Consulting Solutions. Software + WIPO, December 2016 Tehran. Topic 4. Main IP Valuation Methods and Approaches. Patrick PIERRE

Transcription

1 Software + Consulting Solutions WIPO, December 2016 Tehran Topic 4 Main IP Valuation Methods and Approaches Patrick PIERRE Novembre 2017

2 Largely inspired by the report Intellectual Property Valuation Primer for Policymakers and Technology Officers Prepared for : The World Intellectual Property Organization (WIPO) & The Center for Applied Innovation (CAI) by Ocean Tomo, LLC, and review by Licensing Executives Society International (LESI) Valuation Committee

3 Intangible Asset for TTO s Spotlight on IP as an asset class that can be monetized Establishment of startup companies driven by university developed IP; Number of licenses executed to startups; Total number of licenses; Research expenditures that include total research & development, federal, and industrial spending; Number of invention disclosures; Number of new patent applications; Number of new patent issuances; Total license income 3

4 Costs Revenue Revenue Costs Profit Profit IP Assets Add Value to Entity Implementation of IP can differentiate a product, exclude competition, reduce costs and increase profits Without IP With IP 4

5 Introduction to Valuation The value of intangible assets is a measure of how much money can be expected to be received in a commercial exchange of the subject asset From this perspective, the key arbiters of value are : The scope of relevant uses by potential acquirers, The profitability of the specific application, The remaining economic life, And the availability of suitable alternatives. In the practice of valuation, these characteristics are encapsulated in the definition of: The context of the valuation the same asset will have different values when viewed in the context of a large corporation, a midsize company that is looking to gain a strategic advantage over competitors, or a small venture that may be looking to secure its first IP rights. The valuation method applied 5

6 Valuation Methods Income Method More Utilized for IP The value of an asset can be measured by examining the net present value of the predicted future income benefits expected to be generated by the asset, taking into account all of the risks inherent in achieving those cash flows. Market Method The value of an asset can be measured by examining market based transactions of similar assets. Less Utilized for IP Cost Method The value of an asset can be measured by examining the cost to create or recreate the asset or an asset of similar utility. 6

7 The Cost Approach The cost approach examines the replacement cost of an asset under consideration, or an alternative asset of equal utility. This approach is quite useful to value internally developed computer software as well as for determining software license exclusivity rates. Entities may also value a desired patent based on alternative costs to design and manufacture in a way that avoids infringement of the patent. Development Year 1 Development Year 2 Development Year 3 Total Cost Design and specifications development ($k) Computer operations testing ($k) Systems analysis ($k) Programming & testing ($k) $1,000 $500 $100 $2, , ,500 2,400 4,400 Documentation ($k) $1,960 $2,610 $3,410 $7,980 7

8 The Market Approach : Auctions What Have Others Paid The market approach examines market-based transactions for the asset under consideration or similar assets. Market-based transactions of similar technologies or intellectual property can give insight into the value of the asset under consideration Auctions Auction transactions can provide insight into patent portfolio management when using the Auction Market Approach Live IP Auction IP Buyers IP Sellers 8 30

9 The Market Approach : Royalty Rate Comparable 1/ RoyaltySource Transaction Analysis As of Spring 2008

10 The Market Approach : Royalty Rate Comparable with K-H 2/2 10

11 Critical Consideration With Comparable Critical Considerations : How does one find comparable royalty rates for the subject assets/royalty agreements? What clauses or terms in an agreement impact the royalty rate selection? While there is never a perfect comparable due to the inherent unique nature of IP and the multitude of licensing structures available, market data on royalty rates can serve as an appropriate benchmark for these types of analysis. 11

12 Patented Technology Comparison Attributes Subject Patent Comparative Technologies My Technology Technology B Technology C Design Features Cost Reliability Productivity Market Perception Source: BVR s Guide to Intellectual Property Valuation, Michael Pellegrino, Business Valuation Resources, LLC, 2009, Adopted from larger chart on p

13 The Income Approach : Relief From Royalty Relief from Royalty The Relief from Royalty methodology is based on the premise that a property s value can be measured by what the owner of the property would pay in royalties if it did not own the property and had to license it from a third party. Alternatively, this approach may also quantify the amount of income the owner would generate by licensing the intellectual property to others. This method requires the determination of projected royalty payments, which are derived by applying a royalty rate to an appropriate royalty base. Royalty Base The estimated royalty base is the amount of revenues and/or units the subject IP could generate if the owner was able to license the technology to a third party that subsequently generated commercial sales. Royalty Rate Can be determined from prior licensing transactions (both internal and external) and rule of thumb guidelines if verifiable comparables do not exist. 13

14 The Income Approach : Excess Earnings Excess Earnings/Incremental Income The Incremental Income methodology is based on the following premise: a property s value can be measured by the incremental earnings achieved by a proprietary product relative to an essentially identical but non-proprietary product (e.g., a generic version of the same product). The excess earnings may result from the proprietary product commanding a price premium, delivering manufacturing cost savings, or achieving larger sales quantities. With IP Without IP Revenue Less: Cost of Goods Sold Less: Operating Expenses Less: Taxes Revenue Less: Cost of Goods Sold Less: Operating Expenses Less: Taxes Equals: After Tax Income Equals: After Tax Income Plus: Depreciation & Amortization Less: Capital Expenditures Less: Change in Working Capital Cash Flow With IP Apportion Incremental Cash Flows and Discount to Present Value - Plus: Depreciation & Amortization Less: Capital Expenditures Less: Change in Working Capital Equals Cash Flow = Incremental Cash Flow From ALL IP 14

15 The Income Approach : 25% Rule This 25% rule splits the profits that each party could expect to benefit from the relationship proportionately to its investment and level of risk. The 25% royalty rule recognizes that the licensee bears the risks of investment in manufacturing and commercialization of the technology and the risks of competition form the marketplace and the licensor provides a strong technology package the licensor should be entitled to 25% of the predicted profits. This 25% royalty rule is a starting point to be adjusted up or down. 25% 75% Value to intellectual property Operating Profit Year Estimated Operating Margin* Application of 25% Rule 2009E 8.6% 2.2% 2010E 13.6% 3.4% 2011E 17.6% 4.4% 15

16 Preparing the IP Valuation Process through DCF Discounted Cash Flow

17 Value Remaining life of IP and value A fundamental step in a valuation is the determination of the remaining useful life of the subject asset. The legal life of a patent is 20 years from the filing date and; therefore, the benefits associated with that patent may extend through this entire period. Longer is the remaining life, better is the value (pharmaceutical patent). However, in industries with rapid technological innovation the patented technology may be obsolete in only five years. Therefore, a shorter useful life may be appropriate for a nice value (as software in telecommunications). Patent has 17 years of legal protection License Agreement in place for 10 years Management to abandon technology after 7 years Next-generation technology renders technology obsolete in 5 years 17 Time

18 Value Early stages technologies and value The value of intellectual property generally increases as the technology becomes closer to market and the certainty surrounding cash flows increases. Example is biotech or pharmaceutical scenario in which a patented product or technology goes through several regulatory phases and the chance of success increases over time. Early Phase: High uncertainty, low valuations Middle Phase: Uncertainty decreases; valuations increase Late Phase: Known benefits and lower risks; higher valuations 18 Time

19 Value Time and Risk and value of Money Value Risk Time and risk impact value, The notion of the time value of money is based on the assumption that a unit of money in hand today may be worth more than at a future point in time. This notion is based on inflation that reduces the purchasing power of a unit of money over time. There is an inherent risk in attempting to predict future economic events affecting estimated future cash flows. Here the assumption holds that as time increases, value decreases. Time Not to sca3 le. 6 This risk increases over time, as the predictability of the future becomes increasingly speculative. Risk can be related to many factors. The analyst should take care to understand the factors driving the risk profile of each project. Here the assumption holds that as risk increases, value decreases. 19 This notion applies preferably to the Income Approach as the goal is to estimate the present worth of potential future benefits.

20 The Risk Discount Rate In a valuation context, this concept of risk is captured in a calculation of what is referred to as a discount rate. The word discount is used to describe the notion that money in the future is commonly worth less than the same money today. The discount rate is the discount factor that is applied annually to a respective cash flow projection period. The graph below emphasizes the correlation of increasing risk to increasing discount rates. Level of risk 50% 40% 30% 20% Expected cash flows are predictable and nearly certain to occur. Subject asset has risk consistent with a firm s other assets. Uncertainty related to amount and timing of cash flows. Risk high relative to a firm s other investments. Extremely High Risk and high probability of failure. The required return on the investment is higher to account for the risk factor. 10% 20

21 An Additional Adjusting of Discount Rates : RAHR Used in Licensing Negotiations Risk adjusted hurdle rates can also be used to understand risk from the viewpoint of an investor. Characterization of Risk Risk-free such as building a duplicate plant to make more of a currently made and sold product in response to presently high demand. As a reference of a risk free : investment in U.S. Treasury securities. Very low risk, such as incremental improvements with a well-understood technology into making a product presently made and sold in response to existing demand. Low risk, such as making a product with new features using wellunderstood technology into a presently served and understood customer segment with evidence of demand for such features. Moderate risk, such as making a new product using well-understood technology to a customer segment presently served by other products made by the corporation and with evidence of demand for such a new product. Approximate RAHR Approximates the corporate rate of borrowing, which can be in the range of 8-18% 15-20%; discernibly above the corporation s goals for return on investment to its shareholders 20-30% 25-35% High risk, such as making a new product using a not well-understood technology and marketing it to an existing segment or a well-understood technology to a new market segment % Very high risk, such as making a new product with new technology to a new segment. In the context of this document, we assume that risk adjusted hurdle rates (RAHR) are equivalent to discount rates. Extremely high risk (sometimes known as wildcatting, borrowing an expression from the oil exploration industry), such as creating a startup company to go into the business of making a product not presently sold or even known to exist using unproven technologies % 50-70% or even higher 21 Source: Valuation & Dealmaking of Technology-Based Intellectual Property, Richard Razgaitis, John Wiley & Sons, Inc., Hoboken, NJ, 2009, p. 271

22 Concept of Present Value VALUE IP Asset Potential for future cash flows/income Time Today Careful Examination of Risk Profile Likelihood and Timing of Projected Future Cash Flows 22

23 Discount Factor Formula Once the discount rate has been selected a discount factor is computed utilizing the following formula and assumes the cash flows will be collected at the end of the year: 1 (1 +K)^N Wherein, (K) equals the discount rate, and (N) equals the estimated cash flow period. As an example given the assumption of a selected 30% discount rate, the discount factors for the first three years of projected income estimates follows. Discount Factor (30%) Year 1 Year 2 Year

24 Discount Factors Example The calculations with discount rates of 30% and 40%. Year 1 Year 2 Year 3 Net Cash Flow x Discount Factor (30% discount rate) $100 $100 $ Present Value of Future Cash Flows $76.92 $59.17 $45.52 Total Net Present Value* $ Year 1 Year 2 Year 3 Net Cash Flow x Discount Factor (40% discount rate) $100 $100 $ Present Value of Future Cash Flows $71.43 $51.02 $36.44 Total Net Present Value* $

25 Royalty Rate Sensitivity of Changes to Variables Royalty method include the selection of the royalty base, royalty rate, tax rate, time and risk factor/discount rate. Any adjustment and combination to any of these factors, have a very strong impact on the value conclusion. This fact emphasizes the importance of the selection and assessment of reasonableness for each variable. Discount Rate 9.0% 10.0% 12.0% 16.0% 0.10% $531.8 $480.7 $396.5 $ % $1,595.3 $1,442.0 $1,189.6 $ % $2,658.9 $2,403.4 $1,982.7 $1, % $5,317.7 $4,806.8 $3,965.4 $2,

26 Tax Rate (%) The Tax Rate Income associated with the Subject Asset was determined on an after-tax basis. The Appraiser assumes a % tax rate for the determination of cash flows. Different jurisdictions have lower or higher tax rates. 45,00 40,00 35,00 30,00 25,00 20,00 15,00 10,00 5,00 0,00 26 OECD Tax Database, Organization for Economic Co-operation and Development, < >, 2010.

27 Results from Income Approach : Example 1/2 Year Royalty Base $18,675 $31,125 $33,096 $35,192 $37,420 $39,790 $42,309 $43,384 Royalty Rate 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% Pre Tax Royalty Stream (1) $747 $1,245 $1,324 $1,408 $1,497 $1,592 $1,692 $1,735 Tax Rate 39.3% 39.3% 39.3% 39.3% 39.3% 39.3% 39.3% 39.3% After Tax Royalty Stream (2) $454 $756 $804 $855 $909 $966 $1,028 $1,054 Present Value Factor Present Value of Royalty Stream (3) $398 $510 $417 $341 $279 $228 $187 $ Royalty Base $44,486 $45,616 $46,774 $47,963 $49,181 $50,430 $26,635 Royalty Rate 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% Pre Tax Royalty Stream (1) $1,779 $1,825 $1,871 $1,919 $1,967 $2,017 $1,065 Tax Rate 39.3% 39.3% 39.3% 39.3% 39.3% 39.3% 39.3% After Tax Royalty Stream (2) $1,080 $1,108 $1,136 $1,165 $1,194 $1,225 $647 Present Value Factor Present Value of Royalty Stream (3) $116 $92 $72 $57 $45 $35 $14 Total Net Present Value of Royalty Streams $2, (1) Pre Tax Royalty Stream =Royalty Base x Royalty Rate (2) After Tax Royalty Stream = Pre Tax Royalty Stream x (1--Tax Rate) (3) Present Value of Royalty Stream = After Tax Royalty Stream x Present Value Factor

28 Preparing the IP Valuation Process through DCF Reminders

29 Qualitative Assessment Technology Valuations 29 Preliminary guide line for IP valuations : 1. Describe the IP to be valued and in what context. 2. Establish an IP risk profile to truly understand the level of risk inherent in the IP to be valued. 3. If feasible, complete an independent validity assessment to confirm that prior art does not exist that renders the subject patent(s) invalid. 4. Confirmation of the remaining life of the patent or the average remaining life of the portfolio. 5. An analysis that considers the breadth of the patent claims (i.e., are the claims narrow or broad?) 6. What is the strength of the existing portfolio (are the subject assets incrementally valuable, or similar to what is already owned for both defensive and offensive value?) 7. How is the subject technology differentiated in the marketplace? 8. Complete any mandated due diligence steps to establish an objective narrative framework for whether the subject assets may have material, positive value. 9. Indication of the quality of the patents and technology? 10. Existing licensee agreements or others encumbrances? 11.

30 Patented Technology Comparison Attributes Subject Patent Comparative Technologies My Technology Technology B Technology C Design Features Cost Reliability Productivity Market Perception Source: BVR s Guide to Intellectual Property Valuation, Michael Pellegrino, Business Valuation Resources, LLC, 2009, Adopted from larger chart on p

31 Qualitative assessment of patent strength Factor Influence Rationale Did an attorney or patent agent prosecute the patent? How many independent claims are there? How many words are in each independent claim? How many dependent and independent claims does the patent contain? How many backwards citations are there? Patent Strength Patent Breadth Patent Strength Patent Breadth Patent Strength A patent attorney will better understand how to construct claims that will withstand litigation. Independent claims provide the bedrock for patents, describing the foundations for the claimed invention. The greater the number of independent claims, the broader the typical patent. Statistical evidence suggests that patents with fewer words have higher correlations with patent renewals. Patents with dependent and independent claims describe more potential inventions and variations. Statistical evidence suggests that patents with more backward citations exist in a more crowded space and might generate a lower value proposition in the market. How many backwards citations are there? How many forward citations are there? How many inventors are there? Are there any patent assignments? Have maintenance fees been paid yet? Patent Breadth Patent Strength Patent Strength Patent Interest Patent Interest Statistical evidence suggests that patents with more backwards citations have a narrower focus, and might generate a lower value proposition in the market. Statistical evidence suggests that patents with more forward citations generated follow-on inventions that might generate a higher value proposition in the market for the original patent (e.g., it has blocking value on later patented inventions). Statistical evidence suggests that patents with more inventors are more complex and have a lower tendency to survive under challenges. Statistical evidence suggests that patents assigned to companies within the USPTO s assignee database may have a greater chance of licensure as opposed to those held by sole practitioners. Statistical evidence suggests that companies that pay recurring maintenance fees on existing patents find value in them to the extent that dollars are spent to keep them active. 31 Source: BVR s Guide to Intellectual Property Valuation, Michael Pellegrino, Business Valuation Resources, LLC, 2009, p. 6-15

32 The Owner/Inventor Perspective 32

33 Qualitative Assessment - Other Key Points to Visit Are there any remaining development costs required to complete the product prototype? 2. When is the expected year of commercialization? What are all of the risk factors that can impact when the product can be introduced?? 3. How many new units can reasonably expect to be sold, conservatively, on annual basis 4. What are the expected fixed and variable costs of implementation and sale? 5. How do the risk factors translate into an estimation of the discount rate? the exact current stage of the technology from a functional standpoint; the time remaining to commercial introduction; the financial stability of the commercialization entities; analyses of competing technologies; 6. What is the typical market royalty rate, based upon independent research completed, for this type of technology? 7. If the IP developed is going to be patented, when is the patent reasonably expected to be issued? Will commercial product be issued prior to patent issuance? 8. Check the university IP policy to ensure that all written guidelines are strictly followed; 9. Possibly consult an IP attorney to confirm the proper steps to be taken to ensure that ideas and innovations are not at risk when shared externally; and

34 Conduct Qualitative Assessment On Third Party Information 1. Annual reports and financial statements of companies that have commercialized competing technologies 2. Market size, territories 3. Competition and aggressiveness 4. Lines of product per competitor, turnovers and margins 5. Website s visits of competitors 6. Copies of similar or competitors patents, patent portfolio benchmark, strengths and weaknesses 7. Consumer tastes 34

35 Sources Sources of Royalty Rate Data Fee/Subscription Based 1. ktmine 2. Royalty Source 3. RoyaltyStat Publications 1. Licensing Economic Review 2. IPRA, Inc. Intellectual Property Research Associates 3. Licensing Royalty Rates, 2011 Edition, &promoID=ZZ02 4. Licensing Executives Society surveys, published through Les Nouvelles (The Journal of the Licensing Executives Society) 35

36 Patrick PIERRE + 33 (0) ppierre@questel.com Questel Consulting est une marque de Questel Consulting Europe, nom commercial d Avenium Consulting SA à Directoire et Conseil de Surveillance au capital de ,66 - SIRET : Grenoble Siège social : 10 rue d Arménie, Grenoble