. They can be ofpatent owner and patent “carrot” licensing or “stick” licensinglicensee. They will be intermediaries activities. In the latter case, thesewhen they form a link between the IP entities tend to be engaged in activitiescreator and those who commercially like PLEC business model.deploy it in the form of products andservices. In some cases, they do bothmanufacturing and licensing.
• Patent Licensing and EnforcementIP Business Companies (PLECs) - own one or more patent portfolios, attempt to licensePartners them through targeted letter-writing campaigns and then file patent(cont’d) infringement suits against those letter recipients who refuse to enter into non- exclusive licenses. PLECs are often called non-practicing entities (NPEs) or patent trolls. PLECs might have purchased the patents they are asserting or it is otherwise founded by the inventor(s) of the asserted patent portfolio. As for the latter, they are not intermediaries. PLECs earn revenue both from license fees and from the IP awards market.
IP Business Partners (cont’d)• Privateers - Operating companies who have been spinning groups of patents to PLECs to generate additional revenue, by means of outsourcing patent-monetization function, that helps save the costs incurred in cross license and counter-claim exposure, and avoid anti-competitive regulations and bad publicity, etc.• Institutional IP Aggregators/Acquisition Funds – private equities who operate as general partners of a limited partnership and raise money either from large technology companies or from the institutional investors and even high-net-worth individuals. The investors are promised above average ROI from selective, targeted or large-scale patent purchases with the goal of instituting licensing programs and/or employing various arbitrage strategies.
• Litigation Finance/Investment Firms – functioning alike both PLECs and IPIP Business Acquisition Funds. Like IP AcquisitionPartners (cont’d) Funds - general partners of a limited partnership and raise money from large institutional investors and high-net- worth individuals. Like PLECs – with a view to acquiring a financial interest in patent portfolios for assertion by taking the form of targeted letter-writing campaigns, followed with patent infringement suits against those letter recipients who refuse to enter into non- exclusive licenses. Variances in the model (and from a PLEC) include the level and nature of ownership or participation (e.g., equity vs. debt) that the firm takes in the patent portfolios being asserted or in the patent-owning entity itself (typically an LLC formed for the purpose of assertion).
• IP Brokers – function as same asIP Business Licensing Agents with key distinctions that they seek to help IP owners findPartners (cont’d) buyers rather than licensees; and operate both on the sell-side and the buy-side (assisting technology companies in acquiring patents having “strategic” (i.e. defensive) value vis-à- vis their competitors). A typical “one hit and done” engagement term between an IP Brokerage firm and an IP owner is shorter than that of a Licensing Agent firm because once the IP is sold, the IP Broker takes a percentage of the sale as a success fee, without any opportunity for recurring revenue. In contrast, buy- side brokerage engagements can continue indefinitely as the broker’s client strengthens and extends its IP position over time.
• IP-Based M&A Advisory Firms – EntitiesIP Business operating like investment banking (or 2nd generation IP investment banking) by advisingPartners technology companies in their M&A activities and earning fees based on the value of the entire(cont’d) deal (or apportioned according to the value of the IP within the deal of either sell-side or buy- side, focusing on IP assets; followed with services e.g. IP due diligence, IP integration and operations as a result of M&A activity, IP deal structuring advisory and general consultations related to contemplated investments, mergers, acquisitions, divestitures, joint ventures and other corporate transactions. It involves not just maximizing IP value in the context of a “traditional” corporate acquisition or divestiture, but actually sourcing the transaction based, at least in part, on IP considerations. By this, the IP investment banker assist operating companies in identifying potential acquisition targets or acquirors with complimentary IP assets.
• IP Auction Houses – Entities attemptingIP Business to do for the IP marketplace (like Christie’s and Sotheby’s auction housesPartners (cont’d) did for the antique and art marketplace) holding multi-lot, live auctions for patents with the intent of providing a marketplace for facilitating the exchange of such historically-illiquid assets. With various auction formats and structures, such auctions enable sellers to offer one or more patents according to a pre-determined set of terms and conditions and allow the auction house to charge listing fees, attendance fees, buyers’ premiums and/or sellers’ commissions. Also, other entities aim to be the “eBay of patents” by offering online patent auctioning services.
• On-Line IP/Technology Exchanges, ClearingIP Business houses, Bulletin Boards, and Innovation Portals - Functioning like the former B2BPartners (cont’d) web sites; offer web platforms and interfaces specialized for patent and other IP assets. (Like online classifieds Craig’s List, but this is provided for IP.) There are variances such as whether listing fees are charged to patent owners/sellers in addition to, or versus, back-end fees for successful patent sale or licensing transactions. Additional variances include whether these sites are public and browseable for free, or whether they are private, “member’s only” sites that require registration (and presumably a registration and/or annual membership fees). Some of these sites also offer forums, bounties, challenges and idea exchange platforms that aim to spur innovation and thus create new IP.
IP Business • IP-Backed Lending Firms - Entities that provide financing for IP owners, eitherPartners (cont’d) directly or as intermediaries, usually in the form of loans (i.e., debt financing), where the security for the loan is either wholly or partially IP assets (i.e., IP collateralization). Thus, these parties often function as intermediaries between borrowers and commercial lending institutions, such as banks. Unlike traditional bankers who focus on accounts receivable (i.e. Factoring) and tangible assets, however, these IP-backed financiers take into account a borrower’s IP assets or target company’s (potential or actual) IP assets in structuring a financing transaction. Variances in this model include entities who deploy their own capital (and thus resemble IP investment firms) or who maintain a network of technology-specific or industry-specific investors to whom they refer IP owners (and thus resemble patent brokers).
IP Business Partners (cont’d)• Royalty Stream Securitization Firms - Entities providing a consultation and/or capital to patent owners in performing IP securitization financing transactions. In such transactions, an entity sells their IP underlying the transaction to a bankruptcy remote entity or SPV, and the SPV grants a license back the IP to the original owner. Then, SPV issues IP-backed notes/securities to investors to raise cash/fund for IP owner at the agreed-upon purchase price. The notes are then backed by the expected future royalties to be earned from licensing the underlying IP (to the original patent owner and/or third parties). By this, the original IP owner obtains funds raised at much more cheaply than a loan backed by its traditional assets. The IP-backed notes are generally higher-rated commercial paper reflecting the quality of the IP and not necessarily the overall creditworthiness of the original IP owner.
IP Business Partners In Securitization• Securitization - A technique that isolates income- producing assets from bankruptcy risk by assigning them to SPV which then issues debt securities payable from the cash flows generated by the assets.• Debt securities achieve ratings which are set aside from the rating of the sponsor (transferor company/institution). Issuance is made to respond to investor demand for different maturities and credit qualities. Normally, the highest ratings can be achieved via wrapping securities with relevant financial guarantees.
IP Business Partners - Securitization Schematic Diagram
• A means for encouraging theIP Business private sector credit with aPartners - flexible and efficient off-Securitization balance sheet funding sourceof SME Assets • Reduce a cost of capital • Diversify asset exposures x •A • Improve asset-liability management Y •B • Eliminate credit constraints • Overcome the agency costs of •C Z •D asymmetric information where one has information over the other
IP Business Partners - SME Assets Securitization Implementation• Germany: The securitization of • Malaysia: Securitization started in SME loan initiated in 1998 by 1986 when the government set up a Deutsche Bank followed by mortgage financing body called other commercial banks in National Mortgage Corporation (Cagamas) to function as SPV 2000 (Jobst, 2007). To reduce between the house mortgage lenders the financing cost of SMEs, and investors of long-term funds. KfW has been commissioned Apart from mortgages securitized by by the government to Cagamas, securitization for other implement the securitization assets has not been very strong in scheme to raise the financing Malaysia (Rosalan, 2008). The for SMEs. transaction is governed by the Securities Commission Act 1993. In 2001, SC issued Guidelines on the• Japan: Securitization of SME Offering of Asset-Backed Securities loan is one of the program which provides the criteria for implemented by Japan Finance securitization deals. In 2007, Corporation for Small and Cagamas pioneered the securitization Medium Enterprise (Tsukahara, of SME loans via the issuance of RM600 million credit-linked notes by 2006). its wholly owned subsidiary, Cagamas SME Bhd. (Wan Azhar, 2007)
IP Business Partners - SME Assets Securitization Implementation• Thailand: Secondary Mortgage • Scheme: SMC purchased a pool of housing Corporation (SMC) established in 1997 loans from financial institutions in the under the Royal Decree of Secondary primary market, and securitized them by issuing Mortgage-Backed Securities which are Mortgage Corporation with its initial to be sold to both local and foreign investors. capital of Baht 1,000 million, as a state The pool of loans will be transferred to SPV enterprise financial institution under as established by SMC in order to segregate the Ministry of Finance with its major the risk of pools of loans from SMC risk and objective to develop the secondary loan originators. Then, SPV will issue MBS market for housing mortgage loan instrument backed up by the said transferred under the principal of asset pool of housing loans. Investors in MBS securitization for fund raising activities instrument will receive both interest and principal repayment generated from cash for the adequate and stable expansion flow stream collected from loan borrowers of housing mortgage financing, and to under the specified terms and conditions. expand lending activities of housing MBS can achieve a credit rating from rating loan market in order to resolve the agency, and also to be attached with credit problems faced by the real estate enhancement scheme, such as the sector during the country’s economic repayment of loan interest and principal is downturn period. insured by reliable credit insurance institution, to level up the confidence.
IP Business Partners (cont’d)• IP Transaction Exchanges & Trading Platforms/IP Transaction Best Practices Development Communities In further attempts to make IP a more liquid asset class, plans have been announced to create traded exchanges (whether physical or online locations) similar to the NYSE and NASDAQ where yet-to-be- created IP-based financial instruments would be listed and traded much like stocks are today. Another variant involves an on-line trading platform where IP buyers and sellers can come together to execute transactions based on a set of agreed rules developed by a “best practices” steering committee composed of major corporate buyers and buyer-sellers.
IP Business Partners (cont’d) IP Exchange• Innovation – a fast decaying rate of innovation/product has forced the companies to learn as to how to accelerate every aspects of businesses, particularly with IT business• Speed once product was launched, a plagiarism prevails e.g. knock- off and reverse engineering production, marketing campaign and distribution plans can never last for six months but to be substantially shortened to only, for example; 6 weeks, instead• Protection – consideration angle of being worth the effort of regional or global patenting “If only two can be chosen out of the three, what’re yours based on economic aspect?”
IP Business Partners - Coase Theorem• When looking at how to deal with• Freidman looks at “how an item protection for intellectual property, must be useful before it can get a we look at transaction cost, and patent”. No matter what to do in that is the Coase theorem. The the area of productivity, people Freidman book clearly states that have very little incentive to come copyright protection is cheap and up with uses for things, and rather easy to enforce, and patent just get as many patents as you can protection has high transaction and then when someone discovers costs and is hard to enforce. If a use for it, you get paid. But this there is a very small amount that runs into a problem in that no one you are copying, there is a high will be looking for uses. There is no transaction cost of getting incentive for it. This has been an permission. This just makes sense, excellent chapter to read in the fact the smaller affect that you will that it relates directly to both law have on revenues and profits, the and economics, and we can use lower the copyright holder’s the analytical tools it gives us for incentive to get that lost revenue any other form of property rights from you. It would take him time, that we want to look at. in both finding where you copied his work and how many times you copied it and for what purpose.
IP Business Partners (cont’d) - IP Exchange• The patent exchange idea: Implied valued – based patent tax is to be paid by IP owner to a central IP market-making body to meet the administration costs. By issuing a good-faith binder, the 3rd party could challenge the IP valuation at higher level. If agreed, IP owner will pay the patent tax at higher level in return for retention. Otherwise, the 3rd party will buy the IP at higher valuation on which the patent tax is based.
• University Technology TransferIP Business IntermediariesPartners (cont’d) These are entities that function as IP Development Companies, IP Acquisition Funds, Licensing Agents and/or Patent Brokers, but focus on the niche university technology transfer (i.e., licensing) market. The choice to focus on the university market by such entities is not surprising given that in the 2011 fiscal year, U.S. universities and research institutes spent over $61 billion in R&D, filed over 13,000 U.S. patent applications and had over $2.5 billion in licensing revenue.
IP Business Partners (cont’d)• Defensive Patent Pools, Funds potentially “problematic” patents via and Alliances – Of several types auctions, brokers or direct sale, and license them to willing entity to share of defensive entities, one was the financial cost of acquiring the established in response to PLEC patents and the management and Institutional Patent overhead of pool administration, and Aggregator/IP Acquisition then sell them at a profit. Another is “library fund,” where a group of Fund. In acquiring patents, corporate investors pool capital to buy entities focus on one patents that may be “of interest” to technology/ industry segment. certain large operating companies With a “catch and release” who are known to be aggressive in approach, this model results in asserting patent claims against competitors. If the alliance members multiple operating companies are sued by one of these companies, joining forces to create an they can “check out” the patents to independent entity to use in a counterattack (not useful against asserters who have no acquire infringement exposure.)
IP Business Partners (cont’d)• Technology/IP Spinout Financing • Analytics Software and Services - best described as being Firms - Entities providing advanced organized as a traditional venture patent search and analytics software capital (VC) or private equity firm, tools that allow patent owners, but specializing in spinning out prospective buyers, attorneys, promising (non-core) IP which has investors and other players in the IP become “stranded” within larger marketplace to obtain various due diligence intelligence and data points technology companies, or about a single patent or patent creating JVs between large portfolio. These software tools and technology companies to platforms provide varied outputs commercialize the technology related to patent “quality” such as and monetize the associated validity probabilities, maintenance IP. Thus, the revenue is as same fee-related life expectancies, various as a traditional VC or PE firm – infringement-related metrics, prior achieving a high ROI once a art analysis, “related patent” analysis, portfolio company is sold, goes citation-related metrics, etc. These entities earn revenue from pure through an IPO (Initial Public software sales/licenses, as well as Offer) or even evolves into an IP consulting fees. licensing company.
IP Business Partners (cont’d)• IP Insurance Carriers - Typical – IP Abatement Coverage commercial insurance under (Enforcement Coverage), which Commercial General Liability policies funds an attack on a party that carried by businesses do not cover IP improperly uses the insured’s IP. claims. Insurance carriers currently • What items can be insured? market three basic types of IP policies: IP-Rich Products’ future revenue streams; Licensing Revenue; – First-Party IP Coverage, which Royalty Receipts protects the value of an insured’s direct loss sustained when its IP “Value” – accounting revenue streams are diminished principles from a direct and resultant R&D Expenditure impact upon its IP rights; Financial Investment – IP Defense Cost (Defense Loan Arrangement Coverage), which protects a Transaction involving IP rights, company against allegations that etc. it improperly used the IP of another; and
IP Business Partners (cont’d)• Analytics Software and provide varied outputs Services Firms - Entities related to patent “quality” providing advanced such as validity patent search and probabilities, analytics software tools maintenance fee-related that allow patent owners, life expectancies, various prospective buyers, infringement-related attorneys, investors and metrics, prior art analysis, other players in the IP “related patent” analysis, marketplace to obtain citation-related metrics, various due diligence etc. These entities earn intelligence and data revenue from pure points about a single software sales/licenses, as patent or patent well as consulting fees. portfolio. These software tools and platforms
IP Business Partners (cont’d)• Patent-Based Public Stock Index theorized that investing in stocks Publishers – As an evolution of the with valuable patents may allow established Analytics Software and investors to commit a meaningful Services business, once the and sustainable portion of their entities offering these software assets to IP and allow them to tools and platforms realized that outperform other investment nearly 80% of the value of a U.S. strategies. They sought out publicly-traded company now different algorithms to create comes from intangible assets, and baskets of stocks using the that they possessed tools to “quality” of a publicly-traded measure the “quality” of arguably company’s patents as the primary the largest part of those IAs, it’s selection factor. Revenue from obviously that another potential such an emerging business model source of revenue would be the includes the sale of equity creation of formalized stock research and the licensing of such indexes based on their existing indexes to ETF, mutual fund and software tools and platforms. Put other investable financial in different terms, the analytics instrument issuers. software and services industry
• Intangible Assets are those encompassingIP as a subset of domains of Intellectual Capital (IC), Intellectual Assets (IA) and Intellectual Property (IP)Intangible Assets • Intangible Assets = IC + IA + IP, where IC – Knowledge with potential for value embodied in people, processes and customers that comprises reputation, goodwill, business relationships, customer relations, licenses, branding and human resources IA – Knowledge providing value that comprise skills, know-how, inventions data, processes, market data, information unorganized IP – Knowledge legally identified comprises patents (e.g. technology and design), know-how implemented, trademarks, copyrights, trade secrets, geographical indications
IP Parameters• Values defined by situation • Bankruptcy – Fair Valuation Value-Affecting Factors — Liquidation – assumes a distressed sale (appropriate when • IP - Cash Flow debtor is dead or mortally wounded). – Revenues — Going concern – cash realized from a sale over a reasonable period of time. – Costs • Fair Market Value – Profits — Tax Definition • Remaining Life — Willing buyer and willing seller — Economic — Neither under compulsion to buy or sell — Statutory — Both having reasonable knowledge of — Stage of Development relevant facts • Market/Industry Factors • Fair Value — Definition for financial reporting — Growing or Maturing purposes — Competitive — Current transaction between Environment marketplace participants — Both able and willing to transact — Uncertainty/Risk
IP Economic Characteristics Economic Characteristics• Not of a diminishing value by time of Value Sources exploitation • Direct Use• Not always be restricted to a single user, but — Manufacture and/or Marketing of likely to be applicable to multi-users, IP value Products can be managed on a multi-disciplinary basis • Indirect Use to gain benefits as desired for all partners — Strategic Alliance/JV Opportunities• Not necessarily depend on IP asset-creating • Licensing/Sale or inventing investment cost, but rather on — Additional source of revenue commercialization ignition spark after project completion, and perhaps or more likely to be • Strategic/Defensive associated with other assets — Building up higher entry barrier against competitors• Be context specific (e.g. internal development, JV, sale or licensing) with • Tax relevant time specific parameters (e.g. — Built‐in‐gains to offset 382 limitations historical, current or potential) /197 benefits /Donations• Devalued after achieving the saturation of S- Curve
Patent Rights Suppose the invention covered by your patent• A patent gives the patent owner is a chair with four legs, a seat, a back the "exclusive right" to stop others and a pair of rockers -- a rocking chair. from making, using, selling or Under your patent, you have the exclusive offering for sale the product, or right to stop others from making, using, selling or offering for sale your patented process of making the product, that rocking chair. Assume the rockers on your is described by the patent claims. It rocking chair are unique and covered by is important to note that a patent an earlier patent to someone else. The does not give the patent owner the rocker patent owner has the exclusive right under his patent to stop others right to exploit the patented (including you) from using his patented invention himself. The patent rockers. Use of the patented rockers on owner has only the "exclusive your rocking chair would constitute right" to stop others from doing so. infringement of the rocker patent. So while you received a patent for your• In other words, just because you rocking chair, you will not be able to obtain a patent on your product actually make, use, sell or offer for sale does not mean that you can the chair without first obtaining permission from the rocker patent owner. The rocker actually use the product. You may patent owner is not required to give you be blocked by an earlier patent permission, however, and can keep your owner who exercises the "exclusive rocking chair off of the market if he right" granted to him under his chooses to do so. It might make better sense for the rocker patent owner to patent. This is an important participate in your success by giving his distinction and the following permission in exchange for a licensing example will help to explain it. fee.•
Patent Pooling• The patent system has been industry better manage its recognized of negative patent licensing. By “pooling” outcome on account of being patents from many license a tool more likely to stifle holders, licensors are likely than protect innovation. This able to lower transaction negative sentiment stemmed costs and administrative from the recent victory of overhead, and benefit from a Apple over Samsung. centralized model that• As for the future role and encourages patent bundling efficacy of the patent system, and fair play. Licensees product and technology likewise enjoy advantages in licensing is not anathema the form of lower royalty fees (vehement disagreement) to and a single point of contact the qualities of fairness and that eliminates the need to transparency. negotiate separately with• Patent pooling is a proven, multiple license holders. effective tool that helps the
IP Valuation Characteristics - IP assets are of intangible IP Valuationunique characteristics with - not much a matter of sciencetheir inherent values, but rather a matter of art ordepending upon: external judgment: – Widely varying terms & – Purpose – Why are we conditions valuing the asset? – Inherently dissimilar – Description – What is the asset? – IP transfers are often – Application – How will the motivated by unique asset be used? strategic considerations – Standard – Who is the – Details of IPR transfers are assumed buyer of the asset? usually not widely disseminated
IP Valuation • The process is concerned about• IP valuation is involved in gathering of information and in- depth understanding of economy, the process itself with IP industry and specific business driving parameters (e.g. that directly affect the IP value. market share, barriers to • Information are used for entry, legal protection, IP’s structuring a financial model that profitability, industrial and can generate the specific values economic factors, growth based on internationally- accepted standards (e.g. USPAP, projection, remaining IVSC, GAAP, IFRS and FASB), economic life and new where either or combination of technologies). the following approaches are taken into account, that is, cost approach, market approach, income approach, direct approach, and pay-off approach.
IP Valuation• Monetization and valuation their certain marketplaces are indispensable to each in which patents stay other from basic dominant. marketplace to complicated • Other IAs like brand loyalty one. and customer relations will• Sale, licensing, with some definitely help driving the variation or combination of acquisition activities in sale and licensing are basic which intellectual capital part of IP monetization and skills of human among large, medium and resources are specifically small companies and among targeted in the advanced non-practicing entities using technology sector like IT. various IP business models in the marketplace.• Known IP business models are auction and IP infringement insurance in
IP Valuation• A monetization is mechanized in prevailing in many circumstances debt-financing marketplace, with e.g. valuations of patent portfolio an exchange between revenue or trademarks for a brand. stream as generated by the The following are challenges in pledged income-producing IP and determining IP value: fund or loan as provided by IP Lack of data consistency and financier. accuracy• A securitization is invented to issue Lack of patent-related a note/bond secured with revenue metadata e.g. data supporting stream as generated by the subject the apparent data or IP in return for a fund from configuration data investors. Bowie Bonds is for example. Limited legal linkages• As IP valuation is rather art prone, Patent and non-patent not only a valuation of variant IP’s reference visibility inherent uniqueness, but its Lack of standard or accepted transferability course of action is metrics also concerned with uncertainties
IP Valuation• IAs generate incremental returns for compared to competitors who do the business either through revenue not. increase or cost reduction, whereas – Premium pricing method – most of the IP valuation methods figuring out the price difference emphasize a capturing of the values between a branded and of those additional returns. unbranded product, net of• IP valuation approaches: marketing or supporting costs to – Market approach – comparable achieve the revenue. market transactions needed – Cost savings method – – Cost approach – using main costs calculating the present value of and associated costs assumed in the cost savings anticipated from replacement or reproduction of IP ownership the subject IP asset, and its – Royalty savings method – depreciation assuming the non-ownership – Income approach – determining scenario where the business the income of IP asset by also needs to license it to earn the taking into consideration returns that it is earning. anticipated utilization expenses – Pay-Off Method (POM) besides its revenue generated – Excess operating profits – determining the additional profits pertinent to IP possession
IP Valuation for Financial Reporting• Being essential for fulfilling Where are the intangible various information as assets? demanded by the interest group or investors. What the real value of the company in focus is?• If it just provides information about the company itself• Lack of relevant information covering an ability to create on intangible assets (including profit, cash flows and changes intellectual assets) will disable on capital, as well as its the possibility for investors or tangible and financial assets external users to perceive and liabilities. real value of the company and adequate decision making.
IP Valuation for Financial Reporting (cont’d) What criteria should be accepted?• Too rigid - results in undervalued pricing with respect to market price• Leniently – results in over- pricing U.S. Financial Accounting Standards Board (FASB) – 2001 Generally Accepted Accounting Principles (GAAP)
IP Valuation As A Transaction Strategy• A strategic valuation • Transaction strategy of IP is rendered often ends with ‘go when considering on’ or ‘stop’ buying, selling, recommendation. assigning or • That is, at what price transferring the to enter into this asset in a licensing proposed arrangement or transaction? acquisition.
expected term ofIP Valuation in • Information and receipt ; identify the licensees orFinancing other obligors Data Required which will be a) What are the responsible for expected annual these revenues,Financing: An revenues from and show how the licensing and other revenues shownincreasing area of contractual on the pro forma arrangements? are allocatedactivity is the b) What historical among these revenue numbers variousfinancing of IP assets. are available to licensees/obligors support these f) Provide a briefThis can be achieved future projections? summary of the c) What is the term licenses or otherthrough a number of over which these contractual revenues are arrangementsways, including expected to be under which these received, and will revenues areborrowing against the the payable, including, inter alia, for each,license stream (similar d) y diminish or increase overto Factoring) of IP time? e) Provide a pro forma schedule showing these projected revenues over the
IP ValuationCost of Creation — Thecost of creation method ofvaluing intangible assetsrelies on calculating what it • Assets that may be valued using the costwould cost another of creation method include:business to duplicate agiven asset today. This – Internal Softwaremethod does not measure – Patentsan asset’s future impact on – Trademarksprofits; it merely looks at – Copyrightswhat it would cost to – Subscriptionscreate the asset fromscratch at a particular – Customer listspoint in time. – Service contracts, etc.
IP Valuation – Disadvantages Cost-based – There is no direct correlation between cost method of development and the future revenue potential of assets. IP that costs the most toAdvantages produce may not necessarily be the most valuable. - IP becomes – Likewise, IP which is many years old and has visible in the been written down in value could still be the company’s books most valuable to the company, even though the historical cost approach does not show - IP awareness is this. The measure of historic costs is increased. unreliable with rapid technological advancement. - Regarded as a – It is not always possible to provide accurate useful indicator of information on the resources spent on IP value in the development and there will always be a case of IP assets practical challenge to determine which costs to include or exclude. whose future – Cost-based methods make no allowance for benefit is not yet the future benefits which might accrue from evident. the IP.
When are they used?IP Valuation – They are generally used inCost-based accounting, bookkeeping and inMethod accordance with accounting rules. They are only useful for bookkeeping purposes or as a supplement to an income approach. They are only relevant in historical cost-based accounting systems or where taxation methods dictate their use.
IP Valuation – Income–Based Method• Capitalization of Income or Savings • Assets that work well with this Method — The capitalization method method include: measures the future benefits intangible assets will bring to a – Trade names company, when those benefits will be – Customer lists generated and for how long. The – Commercial Software capitalization rates used in this – Patents method should reflect the risk – Trademarks associated with the intangible asset being valued. – Brand names, etc.• In addition to the income an intangible • The capitalization method works well asset may bring to a company, the for all of these assets when they are benefits may also include savings to relatively new. As they come closer to the company as a result of owning the the end of their economic usefulness, asset, or not having to pay a royalty to however, other methods of valuing someone else who owns the asset or them may become more appropriate. of efficiencies generated by the asset.
IP Valuation – Income-Based Method • Disadvantages – Although the methods are conceptually robust, they can prove difficult to implement• Advantages in high-uncertainty environments. This task – It is simple to assess the always includes some uncertainty and subjective assumptions. value on the basis of the – There are both uncertain and distant cash conditions set up. With the flows and the discount rate have to be likely availability of many of estimated. For example, there is rarely an the required inputs from the experience base when estimating the market potential and therefore cash flow of firm’s financial statements early stage IP developments. and market information it – All risks are summed together and may be possible to identify assumed to be appropriately adjusted for in and or forecast particular the discount rate and the probabilities of cash flows. success, rather than being dealt with individually (such as legal risk, technological – In specific circumstances this risk etc.). method is useful, especially if – A significant drawback of the relief from there are suitable royalty method is that a royalty rate can always be assumed, when in reality it may comparable transactions never materialize. involving third parties or – It ignores changes in the time value of industry standard royalty money and maintenance Cost. rates. – Does not account for market demand.
IP Valuation – Income-Based Method When are they used?• Income approach to IP valuation is only accurate if the following variables are available or can be accurately estimated: – an income stream either from product sales or license of the IP – an estimate of the duration of the IP’s useful life – an understanding of IP specific risk factors for incorporation into the valuation and a valid discount rate.
IP Valuation - DCF• Discounted Cash Flow — The discounted cash flow method is good for assets with predictable life spans and future financial benefits, including: – Contracts (current and future yearly benefits); – Subscriptions and service contracts; and – Patent royalties.• The DCF method can be applied to savings flows as well as to income flows.
Exhibition on DCF CalculationThe sources of risk are the revenue growth rate and the variable costs as a percentage of sales.The average of theDCF is known as the net present value (NPV) and standard deviation as volatility. The results show that the averageDCF is positive (about 40), whereas the probability of a negative DCF is about 15%. The decision as to whether toproceed or not with this project will therefore depend on the risk perspective (tolerance) of the decision-maker. Thisexample has also been extended to calculate the distribution of bonus payments on the assumption that a bonus ispaid whenever the net DCF is larger than a fixed amount (such as 50).• 1 2 3 4 5 6 7 8 9 10• Revenue 100 105.0 110.3 115.8 121.6 127.6 134.0 140.7 147.7 155.1• % growth 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%• Average 5% 5% 5% 5% 5% 5% 5% 5% 5%• S.D. (Volatility ) 8% 8% 8% 8% 8% 8% 8% 8% 8%• Fixed Cost 35 35 35 35 35 35 35 35 35 35• Variable Cost 50 53 55 58 61 64 67 71 74 78• Variable Cost 50.3% 50.3% 50.3% 50.3% 50.3% 50.3% 50.3% 50.3% 50.3% 50.3%• min 48% 48% 48% 48% 48% 48% 48% 48% 48% 48%• ml 50% 50% 50% 50% 50% 50% 50% 50% 50% 50%• max 54% 54% 54% 54% 54% 54% 54% 54% 54% 54%• Profit/Cash Flow 15 17 20 22 25 28 32 35 38 42• DCF 12% 139.6• Investment 100• Net DCF (NPV) 39.6 Average N/A• p(<=0) N/A• Bonus limit 50• Bonus 0.0 p(>0) 37.4
IP Valuation - DCF Method• Limitations of DCF Methods Use of DCF based method can become inordinately complex when; In situation where a decision may have to be taken continuously The discount rate need to change continuously varying with underlying IP asset value and time Proponents of use of real option methods for IP valuation argue DCF based methods do not address issue of managerial flexibility
Monte Carlo Method• Monte Carlo method is • Useful in considering intrinsic understood as any uncertainty in underlying earnings potential of IP asset technique of statistical • Based on DCF method sampling employed to • Usually used in income approximate solutions to projection sensitivity analysis quantitative problems. • Addresses a situation where more than one analysis variables• Evaluates how possible future are related e.g. price of outcomes can affect a current product/service and market decision. penetration Assign appropriate probabilities • Each simulation exercise one or to different outcome more variable is changed• Very useful in considering IP with no prior commercialized track record (new or unique in the market)
Monte Carlo Method• Procedural Process • Variables used – Identify inputs (e.g. market – Capital investment needed to size, cost of goods sold) develop a technology – Identify useful life time – Time needed to deliver – Choose discount rate product to the market – Choose minimum, – Potential market size maximum – Potential product/license – Prescribe randomness revenue through distribution (e.g. uniform, normal, • Sensitivity analysis is useful in triangular, etc) and highlighting key uncertainty probability – Enter into model • Identifying such uncertainty – Run sensitivity analysis provide an opportunity to reduce them which greatly improves – Make a decision quality of prediction
Monte Carlo Method Challenges Benefits– More complex in – Able to identify manual computation probability of specific outcome– Prone to be Garbage- – Able to identify variables In Garbage-Out which have influence in (GIGO) the model (e.g. net present value) – Add more flexibility to the model – Obtain clear charts and reports
IP Valuation – Option pricing based methodsOption Pricing- The theory behind option pricing was primarily developed for use in pricing financialBased Method options but can also be applied to a numberReal Options Method (Non- of other situations other than directlyfinancial Options) financial assets. The valuation of IP still inReal (non-financial) option development or being commercialized is onevaluation methods treat the such framework. Option based methodsdevelopment as well as essentially belong in the income basedcommercialization of IP as a series methods category as they too use expectedof options. As the IP is developed future cash flows to measure value.and commercialized, manydecisions about investmenttiming, when to patent, The basic definition of an option is a right butabandonment, direction of not an obligation, at or before some specifiedresearch etc. must be made. The time, to purchase or sell an underlying assetinformation to make these whose price is subject to some form ofdecisions is often not available atthe time of valuation, but random variation. Options are priced usingbecomes available later. The real the Black-Scholes option-pricing model,options method, using the Black- which is a mathematical model for theScholes model, takes into account valuation of options.the flexibility of these futuredecisions.
IP Valuation OPT vs Real Option OPT Real Option• Time to expiry • Time to invest in• Exercise price of the • Investment cost of financial option on share real option project• Current price on the • Present value of underlying share project cash flows• Standard deviation of • Standard deviation of the underlying share return project value (volatility)• Risk free interest rate • Risk free interest rate
IP Valuation – Option Pricing-Based MethodAdvantages Disadvantages It incorporates the valueassociated with the uncertainty The main disadvantage of theand accounts for the flexibility real options method is theinherent in the development of IP. complexity of the model. It isThe value associated with the difficult to understand and theuncertainty of cash flows and theability to manage the evaluation can be costly todevelopment of the IP is perform. Some experts doubt theaccounted for. Like the DCF accuracy of options based modelsmethod it values the stream of for use with real investmentscash flows but it also accounts foracquired knowledge. As a result, it such as IP. The main argumentsprovides a more complete are that option based modelsevaluation than the DCF as it over-value IP through thecaptures more than simply cashflows and static costs. inclusion of non-viable development as well as commercialization decisions.
IP Valuation – Option Pricing-Based Method When are they used?• The real options method is Conclusion applicable when confronting a • Monte Carlo Simulation high degree of uncertainty or uses a random number being in the situation of generation to simulate complexity, adding some reality managerial flexibility, and not all • Possible to generate the information is known at a thousands possible particular time. scenarios• Based on Black-Scholes • Made easy by model used in valuing options on financial assets. availability of software• It is increasingly used in the packages biotechnology as well as pharmaceutical industries and early stage IP developments.
IP Valuation –Market-Based Auction In a perfect auction, there are many potential buyers with perfectMethod information about all aspects of the IP. The value of the IP is determined by theMarket-based methods value price reached through bidding.IP through comparison with Comparable market value The value ofprices achieved in recent the IP is given by comparison with similarcomparable or similar IP comparable independent IP or similartransactions between transactions.independent parties. Comparable royalty rate Market basedObserving the prices of valuation methods may also be based oncomparable assets traded the comparison of royalty rates usedbetween parties in an active when licensing similar IP. Many sectorsmarket gives a value to the often use industry averages as a basis forsubject IP. The idea behind setting royalty rates in licensethese approaches is that the agreements or in establishing damages in litigation. The value of the IP is givenmarket decides the accurate through the comparison of the subject IPprice and therefore the value with the royalty rates in similar licenseof the IP. Market based agreements.methods include IP auctions,comparable market andcomparable royalty ratemethods.
IP Valuation – Market-Based Method Advantages Disadvantages (Cont’d) Observing the market is - There is a risk of comparing the subject IP with other IP which has been traded a relatively but which has still not been utilized in full straightforward stretch. In these cases the IP can be valuation method. It is undervalued. useful to check the - When royalty rates are compared, there validity of other are also some potential distorting approaches. problems. Royalty rates set using returns to R&D costs, return on sales figures orDisadvantages industry averages run the risk of valuing - Lack of IP markets and costs or other factors rather than value. information - Search for a comparable market transaction is futile - Uniqueness of IP makes – Lack of compatibility direct comparison difficult – IP transactions are part of a larger transaction and details are kept extremely confidential, it is never possible to find a transaction
IP Valuation – Market-Based Method When are they used? Market based methods are useful when a market value is required for any given subject IP. These methods require an active market, a comparable exchange of IP between two independent parties and sufficient access to transaction price information. There are limited formal markets for IP and the relevant pricing information is not usually public. As a result, the use of the comparable market value approach to valuing IP is rare. The use of comparable royalty rates are more widespread, especially as databases of industry royalty rates and comparable transaction information have been collated by larger IP right- holders and independent companies offering valuation services. In the future, when IP markets become active and public, the use of market based approaches can become more established.
IP Valuation – Royalty Savings Method• Execution of the Royalty Savings method in a scenario of M&A -- Select an appropriate royalty rate (as a percent of revenue) • Search for agreements regarding the licensing of comparable technologies • Review of the royalties paid as for the use of the comparable technologies, and a comparison relative to the insured patent • Analyze the company’s excess earnings, and hence its ability to pay a royalty and still generate a fair return – Project the expected future annual revenue attributable to the IP; – Calculate the royalties that the owner is relieved from paying by multiplying the projected annual revenue by the royalty rate; – Reduce the royalties by the taxes that would be due on the incremental profit created by the relief from paying royalties; – Discount the after-tax annual royalty savings to present value at the appropriate discount rate; – Sum the discounted after-tax royalty savings to estimate the value of the Intellectual Property.
IP Valuation – Royalty Savings Method• Execution of the Royal Savings Method under a scenario of owning IP and in a development process for technological feasibility or market commercialization . – The application of this approach is in the same manner as detailed in the M&A scenario, with the exception of probability weighting the expected future royalty income to reflect the uncertainty associated with the project achieving technological feasibility. – Application of this approach assumes that the owner would license the rights to the IP in exchange for future royalty payments to a third party during or at the end of the R&D phase, rather than commercializing and marketing the completed product using its own resources.
IP Valuation – Pay-off Method (POM)• POM is an analysis method that is suitable for cases, where the value information is in the form of scenarios. It is about the way to create a distribution from values of, usually three value scenarios, minimum possible value scenario, and maximum possible value scenario.• Observe that the best guess scenario is the most likely one and assigning it full degree membership in the set of expected outcome. Decide that the maximum possible (optimistic) and the minimum possible (pessimistic) scenarios are the upper and lower bounds of the distribution. Do not consider values higher than the optimistic scenario and lower than pessimistic scenario. Assume the shape of the POM distribution is triangular. Calculate a real option value for the patent under analysis directly from the pay-off distribution by using fuzzy pay-off method for real option valuation.
IP Valuation – Qualitative Evaluation Method• Qualitative evaluation methods framework for evaluating and provide a value guide for the strategically managing patents. subject IP through the rating It consists of five categories: and scoring of different factors legal, technology, market, related to the IP. These factors finance and strategy, each of which has 5-10 associated or “value indicators” can index questions. Each question influence the value of the IP relates to a different value both positively and negatively. indicator. Each question is rated Patent information related 1-5 according to the patents value indicators used to strengths and weaknesses. suggest the existence of strong Together, the 40 or so value correlation between patent indicators form a whole picture value and standardized of the patent and its relative indicators observable in patent risks and opportunities. These information documents. are then displayed in various Evaluation of value indicators: tables and graphical forms to IPScore is used to value be used by management for technology, patents and patent making strategic decisions. portfolios internally, within companies. The tool provides a
IP Valuation – Qualitative Evaluation Method• Advantages • Disadvantages - Simplicity is the main advantage - Valuing IP using patent information of patent information related and related value indicators have many non-patent value indicators. Once drawbacks. For example simply counting the relevant information has been citations avoids taking a stand on questions such as how and why citations researched and is available in a arise and what type of information they useable form its relatively easily to convey. Focusing on simple counts classify and evaluate the IP without deliberately ignores any added the need for complex methods. information within the network of citations. Using value indicators as a proxy - Data for the evaluation is often for value is only as useful as the level of publicly available. With sufficient expertise of those who are conducting the expertise it is possible to value IP valuation. One must also decide which belonging to other parties. As a indicators are relevant to the value of a result, these qualitative methods particular IP, and which are not. The quality and realism of the qualitative facilitate the comparison and evaluation in IPScore, for example, is ranking of IP within a company’s greatly dependent on the quality of own portfolio or against information used. competitors’ IP.
To optimize the value Cost savings canIP Strategy of IP assets, value creation function be achieved if granted tax can be simply incentives and formulated where other taxΣ Profiti profitability rests upon price and privileges, and due to economy of cost mechanism.= (Pricei – Costi) The price will be scale and skilled work force. rising on account x Volumei of strategic management such as product uniqueness, product differentiation, monopolistic competition, higher barrier to entry, innovation and branding.
IP StrategySWOT analysis provides Qualitative evaluationself assessment through methods are most ofteninternal audit that reveals used for the purpose ofstrengths and weaknesses, internal IP management.while taking opportunities They are most useful forfrom the external factors comparing, categorizinglike technological progress, and ranking IP within agovernment laws and portfolio or vis-à-visregulation, life styles, competitors’ IP. They aredemography, political and also useful for assessingeconomic situation; and the risks and opportunitiesescaping the risks from IP of IP.infringement, the act ofnot pursuing IPcircumvention andplagiarism.
IP AuditIP audit is a strategicexercise where IP assets are Taxonomy can assist theto be inventoried and then Company in determining themapped against the current extent to which current and future products arebusiness and future protected (e.g. to identifystrategic priorities. Within the existence of strategican audit process through a gaps in the portfolio andclassification or taxonomy, pockets of non-core IP), andIP assets will be categorized further performingin manner that actionable competitive assessmentinformation is provided for (e.g. to determine theIP asset optimization by position and trajectory of rivals’ portfolios).means of technical analyses(e.g. SWOT).
understanding IP assessment entire business competitive strategy (e.g. SWOT,IP Audit (cont’d) to align IP strategy with GAP, trajectories) business goals opportunityIP audit to identify key target (e.g. licensing and sale,process which markets, products and utilization across SBUs) technologiesis used to IP assets and risk (e.g. litigation) identification process andsupport the IP To ensure not missing all control (e.g. best practices,business plan relevant IP assets strategic patenting,needs these IP assets categorization licensing compliance) Usingessential steps taxonomy to assess theof action: strength and relevancy of IP