1. Intellectual Property Valuation in Healthcare
Although the principals explained in this article apply to other fields, the authors
have a combined 50+ years in healthcare appraisal. Lets do some background.
We first must look at the market, measurements, opportunities, and outlook.
Healthcare technology can be broken down to Connectivity, Commerce, Content,
and Communities in the business areas. Additionally, Life areas such as:
1. Biotech (genomics, proteomics, platform/drug delivery, medical devices &
therapies/treatments)
2. Agritech (food science, animal feed, horticulture, fertilizers)
3. Chemistry (combinatorial, synthesis, processes/reactions)
4. Veterinary Science (diagnostics, therapies, vaccines).
5. Material (composites, plastics, metals/alloys, liquids/solutions, ceramics,
plasma)
6. Environmental (meteorology, oceanography, geology)
7. Optics (lasers, spectroscopy, x-ray)
8. Engineering (consumer products, mechanical engineering, acoustics,
energy
9. Communications (fiber, switches, wireless)
10. Software (biomedical/bioinformatics database, educational, financial, os,
algorithms)
11. Hardware (robotics, storage)
12. Electrical engineering (sensors, super-conductors and semi-conductors).
The appraiser must look at the market opportunity, endgame, and barriers to
entry, revenue models, success factors, future outlook and other key metrics.
Four areas to evaluate are:
1. The technology’s scalability (will it go from bench top to full scale?)
2. Its technical viability (will it actually work as advertised?)
3. Its business viability (will it make money?)
4. It’s political suitability (will politics kill the project?)
INVENTORY OF METHODS FOR VALUING HEALTHCARE TECHNOLOGY
METHOD ADVANTAGE DISADVANTAGE WHEN
25% Rule (1) Simple Not considered Quick/Rough
-potential profitability IP at
-risk/fair ROI commercial
stage
Market Very credible Assumes-industry norm Preferred if
Is correct, active mkt disadvantage
W/ similar tech, cos. W/ addressed
Similar product, high cost
Of data
Return on Sales Quick Value stream not Est. Ind.

2. Est. Ind. norm exist considered, profit norms, sales
allocation difficult projections
Investmt risk not agreed on
considered
Cost Quick/definable Value/Revenue not Method used
related, imprecise, in negotiation
Good for tech beyond
semicommercial scale
Auction Identifies willing Less control of willing Many buyers
Buyer, no calc. Seller, Buyer may not low negot.
commit to commercial- cost for seller
Ization or be compatible Targets up
front pmts.
Income/DCF Most accepted. Knowledge of competit. Unique tech
Cash flow from all envir. Difficult data acq. applied at
potential rev. on market and time any stage
Considers stage consuming Both have
of proj. dev. licensing
ability
Risk Hurdle Rate Math. risk calc. Intensive math calc. Like Investmt
Risk related to Full tech potential Banker, Fin.
dev. Stage not addressed inv. focus,
Early stage
project
Technology Internal consensus Req. expert teams For internal
Factor Incr. cash flow Must know compet. Val., One
not tot. rev. Detailed bus. & mkt. Patent or
Methodical plans required many
Easy, Bus. Ent.
Value
Monte Carlo Powerful for Requires computer and Line of bus.
addressing contribution margin valuation,
cash flows on understanding, difficult portfolio
line of business data acquisition analysis
CFROI Forward looking Req. knowledge of Portfolio
& integrated cap. Varying cap rates analysis
rate as products mature
Difficult data acq.

3. The above table abstracted from Valuing Intellectual Properties by Sam Khoury,
PhD., Dow Chemical Co. and amended by Wier and Holdren.
(1) Calculates a royalty as 25% of the gross profit, before taxes, from the
enterprise operations in which the licensed IP is used.
Macroeconomics dictates that a portfolio approach be taken, i.e. there are many
more tech-transfer opportunities than buyers (estimates are that NASA only finds
licenses for 5% of its technologies). These should be approached like an option
which value depends on the strike price of the stock, the time remaining until the
option expires and it’s volatility. That is why the Black-Scholes formula is the
starting point for most valuations.
The Black-Scholes formula however requires strict adherence to many
assumptions the most critical being that the option can only be exercised at
expiration. This does not fit the U.S. market for options or the underlying
similarity that technology may be resold at any point. Most healthcare
technology involves high initial investment or “sunk” cost. Witness the cost to
develop new drugs. Once the sunk cost is funded the technology can be resold,
i.e. the option can be exercised for a new player to realize future revenue. An
alternative method will be a better and easier predictor of value.
Preliminary invention evaluation is the first step because companies license
revenues not technology and only 2% of inventions ever make money. Do your
market research first, making the Internet your first stop. Are there similar
products, if so, then search magazines, call trade associations, e-zines,
newsgroups, Wall Street research reports, and even librarians are a big help.
Next do a patent search at www.uspto.gov/web/offices/ac/ido/ptdl/ptdlib.htm,
additionally IBM at www.Patents.ibm.com. A patent attorney will charge $500
for this search. Is this Transfer out (transfer technology from the government to
business or from a university) or ‘in’ from the inventor/author to business.
Healthcare technology requires a big investment for development (sunk cost) but
once developed it can be sold for very little incremental costs. Appraisers should
realize at this point, this is a valuation of a potential profit center not a business.
Licensing valuation and particular tech transfer are even more difficult because
they often occur between entrepreneurs who have the resources (or universities
that can’t market) and a larger company that has the research and development,
production, human resources and marketing capability to make the best use of
the technology. The appraiser should review the scope of the grant, term and
renewal, performance standards and quotas, payment to licensor, technical
assistance, training and support and warranties and make non-financial
judgments on the technology PRIOR to appraisal techniques that follow.
Appraisers should also be thoroughly familiar with healthcare rates of return.
Following is a table used by Hambrecht & Quist venture capital as targeted rates
of return requirements.

4. Development Stage Req. Rate of Return
Discovery 80%
Preclinical 60%
Phase I Clinical Trials 50%
Phase II Clinical Trials 40%
Phase III Clinical Trials 25%
New Drug Application 22.5%
Product Launch 17.5-15%
In the usual business appraisal assets are identified and usually valued through a
known comparative market (real estate, common public stocks) or on an
analyzed cash flow basis. Often these market comparisons are averaged to
arrive at a value. Statistically this is the mean value. With healthcare technology
revenue models may change, success factors may change and other key metrics
may change.
Because these multivariable metrics can change the assumption of averages will
be wrong on the average! This is when a Monte Carlo simulation varying
investment, capacity, demand, price, sales, revenue and profit will provide
perhaps the best theoretical view of the future. The appraiser will have his work
cut out to get this information from management interviews or any of the many
previously mentioned sources.
As another statement of the multiple variables look at what venture capital
requires for investment. Market opportunities must be 500 million, the endgame
must be defined (lower prices, footprint, improved product, system integration),
barriers to entry defined (customer acceptance, proprietary), revenue defined
(license fees, subscription, transaction fee), success factors (system integration,
adoption, fulfillment, value-added), defined metrics (demographics, cost, paid
subscriber), and future outlook (data warehouses, biometric data access, vertical
markets, global competition, substitutes). Having heard hundreds of pitches the
VC wants a real possibility of ROI (50%/5 years), defined exit strategy, a
management team that can exploit the technology, a large and growing market, a
compelling value proposition, & clear path to profitability (no white-papers).
There are four widely used Monte Carlo software packages that can assist the
appraiser in this analysis. They are XLSim, INSIGHT.XLA, @RISK and Crystal
Ball. To get an interactive idea of how wrong averages can be go to
http://analycorp.com/uncertainty/main.htm for XLSim Excell spreadsheet Monte
Carlo analysis of exactly the variables first mentioned above.

5. So the problem is to
Identify areas related to the technology best suited for transactions
Identify users/companies who may be interested in technologies or who
are developing a competitive technology
Define synergies in IP portfolios and technologies
Make sure IP protection is in place and has broad claims
Use all resources, on-line intellectual property marketplaces, cold calling,
technology memorandums, and IP auctions
Talk to industry participants, users, suppliers and analysts
A final note, remember tulip mania, the emperor’s clothes and PT Barnum’s
rules…simply put early stage technology is RISKY.
There are 2.5 million big ideas per year in the U.S. From them come 500,000
business plans, but only 15,000 of these receive non-VC funding. Another 3,000
to 5,000 receive venture funding, and of these only 600 make it big (defined by
acquisition or IPO).
So discount accordingly…good luck!
Richard C. Holdren has appraised and brokered medical practices and medical
related companies for over 25 years including founding several public physician
management companies. Rick has numerous publications and has provided
testimony in landmark medical valuation cases. farmteam@houston.rr.com
281-496-7777
Thomas P. Wier, III, CPA, Certified Valuation Analyst, has spent 25 years valuing
health care businesses with a primary focus on business sales at fair market
value or in bankruptcy. twier@houston.rr.com 281-531-8002