patent marketplace - copyright immendo ltd 2011

The Patent Marketplace

2010 02 24 Marcus Malek

©Immendo Ltd. 2011

Agenda

• Recap sine we last met – Revisiting key concepts and answering potential questions

• Background – What is really a marketplace. Some financial concepts

• Patents as an asset – Are they comparable to art, financial instruments, property or none/all of the above?

• Patent valuation – Black magic, methods or madness?

• Why would anyone buy or sell patents? – Why is there even a need for a marketplace?

• The Patent marketplace – Looking at the market makers and participants of the ecosystem

• How is a deal really done – An insight into the nitty gritty of patent transactions

• Key take outs

RECAP SINCE WE LAST MET

Revisiting key concepts and answering potential questions.

Last time we discussed how to make money with patents and touched upon:

• The importance of litigation

• The vast number of different business models

• The difficulty to prove a working model

• The US Patent System as a catalyst

Litigation was important for business models / marketplace because:

• In one way it constitutes the opportunity cost of patents

• Litigation is one kind of bet that people choose to invest in

• If seen through, the punitive damages that are awarded are huge.

• Regardless, almost 90%, of cases settle outside of court

Offensive Patent Strategy

Defensive Patent Strategy

Institu

al Fun

We looked at a wide number of business models

Source: Internal analysis

1. Design and license 2. Research, license tech + IP 3. Research & license patents 4. Research and litigate 5. Acquire and license 6. Acquire and litigate 7. Pool

a) Aggressive b) Non-Aggressive

8. IP Trust 9. Litigation Trust 10.Aggregation 11.IP Secondaries 12.IB Funds 13.Defensive Pools

a)Non-Profit b)VC Backed c)Open Source

14.Securitization 15.Collateralization 16.Brokerage 17.Consultancy 18.Auctions 19.Patent based ETFs 20.Invalidation

18 19 20

But even if we saw 20+ models, not all are proven or practiced by many entities

• Many of the business models are less than 10 years old

• Many still have only one entity who is trying to find their “blue ocean”

• Many are also in some way connected to litigation (offensive and defensive)

The US Patent system also plays it part for the marketplace and business models

• The punitive damages rewarded incentivize litigation

• By filing suit you can force other people to court, i.e. forcing them to costs

• Another large discussion is regarding the quality of patents, do we have too many or too bad patents?

• The only way to determine patent scope is in court.

One could say that the USPTO turns patents into a multi-billion dollar betting game that’s often

settled in the business arena rather than any other arena.

BACKGROUND

What is really a marketplace?

Some financial concepts.

I know you are from different backgrounds, so let’s go through some key concepts

• The marketplace – We take it for granted, but what is it really

• The importance of liquidity – What does it really mean.

• Information asymmetry – A key concept in understanding markets

• Understanding Risk – The risk/return trade-off in a patent setting

• Transaction costs – In many markets this is virtually nil – how about IP?

The concept of the marketplace is probably clear to you..

• There are exchanges that trade stocks and derivatives at massive volumes around the clock at very low transaction costs (t-costs)

• A (scary) large amount of the Swedish students have probably bought/sold a flat

• The concept and success of Ebay, Tradera, Blocket is perhaps another good example

…but imagine the following

• You find a Rembrandt in your attic:

– What do you do to find a seller?

– How do you know the price of it?

• You want to sell your flat, but not use a real estate agent

• You want to buy 10 bags of wheat from Tuscany

• You want to sell shares in your small limited company (AB)

Although some markets are transparent and operate at low (no) t-costs, there are still many opaque markets with enormous

transaction costs.

Let’s take the example of buying or selling shares online – we take much for granted

• Do we ever question that the broker has rights to sell the shares?

• How often do we ask if the seller really is the owner of the shares?

• How often do we really know (as in written letters) that ownership has been transferred.

• How often do we check what we can/cannot do with the shares (e.g. collateralize)

The reason we take this for granted is (probably) that – god forbid- everything should go wrong: “We could always re-sell” ...

… which brings us on to another thing most people (and US home owners until 2008 in particular)

take for granted: Liquidity

Liquidity = how active a market is (i.e. how easy it is to buy and sell certain assets)

• The low t-costs, (full) transparency and (seemingly) never ending amount of buyers makes the stock market extremely liquid.

• In good times, the housing market is very liquid because of easy access to capital (loans) and abundance of brokers lowering t-costs

• Fine art has very low liquidity as there are few buyers, low access to capital and ever fewer sellers.

Patents are very illiquid because:

• Little access to capital

• Few sellers and few buyers

• High transaction-costs

• Difficult to establish price

• No open market and brokers of variable quality

Information asymmetry – the real reason for many transactions / profits

• In its simplest format it’s about the buyer and seller having access to different information

• For stock markets (institutional traders) that’s seen as virtually transparent (symmetric) because information is public (but there’s too much information)

Information asymmetry for patents is fairly low because:

• Patents are public documents

• For high value patents all cards are on the table (e.g. claims charts etc)

• Sellers are often keen on making a clear case.

• One instance where it’s not true is for emerging tech (non infringement) – where the seller has no idea of buyers intentions

The concept of risk and reward is probably clear – but what are specific patent risks?

• Main concept is (of course) high risk = high reward

• For shares that’s usually a risky business segment / geography / venture

• For patents it could be things like: – Validity of the patent – Outcome of Jury judgments – Infringement opinions – Technical essentiality (falling into FRAND / RAND)

• In essence, patent risk is quite binary

All this talk about transaction costs – what is it really?

• T-costs are costs associated with closing a deal.

• For online trading it’s virtually nil as all is standardized (contracts, change of ownership)

• For property it’s quite straightforward only needing certain documentation (country specific)

• For art it’s more costly – often requiring 3rd party evaluation (of authenticity etc.)

• For patents it’s just a nightmare..

Examples of transaction costs for patents

• Chain of title • Encumbrances

– Scope of previous licenses – Technology consolidation and exhaustion

• Representations and warranties – What info can we (as seller) guarantee and what do

we know about the patent

• Technological definitions – Field of use licensing – Essentiality and other standards issues

Key concepts – intermediate summary

• The marketplace, as we tend to know it, does not exist for patents

• One reason for non-existent market is the illiquid nature of patents

• Although in theory patents are public, there’s still some information asymmetries

• There are also many specific risks associated with patents, almost making it binary

• All of the above factors leading to very large transaction costs

So in essence people try to create a marketplace. As always people like shortcuts – so naturally they try to

extrapolate existing markets to “explain” patents as assets…

PATENTS AS AN ASSET

Are they comparable to art, financial instruments, property or none/all of the above?

Patents as an asset class

• This is a topic which is loved by academics and most zealous IP evangelists

• Because of the vast number of other assets (classes) available, people are very keen on putting patents in one of those “boxes” based on their characteristics.

• One of the main drivers of this is to (again..) try and find a known model to work for 80/20 work

• Let’s take a look at the most popular comparisons..

Patents = art?

• Some people like to look at patents as very similar to art:

– Very few people know the true value

– Limited numbers of interested parties

– Limited numbers of parties with financial muscle

– No real market, but rather all handled through few auction houses

Patents = derivatives / financial instruments

• Some people like to look at patents as a financial asset similar to shares, derivatives

– Can be collateralized / securitized

– Are found on the balance sheet

– Can be traded

– Use a broker structure for markets

Patents = property

• Some like to look at patents as similar to property

– No open market

– Brokers are key

– Auctions needed to establish real price

– Can be collateralized

– Market pricing is main method

My personal view on this: trying to fit a square peg through a round hole

• We should accept that patents are patents, nothing else.

• The aspect many people miss is the “value adding” aspect and it’s effect on pricing

• The models get many things right – but no one is spot on.

• My alternative comparison: patents = commodities – Market pricing is main method – Only few retail outlets – Need skilled brokers – Adding value (refining product) opens up to new markets

Again we’re seeing that people are trying hard to get their head

around how to categorize patents. Mainly to be able to do “quick and

dirty” pricing / valuation …

PATENT VALUATION

Black magic, methods or madness?

How on earth do you value a patent?

• Yet another “hot” topic for academics (myself included)

• There are very many elaborate models, but in real life it’s a different game

• Let’s look at the main approaches used:

– Cost based

– Market based

– Income based

Cost based patent valuation

• “The value of a patent is the cost of inventing it and patenting it”

• “The value of a patent is the cost of inventing around it”

• In general – the idea is more similar to buying a refined commodity and saving time/effort

Income based patent valuation

• “The value of a patent is the amount of money it can generate”

• Seems very straight forward and intuitive, but has some key issues: – How do you know how much money to attribute to a

certain patent

– And what would the value have been without the patent?

• Regardless – it’s a strong method for licensing

Market based patent valuation

• “What have other people paid for similar patents”

• Perhaps even more intuitive, but suffers from two main flaws:

1. There is very little (if any) public information

2. Per definition each patent is unique

So that was theory, how about real life situations?

In reality a combination is the most effective way – in reality calculate a spread

• Cost based is always taken into account as the base scenario – Note: cost can be either for in house or purchase

• Then pending if it’s licensing or sales the other methods are used to calculate upside: – For sales, market comparables tend to work best

– For licensing, a royalty rate is often applied to sales figures of affected products • But in fact, that royalty rate is often market based

The honest truth, however, is that due to low liquidity it’s often a buyers

market.

Roughly meaning: whatever the buyer can afford becomes the price.

WHY WOULD ANYONE BUY OR SELL PATENTS?

Why is there even a need for a marketplace?

POP Quiz: Why would anyone sell patents?

OK – so that was the easy one, but why would anyone buy patents?

(Unsurprisingly perhaps) I’ve developed a framework / model I find helpful

Buyer Reasons

Litigation M & A New Market New Product R&D Portfolio Pool New Tech

Counter Assert Defensive Offensive Assertion

Claim Chart importance

(lo -> hi)

Price / Patent

License Preference

Amount of seller “homework” / product refinement needed

Amount of patens in deal

You could say immediate need for patents is in two scenarios: litigation and expansion • Although similar they’re vastly different in types and

quantities of patents. • Litigation requires few (one) “silver bullets” to (counter)

assert. – Very large t-costs (DD and SMEs) – High price – Claim charts are a requirement

• Expansion (segment, geography or product) is more strategic looking more for bulk – Lower t-costs – Low per-patent price – Looking more for heritage patents or certain IPC codes

You could probably also look at it more comparatively in this 2x2

Patent Quality

Price / patent

Size of bubble denotes number of patents / transaction

Litigation (Assert.)

Litigation (Counter.)

New Market

New Technology

New Product

Build Portfolio

Pool (Offensive)

Pool (Defensive)

So after all – there are a few scenarios where patents are transacted.

However, they are all very different. Let’s look at some real life examples:

Example 1 – Strategic sale of large portfolio to new entrant

• Hundreds of patents

• Double digit M$

• Strategic fit for buyer entering new market and moving out of OEM

• Roughly 5-8 infringed patents

Example 2 – Single patent sale to defensive buyer.

• One patent

• Hundreds of $k

• Buying patent to take it of market and to avoid nuisance suits

• Strong indication of infringement

Example 3 – Sale of small portfolio for assertion entity

• 3 patents

• Millions $

• Patents bought for assertion by anonymous LLC

• Patents were reverse engineered

THE PATENT MARKETPLACE

Looking at the market makers and participants of the ecosystem

The size of the patent market is debatable and depends much what you include.

• Do you count only secondary IP transactions

– Corporate sales

• Do you include licensing?

• Do you include settlements?

• How about cross-licensing ?

The difference of definitions can change the market size thousand fold.

2000 2002 2004 2006 2008

Size of IP secondaries market (mill USD)

2000 2002 2004 2006 2008

Billions Global royalty revenues (bill USD)

Source: Internal analysis, Oliver Wyman, World Bank

Maybe a third way could just be to look at liquidity

Patent Portfolios Offered for Sale

Source: IAM Magazine 2008

So the market size is really how you define it, but at least there is a

(growing) market.

Let’s now look at WHO is in the market

As always (ICM thought me well) it’s handy to have a framework..

Although it’s interesting, we’ll not look at licensing / pools / litigation / venturing…

.. but instead focus on the transactional (and re-transactional) side of things

59 Source: Internal analysis

The main actors in IP transactions

• First observation:

– same actor can do many things (e.g. buy and sell)

• Second observation:

– patents can be re-sold multiple times.

The main actors in IP transactions (cont’d)

• Third observation: – entities with “an

agenda” (defense / offense) often are end of the line

• Fourth observation: – Intermediaries

(brokers) and people providing liquidity play a major role.

Hopefully it’s now clear WHO is trading and that entities “wear many

hats” creating a complex system.

Let’s now turn to the WHAT & HOW..

Oliver Wyman (2009 study) presented some figures/thoughts worth discussing.

“Litigation grade” patents sold as real “silver bullets”. I’d assume market volume is closer to 3-5% and value

closer to 50%

“Nice to have” patents, presenting a good solution, not necessarily

infringement (maybe future use)

“Bulk” patents sold only for quantity. This market volume / value has really

dropped, almost non-existent

Source: Oliver Wyman 2009, Internal Analysis

Here’s another way of looking at it – tied to strategy, alternatives and tech maturity

Technology Licensing

IP Venturing

Patent Sales

Litigation

Soft Assertion

Hard Assertion

High Risk / High Return

Lower Risk / Low Return

Technology/market maturity

Mature Market (in-use)

Emerging Market (5+ years)

Source: Internal analysis

So no more beating around the bush..

Where do the patents really end up then??

Oliver Wyman (2009 study) has one answer: Financials and NPEs

Patent Freedom are implying the same based on growing NPE suits…

Number of NPE’s filing suit, per year and total Total No. companies being sued by NPE’s

… but at the same time promoting sister-company AST as a (well solicited) buyer

Patents offered for sale to defensive pools

Naturally large corporate purchases are made, data is rare, but here are examples: • Microsoft (2010) buying 882 patents related to Linux

(from Novell) for 450 $M

• Biophan (2007) buying pacemaker patents from Medtronic for 11 $M.

• CR Bard (2003) bought biopsy patents from Biomedihal Instruments and Products GMBH for 53 $M

• Wi-Lan (2009) acquired 200 wireless patents for 21 $M from Infineon and Airspan.

• Wi-Lan (2006) acquired 35 ADSL patents from Nokia for 29 $M.

So now to tie it all together: How are patent deals really done?

HOW IS A DEAL REALLY DONE

An insight into the nitty gritty of patent transactions

The different steps of buying patents

1. Initial review for feasibility

2. Thorough technical due diligence

3. Using SMEs for additional technology evaluation

4. Reviewing encumbrances

5. Pricing discussions

6. Terms and conditions (reps & warranties)

The different steps of selling patents

1. Mining the portfolio 2. Grouping portfolio based on strategy 3. Second deep techno-legal review 4. Adding market analysis of highlighted patents 5. Developing claims charts and similar collateral material 6. Potential reverse engineering 7. Developing sales material 8. Going to market 9. Incorporate customer feedback 10. Encumbrance review by customers 11. Pricing 12. Terms and conditions (reps & warranties) 13. Closure

Some key steps in selling: a) Product Development

• Need strong (mixed) group of people working in interaction

• Tackling techno-legal issues

• Adding market analysis to find feasible markets

• Have patience

• Elbow grease, elbow grease, elbow grease..

Some key steps in selling: b) Sales Strategy

• Might seem very rudimentary – but really helps to look at it from the buyers perspective

• Find the buyer with most immediate need (e.g. litigation, strategy, new entrant)

• In addition to need, the buyer needs cash and (almost exclusively) needs to be used to dealing with and transacting IP

Some key steps in selling: c) Negotiations / Pricing

• It’s a buyer’s market, but there are some ways around it: – Delaying payments – License vs. Sales

• Best situation are multiple buyers going head to head

• Develop a reasonable pricing spread, for interna and external communications

• Be very aware of the buyers internal/corporate situation and how you can help that individual

Some key steps in selling: d) Encumbrances / Reps & Warranties

• Could be the nail in the coffin

• Must make buyer feel comfortable with assets

• Seller (or seller’s investors) must be comfortable with the reps & warranties given

• This is really a costly and legally intensive exercise

KEY TAKEOUTS

Summarizing todays lecture

Key take outs from today

• Patents are patents, not art / property / shares – Trying to use other models might do more bad than good.

• Patent market is active and growing but very opaque

• The specifics of the market are demanding and costly, but necessary

• There are few actors doing many parts of the ecosystem

• It’s a large sum game, also for sales

• Product development (“nitty gritty sales”) is not that hi-tech, but very time consuming

Transacting Patents is a fine but very complex trade.

It’s mastered by a few.

If you master it – you’ll get successful (and probably very rich and working wherever you want in the world..)

THANKS AGAIN FOR HAVING ME! THANKS FOR YOUR ATTENTION !

Please direct any questions to:

mmalek@immendo.com

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