Intellectual Property Finance

Training of Trainers Program on Effective Intellectual Property Asset Management by Small and Medium-sized Enterprises (SMEs)

Bishkek, November 20 and 21, 2013

Anil Sinha, HeadSmall and Medium-sized Enterprises (SMEs) Section, WIPO

Intangible assets defined

•According to Valuation of Intellectual Property and Intangible Assets, Second Edition, by Gordon V. Smith and Russell L. Parr, 1994, (“Smith and Parr”), page 83:

“Intangible assets are all the elements of a business enterprise that exist in addition to working capital and tangible assets. They are the elements, after working capital and tangible assets, that make the business work and are often the primary contributors to the earning power of the enterprise. Their existence is dependent on the presence, or expectation, of earnings”

Characteristics of intangible assets

Property open to legal enforcement and transfer of ownership

Produce revenues in their own right

Assets that generate additional resources / cash flows / profits over and above those which the business would otherwise make if it did not own the rights in question

What are Intangible Assets?Intellectual Assets

Intellectual Property Intellectual Capital

Patents

Trademarks

Publishing

Rights

Brand logos

designs

Copyrights

Information

databases

Industrial

Design

Software

Platforms

Trade

Secrets

Confidential

Information

Technology

Know-How

Customer Capital

Unpatented

research

Knowledge Providing

Value

Human capital

Most

Tangible

Least

Strategic Intellectual Property Management Executive Course Geneva Tony Hadjiloucas September 2007

Why intangible assets are important? PwC research shows that total intangible assets comprise, on average, nearly 80% of companies’ value1

Intangible assets may be the only thing of significant value in the business.

This is because:- They provide barriers to entry- They differentiate products (even commodities)- They provide a more stable and profitable earnings stream- They can have a long life (e.g. brands / trademarks)- They may provide international recognition- They may be capable of being leveraged into new

geographic or product markets (e.g. Virgin, Orascom)1 Based on analysis of the purchase price allocations relating to 175 transactions made by US companies during 2004.

SPECIAL FOCUS CHAPTER Valuing IP and determining the cost of capital John Rugman and Tony Hadjiloucas PricewaterhouseCoopers LLP.

http://www.wipo.int/academy/en/execed/sipm/goa_mar_07/pdf/Valuing-IP-Cost-capital-05.pdf

Managing IP Assets -Denise Raybould, Associate, BDO Kendalls

Stages of Technology Transfer:

From Research Support to Economic Growth

Research

Support

Inventions

DisclosurePatents

Licenses

Startups

New Products

Higher Standard of living

Economic

Growth

More in Tax

RevenuesFederal State

Corporate EndowmentNew Jobs

IS A COMPANY READY?IS A COMPANY READY?

• Business plan?

• Stage of development of the company

• Type of investment?

• Valuation?

• Management team ready?

• Has the management team enough time and energy to raise funds?

• Is the team shaped to talk to investors?

• Does the company know where to go?

Add value before raising capitalAdd value before raising capital

Documentation and PresentationDocumentation and Presentation

Government grantsGovernment grants

Intellectual Property ProtectionIntellectual Property Protection

R&D PartnersR&D Partners

In principle agreementsIn principle agreementsLicencesLicences

CustomersCustomers

SOURCES OF START-UP CAPITAL (USA)SOURCES OF START-UP CAPITAL (USA)

PERSONAL SAVINGS (78,5%)

BANK LOANS (14,4%)

FAMILY MEMBERS (12,9%)

EMPLOYEES / PARTNERS (12,45)

FRIENDS (9,0%)

VENTURE CAPITALISTS (6,3%)

MORTGAGED PROPERTY (4,0%)

GOVERNMENT LOANS (1,1%)

OTHERS (3,9%)

Other ways of raising money through IP

Licensing

Sale

Auctions

Donation

Grants

Methods of Valuing

Market Approach

Cost Approach

Income Approach

Valuation approaches - Overview

Valuation approachesValuation approaches

Market ApproachMarket Approach Cost ApproachCost Approach Income ApproachIncome Approach

Present value of earnings

attributable to the asset or costs

avoided as a result of owning the asset

Reproduction/replace-ment cost-

adjusted for depreciation and

obsolescence

Look at market transactions

involving the sale of comparable

assets

Market approach

Difficult to apply to intangibles: sufficient number of transactions of truly comparable assets is rarely available

Valuation approaches

Cost Approach Income Approach

Market ApproachMarket Approach

sale of comparable

Cost approach

Dose not capture expected returns

Good for intangibles that do not directly generate cash flows: e.g. software for internal use and workforce

Good to cross check with income approach

Valuation approaches

Market Approach Income Approach

Cost ApproachCost Approach

reproduction cost

Income approach

Most common approach for intangibles:- Captures expected future returns - Estimate values for unique assets- Based on cash flows or earnings generated - Based on costs avodance

Valuation approaches

Cost ApproachMarket Approach

Income ApproachIncome Approach

value of earnings

Example intangible assets

Brand / trademark

Customer relationships

Key employees / non-compete agreement

Software

Typical methodologies for example intangible assets

Which cash flows?

Overall cross checks (Return on assets, residual goodwill etc)

Typical valuation method

Market benchmarks and income based method (e.g. relief from royalty and excess earnings)

Income based method value of earningsIncome based method value of earnings

Cost Approach: Replacement cost

Always preferable to apply two or more methodologies to cross check results

Pros and cons of each approachADVANTAGES DISADVANTAGES

IncomeApproach

Considers the estimated remaininglife of the asset and appropriaterisk-based rate of return at which todiscount cash flows

Captures the unique economicfeatures of the subject intangible

Relies on the ability to accurately forecastfuture performance

Ensuring consistency of measure of

economic income and cost of capital Estimating remaining useful life of asset

MarketApproach

Provides compelling empiricalevidence of value

Relatively easy to apply Conceptually pleasing

Generally not feasible because transactionsregarding intangible assets are often uniqueto that particular asset

Much of the information necessary to makemeaningful comparisons is not publiclyavailable

Cost Approach When comparable market data notavailable

When intangible is of unusual type

and not normally income producing Works well with internally

developed intangibles or inliquidation scenarios

Costs associated with developing intellectualproperty generally have little to do with thevalue inherent in the right to exploit thatproperty

Difficult to apply because data not readily

available May require numerous adjustments to

financial dataStrategic Intellectual Property Management Executive Course Geneva Tony Hadjiloucas September 2007

IP Due Diligence

In order to obtain financing whether debt or equity those who are providing the financing will need to be satisfied as to whether the company is worthy of it.

Important to be “investor ready”. That is show that you have taken all possible steps to identify, protect and manage your IP assets.

START-UP CAPITALSTART-UP CAPITAL

25% start with less than $5,000

50% start with less than $25,000

75% start with less than $75,000

Less than 5 % with $ 1,000,000 or more

The Paradox of Access to FinanceThe Paradox of Access to Finance

BanksBanks

Venture Capitalists Venture Capitalists have money have money

Stock ExchangeStock Exchange

ButBut argue that there aren’t enough good argue that there aren’t enough good

projectsprojects

What is a good project? What is a good project?

A Good Project!A Good Project!

A good project is a project presenting in theA good project is a project presenting in the

eyes of an investor:eyes of an investor:

acceptable risk profileacceptable risk profile

a good perspective of returna good perspective of return

this means:this means:

access to market = access to market = innovationinnovation

profitsprofits

THE ENTERPRISE FINANCING PROCESSTHE ENTERPRISE FINANCING PROCESS

R&D Start-upEarly

growth

Accelerating

growth

Sustaining

growth

Maturity

growth

Proof of

Concept

Funding

Seed

Corn

First

Round

Second

Round

Development

Capital

Replacement

Capital

Development

Capital

Founders, family and friends

Public Sector

Business angels

Venture capital funds

Corporate venturing

Public listing / IPO

Source of

Funding

Type of

Funding

Stage in

Cycle

Investment ContinuumInvestment Continuum

Angel market addresses the $500K investment Angel market addresses the $500K investment gap between love money and serious moneygap between love money and serious money

High

LowSeed Start-Up Early Growth Established

Level of Investment

Risk Assumed

by Investor

Founder, friends

and familyBusiness Angels

Venture Capitalists

Commercial banks

Equity Markets

Corporate VC

* “Angel Investing” Osnabrugge & Robinson

VENTURE CAPITAL (Formal & Informal)VENTURE CAPITAL (Formal & Informal)

► Institutional operators Institutional operators (formal venture capital)(formal venture capital) ► Private subjectsPrivate subjects► Banks Banks ► InsuranceInsurance► Corporate venture capital Corporate venture capital

► Non-institutional operatorsNon-institutional operators (informal venture capital)(informal venture capital)

► Business Angels Business Angels

FORMAL AND INFORMAL EQUITY FORMAL AND INFORMAL EQUITY PROVIDERSPROVIDERS

* Source: van Osnabrugge, 1998, p.2

Personnel Firms funded Due diligence Investment's location Contracts used Monitoring ex-post Exiting the firm Rates of return

Business Angels Entrepreneurs Small, early stage Minimal Of concern Simple Active 'hands-on' Of lesser concern Of lesser concern

Formal venture capital Investors Large, mature Extensive Not important Comprehensive Strategic Highly important Highly important

FORMAL AND INFORMAL EQUITY PROVIDERSFORMAL AND INFORMAL EQUITY PROVIDERS

VC– Easy to find via directories

– Your request is only one among many hundred a VC receives

– Can often via syndication provide large investment

– Thorough and formal due diligence and investment process

– Exit route very important

BA– Difficult to find

– Request often strong personal involvement

– Limited amount to invest

– Investment decisions often quick and less formal

– Syndication more and more usual

– Exit route less in focus

BUSINESS ANGEL (BA) - DBUSINESS ANGEL (BA) - Definitionefinition

“A Business Angel is a middle aged male with reasonable net income, personal net worth, previous start up experience, who makes one investment a year, usually close to home or office, prefers to invest in high technology and manufacturing ventures with an expectation to sell out in three to five years time”. (Kelly and Hay, 1996)

”Business angels (informal investors, independent investors) are investors who provide risk capital directly to new and growing businesses in which they have no prior connection”.(Harrison and Mason, 1996)

BUSINESS ANGEL (BA)BUSINESS ANGEL (BA)

• male, rarely female

• successful experience as an entrepreneur or manager

• high net worth individual and / or sophisticated investor

• have a declared propensity to invest and to risk in a start-up firm

• invest their own money (around 50K – 250K euro) (part of their cash capital: 20 - 30 %)

• Seeking profit, but also fun (seeking minimum 20% return)

• are willing to share their managerial skills and their enterprise background

• often invest in their region of residence

• make one investment a year

• prefer high-technology and manufacturing

• take a minor participation – medium term investment

• are willing to wait for an exit for 3-5 years

Attitudes, behaviour and characteristics:

ANGEL’S – Success SANGEL’S – Success Storiestories

Company name Angel Investor Business Investment Value at Exit

Apple Computer (Name Witheld) Computer hardware

$91.000 $154 million

Amazon.com Thomas Alberg Online bookshop

$100.000 $26 million

Blue Rhino Andrew Filipowski

Propane cylinder replacements

$500.000 $24 million

Lifeminders.com Frans Kok Internet e-mail reminder service

$100.000 $3 million

Body Shop Ian McGlinn Body care products

£4.000 £42 million

ML Laboratories Kevin Leech Kidney medical treatment

£50.000 £71 million

Matcon Ivan Semenenko Bulk containers

£15.000 £2.5 million

Source: partially adapted from unpublished data provided by Amis Ventures in 1999

ANGEL STRATEGYANGEL STRATEGY

• New products or technological improved products in an existing market

• A product or service that can be taken to market without further development (i.e., past the initial concept stage)

• Creation of new markets

• Company’s growth should be expected to be higher than market growth

• Increase of market share against competitors

• Superiority regarding competitors

High-growth start-ups: new businesses that are likely to see sales grow to around € 1M and employment to between 10 and 20 people in early years and export oriented.

Key selection criteria of risk capital investors (generally):

ANGEL DUE DILIGENCE PROCESSANGEL DUE DILIGENCE PROCESS

TechnologyTechnology developmentProduct developmentProcess developmentProduct supplyDeliveries

MarketMarketingSalesPRCompetitorsIPR

OrganizationRecruitment BoardNetwork of service suppliersOffice

Economy / FinanceCash forecastFinance activitiesCost estimateBudget

Angel MotivationsAngel MotivationsAltruistic - willing to provide:Altruistic - willing to provide:

AdviceAdvice - financial and management - financial and management

ContactsContacts - broad range to assist in development of venture - broad range to assist in development of venture

Hands-on InvolvementHands-on Involvement - at basic level, if required - at basic level, if required

GovernanceGovernance - Board of Directors / Advisors - Board of Directors / Advisors

CredibilityCredibility - sends good signals to customers, partners & - sends good signals to customers, partners & investorsinvestors

PragmaticPragmaticWill hand off involvement to next level of investors …Will hand off involvement to next level of investors …

Therefore will use same criteria as VC to evaluate opportunityTherefore will use same criteria as VC to evaluate opportunity

57% of companies with angel investment achieve VC funding57% of companies with angel investment achieve VC funding

10% of companies with no angels achieve VC funding10% of companies with no angels achieve VC fundingDr. Allan Riding, Carleton University research on Ottawa angels

Types of Business AngelsTypes of Business AngelsProfessionalProfessional

Doctors, lawyers, accountantsDoctors, lawyers, accountants

MicromanagementMicromanagementVery hands on with lots of Very hands on with lots of experience, but may be toxicexperience, but may be toxic

EnthusiastEnthusiastUsually retired, investing is a Usually retired, investing is a hobby, little value addhobby, little value add

CorporateCorporateRetired senior managers Retired senior managers looking to support their looking to support their investments or create a new investments or create a new senior job for themselvessenior job for themselves

EntrepreneurialEntrepreneurialMost active, successful Most active, successful entrepreneurs looking to entrepreneurs looking to diversify portfolio or expand diversify portfolio or expand current businesscurrent business

“Millions of years of evolution, and that’s the latest model?!?”

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Amgen: A Capital VentureAmgen: A Capital Venture

World’s largest biotech company World’s largest biotech company

Founded 1980Founded 1980$19 million venture capital investment$19 million venture capital investment

2007 Financial Year2007 Financial Year$14.8 billion revenues$14.8 billion revenues

$4.8 billion profit (before tax)$4.8 billion profit (before tax)

Market capitalisation: $51 billionMarket capitalisation: $51 billion

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Venture CapitalVenture CapitalInvest in:Invest in:

Private companies with high growth potentialPrivate companies with high growth potentialLaunch, early development, or expansionLaunch, early development, or expansionManagement buy-outs and buy-insManagement buy-outs and buy-ins

Raise funds for investment from:Raise funds for investment from:Private and public pension fundsPrivate and public pension fundsEndowment fundsEndowment fundsFoundations, corporations, wealthy individualsFoundations, corporations, wealthy individuals

Looking for >5-fold return on Looking for >5-fold return on investment within 5 yearsinvestment within 5 years

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Venture CapitalVenture CapitalProfit and risk sharingProfit and risk sharing (high risk – high return)(high risk – high return)10 to 15% of portfolio will give very high returns10 to 15% of portfolio will give very high returnsDetailed due diligence Detailed due diligence High level of hand holdingHigh level of hand holdingOwnership and control of business sharedOwnership and control of business sharedPatient, flexible financing (5-7 years to exit)Patient, flexible financing (5-7 years to exit)Highly selective financing – importance of deal flowHighly selective financing – importance of deal flow

Thank you for your attention!

anil.sinha@wipo.int