IP Valuation

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Intellectual Property: Valuation, Assessment and Audit

Project Presentation

Intellectual Property Management

IIM Lucknow, Noida Campus

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Agenda

The 9 reasons for valuing IP The Basics

Fundamental Principles The three approaches to value IP

Specific IP Valuation Patents Trademarks and Brands

IP Risk Assessment Damage Assessment IP Audit

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Why Value IP?

1. Exploitation, as any other asset.

A basis for negotiations involving sale, licensing or exchange of IP.

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Why Value IP?

2. For Taxation

Transfer of IP from parent to subsidiary company. Donation of IP as a tax-free gift to some

institution.

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Why Value IP?

3. For raising funds and securing Financing

IP may serve as a collateral with banks

IP value helps startups raise venture capital

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Why Value IP?

4. Profit sharing - when there are multiple IP owners

As in a R&D consortium that involves multiple companies contributing - to determine the allocation of net income.

Joint Ventures and Strategic Partnerships

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Why Value IP?

5. Assessing damage claims in a dispute, infringement or breach of contractual rights.

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Why Value IP?

6. Financial Reporting

Indian Accounting Standard on Intangibles

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Why Value IP?

7. Transfer Pricing

What price is right, for transfer of patents, licensing a trademark, within the firm?

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Why Value IP?

8. In any restructuring or liquidation procedure

As in mergers, spin-offs or bankruptcy

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Why Value IP?

9. IP drives market Value of Stock

Not only for smaller startups without significant real assets, but increasingly for larger companies such as IBM

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Basic Principles of Asset Valuation

The value of an asset is based on the future returns that are expected to be generated by that asset

Returns in the future are worth less than returns now (“time value of money”)

Future returns are uncertain (or ‘risky’) Intangible assets can affect the returns and/or the risks of cash flows

Cash flows

Time

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IP Valuation - Approach

The nature of the asset doesn’t changes the fundamental principle of valuation.

Determine basis/context of

valuation

Select and apply appropriate valuation

methodologies

Identify asset(s) / understand rights

Open market value

Value in use

Fair value

Liquidation value

Book value

Copyright

Database

Trade mark / passing off

Patent

Know-how / trade-secrets

Design right

Calculate the incremental value added by the IP

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But Valuing IP is a bit harder …

1. IP doesn’t comes alone

Intangibles are often composite assets. Value is realised in combination with other assets (tangible and intangible)e.g. brand – value in combination of trade marks (registered; rights in passing off) trade dress copyright logo get-up recipes/formulaen.b. trade mark licence v. brand v. branded business

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Valuing IP is a bit harder

2. Value may depend on form and scope of legal rights protecting the asset

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The fuzzy nature of IP Rights

Unclear how claims will be interpreted in practice inadvertent infringement can occur Unclear boundaries fouls up workings of the

Coase Theorem Disputes over value are not uncommon

IP discounted in the marketplace as a consequence

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Valuing IP is a bit harder

3. Values can vary hugely depending on circumstances between uses between users over time

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Valuing IP is a lot harder

4. Availability of information/incomplete data

Novelty and Secrecy in the IP market

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IP Value Chain

Licensor

Licensee

Customer

IP

IP

Royalty

Revenue

IP Market

Product Market

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Valuing IP is a lot harder

4. Availability of information/incomplete data

The market for IP is private and non- observable - Novelty and Secrecy

Traditional deal structures use no commonly observed or rigorous economic valuation methods reflecting the private and non-observable nature of IP market

Deals are based on emotion and haggling

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All IP valuation methods derive from one of three approaches

Deprival value

Value$$$

Value$$$

Replacementcost

Replacementcost

Net realisable value

Net realisable value

Net present value/value in use

Net present value/value in use

Lower of

Higher of

Valuation methodology

MarketMarket

CostCost

Income (DCF)Income (DCF)

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Cost-based methods

Historic cost v. replacement cost money well spent? investment or expense? obsolescence “inflation”/required return on original investment

Relevant to intangibles which can be “readily” replicated databases “functional” software brands? technologies? know-how?

Value = avoided cost of purchase / reconstruction

Don’t forget opportunity cost of delay (late to market?) risk of failure in attempting to replicate

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Market-based methods

Frequency of transactions evidence of an active market?

Comparability of “market” transactions licences, more often than sale/assignment of IP rights transferred circumstances of transaction (e.g. cross-licence, licence agreed in settlement

of litigation)

Headline data only? summary royalty terms, but what about the rights and obligations under the

licence? summary transaction terms, but what about manufacturing and distribution

contracts?

But still likely to provide some relevant data

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Income method

All IP is worthless if it can’t create, maintain or increase future cash flows

Some examples … Excess Income method Relief from Royalty Premium Profit

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So far …

The valuation of IP is, in principle, no different to a general business valuation

understanding the dynamics of the business and how it creates value is critical the value derived from IP must come from increased prices or volumes, lower

costs, lower risk or greater “optionality”

Valuation methods designed to estimate this incremental value

implicitly through royalty based or residual value calculations explicitly through economic benefits analysis

Valuation is based on expectations of the future and therefore contains significant uncertainty

using multiple methods improves the rigour of the valuation

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Valuation of Patents

Not all patents are equal What is the Strength of Patent Protection ? Length: how much time left to run? Breadth: range of products covered? Validity: likelihood of being upheld if challenged? Exclusionary power: can the owner refuse to

license without raising antitrust or other issues (compulsory licensing)?

Available remedies if patent infringed

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Real Options Valuation

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Patents - Qualitative Valuation methods

Citation Data

Renewal Data

Prism

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Valuation of Trademarks

Income Based Direct Assessment of Benefits DCF - Excess Returns Relief from Royalty

Cost Based Residual Development Cost Recreation Cost

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Income method – Trademark valuation

Premium prices v.generic product adjust for quality/cost differences

Premium profits (brand contribution) v.generic competitors/ utility provider of goods and services adjust for quality/cost differences

Relief from royalty deprival value (value added/cost savings through ownership of asset) discounted cash flow (“DCF”) analysis based on after-tax royalty applied to

projected revenues most commonly used approach by accountants/valuers/Courts and regulators

Excess return on capital

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Income method – Trademark valuation

•Consumer•Business•Consumer•Business

•Premium services•Premium services

•Mix of services•Mix of services

Brand extension•products / services•channels•sector / geography

Brand extension•products / services•channels•sector / geography

Brand loyalty•certainty of demandBrand loyalty•certainty of demand

Demand side factors

Incremental cash flows

Supply side factors

Volumes x Prices x Margins – Capex / Working capital Risk and return

Customer acquisition / retention

Customer acquisition / retention

Staff acquisition / retentionStaff acquisition / retention

Brand supportBrand support

Brand extension costsBrand extension costs

Supply termsSupply terms Financial CapitalFinancial Capital

Economies of scale

Growth Value

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Relief from royalty: discounting projected royalty flows to a present value

Range ofroyalty rates

Taxation

Incrementalcash flows

Discountrate

Presentvalue

Forecast revenues

Other costs

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Comparable royalties approach

‘Comparable’ licence agreements need to be adjusted to reflect specific licence terms, such as duration, geographical coverage, exclusivity lump sum and minimum royalty payments extent to which asset contributes to market demand for the final product the availability of substitutes licensor’s anticipated profitability from use of the IP (including collateral or ancillary

sales/profits) state of development of the IP

The circumstances in which a previous licence was agreed can be significant product of willing negotiations? court-imposed solution cross-licensing uncertainty re validity of IP rights

Interaction of royalty rate and royalty base: the “result”- must reflect the underlying economic position

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Income approach and royalties – allocation of available profits

Typically 25-33% of incremental profits are allocated to the licensor (in situations where licensor has no presence in the market to be licensed) as a royalty

50:50 split may be appropriate where licensee will compete directly with licensor

Allocation reflects inter alia relative risks borne by parties licensor: development of technology licensee: financial and marketing risks

“Rule of thumb” split of profits: beware different interpretations different measures of “profits” application different forms of IP rights

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Excess return on capital

Tan

gibl

eIn

tang

ible

Operating profits

Cost oftangible

assets and other

resources

Rate ofReturn

x

Bra

ndO

ther

s

DiscountRate V

alue

x

Example: the method used by Interbrand in its “Top 100 Brands” tables.

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IP Risk and Damage Assessment

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Risk Assessment

Any financial valuation (rewards) must be weighted down by the risks.

Ignoring the risks leads to overvaluation

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Different assets face different types of Risk

Patents Technological - Is it feasible/viable. Legal - Validity, the ability to stand when

challenged in court of law Trademarks

Priority Freedom to use

Software/Copyrights Piracy Risks

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Damages: The Cost of infringement

Hewlett-Packard pays Pitney Bowes $400 million to settle patent dispute

ASSOCIATED PRESS Tuesday June 5th, 2001

STAMFORD, Conn. — Hewlett-Packard Co. agreed Monday to pay Pitney Bowes Inc. $400 million to settle a lawsuit over print technology patents….

The companies resolved all litigation without admitting wrongdoing.

In CY2000 HP had net earnings of $3.7B on sales of $48.7B. To earn $400M HP had to generate $5.26B in Sales.

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The nature of infringement

On August 31, 1993 a US jury found that Honeywell had infringed a Litton Ring Laser Gyroscope patent and should pay $1.2 billion in damages. This was somewhat less than the $1.96 billion Litton claimed but nevertheless perhaps the largest ever award of damages for patent infringement. However, on July 3rd, 1996 the CAFC whilst upholding the jury verdict on infringement awarded a new trial concerning damages saying that the study by Litton's damages expert Dr. Phillips was predicated on peculation and unrealistic assertions and supported the trial court conclusion that Dr. Phillips' study was "pure fantasy."

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The Theory of Infringement

“The basic theory of damages is to make the IP owner whole for losses caused by the infringers illicit activity. The IP owner is to be restored financially to the position he would have occupied but for the infringement.”

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Wilful Infringement

Treble damages The court may triple the damage award if it is

proven wilful.

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So far …

Valuation may be triggered by an event, like M&A Financing - use of IP as collateral Joint Venture, Sale or Licensing of IP In case of infringement

But the growing importance of IP makes IP assessment is an ongoing process

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IP Audit

Identification, organization and review of a client’s intellectual property assets and potential liabilities Ownership Recordation of transfers Perfection of security interests Compliance with statutory formalities Infringement on third party rights Client’s rights being infringed

Could be General Purpose IP Audit Event Driven Audit Narrow Focus Audit

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Why do an IP audit?

Other than quantifying the value

Identify, organize, and review existing IP portfolio Resolve current issues in IP management practices Establish procedures to ensure protection of assets in the

future Better guarding of trade secrets Docketing system for payment of fees and renewal filings Assignments of IP in employment and consulting agreements Better marking of products

Add value the company What IP assets are underutilized What are the potential value creators

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Benefits of IP Audit

Prevent asset losses Make effective economical use of IP assets Address gaps in licensing and agreement

procedures Minimize risk of third party infringements Determine position in relation to competitors

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Issues unearthed in IP

Defects in title to IP Assignments of ownership from consultants Quitclaim from alleged author or inventor Employee inventions within the scope of work License rights from third parties to make

derivative works Third party joint ownership Defects in patents (copyrights or trademarks as

well) Requests for reexamination or reissue of a patent Amendments to applications Certificates of correction

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Thank You

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