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IP Valuation September, 2011

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CONSOR Intellectual Asset Management

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Why IP Valuation?

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Beyond specialized IP law practices,

business, commercial, tax and estate practitioners

Increasingly involved in identifying, protecting, applying, and defending intangible assets owned by clients.

• Value to whom?

• How much value?

• How and when does value change?

• Buy, sell or transfer

• Disputed ownership

• Improve performance

• Collateralization

Context Purpose

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What is IP?

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Intellectual Property vs. Intangible Assets

Bundles of IP and IA Assets

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Context: Property Types

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IA vs. IP: Commercialized Separate from Other Assets

Internet Assets

Data Bases

Intellectual Properties

Intangible Assets

Customer & Vendor

RelationshipsPatents

Copyrights

Trademarks

Trade Secrets

Proprietary Systems

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IP Property Types

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Bundles of Intangible Assets (IA), each contains Intellectual Properties (IP)

Marketing Relationship (Customer / Supplier)

Technology Contract

Marks, brands, names, domains

Trade-dress, packaging, logos

Non-competes, key-person

Customer / Supplier relationships

Distribution networks

Order backlog

Technologies, know-how, systems, methods

Patents, software, recipes, content, databases

License / royalty, lease, franchise

Permits, use rights, broadcast rights

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Valuation Methodologies

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Economic principal of substitution

Measures expense required to replace

Neglects future benefit

Present value of future economic benefit

Requires projections and a risk assessment

Requires allocation of benefit specific to the

asset

Value based on price of similar assets

Requires suitable comparable assets

Des

crip

tio

n

Replication / replacement feasible

Benchmarking

DCF

Relief from Royalty

Comparable transactions

Benchmarking

Ap

plic

atio

n

Valuation as Art and Science

Cost Income Market

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Valuation Tools of the Trade

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Discounted Cash Flow Models

Comparable Valuation Ratios

Replacement Cost

Relief from Royalty

Allocation / Excess Earnings

Option Models

Proprietary Approaches

The “Science” of Valuation

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Changing Valuation Terminology

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MVIC

= Assets + Liabilities

MVE

= Equity Ownership Minority

Interests

Level of Value Value Definitions

Fair Market Value

Fair Value

Strategic Value

Liquidation Value

Defining the Assignment to Avoid “Bad Art”

Who’s Setting Standards?

AICPA, ASA, ISO, NACVA, IRS, Courts, FASB, LESI, and more

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Case: Improper Use of a Character

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Background

• Defendants used a character to promote products outside of the permitted terms of agreement with IP owner

• Financial data from the defendants unavailable

• Multiple methodologies applied

• Income approach calculation yields different value than market and cost approaches

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Methodology Approach

Defendant's Annual Advertising Budget Cost 875 925

Comparable Endorsements Market 50 90

Comparable Sponsorship Fees Market 25 85

Reasonable Royalty Income 1,100 1,200

Results ($millions)Methodology Approach

Defendant's Annual Advertising Budget Cost 875 925

Comparable Endorsements Market 50 90

Comparable Sponsorship Fees Market 25 85

Reasonable Royalty Income 1,100 1,200

Results ($millions)

Case: Improper Use of a Character

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Case Take-away: Context is Key

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A more complex case showing

the importance of Context, and

the importance of identifying IP

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Case: Identifying IP

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• Client assists municipal agencies issue bonds for public interest projects (a Public Private Partnership)

• Client has achieved substantial profits for several years

• Key competitor is a state-run agency

• State accuses client of gouging the parties it serves

• Has Client developed IP that justifies the excess profits?

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Case: Identifying IP

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Can see its there . . .

Net Revenue

Comps Average Subject

Earnings Margin 10% 25%Operating Income 2,000,000 5,000,000Market Earnings Multiple Comp. public

financial companies6.0x 6.0x

Implied MVIC 12,000,000 30,000,000

Value of Tangible Assets Book value per Balance Sheet

(500,000) (500,000)

Value of Goodwill 11,500,000 29,500,000

Subject's Excess EarningsSubject's Proprietary Intangible Assets

20,000,000

3,000,00018,000,000

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Case: Identifying IP

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• We can see IP exists . . . • What are the key types

of IP Assets?

Case Take-away: Both IP and IA Contribute to Value

Proprietary systems (some could be commercialized)

Proprietary methodsRelationships / key people

(can’t be commercialized)

History / Longevity / 1st to Market (can’t be commercialized)

IA at the CLIENT

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Value Constraints

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Present Value of Expected Future

Benefit

Val

ue

of

Bu

sin

ess

=

Tangible Assets

Intangible Assets

= =

Tangible Assets

Intangible Assets

Brand / Trade Names

Intellectual Properties

Could a company’s IP assets exceed the market value of the business?

• Context: Fair Market Value (transaction did occur)• Context Implication: Value driven by expected future benefits

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Case: Impact of Context

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• Frequent Context for IP Valuation: Purchase Price Allocation (FAS 141/142)

• Purchase Price Creates Goodwill• What Portion of the Acquired Goodwill should be allocated to IP?• What are the components of the IP Allocation?

Could a company’s IP assets exceed the market value of the business?

Sources of Funds Use of Funds AllocationCash 50 Buy Equity 400 A/R 25Stock 275 Repay Debt 100 Inventory 50New Debt 200 Costs 25 PP&E 100

Goodwill 350

Total 525 Total 525 Total 525

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Can Value of IP > MVIC?

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Tools / Science• Forecast cash flows by product• Quantify the interaction of IP Assets and

their contribution to earnings

Context Drives the Science• Value of IP cannot

exceed MVIC in a purchase price allocation

• Value of each IP = PV of future benefit each IP provides to Company’s cash flow

Case Take-away:

Context is key / Context Can Be Forced on the Value Analyst

Allocation Goodwill AcquiredA/R 25 Brands 150Inventory 50 Patents 65PP&E 100 Databases 115

Goodwill 350 Other IA 20

Total 525 Total 350

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What if the Context Changes?

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Frequent Contexts• Infringement Damages• Licensing / Endorsement

Damage Calculations: require application of traditional valuation methodologies to determine value of economic benefits lost, or not achieved (often when an arm’s length transaction would never have occurred)

Licensing: requires both parties understand and estimate the present value of future economic commitments (without the benefit of an existing arms-length transaction)

What if we don’t have a completed transaction between a wiling buyer and a willing seller?

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What if the Context Changes?

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IP Valuation Methodologies• Comparable Transactions• Relief from Royalty• Discount Future Benefit• Replacement Cost

What if we don’t have a completed transaction between a wiling buyer and a willing seller?

All these approaches construct a

hypothetical agreement between IP Owner and IP User

Crafting the Hypothetical Agreement Requires Art and Science

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Hypothetical Agreements

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• Uniloc USA v. Microsoft Corp: applicable specifically to IP analysis

• End of the 25% rule = “End of the unsupported conclusion”

• Averages & Surveys as the lemming’s rule of thumb

• If it’s a universal norm, it can’t meet the criteria for comparables

This Shouldn’t be Shocking

No More Rules of Thumb

• Licensing agreement = contractual financial agreement

• Commitments can and do take many forms

• Hypothetical agreements must reflect their real-world counterparts

Replacing Rules of Thumb

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Reflecting Real-world Complexity?

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Did Consider . . . • Forecast benefit (sales, term)• Industry dynamics (rate)• Risk assessment

A Typical Relief From Royalty Calculation

Annual Sales of Brand X 100,000$ Industry Average Royalty Rate 8.0%Estimated Annual Royalty Income 8,000 Term (years) 10 Annual Discount Rate 15.0%Total Value / Damages 40,150$

Assumed . . . • Constant sales• Industry average royalty rate • No changes during term

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Case: Alternative Royalty Rate Analyses

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• Value of trademark and related brand assets to a partner business?

• Method Applied: PV of license-derived economic benefits

• Subject IP did not resemble comparable IP transactions• Parties had a standing relationship

Ranges observed in Comparable Transactions

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Case: Alternative Royalty Rate Analyses

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Surveys and Comparable Transactions are not The Only Tools Available

Royalty Rate Build-up Method: BVEq

CBV Core Brand Value 1.0 2.0

IVE 1 Sub-brands 0.0 0.0

IVE 2 Global Brand Marketing 0.1 0.1

IVE 3 Incremental Sales for Licensee 0.1 0.1

IVE 4 New Product Development 0.2 0.3

IVE 5 Other Brand Assets 0.1 0.3

Total 1.5 2.8

Range (%)Brand Value Components

BVEQ= CBV + (IVE1 + IVE2 + …. + IVEN)

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Period 0 1 2 3 4 5

Licensee Sales 1,024 1,229 1,290 1,322 1,356

Annual Royalty Rate 8.0% 5.0% 5.0% 3.0% 3.0%

Licensee BenefitsUp-front Payment (50)

Additional Margin 52 179 205 210 215

Annual Fee (5) (5) (5) (5) (5)

% of Sales Royalty (82) (61) (65) (40) (41)

Total Benefits (50) (35) 112 135 165 169

Present Value @ 16% (50) (30) 83 86 91 81

Value of IP to Licensee 261

Licensor BenefitsUp-front Payment 50

Promotions Commitment (10) (10) (5)

Annual Fee 5 5 5 5 5

% of Sales Royalty 82 61 65 40 41

Total Benefits 50 77 56 65 45 46

Present Value @ 13% 50 68 44 45 27 25

Value of IP to Licensor 259

Case: Reflecting Reality

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Take-away: “Hypothetical Negotiation” Drives Greater Analytical Burden

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When Valuation Issues Arise?

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Question Answers

Why is valuation needed? Transaction, Infringement, Financial Reporting, Tax/Transfer, etc.

What level of value? MVIC, MVE, Minority Interest

Who will use the value result? Accountants, IRS, Potential partners or investors, Management, other

What information is available? Audited financials, business plans, industry studies, etc.

What types of assets exist? Tangibles, know-how, brands, patents, designs, relationships, etc.

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The Valuation Answer

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Reconcile results from multiple approaches

Reconcile the calculations to the context

There Are No Valuation Answers: Only Good Choices

Context + Time = Value

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HandoutsLaw 360 on Rules of Thumb

Considerations for Hypothetical Negotiations20 Licensing Structure Alternatives

Criteria for Comparable Transactions

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Discussion

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CONSOR’s Services

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www.consor.com

• Valuing patents, trademarks, copyrights, trade secrets, celebrity rights, and technology

• Helping businesses understand the value of their IP

• Valuation for transactions, tax purposes, litigation, licensing deals, and more

IP Valuation

858 454 9091

• Assisting attorneys with damage calculation parameters & case strategy

• Proven success as expert witnesses

• Economic damages in litigation

• Federal, state & international experience

• Arbitration, and mediation

IP Litigation Support

• Assisting clients in maximizing the licensing value of their IP assets

• Develop licensing strategies, execute, negotiate license agreements

• Licensing experts in litigation

• Evaluate financial and economic commitments of a potential transaction

Licensing Consulting• Maximize the value of bankrupt assets

• Identify valuable IP in bankruptcy

• Market and sale of bankrupt IP assets

• Value and dispose of intellectual property

IP Transactions