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 Environment of TTO valuations
 The key to valuation
 Valuation approaches
    › Rules of thumb
    › Comparables
    › ‘Scientific’ approaches
   Section 9 of IP Handbook
    › http://www.iphandbook.org/handbook/ch09/
   Anything written by Richard Razgaitis
   Three examples of technologies:
    › US 6,684,702 – Flow Duct Obstruction
    › US 6,386,217 – Axillary Crutch
    › US 6,048,850 – Method of Inhibiting
      Prostaglandin Synthesis in a Human Host
   For each example:
    › Patent abstract, diagrams, claims
   Each is a real TTO valuation issue
100.00


 90.00


 80.00


 70.00


 60.00


 50.00


 40.00


 30.00


 20.00


 10.00


  0.00


-10.00



McMaster University FY97 to FY06, Net
Revenues/Disclosure over Disclosures, Max revenue=100
 What happened to Pareto?
  (80/20)
 More likely:
    › Long Tail distribution (98/2)
   Valuation implications
    › Do we make any money except
      on a home run?
    › Most valuations will be wrong
    › A lot of money in thin lines
    › But watch out for the expenses
   Process control
    › Want to concentrate on big winners
   Help with subsequent negotiations
    › Knowledge of the market
    › Good valuations = Good deals
 Helps set targets
 Classic Definition of Valuation
    › Between willing buyer and seller
    › Having full possession of all relevant facts
Technology           Patents
                      Know-how
                      Expertise
Exclusivity          Yes / No
Confidentiality      Yes / No
Licence Back         Yes / No
What Plan?           Spin-off
                      Licence
                      Other
   Key to value: the Market
    › The ‘value’ proposition
 Who decides to buy?
 e.g.: who decides on choice of a
  specific drug for a condition?
 Q: For an example, what are our
  relevant markets?
 Q: Are there other markets we should
  consider?
   Before anyone can buy product, what
    still needs to be done?
    › Regulatory approvals
    › System creation
 Q: for an example, which will require
  approvals? Will approvals be
  maintained?
 Q: what still needs to be done to
  generate revenues?
 Very common belief that research $$
  spent is the value
 Economics analysis
    › Value of sunk costs?
    › If there is no recovery on
     research costs value is ZERO
   Costs can create a
    real expectations
    problem
 Start-up Companies
 Internal use
 Traditional licensing:
    › Rules of thumb
    › Comparables
    › ‘Scientific’ or ‘B School’ approaches
 e.g.: VC invests $20M in seed capital in
  company based on technology; subsequently
  company generates $50M on an initial public
  offering (IPO)
 What is value of technology?
 Analysis:
    › What does university get out of the company?
    › What do inventors get?
    › Does university still share with inventors?
    › Is there sponsored research coming in from
      company?
   Depends on each individual negotiation
    › Is there a double dip? (i.e. both shares and a
      royalty)
    › Only real determinant is post dilution
      percentage left
   Some suggestion that technology value
    may be as little as 1 or 2% pre-IPO
   Two types:
    › Institution wants to sell a product
    › Technology to be added to defensive portfolio
   Sales
    › Isolated situations
        e.g.: Isotope sales;
         Medical instruments
    › What to do with sharing
      formulae?
       How to calculate expenses
 Technology will be added to portfolio to
  enable some other technology or to overcome
  ‘patent thicket’
 Good situation is ‘patent pooling’
    › See: Parish and Jargosch, AUTM Journal 2003
    › e.g. of MPEG pool
    › Future of bio: Patenting to permit use; e.g. SARS
   Bad situation is where company wants to use it
    defensively
    › Q: Can university even do this type of deal?
    › What is appropriate price?
   Rules of Thumb
    › Usually based on specific industries
    › May be confused with comparable rates
   Most used Rule of Thumb:
    › The Razgaitis Rule aka The Rule of Quarters
   Need to be able to analyze what is the ‘incremental’
    margin before G&A
   Rule suggests that ¼ of that increment should be
    licensors
   In practice see anywhere from 10 to 50%
   Best suited to clear commercial products
Before             After

  Sales –             $100              $200
  CGS –                $50               $70
  Margin –             $50              $130
  G&A –                $20               $20

Net profit             $30              $110

  Incremental Margin $80; therefore, royalty would
  be $20 or 10% of Sale Price
 Q: of 3 examples, which is (are) suited to
  ‘Rule of Quarters’ analysis?
 How to price the royalty?
 The realities of the target industry
 More information on this: LES
   The 50% Rule:
    › At point of product introduction, 50% of total
      risk remains
    › IF inventing org brings product to
      introduction stage, entitled to 50% of profits
    › Therefore, if commercializing org does part
      of product introduction entitled to more than
      50% of profits
   More a starting position for discussions
   Some industries have ‘standard’ rate
    › Shrink-wrap software in 25 to 50% range
    › Some types of pharmaceuticals
   What is the base?
    › Stacking royalties problem
   How to get information on comparable
    rates?
    › Colleagues
    › Subscriptions to Newsletters
   More similar deals is better
   But are the deals the same?
    › Industry segments; Margins; Use of IP
    › Licensing terms: exclusive; non; options
   Risk analysis
    › What is usual risk profile of our technologies?
      Compared to industrially-generated
      technologies?
   Certainty analysis
    › Similar to risk but one component separate:
      certainty of measurement
 Different   types of Risk
  › Technology: can we develop the
    technology as envisaged
  › Market: will the market adopt the
    technology
  › IP issues: will our IP protection hold up
  › Societal Norms: will our technology
    continue to be accepted?
   Internet: Publicly-filed information like SEC
    and SEDAR information
    › www.sec.gov (look for EDGAR)
   Court and other public records
    › http://pacer.psc.uscourts.gov/
   Specialty information
    › www.10kwizard.com
    › www.fda.gov
   Company’s own websites and competitors
   Leading Fed Ct decision
   Court established factors to consider in
    establishing a ‘reasonable’ royalty
   15 Factors include:
     › Existing royalty rates for licensor and licensee
     › Exclusivity; territory; field of use
     › Practice in licensing; relationship between
       parties; potential related sales
     › Duration and term of patent


1: Georgia-Pacific Corp. v. U.S. Plywood-Champion Papers, 318 F. Supp. 1116, (S.D.N.Y.
1970), modified, 446 F.2d 295 (2d Cir. 1971).
 Discounted Cash Flow (DCF) and
  Net Present Value (NPV)
 Real options theory
 Auctions
 But first some arithmetic!
   What are assumptions that go into a DCF or
    NPV calculation?
    ›   Market size
    ›   Percentage of market
    ›   Product price
    ›   Royalty Rate
    ›   Discount (interest rate)
   How precise is any of these five
    assumptions?
    › The lowest of these is the most precision our
        answer can have!
   Using probability distribution, which is
    best estimate of discount (interest) rate?




                     σ = small
   Using probability distribution, which is
    best estimate of discount (interest) rate?




                     σ = large
   How much is 2 ± 3 times 5 ± 5 ?
    › -1 x 10 ( -10) to 5 x 10 (+50)
   More importantly, how much is:

                  times                      = ??




   More simply: is the result the fat or skinny
    distribution?
    › Answer: it is an even broader distribution
 If you’re lucky you have maybe 1 digit of
  precision in your answer!
 The best you are likely to get in precision is
  order of magnitude
    › i.e. $106 vs. $107
 Any sensitivity analysis going to result in very
  broad spread for the answer
 Put both of these conclusions together:
    › Value for just about anything is going to be
      somewhere between minus $106 and plus $108!
   Based on possible cash flows during life of
    technology
    › Usually patent life
   Likely distribution:
   Create Annual Cash Flows
    › Market size
    › Percentage of market
    › Product price
    › Royalty rate (or CGS)
   Then need to establish the appropriate
    discount rate
   Relationship between rate of return and risk:

         0




return

                                     Company Ave Cost of Capital


             Risk-free rate – T-bills + Inflation: ~7%

                                                         risk
   Need to know appropriate average cost of
    capital
   Then add risk factors:
    › Technology: can we develop the
      technology
    › Market: will the market adopt the
      technology
    › IP issues: will our IP protection hold up
    › Societal Norms: will our technology continue
      to be accepted?
   Superimpose NPV at, say, 15%
   Sensitivity Analysis at 7%, 15% and 30%
   Cumulation at 15%




   Note break-even point
 Discount rate is market driven
 AUTM TTM (Part X, Ch. 2)
    › Low risk rates (known product): 15 to 20%
    › New product, known manufacturing ability: 25% to
      35%
    › New product, new manufacturing, known business:
      30% to 40%
    › New business, product ready (no R&D): 40% to 50%
    › New business, product needs R&D: 50% to 70% and
      up
   Q: for three examples, what discount rate?
 Despite name not a ‘bet the bank’
  strategy
 Uses probability distributions to create a
  new probability distribution
 Hand calculation difficult
 Software implementations:
    › Crystal Ball:   www.crystalball.com
    › @RISK:          www.palisade.com
   Based on Black-Merton-Scholes options
    analysis
   Best example is stock market options
   Why pay anything for an Oil future at $200
    per barrel 12 months from now?
   Actual formula:




   Time sensitive
   Also depends on volatility
    › Volatility related to risk
    › Risk up  Volatility up  Option value up
   More information: Black-Scholes on
    Wikipedia
 Theoretically, the best way to obtain the
  highest value
 Depends on exposure to largest number of
  potential buyers
 cf. success of eBay
 In patent field:
    › Ocean Tomo – Summer 2009 IP Catalogue online
    › Results from last auctions not like an Art Auction
       Will grow over time as bidders understand process
   Prediction: will become a larger force as
    business understands IP better
   You have prospects for
    sales efforts
    › From brainstorming markets
    › From comparables research
   You’re ready to negotiate
    › You have ideas on:
       Field and Territory of Use
       Exclusivity or not
       Comparable rates
       etc. etc.
   Richard has spent $500,000 developing a
    new way of arranging an electric steel-
    making furnace which increases the
    efficiency. R approaches UniSteel about
    licensing the technology.
   UniSteel is interested and figures that they
    will save about $100,000 per year in costs.
   What issues would you consider in valuing
    the technology?
   M University has been asked by a new faculty hire, Professor Roe,
    to take on the commercialization of a technology developed by
    Professor Roe previously. The technology is currently 100% owned
    by R Inc. which is, in turn, 100% owned by Prof. R and his wife. M is
    being offered shares in R Inc. to take on the project.
   The technology is a new means of measuring someone’s blood
    alcohol level by a skin testing device. A prototype has been
    developed by R Inc. at a cost of $50,000. It is expected that it
    might cost $2,000 per unit to build a production model. The
    current number of units of breathalyzers sold in North America is
    4,000 per year at a retail cost of $2,500. There are two major
    competitors.
   What is an appropriate percentage of shares in R Inc. that M
    Univ. should receive? What other information would you like to
    receive? How would you obtain it?
   You have heard that patent law’s ‘first sale doctrine’
    does not allow you to collect ongoing royalties from
    a machine that you sell outright.
   You have invented a new patented machine for
    conducting laser eye surgery. The machine has a
    useful life of 10,000 operations which normally sell (by
    the eye surgeon) for $900 per operation. The
    machine costs you $175,000 to build and $40,000 per
    year to maintain for the 10 years useful life of the
    machine.
   Discuss an appropriate sales or licensing strategy
    and pricing model to maximize your financial returns.
 Valuation is not an exact science!
 Valuation can be a good start in getting
  information you will need at various
  stages of process
 Remember the ‘long tail’!
 The answer is likely going to be between
  -$105 and $108 !
Marcel D. Mongeon
             +1 (905) 390 1818
marcel@mongeonconsulting.com

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Technology Valuation Methods

  • 1.
  • 2.  Environment of TTO valuations  The key to valuation  Valuation approaches › Rules of thumb › Comparables › ‘Scientific’ approaches
  • 3. Section 9 of IP Handbook › http://www.iphandbook.org/handbook/ch09/  Anything written by Richard Razgaitis
  • 4. Three examples of technologies: › US 6,684,702 – Flow Duct Obstruction › US 6,386,217 – Axillary Crutch › US 6,048,850 – Method of Inhibiting Prostaglandin Synthesis in a Human Host  For each example: › Patent abstract, diagrams, claims  Each is a real TTO valuation issue
  • 5. 100.00 90.00 80.00 70.00 60.00 50.00 40.00 30.00 20.00 10.00 0.00 -10.00 McMaster University FY97 to FY06, Net Revenues/Disclosure over Disclosures, Max revenue=100
  • 6.  What happened to Pareto? (80/20)  More likely: › Long Tail distribution (98/2)  Valuation implications › Do we make any money except on a home run? › Most valuations will be wrong › A lot of money in thin lines › But watch out for the expenses
  • 7. Process control › Want to concentrate on big winners  Help with subsequent negotiations › Knowledge of the market › Good valuations = Good deals  Helps set targets  Classic Definition of Valuation › Between willing buyer and seller › Having full possession of all relevant facts
  • 8. Technology  Patents Know-how Expertise Exclusivity  Yes / No Confidentiality  Yes / No Licence Back  Yes / No What Plan?  Spin-off Licence Other
  • 9. Key to value: the Market › The ‘value’ proposition  Who decides to buy?  e.g.: who decides on choice of a specific drug for a condition?  Q: For an example, what are our relevant markets?  Q: Are there other markets we should consider?
  • 10. Before anyone can buy product, what still needs to be done? › Regulatory approvals › System creation  Q: for an example, which will require approvals? Will approvals be maintained?  Q: what still needs to be done to generate revenues?
  • 11.  Very common belief that research $$ spent is the value  Economics analysis › Value of sunk costs? › If there is no recovery on research costs value is ZERO  Costs can create a real expectations problem
  • 12.  Start-up Companies  Internal use  Traditional licensing: › Rules of thumb › Comparables › ‘Scientific’ or ‘B School’ approaches
  • 13.  e.g.: VC invests $20M in seed capital in company based on technology; subsequently company generates $50M on an initial public offering (IPO)  What is value of technology?  Analysis: › What does university get out of the company? › What do inventors get? › Does university still share with inventors? › Is there sponsored research coming in from company?
  • 14. Depends on each individual negotiation › Is there a double dip? (i.e. both shares and a royalty) › Only real determinant is post dilution percentage left  Some suggestion that technology value may be as little as 1 or 2% pre-IPO
  • 15. Two types: › Institution wants to sell a product › Technology to be added to defensive portfolio  Sales › Isolated situations  e.g.: Isotope sales; Medical instruments › What to do with sharing formulae?  How to calculate expenses
  • 16.  Technology will be added to portfolio to enable some other technology or to overcome ‘patent thicket’  Good situation is ‘patent pooling’ › See: Parish and Jargosch, AUTM Journal 2003 › e.g. of MPEG pool › Future of bio: Patenting to permit use; e.g. SARS  Bad situation is where company wants to use it defensively › Q: Can university even do this type of deal? › What is appropriate price?
  • 17. Rules of Thumb › Usually based on specific industries › May be confused with comparable rates  Most used Rule of Thumb: › The Razgaitis Rule aka The Rule of Quarters  Need to be able to analyze what is the ‘incremental’ margin before G&A  Rule suggests that ¼ of that increment should be licensors  In practice see anywhere from 10 to 50%  Best suited to clear commercial products
  • 18. Before After Sales – $100 $200 CGS – $50 $70 Margin – $50 $130 G&A – $20 $20 Net profit $30 $110 Incremental Margin $80; therefore, royalty would be $20 or 10% of Sale Price
  • 19.  Q: of 3 examples, which is (are) suited to ‘Rule of Quarters’ analysis?  How to price the royalty?  The realities of the target industry  More information on this: LES
  • 20. The 50% Rule: › At point of product introduction, 50% of total risk remains › IF inventing org brings product to introduction stage, entitled to 50% of profits › Therefore, if commercializing org does part of product introduction entitled to more than 50% of profits  More a starting position for discussions
  • 21. Some industries have ‘standard’ rate › Shrink-wrap software in 25 to 50% range › Some types of pharmaceuticals  What is the base? › Stacking royalties problem  How to get information on comparable rates? › Colleagues › Subscriptions to Newsletters
  • 22. More similar deals is better  But are the deals the same? › Industry segments; Margins; Use of IP › Licensing terms: exclusive; non; options  Risk analysis › What is usual risk profile of our technologies? Compared to industrially-generated technologies?  Certainty analysis › Similar to risk but one component separate: certainty of measurement
  • 23.  Different types of Risk › Technology: can we develop the technology as envisaged › Market: will the market adopt the technology › IP issues: will our IP protection hold up › Societal Norms: will our technology continue to be accepted?
  • 24. Internet: Publicly-filed information like SEC and SEDAR information › www.sec.gov (look for EDGAR)  Court and other public records › http://pacer.psc.uscourts.gov/  Specialty information › www.10kwizard.com › www.fda.gov  Company’s own websites and competitors
  • 25. Leading Fed Ct decision  Court established factors to consider in establishing a ‘reasonable’ royalty  15 Factors include: › Existing royalty rates for licensor and licensee › Exclusivity; territory; field of use › Practice in licensing; relationship between parties; potential related sales › Duration and term of patent 1: Georgia-Pacific Corp. v. U.S. Plywood-Champion Papers, 318 F. Supp. 1116, (S.D.N.Y. 1970), modified, 446 F.2d 295 (2d Cir. 1971).
  • 26.  Discounted Cash Flow (DCF) and Net Present Value (NPV)  Real options theory  Auctions  But first some arithmetic!
  • 27. What are assumptions that go into a DCF or NPV calculation? › Market size › Percentage of market › Product price › Royalty Rate › Discount (interest rate)  How precise is any of these five assumptions? › The lowest of these is the most precision our answer can have!
  • 28. Using probability distribution, which is best estimate of discount (interest) rate? σ = small
  • 29. Using probability distribution, which is best estimate of discount (interest) rate? σ = large
  • 30. How much is 2 ± 3 times 5 ± 5 ? › -1 x 10 ( -10) to 5 x 10 (+50)  More importantly, how much is: times = ??  More simply: is the result the fat or skinny distribution? › Answer: it is an even broader distribution
  • 31.  If you’re lucky you have maybe 1 digit of precision in your answer!  The best you are likely to get in precision is order of magnitude › i.e. $106 vs. $107  Any sensitivity analysis going to result in very broad spread for the answer  Put both of these conclusions together: › Value for just about anything is going to be somewhere between minus $106 and plus $108!
  • 32. Based on possible cash flows during life of technology › Usually patent life  Likely distribution:
  • 33. Create Annual Cash Flows › Market size › Percentage of market › Product price › Royalty rate (or CGS)  Then need to establish the appropriate discount rate
  • 34. Relationship between rate of return and risk: 0 return Company Ave Cost of Capital Risk-free rate – T-bills + Inflation: ~7% risk
  • 35. Need to know appropriate average cost of capital  Then add risk factors: › Technology: can we develop the technology › Market: will the market adopt the technology › IP issues: will our IP protection hold up › Societal Norms: will our technology continue to be accepted?
  • 36. Superimpose NPV at, say, 15%
  • 37. Sensitivity Analysis at 7%, 15% and 30%
  • 38. Cumulation at 15%  Note break-even point
  • 39.  Discount rate is market driven  AUTM TTM (Part X, Ch. 2) › Low risk rates (known product): 15 to 20% › New product, known manufacturing ability: 25% to 35% › New product, new manufacturing, known business: 30% to 40% › New business, product ready (no R&D): 40% to 50% › New business, product needs R&D: 50% to 70% and up  Q: for three examples, what discount rate?
  • 40.  Despite name not a ‘bet the bank’ strategy  Uses probability distributions to create a new probability distribution  Hand calculation difficult  Software implementations: › Crystal Ball: www.crystalball.com › @RISK: www.palisade.com
  • 41. Based on Black-Merton-Scholes options analysis  Best example is stock market options  Why pay anything for an Oil future at $200 per barrel 12 months from now?
  • 42. Actual formula:  Time sensitive  Also depends on volatility › Volatility related to risk › Risk up  Volatility up  Option value up  More information: Black-Scholes on Wikipedia
  • 43.  Theoretically, the best way to obtain the highest value  Depends on exposure to largest number of potential buyers  cf. success of eBay  In patent field: › Ocean Tomo – Summer 2009 IP Catalogue online › Results from last auctions not like an Art Auction  Will grow over time as bidders understand process  Prediction: will become a larger force as business understands IP better
  • 44. You have prospects for sales efforts › From brainstorming markets › From comparables research  You’re ready to negotiate › You have ideas on:  Field and Territory of Use  Exclusivity or not  Comparable rates  etc. etc.
  • 45. Richard has spent $500,000 developing a new way of arranging an electric steel- making furnace which increases the efficiency. R approaches UniSteel about licensing the technology.  UniSteel is interested and figures that they will save about $100,000 per year in costs.  What issues would you consider in valuing the technology?
  • 46. M University has been asked by a new faculty hire, Professor Roe, to take on the commercialization of a technology developed by Professor Roe previously. The technology is currently 100% owned by R Inc. which is, in turn, 100% owned by Prof. R and his wife. M is being offered shares in R Inc. to take on the project.  The technology is a new means of measuring someone’s blood alcohol level by a skin testing device. A prototype has been developed by R Inc. at a cost of $50,000. It is expected that it might cost $2,000 per unit to build a production model. The current number of units of breathalyzers sold in North America is 4,000 per year at a retail cost of $2,500. There are two major competitors.  What is an appropriate percentage of shares in R Inc. that M Univ. should receive? What other information would you like to receive? How would you obtain it?
  • 47. You have heard that patent law’s ‘first sale doctrine’ does not allow you to collect ongoing royalties from a machine that you sell outright.  You have invented a new patented machine for conducting laser eye surgery. The machine has a useful life of 10,000 operations which normally sell (by the eye surgeon) for $900 per operation. The machine costs you $175,000 to build and $40,000 per year to maintain for the 10 years useful life of the machine.  Discuss an appropriate sales or licensing strategy and pricing model to maximize your financial returns.
  • 48.  Valuation is not an exact science!  Valuation can be a good start in getting information you will need at various stages of process  Remember the ‘long tail’!  The answer is likely going to be between -$105 and $108 !
  • 49. Marcel D. Mongeon +1 (905) 390 1818 marcel@mongeonconsulting.com