attorney's guide to the valuation of intellectual property
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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.
© 2014 Armitage, Billion, Hanson 2
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
© 2014 Armitage, Billion, Hanson 3
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.
© 2014 Armitage, Billion, Hanson 4
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.
5© 2014 Armitage, Billion, Hanson
Purposes of IP Valuations
Transaction pricing & deal structureFinance collateralization & securitizationTaxation planning & complianceManagement information & strategic
planningIP portfolio management decisionsBankruptcy & reorganization analysisLitigation support & dispute resolution
© 2014 Armitage, Billion, Hanson 6
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
© 2014 Armitage, Billion, Hanson 8
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
© 2014 Armitage, Billion, Hanson 9
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
© 2014 Armitage, Billion, Hanson 10
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
13(c) 2014 Armitage, Billion, Hanson
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,
Hanson 14
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
© 2014 Armitage, Billion, Hanson 15
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
© 2014 Armitage, Billion, Hanson 16
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
© 2014 Armitage, Billion, Hanson 17
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
© 2014 Armitage, Billion, Hanson 18
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
© 2014 Armitage, Billion, Hanson 19
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
© 2014 Armitage, Billion, Hanson 20
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,
Hanson 22
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
© 2014 Armitage, Billion, Hanson 23
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
© 2014 Armitage, Billion, Hanson 24
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
© 2014 Armitage, Billion, Hanson 25
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
26
© 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
© 2014 Armitage, Billion, Hanson 27
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)
© 2014 Armitage, Billion, Hanson 28
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
© 2014 Armitage, Billion, Hanson 29
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
© 2014 Armitage, Billion, Hanson 30
IP Asset Due DiligenceTeam approach
Patent attorneysBusiness evaluators Industry veteransContract attorneys
31© 2014 Armitage, Billion, Hanson
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.)
32© 2014 Armitage, Billion, Hanson
IP Asset Due DiligenceRest of team
Any liens or mortgages on IPMarket/product evaluationIndustry players
Litigious? Potential partners? etc.
33© 2014 Armitage, Billion, Hanson
Patent File History Review
All relevant art cited and review by ExaminerLimitations disclaimed in prosecutionAdmissions by patent attorney
34© 2014 Armitage, Billion, Hanson
OwnershipCorrect inventorsAssignments or other transfer of rightsGovernment rightsThird party challenges
35© 2014 Armitage, Billion, Hanson
Claim EvaluationScopeProduct coverageDetectabilityEnforceability
36© 2014 Armitage, Billion, Hanson
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
37© 2014 Armitage, Billion, Hanson
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
© 2014 Armitage, Billion, Hanson 38
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?
© 2014 Armitage, Billion, Hanson 39
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?
© 2014 Armitage, Billion, Hanson 40
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.
© 2014 Armitage, Billion, Hanson 41
Q & A
© 2014 Armitage, Billion, Hanson 42
Special ThanksFrank Farrell
Frank@fsfarrell.comMarkus Lacis, CPA
Markus.Lacis@McGladrey.com
43© 2014 Armitage, Billion, Hanson
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
© 2014 Armitage, Billion, Hanson 44
For More InformationClyde Hanson, CPVAClyde.hanson@ventureisles.com(612) 418-1192 Minneapolis
Richard Billionrbillion@billionarmitage.com (952) 697-2633
Ben Armitagebarmitage@billionarmitage.com(952) 697-2632
© 2014 Armitage, Billion, Hanson 45
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