OPTEONPTY LTD

Philip Mendes

Director

Level 3, 380 Queen St

Brisbane QLD, Australia

Ph + 61 7 3211 9033

Fax + 61 7 3211 9025

philip@opteon.com.au

Structure of Financial Terms in a License

Benchmarking financial terms

. Benchmarking Financial Terms

In licenses

Structure

What types of financial terms

Amounts

RoyaltiesMilestone Payments

1. Royalty on sales by a licensee

X% of sales price Gross sales price; or Net sales price

Most common type of royalty provision

Royalty is remuneration for quantity of use Greater the quantity of use, the greater the royalty The more sales, the greater the royalty

But more to a license than a royalty on sales Clever ways for licensors to increase their remuneration Clever ways for licensees to reduce their royalty overhead

2. Royalty upon sub-license income received by licensee

Licensee grants sub-license Sub-licensee will pay to

Licensee Royalties on the sub-

licensee’s own sales Milestone payments, etc

All that income is sub-license income

Licensee pays a royalty of Y% to Licensor on all that income

.

Licensee

Licensor

Sub-Licensee

3. Royalty upon Last Licensee’s Sales

Royalty on sale price for which the last licensee sells product

Royalty rate remains fixed, e.g. 2% of sale price of last sale – that is all licensor will receive

Licensor might be better off receiving Y% of Sub-license income – might be greater than this 2% - as Licensee will sub-license after value adding and will secure a substantially higher royalty

.

Licensee

Sub-Licensee

Licensor

Buyer

4. Ramped Up Royalties

As a product is more successful, and costs reduce, royalty increases

Licensor forgoes royalties in early stages, in return for higher royalties later

Infrequently seen

Cumulative Gross Sales in US$mup to 100m 4.0%100m to 250m 5.0%250m to 500 6.0%over 500m 7.0%

5. Royalty on sales in countries where patent granted

Expressed as: “Valid Patent Claim” Sales in country where but for license product would infringe a

granted patent That is, you only receive a royalty where sales are made in countries

where the sale of a product is protected by a granted patent Traps:

No royalties on sales made while patent pending (e.g., delays in examination, opposition proceedings etc)

No royalties on sales in countries where patent is not sought, nor granted – ie, if patent in US only, you only get royalties on sales in US

6. Royalty on sales in countries where no patent is granted

This royalty often resisted by licensee – “why should I pay a royalty for sales in countries where there is no patent and I have no power to prevent competitors ?

Royalty might still fairly be payable: Patent is likely to be taken out in 20 – 25 countries and that may

represent 90% - 95% of the world market – so why shouldn’t royalty be paid on sales in remaining countries ?

Licensee will select the countries where patent will be sought Result

pay full / part royalty, reducing by 50% if a competing product enters the marketplace, if

it would have infringed the patent

7. Royalty stacking

Can arise in two ways

1. Product to be sold needs license in of complementary technology, e.g., a delivery system another active ingredient a complementary product where both sold together

e.g., a vaccine cocktail

Sale price of product sold reflects complementary technology as well

2. Freedom to operate – license in patent that is

infringed Cannot reduce royalty by whole amount of royalty paid to

another person Alternative: in each case, reduce royalty by X% of royalty

paid out, up to max of y% reduction on any royalty payment

Stack forfreedom tooperate z%

Stack fordeliverysystem y%

Royalty x%

8. Royalty Splitting – know how

Split royalties so that they are referable to different parts of the IP that

is licensed

Instead of seeking a royalty of 5%:

Royalty of 3% for use of patent

Royalty of 2% for use of know how

Purpose:

If patent is invalidated, license on foot, with a royalty

getting a royalty in countries where there are no patents

9. Reach Through Royalties

Are royalties Not on a Product derived from your IP Instead, on a product derived from someone else’s IP, but which

your IP validated Examples:

License of a Mouse Model Mouse Model validates a drug target Therapeutic drug developed that acts on that target

Software program – royalties on reagents Catalyst that reduces manufacturing costs

10. Suspending royalties

Suspend royalties while revocation proceedings are on foot against a patent

Licensee will be concerned that it may be unnecessarily paying royalties if the patent is revoked

Licensor will be concerned to receive royalties if patent stands up A middle ground is that royalties are

Paid to a trustee Returned to licensee if revocation proceedings successful Paid to licensor if revocation proceedings unsuccessful

11. “Most favoured” royalty

Most favoured clause is very common in the case of a non exclusive license

Agree on royalty of 10% If licensor later grants a license in the same country to a competing

licensee for a lower royalty, that lower royalty will apply in lieu of the 10% royalty

Sought by non exclusive licensee to enable it to be better able to compete

12. Royalties on damages

Does Licensor get a royalty of X% on damages ? Assume:

Cost of Good: $60 Profit Margin: $40 Retail price: $100.00 Royalty: 5%

Damages for lost profits: therefore are: $40.00 Should licensor get:

5% of $40.00 ($2); or 5% of $100.00 ($5) ?

13. Lump Sum License Fees

Once Only License Fee

License fee payable by installments

Signing Fee

To offset past patent expenses, expenses of doing the deal (travel, legals etc) some part of R & D costs,

14. Minimum Annual RoyaltyAlternative to performance obligations

Performance obligations are obligations that a licensee must meet to continue to be licensed

Avoids shelving (non use) of IP Licensor gets no financial return and wants to be able to license

someone else Avoids inadequate performance (e.g., no commercialisation in a major

market, such as US) Licensor gets inadequate financial return and wants to be able to

license someone else

14. Minimum Annual Royalty Examples of performance obligations

Pre market entry milestones to be achieved:

(a) If following completion of research, more research is needed to bring products to a market ready state, the completion of that research

(b) Completion of animal studies(c) Completion of collection of data for lodging IND in USA(d) filing IND in USA(e) Commencement of Phase 1 Clinical Studies(f) Commencement of Phase 2 Clinical Studies(g) Commencement of Phase 3 Clinical Studies(h) Filing of PLA in USA(i) Approval of PLA. in USA(j) First sale anywhere in the world

Failure leads to termination

14. Minimum Annual Royalty Examples of performance obligations

Sell X quantity of product worldwide by 01.01.05

Or, sell the following quantities (revenues) in the following Territories in the following Periods:

Failure leads to termination All motivated by Licensor seeking to maximise commercialisation and

therefore revenue

Territory Period Units of ProductUSA 2003 1m

2004 1.5meach year thereafter 2m

Europe 2003 1.5m2004 2m

each year thereafter 2.5m

14. Minimum Annual Royalty Alternative to performance obligations

A Pharma / multinational will not accept performance obligations of these type

A large biotech company will not be able to secure those types of performance obligations from a pharma, and so will also not accept them from a licensor

Alternative is Minimum Annual Royalties A minimum amount of royalties to be paid Licensee must pay the higher of

Actual royalties, or Minimum annual stipulated amount

Ramp up the amount year by year If Licensee elects not to pay, termination

15. Minimum Annual Payments

Similar concept to Minimum Annual Royalties But refers to all payments payable under the license For example, credit Milestone payments against the minimum payment

amount May credit other things

Research monies paid Consultancy fees paid

16. Milestone Payments

Payments made at identifiable points along the development / regulatory pathway

No Milestone Amount US$1 Phase I trials commence 20000002 Phase II trials commence 50000003 Phase III trials commence 10000000

Pay royalties on whatDefinition of “Gross Sale Price”

Gross / Net – only labels - definition that is important Pay on invoice price Deduct taxes, duties, VAT, GST etc on sale Deduct returns Deduct packaging, freight and insurance

Only if separately invoiced Or lump sum deduction, maximum of 3-5%

Sales to Related companies – transfer pricing Licenses to Related Companies (with consent)

Royalty Rate Methodologies

Arriving at the right royalty rate

Most reliable method to arrive at a royalty rate

Benchmarking combined with DCF

Second least reliable method Rules of thumb

Statistics and averagesLeast reliable method

25% RuleRule of thumb

Rule of Thumb As with all Rules of Thumb – need to use with caution May be a starting point only – with justifiable departures Sam Davis, “Patent Licensing”, Patent Law Institute 1958, see

Goldscheilder & Marshall, “The Art of Licensing from a Consultant’s Point of View”, Les Nouvelles No 6, 1971

Licensor should receive 25% of the pre tax profits, and the licensee should receive 75% of the pre tax profits.

Principle is that a royalty should be 25% of an expected profit margin. Rule used not just to value IP for licensing purposes, but used to assist in

determining damages in infringement proceedings. Rule formulated having regard to a study of numerous worldwide licenses

negotiated over many years.

25% RuleOperation

Relies on knowing the margin for an industry If a margin is generally known or accepted, the 25% can work as a rule

of thumb

Margin / Profits subject to interpretation

Anticipated Sale Price 400

Margin 10% 40

25% Rule 10

Royalty % 40010 2.5

Anticipated Sale Price 400

Margin 15% 60

25% Rule 15

Royalty % 40015 3.75

25% RuleDiscounting for early stage

Assumes that the IP is market ready Development costs are therefore not taken into account Should licensee pay same royalty rate if IP is market ready / still requiring

$100m of development / regulatory costs ?

Anticipated Sale Price 800

Margin 20% 16025% Rule 40Royalty 800

40 5

Discount for early stage50% 2.560% 270% 1.580% 1

25% RuleHow reliable is it ?

A starting point, A guide Not an inflexible rule

Royalty Source database table – and new study of applicability of 25% Rule

“Use of the 25% Rule in Valuing IP Les Nouvelles December 2002 p 123

25% RuleA starting point

Decrease IP not market ready Further R&D Regulatory and compliance matters A highly competitive market High plant production costs High marketing costs Extraordinary capital expenditure

that has to be incurred Volatile Margin

Increase A robust patent position Access to ongoing know how and

trade secrets R&D Program by licensor and

prospect of improvements Marketing networks and leads Marketing assistance Proven track record

Once you have a starting point What factors may suggest that the royalty should:

25% RuleDon’t make that the royalty rate

Don’t make the royalty rate 25% of pre tax profits The concept of profit is too easily capable of manipulation Onerous to keep separate accounting records in relation to different

products of a business

25% is a rule of thumb, an approach Ascertain the margin Model the revenues and costs Arrive at an amount that represents 25% of margin Apply that as a percentage Adjust upwards or downwards as the circumstances justify

Royalties responsive to development costs / risk

The more development costs a

licensor has incurred, the greater

return it seeks, the higher the

royalty it requires

Put another Way:

The more risk a licensor has taken,

the greater the return it seeks

The more development costs a

licensee will incur, the lower the

royalty it is prepared to pay

Put another Way:

The more risk that a licensee

takes, the lower the royalty it is

prepared to pay

Royalties responsive to development costs / risk

Research organisation licensors typically get a low royalty rate: compared to the licensee, they take comparatively little risk, and pay

comparatively little of the development cost Research organisations may typically pay $500K to $1-2m in research Pharma / multinational licensee will typically pay $25 m to $300 in

Further research costs Development costs Regulatory costs

Average financial terms in University Biotech Deals

Average financial terms in University Biotech Deals in US$ 1980 to 2003

Type of financial term: 1980-1986 1987 - 1990 1991 - 1994 1995- 2003Up front fee $20,085 (n=21) $40,655 (n=35) $48,649 (n=53) $87942 (n=24)Royalties on sales 4% (n=25) 5.1% (n=43) 4.2% (n=62) 3.9% (n=24)Royalties on sub license income 37.4% (n=9) 34.3% (n=17) 28.4% (n=27) 28.4% (n=14)Source: Nature Biotechnology June 2003 p 620

Pathway to Market - Value

Discovery Lead Pre-Clinical Phase I Phase II Phase III Registration

VALUE

PATHWAY TO MARKET

Pathway to Market - Risk

Discovery Lead Pre-Clinical Phase I Phase II Phase III Registration

VALUE

PATHWAY TO MARKET

Discovery Lead Pre-Clinical Phase I Phase II Phase III Registration

RISK

PATHWAY TO MARKET

Royalties on Therapeutic Drugs

Technology is at the following stage: Royalty % Milestone payments in US$

1.Identification of new chemical entity (new compound etc)

3-5 100K – 1m

2.Therapeutic indication based on structure 3-6 200K – 2m

3.In vitro data upon the chemical entity showing a positive therapeutic indication

4-7 300K – 4m

4.Animal studies upon a suitable animal model showing a positive therapeutic indication

5-10 500K – 5m

5.Toxicology studies indicating no adverse toxicological effects

6-12 500K – 8m

6.Commencement of Phase I trials 6-12 500K – 10m7.Commencement of Phase II trials 8-15 1m – 25 m8.Commencement of Phase III trials 9-18 2m – 100m9.Product licensed by FDA 12-30 2 x previous

milestones +/- < 20%

THERAPEUTIC DRUG.

Clinical Trials

. Clinical TrialsPhase I: Testing a new drug or treatment in a small

group of people (20-80) for the first time to evaluate its safety, determine a safe dosage range, and identify side effects

Phase II: Drug or treatment is given to a larger group of people (100-300) to see if it is effective and to further evaluate its safety

Phase III: Drug or treatment is given to a larger group of people (1,000-3,000) to confirm its effectiveness, monitor side effects, compare it to commonly used treatments, and collect data

Variables impacting upon royalty rates

who pays development costs

a research organization perceived to be inexperienced will get a comparatively

lower rate a product with a small market will attract a small royalty rate (e.g. a rare

disease)

product with lots of competing products (e.g. headache tablet) likely to attract a small royalty rate

product with a large market, and few competitors will attract a very high royalty rate

Structure of Milestone Payments

No

Milestone Amount US$

1. Phase 1 clinical trials commence anywhere in the world 1,500,000

2. Phase 2 clinical trials commence anywhere in the world 3,000,000

3. PLA approved, but only in respect to the first such approval anywhere in the world

8,000,000

Pre-clinical Milestone Payments

Source: Health Advances LLC Analyses of selected Recap reported deals

Royalty on Vaccines

VACCINE

Technology is at the following stage:

Royalty % Milestone payments in US$

1.Identification of antigen 3-5 100K – 2m

2.Animal studies showing immune response 4-7 250K – 2.5m

3.Animal studies showing immune response and protection

5-8 500 – 3m

4.Toxicology studies indicating no adverse toxicological effects

5-10 500 – 3.5m

5.Commencement of Phase I trials 7-10 750K – 5m

6.Commencement of Phase II trials 7-12 2m – 10m

7.Commencement of Phase III trials 8-15 5m – 15m

8.Product licensed by FDA 10-20 2 x all previous milestones +/- up to 20%

Royalty on Diagnostic product

DIAGNOSTIC

Technology is at the following stage:

Royalty % range Milestone payments in US$

1.Identification of punitive marker (protein, gene sequence etc)

4-8 for 3-5 years then declining to 15-35% of estimated profit in 5th year after product launch

10-25% of aggregate of total milestone payments Range of Total: 0-5m

2.Correlation between disease state and marker in small study of 10-20 patients

6-12 for 3-5 years then declining to 25-60% of estimated profit in 5th year after product launch

20-30% of aggregate of total milestone payments on filing PLA with FDA Range of Total: 0-5m

3.Correlation between disease state and marker in large study of 100 patients

8-15 for 3-5 years then declining to 50-75% of estimated profit in 5th year after product launch

50-70% of aggregate of total milestone payments on PLA approval Range of Total: 0-5m

Royalty rate distribution

Licenses by Industry: Probability of RangesLicense In 0-2% 2-5% 5-10% 10-15% 15-20% 20-25% >25%

Aerospace 50% 50%

Automotive 52.50% 45% 2.50%

Chemical 16.50% 58.10% 24.30% 0.80% 0.40%

Computer 62.50% 31.30% 6.30%

Electronics 50% 25% 25%

Energy 66% 33%

Food/Consumer 100%

General MFG. 45% 28.60% 12.10% 14.30%

Gov't/University 25% 25% 50%

Telecommunication/Other 40% 37.30% 23.60%

License Out 0-2% 2-5% 5-10% 10-15% 15-20% 20-25% >25%

Aerospace 40% 55% 5%

Automotive 35% 45% 20%

Chemical 18% 57.40% 23.90% 0.50%

Computer 42.50% 57.50%

Electronics 50% 15% 10% 25%

Energy 50% 15% 10% 25%

Food/Consumer 12.50% 62.50% 25%

General MFG. 21.30% 51.50% 20.30% 2.60% 0.80% 0.80% 2.60%

Gov't/University 7.90% 38.90% 36.40% 16.20% 0.40% 0.60%

Telecommunication/Other 11.20% 41.20% 28.70% 16.20% 0.90% 0.90% 0.90%

Royalty Source data

Royalty upon sub-license income received by licensee

Sub-licensee will pay to Licensee Royalties on the sub-

licensee’s own sales Milestone payments, etc

Licensee pays a royalty to Licensor on all that income

Up to 50% non pharma Pharma deals:

30% a good result 25% a poor/ fair result 20% a poor result 15% a very poor result

.

Licensee

Licensor

Sub-Licensee

Benchmarking Royalty Rates

Benchmarking

Nobody wants to get 3% when the benchmark is 10% Nobody wants to put a deal at risk by demanding 8% when benchmark is 2% Need to know what is the right royalty rates

Benchmarking or comparables Something is worth X because something else that is similar to it achieved

X in the market place Challenge is whether it is truly comparable No two technologies are identical How similar / different are they ? The greater the similarities the greater the reliance on the comparable deal

To benchmark need to source information about deals that concerns comparable IP

Sources of informationDatabases

Databases www.recap.com www.pharmaventures.com www.knowledgexpress.com www.royaltystat.com www.royaltysource.com

Bioworld Today news archives on www.knowledgexpress.com

Recap: best biotech source – contains most deal making information Pharmaventures – mostly press releases Royalty stat and royalty source – broad cross section of industries – compiled

from EDGAR Knowledgexpress: Accesses pharmaventures and royaltysource

Sources of informationProfessional Reports

Professional reports Intellectual Property Research Associates issues reports on royalty rates

for all industries, - fragmented information http://www.ipresearch.com/index.html

US $995 US$250 US$1500

Sources of informationProfessional Associations

Licensing Executives Society “Les Nouvelles” Journal www.lesi.org Members can search journal on line Wealth of opinions and observations about royalty rates for different

types of industries

Techno-L Discussion group Accessible at http://www.autm.net/index_ie.html Searchable archive of queries posted and replies with opinions and

views onroyalty rates for different types of industries

Sources of InformationPress releases and web searches

Press releases about deals in a particular industry or dealing with certain categories of products

Sources of press releases Archived press releases on the web:

http://www.prnewswire.com http://money.cnn.com/ http://www.businesswire.com http://www.prweb.com/

And Google

Benchmarking

Find comparable deals Ascertain their financial terms Ascertain the things about the deals that are

Similar Different

Assess the extent to which a deal can be a Comparable Assembles all the comparable deals and form conclusions

The closer other deals are, the more reliable they are as benchmarks The further away they are, the less reliable they are