Attorney's Guide to the Valuation of Intellectual Property

1© 2014 Armitage, Billion, Hanson

Attorney’s Guide to the Valuation of Intellectual

PropertyBen Armitage

Rich BillionBillion & Armitage®

Intellectual Property that Drives Business®

Clyde Hanson, CPVAVenture Isles, LLC

The business-side of patents & innovation

IntroductionValuation of intellectual property is not the core work of most attorneys. The goal today is to provide a working knowledge so you’ll know what questions to ask and have a better sense of the process.Intellectual property has become the driver of value creation in many industries. 80% of the market value of Fortune 500 is attributed to intangible assets, including IP, up from 40% in 1975Managing tangible assets is well-established, managing intangible assets, less so. “You can’t manage what you can’t measure” --Peter Drucker. Valuing IP is basic to managing it well.

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Overview1. Types of Intellectual Property (IP) 2. Determining the Valuation Assignment3. IP Valuation Methods4. Performing Due Diligence5. Selecting a Valuation Specialist6. Data & Document Gathering: Analyst

Support7. Reviewing & Interpreting the Valuation

Report


Types of Intellectual Property

PatentsUtilityDesign

Trade SecretsTrademarksCopyrightsDomainsBrands

Intangible assets that can be sold separately from the entire firm are intellectual property

Technology-usually pre-commercial designs, data, and knowhow.


Considerations: Context of Value

What is the context?

Licensing

Selling

Buying

Litigation

Gift

Taxation

M&A reporting

Based on the context, the value might change.

For example, licensing, buying and selling involves negotiation. As a result the royalty rate might not be indicative of the actual value.

Litigation involves damages between two adverse parties, who were unwilling to come to an agreement prior to litigation.


Purposes of IP Valuations

Transaction pricing & deal structureFinance collateralization & securitizationTaxation planning & complianceManagement information & strategic

planningIP portfolio management decisionsBankruptcy & reorganization analysisLitigation support & dispute resolution


Defining the AssignmentWhat exactly is the property to be valued?How will the valuation be used?Value at what date? Current? Historical?Who is the audience? What is their focus?What level of documentation?Does client or analyst select techniques?When is the work product needed?Who is to be the analyst’s contact?Is the existence of the valuation

confidential?© 2014 Armitage, Billion, Hanson 7

Defining the AssignmentWhat definition of value is to be used? Value to

whom?Fair market valueFair valueMarket valueAcquisition valueUse valueInvestment valueOwner valueInsurable valueCollateral valueAd valorem value


Defining the AssignmentPremise of Value: How the value will be created

Value in continued use, as part of a going-concern business enterprise

Value in place, but not in current use in the production of income

Value in exchange, as part of an orderly disposition

Value in exchange, as part of a forced liquidation


Defining the AssignmentWhich, if any, certification standards?

Uniform Standards of Professional Appraisal Practice (USPAP)?, Federal Court Rule 26?, IRS regulations 197 (Definition and valuation of intangible assets), 482 (Intra-company transfer prices), & 170 (qualified appraisal & appraiser)? Non-certified?

What level of precision is desired?Maximizing−very existence of the enterprise is at stakeOptimizing−cost and value of precision is balancedSatisfying levels−when lower cost information is “good

enough”An opinion letter states analyst’s judgment of value

based on experience without a bottom-up analysisSingle asset vs. portfolio of related or unrelated assets

Separate calculations for each assetSampling/ Key assets


Getting the Lay of the Land

Is asset an entire product? Business model? Franchise?

Is it a platform technology?Is it a component?Is it a sustainable competitive advantage?Does it have or justify a premium price?Is it a new or established market? Who or what is competition? Situation of client? Growth? Profitable? Stable? Who has more power in the hypothetical transaction?

Which side may end up with more of the value?© 2014 Armitage, Billion, Hanson 11

Risk Lowers Value Risks—Where handled in the valuation?

Technology—Will it work? Stay on budget? Execution: Quality of management & workforce Intellectual Property

Invalidity risk, claim limitation risk Design-around risk Freedom-to-operate / blocking patents

New competition, obsolescence Market acceptance Environment-economy, interest rates, buyer confidence,

regulatory

Risk AdjustmentsDiscount interest rateDirect increase or decrease in value by factors(c) 2014 Armitage, Billion,

Hanson 12

General Valuation Approaches

Disaggregate the value question into many smaller questions which can be answered with public data or assumptions that are are narrower and can be evaluated

Three traditional approaches like appraising a house Income: values the future benefit stream, then discounts back to a

present value. Looking ahead.

Market: uses comparables to establish relative value. Looking around.

Cost: cost to create the asset. Looking back.

Use multiple approaches & techniques in a single valuationReality checks from multiple perspectives

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Cost Approach Cumulative investment in asset

Cost is close to value in building construction, but not all IP Profit leverage of IP can be significant, so cost ≠ value

Cost Techniques Replacement or Historical Cost Equal Return Payments-ERP

“Fair” split of between buyer/seller for more developed assets

Both parties earn the same rate of return on their investments

Remaining cost to market, Risk-adjusted NPV EBIT Disaggregation of profits by asset class

SG&A Reputational IP Technical IP

Assumes tangible assets are commodities that don’t earn economic rents © 2014 Armitage, Billion,

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Market ApproachCompare to values of similar assets sold in an

arms length transaction in a well-organized marketAuctions ideal arbiter of valueChallenge: Thin and secretive IP marketplace

Adjusting market values to make comparableWeighted average, score closest assets higher

Sources: News releases, IP Offerings quarterly newsletter “IP Quotient”, ICAP Auctions (Ocean Tomo), court filings & published opinions

There may be no comparable transactionsComparable licenses are more common


Other Market Techniques

Rule of Thumb: Poltorak Rule (Base year EBIT * 1.3)

Current brokerage rate—Pay 1-10% of economic benefits in a lump sum paymentApply to discount to sum of future royalties

(Comparable royalty rate applied to the forecast flow of (wholesale) sales over the economic life of asset)

The more predictable & established the royalty flow, the lower the current brokerage rate


Patent Market Technique

Econometrics-Pantros Patent Value ReportPredicts a sale price for a patent that considers

a computer score of the quality of the patent and its licensing potential as indicated by patent data. Black box, technique proprietary.

Cumulative economic flows to patent space (size of technology area’s share of US GDP)

Inventors misinterpret market size value as what they should get for their patent

Issued US patents onlyAbout $250 per report


Income ApproachData Needed

How big is the market in dollars? Units? What is the is the asset’s economic life?How much of potential market is reachable

profitably?What are major segments of the market? What marketing channels serve each segment?What prices, gross margins and costs are relevant?

Dealing with UncertaintyRating & scoringProbability treesMonte Carlo method


Income Approach Techniques

Rule of Thumb: 25% Rule (% of EBIT created goes to IP developer)

Discounted cash flow (NPV) of gross margin or cost savings Economic life of asset Selecting the discount rate (what risks are covered, cost of capital)

Examples of Specific Techniques NPV (less R&D and launch costs paid by buyer) of EBIT NPV with Probabilities Method

Technical success Commercial success Cost of failure

Cost Savings NPV*25% (cost saving are a positive economic benefit)

Expected Commercial Value Probability of commercial success applies to launch costs Probability of technical success applies to R&D costs Adjusts the present value of future earnings from the asset


Income Forecast FactorsMarket share growth of asset owner

Existing solutions will retain some share for some time

Takes time to sell channels, end-buyers Except phone apps & games, toys, fashion, etc.

New, non-infringing competitors likely to ariseTechnology adoption curve

Market share aside, getting customers to adopt a truly disruptive innovation is a challenge and takes time.

Published studies of adoption curves are used by analysts


Combining Results of Several Techniques into Single Value

Analyst judges which techniques are most relevant to this situation and weights them higher in the calculation of a combined monetary value.

Written rationale for the weightsSensitivity analysisInfringement damages usually one approach

Two Summary Values (Venture Isles practice)NPV of the flow of economic benefitsLikely sale price of asset with & without multiple

offers© 2014 Armitage, Billion, Hanson 21

Adjusting Combined Value

Stage of technology developmentIndustry openness to innovationNumber of decision-makers for IPPatent and IP quality and quantity

Litigation tested +15%Portfolio size (single patent -15 to -30%)Forward citations +1-3% each

Stature of the inventorsEconomic cycleEmerging competitionProfit flow large enough to justify asserting

patent(s)?Caution not to double discount for risks© 2014 Armitage, Billion,

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Valuation OpinionSummary statement of valuePurpose for which valuation was created Limitations on use of valuationValue “as of” dateProfessional liability boilerplatePage 24 in ABC Company example valuation

report


Infringement DamagesHistorical sales/cost data gained through

discoveryAnalyst focus is on:

Comparable royalty rates; Georgia-Pacific case factors Discount rate justification

Higher standards for documentationDaubert Case Principles for Experts

Testable Peer review and publication Acceptable rate of error and maintenance of standards Community acceptance

Expert witness experienceCredentials become more importantTrending toward academics, economists


Considerations for Marketing IPTrademarks—Symbol of the brand, can be

shared and licensed to go on products of other firms

Brands—customer perception relative to competition; premium price, higher market share, or both

Domain names—ease of use, memorable? Online estimators (free).

Valuation IssuesHard to untangle brand & trademarkFew comparables


Example: ABC Company Actual valuation, used with permission after redactions & modified

demand estimates

Purpose: Set a reasonable asking price for portfolio and show buyer the economic benefits (Value-created)

Primary market research on adoption obstacles

Value date: calculations going forward till end of patent term (17 years)

Portfolio: Patent, trademark, hardware system design & software (p. 4)

Potential buyers with 3 business models valued Potential market size—8 market segments sized Addressable market-13-50% of potential by biz model Cash-flow by type of buyer (3) * 8 segments = 24 estimates Valuation by Buyer Type and Market Segments (Field-of-Use) created

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© 2014 Armitage, Billion, Hanson

ABC Example: Income Approach

Pages 10-15 covers Income ApproachUS Patent so US only demand estimatedOther assumptions & comparable royalty results p 11-12Five techniques, 4 used in Value-created estimate, 1 in

Market (sale price) estimate. 1 rule of thumb, 4 NPV calculations

Excel Workbook model: 9 linked spreadsheets. EBIT & royalty forecasts Technique calculations Industry trend & market segment data and assumptions

documentedTechnology adoption curve & market share growth adjust

demandEconometric technique also in Value-created estimate


ABC Example: Market ApproachPage 20 of valuation reportRoyalty rate weighted average scoring of

comparable licenses, 4.17% usedEBIT based on % of sales in published data

for similar types of business3 techniques, all used in asking price

estimatePoltorak RuleCurrent Brokerage Rate (2 rates)


ABC Example: Cost ApproachPage 15-18 of reportTwo techniques

Replacement Cost (used in Value-created)Equal Return Payment (used in asking price)

Lump sum also shown as annual royalty payments

Calculated by buyer type


Selecting a Valuation Analyst

Face-to-face meetings or telecom preferenceBudget DeadlinesTechnical/industry expertiseWorking relationshipLitigation/non-litigationIRS/non-IRS audienceProfessional certificationsA person, not the firm, does the work


IP Asset Due DiligenceTeam approach

Patent attorneysBusiness evaluators Industry veteransContract attorneys


IP Asset Due DiligencePatent Attorney

File history reviewMaintenance feesPrior art searchFreedom to operateLitigation searchDocket reviewClaim evaluation

Enforceability, coverage, etc.Check ownership (assignments, employment

agreements, etc.)


IP Asset Due DiligenceRest of team

Any liens or mortgages on IPMarket/product evaluationIndustry players

Litigious? Potential partners? etc.


Patent File History Review

All relevant art cited and review by ExaminerLimitations disclaimed in prosecutionAdmissions by patent attorney


OwnershipCorrect inventorsAssignments or other transfer of rightsGovernment rightsThird party challenges


Claim EvaluationScopeProduct coverageDetectabilityEnforceability


Best PracticesTalk to your patent attorneyAssignments/Ownership locked up

Employment agreementsConsultant agreements

File continuationsMonitor deadlines, file on outstanding

disclosuresDeal with warts head-on

Stalled prosecution, third-party issues


Data & Document Gathering

Internal data & interviews with key personnelPatent, trademark, etc. listsEncumbrances to IP assetsPast offers for the IPLitigation historyProduct lists, marketing materials, tech

manuals, price lists, customer listsProduct/division/firm financialsResource people contact information


Interpreting Valuation Reports

What was valued and why?How was value defined? Value as of when?What are the sources for market demand

data?What methods & techniques were used?


Reviewing Valuation Reports

Was the IP understood by the analyst?Did the due diligence verify the government

recognition of the IP?Who was interviewed about the IP?Are the methods relevant to the situation?Are assumptions about the future clear?

Reasonable?Did independent legal council review the IP?Do modeling spreadsheets match the report

tables?Are risks addressed explicitly?


IP Valuation: In Conclusion

Valuing IP is key to maximizing its financial return

There is a wide-range of valuation typesClarification of assignment upfront pays

dividendsHow important is the decision the valuation

will influence to the sponsor of the valuation?Better to have a simpler valuation that its

users understand than a complex one understood only by the analyst.


Q & A


Special ThanksFrank Farrell

[email protected] Lacis, CPA

[email protected]


Reference BooksValuation and Pricing of Technology-Based

Intellectual Property, Richard RazgaitisBusiness Valuation Resources (BVR) Guide to

Intellectual Property Valuation, Michael Pellegrino

Valuing Intangible Assets, Robert Reilly, Robert Schweihs

Fundamentals of Patenting and Licensing for Scientists and Engineers, Matthew Y. Ma


For More InformationClyde Hanson, [email protected](612) 418-1192 Minneapolis

Richard [email protected] (952) 697-2633

Ben [email protected](952) 697-2632


mailto:[email protected]



Attorney's Guide to the Valuation of Intellectual Property

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