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Intellectual Property: Valuation,

Assessment and Audit

Project Presentation

Intellectual Property Management

IIM Lucknow, Noida Campus

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Agenda

 The 9 reasons for valuing IP

 The Basics
 Fundamental Principles
 The three approaches to value IP
 Specific IP Valuation
 Patents
 Trademarks and Brands
 IP Risk Assessment
 Damage Assessment
 IP Audit
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Why Value IP?

1. Exploitation, as any other asset.

A basis for negotiations involving sale, licensing

or exchange of IP.

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Why Value IP?

2. For Taxation
 Transfer of IP from parent to subsidiary company.
 Donation of IP as a tax-free gift to some
institution.

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Why Value IP?

3. For raising funds and securing Financing

IP may serve as a collateral with banks
IP value helps startups raise venture capital

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Why Value IP?

4. Profit sharing - when there are multiple IP

owners

As in a R&D consortium that involves multiple

companies contributing - to determine the
allocation of net income.

Joint Ventures and Strategic Partnerships

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Why Value IP?

5. Assessing damage claims in a dispute,

infringement or breach of contractual rights.

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Why Value IP?

6. Financial Reporting

 Indian Accounting Standard on Intangibles

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Why Value IP?

7. Transfer Pricing
What price is right, for transfer of patents,
licensing a trademark, within the firm?

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Why Value IP?

8. In any restructuring or liquidation procedure

As in mergers, spin-offs or bankruptcy

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Why Value IP?

9. IP drives market Value of Stock

Not only for smaller startups without significant
real assets, but increasingly for larger companies
such as IBM

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Basic Principles of Asset Valuation

Cas h
f lo w s

T im e
 The value of an asset is based on the future returns that are expected to be
generated by that asset
 Returns in the future are worth less than returns now (“time value of
money”)
 Future returns are uncertain (or ‘risky’)
 Intangible assets can affect the returns and/or the risks of cash flows

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IP Valuation - Approach

 The nature of the asset doesn’t changes the

fundamental principle of valuation.

Determine Select and apply

Identify asset(s) /
basis/context of appropriate valuation
understand rights
valuation methodologies

• Open market value • Calculate the incremental

• Copyright
value added by the IP
• Database • Value in use

• Trade mark / passing off • Fair value

• Patent • Liquidation value

• Know-how / trade-secrets • Book value

• Design right

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But Valuing IP is a bit harder …

1. IP doesn’t comes alone

Intangibles are often composite assets. Value is realised in
combination with other assets (tangible and intangible)
e.g. brand – value in combination of
 trade marks (registered; rights in passing off)
 trade dress
 copyright
 logo
 get-up
 recipes/formulae
n.b. trade mark licence v. brand v. branded business

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Valuing IP is a bit harder

2. Value may depend on form and scope of legal rights protecting

the asset

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The fuzzy nature of IP Rights

 Unclear how claims will be interpreted in practice

 inadvertent infringement can occur
 Unclear boundaries fouls up workings of the
Coase Theorem
 Disputes over value are not uncommon
 IP discounted in the marketplace as a
consequence

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Valuing IP is a bit harder

3. Values can vary hugely depending on circumstances

 between uses
 between users
 over time

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Valuing IP is a lot harder

4. Availability of information/incomplete data

Novelty and Secrecy in the IP market

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IP Value Chain

Licensor

IP IP Market
Royalty

Licensee

IP Product Market
Revenue

Customer
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Valuing IP is a lot harder

4. Availability of information/incomplete data

 The market for IP is private and non- observable - Novelty and Secrecy

 Traditional deal structures use no commonly observed or rigorous

economic valuation methods reflecting the private and non-observable
nature of IP market

 Deals are based on emotion and haggling

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All IP valuation methods derive from one of three

approaches
Deprival value Valuation methodology

Cost
Replacement
cost
Lower
of
Value
$$$ Net realisable Market
value

Higher of

Net present
value/value in use Income (DCF)

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Cost-based methods
 Historic cost v. replacement cost
 money well spent?
 investment or expense?
 obsolescence
 “inflation”/required return on original investment

 Relevant to intangibles which can be “readily” replicated

 databases
 “functional” software
 brands?
 technologies?
 know-how?

 Value = avoided cost of purchase / reconstruction

 Don’t forget
 opportunity cost of delay (late to market?)
 risk of failure in attempting to replicate
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Market-based methods

 Frequency of transactions
 evidence of an active market?

 Comparability of “market” transactions

 licences, more often than sale/assignment of IP
 rights transferred
 circumstances of transaction (e.g. cross-licence, licence agreed in settlement
of litigation)

 Headline data only?

 summary royalty terms, but what about the rights and obligations under the
licence?
 summary transaction terms, but what about manufacturing and distribution
contracts?

 But still likely to provide some relevant data

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Income method

 All IP is worthless if it can’t create, maintain or

increase future cash flows

 Some examples …
 Excess Income method
 Relief from Royalty
 Premium Profit

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So far …
 The valuation of IP is, in principle, no different to a general business
valuation
 understanding the dynamics of the business and how it creates value is critical
 the value derived from IP must come from increased prices or volumes, lower
costs, lower risk or greater “optionality”

 Valuation methods designed to estimate this incremental value

 implicitly through royalty based or residual value calculations
 explicitly through economic benefits analysis

 Valuation is based on expectations of the future and therefore contains

significant uncertainty
 using multiple methods improves the rigour of the valuation

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Valuation of Patents

 Not all patents are equal

 What is the Strength of Patent Protection ?
 Length: how much time left to run?
 Breadth: range of products covered?
 Validity: likelihood of being upheld if challenged?
 Exclusionary power: can the owner refuse to
license without raising antitrust or other issues
(compulsory licensing)?
 Available remedies if patent infringed

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Real Options Valuation

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Patents - Qualitative Valuation methods

 Citation Data

 Renewal Data

 Prism

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Valuation of Trademarks

 Income Based
 Direct Assessment of Benefits
 DCF - Excess Returns
 Relief from Royalty
 Cost Based
 Residual Development Cost
 Recreation Cost

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Income method – Trademark valuation

 Premium prices
 v.generic product
 adjust for quality/cost differences

 Premium profits (brand contribution)

 v.generic competitors/ utility provider of goods and services
 adjust for quality/cost differences

 Relief from royalty

 deprival value (value added/cost savings through ownership of asset)
 discounted cash flow (“DCF”) analysis based on after-tax royalty applied to
projected revenues
 most commonly used approach by accountants/valuers/Courts and regulators

 Excess return on capital

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Income method – Trademark valuation

Demand side •Consumer •Premium •Mix Brand Brand loyalty
factors •Business services of services extension •certainty of demand
•products / services
•channels
•sector / geography

Incremental Volumes x Prices x Margins – Capex /

Working capital Risk and return
cash flows Growth Value

Customer Supply terms Financial

acquisition / Capital
retention

Staff acquisition / Brand extension

retention costs
Supply side
factors
Brand support

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Relief from royalty: discounting projected royalty flows to a

present value

Range of
royalty rates

Forecast revenues Incremental

cash flows
Other costs Present
value
Taxation Discount
rate

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Comparable royalties approach

 ‘Comparable’ licence agreements need to be adjusted to reflect
 specific licence terms, such as duration, geographical coverage, exclusivity
 lump sum and minimum royalty payments
 extent to which asset contributes to market demand for the final product
 the availability of substitutes
 licensor’s anticipated profitability from use of the IP (including collateral or ancillary
sales/profits)
 state of development of the IP
 The circumstances in which a previous licence was agreed can be significant
 product of willing negotiations?
 court-imposed solution
 cross-licensing
 uncertainty re validity of IP rights
 Interaction of royalty rate and royalty base: the “result”- must reflect the
underlying economic position

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Income approach and royalties – allocation of

available profits
 Typically 25-33% of incremental profits are allocated to the licensor (in
situations where licensor has no presence in the market to be licensed) as a
royalty

 50:50 split may be appropriate where licensee will compete directly with
licensor

 Allocation reflects inter alia relative risks borne by parties

 licensor: development of technology
 licensee: financial and marketing risks

 “Rule of thumb” split of profits: beware

 different interpretations
 different measures of “profits”
 application different forms of IP rights

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Excess return on capital

Example: the method used by Operating profits

Interbrand in its “Top 100
Brands” tables.

Brand

Value
Discount
x

Intangible
Rate

Others
Cost of Rate of

Tangible
tangible Return
assets and x
other
resources

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IP Risk and Damage Assessment

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Risk Assessment

 Any financial valuation (rewards) must be

weighted down by the risks.

 Ignoring the risks leads to overvaluation

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Different assets face different types of Risk

 Patents
 Technological - Is it feasible/viable.
 Legal - Validity, the ability to stand when
challenged in court of law
 Trademarks
 Priority
 Freedom to use
 Software/Copyrights
 Piracy Risks
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Damages: The Cost of infringement

Hewlett-Packard pays Pitney Bowes $400 million to settle

patent dispute

ASSOCIATED PRESS
Tuesday June 5th, 2001

STAMFORD, Conn. — Hewlett-Packard Co. agreed Monday to pay Pitney Bowes Inc. $400
million to settle a lawsuit over print technology patents….
The companies resolved all litigation without admitting wrongdoing.

In CY2000 HP had net earnings of $3.7B on sales of $48.7B. To

earn $400M HP had to generate $5.26B in Sales.

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The nature of infringement

 On August 31, 1993 a US jury found that Honeywell had

infringed a Litton Ring Laser Gyroscope patent and should pay
$1.2 billion in damages. This was somewhat less than the $1.96
billion Litton claimed but nevertheless perhaps the largest ever
award of damages for patent infringement. However, on July
3rd, 1996 the CAFC whilst upholding the jury verdict on
infringement awarded a new trial concerning damages saying
that the study by Litton's damages expert Dr. Phillips was
predicated on peculation and unrealistic assertions and
supported the trial court conclusion that Dr. Phillips' study was
"pure fantasy."

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The Theory of Infringement

“The basic theory of damages is to make the IP

owner whole for losses caused by the infringers
illicit activity. The IP owner is to be restored
financially to the position he would have
occupied but for the infringement.”

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Wilful Infringement

 Treble damages
 The court may triple the damage award if it is
proven wilful.

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So far …

 Valuation may be triggered by an event, like

 M&A
 Financing - use of IP as collateral
 Joint Venture, Sale or Licensing of IP
 In case of infringement
 But the growing importance of IP makes IP
assessment is an ongoing process

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IP Audit

 Identification, organization and review of a client’s intellectual

property assets and potential liabilities
 Ownership
 Recordation of transfers
 Perfection of security interests
 Compliance with statutory formalities
 Infringement on third party rights
 Client’s rights being infringed

 Could be
 General Purpose IP Audit
 Event Driven Audit
 Narrow Focus Audit

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Why do an IP audit?

 Other than quantifying the value

 Identify, organize, and review existing IP portfolio

 Resolve current issues in IP management practices
 Establish procedures to ensure protection of assets in the future
 Better guarding of trade secrets
 Docketing system for payment of fees and renewal filings
 Assignments of IP in employment and consulting agreements
 Better marking of products
 Add value the company
 What IP assets are underutilized
 What are the potential value creators

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Benefits of IP Audit

 Prevent asset losses

 Make effective economical use of IP assets
 Address gaps in licensing and agreement procedures
 Minimize risk of third party infringements
 Determine position in relation to competitors

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Issues unearthed in IP

 Defects in title to IP
 Assignments of ownership from consultants
 Quitclaim from alleged author or inventor
 Employee inventions within the scope of work
 License rights from third parties to make derivative
works
 Third party joint ownership
 Defects in patents (copyrights or trademarks as well)
 Requests for reexamination or reissue of a patent
 Amendments to applications
 Certificates of correction
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Thank You

[email protected]

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