leveraging patents to finance life sciences companies geneva, july 20, 2006 world intellectual...
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Leveraging Patents to Finance Life Sciences Companies
Geneva, July 20, 2006
World Intellectual Property Organization
Roya Ghafele, e-mail: [email protected]
IP Finance
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The Main Take Away
While Life Sciences is a crucial sector of the economy, it currently is not financed to its full extent. How can that paradox be explained?IP is key in innovation, however due to historically evolved practices it has not been given full attention in the investment process.
On the investor’s side little knowledge about IP, paired with even less experience in valuing IP can be seen as key obstacles. The situation is further hampered by inadequate accounting standards.On the borrower’s side many firms seeking funding do not have an adequate IP strategy and often lack managing their intangible assets.
To overcome this market failure there is a need for a cohesive approach including regulatory reform, awareness raising and training.At the borrower’s level firms need to better align their IP to their overall business strategies. At the lender’s level investors should seek to get better information about IP.
IP Finance
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Source:R.Ghafele
Hypothesis: IP is crucial for Innovation
However most investors lack the IP view
Why? Inadequate IP Accounting
Confusion with IP Valuation
Lack of IP strategies among borrowers
What are possible solutions?
AGENDA
IP Finance
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Source:R.Ghafele
IP is an intangible asset, ...
SpontaneitySuccessful IP creation is risky since there is a creative & a business element to it
Non Rivalry in ConsumptionIP can be used simultaneously by different people without diminishing in its worth
TransferabilityIP is transferable to a newor similar business context
Knowledge ContentBackground of users & context determine relevance of IP to business
Partial ExcludabilityIP guarantees a firm exclusivity and freedom to operate in the market
Natureof IP
PerishabilityOver time IP may become outdated,e.g. technology cycles
IP Finance
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Source:R.Ghafele
… which is key in Life Sciences
IPR&D
• Risky• Uncertain• Costly• Explorative• Complex
• Hedges against risk• Rewards discovery• Attributes ownership• Facilitates knowledge
trade• Codifies knowledge
IP Finance
Chart 6
Source:R.Ghafele
Ignoring IP means giving up strategic choices
Not IP ProtectedInnovation
IP protected
Innovation
• Owner decides what to do with research: IP can be gifted, donated, sold, licensed
• Both basic and advanced research may be promoted
• Research Findings are available for free
• Basic Research may not get further developed
IP Finance
Chart 7
Source:R.Ghafele
Hypothesis: IP is crucial for Innovation
However most investors lack the IP view
Why? Inadequate IP Accounting
Confusion with IP Valuation
Lack of IP strategies among borrowers
What are possible solutions?
AGENDA
IP Finance
Chart 8
Source:R.Ghafele
Who are Potential investors?
PUBLIC
Family, Friends Informal, key is borrower’s network and social
capital.
Business Angels Informal, key is to convince a high net worth individual to invest.
Venture Capital/ Private Equity Firm
Formal, key is borrower’s will and ability to sell part of an early stage business. PE invests in late stage business, e.g. Leveraged Buyouts (LBOs)
Joint Ventures/Licensing Formal, key is mutual interest of licensor and
licensee in the technology.
Formal, key is borrower’s academic potential. Profitability is not core, rather scientific novelty
Research Foundation
Formal, key is growth and critical mass of revenues, late stage business.
Stock Exchange (IPO)
Formal, traditionally are hesitant to invest in innovation.
Commercial Banks
Formal, key is borrower’s potential to demonstrate positive socio-economic impact of his/her project. Use entire variety of financial tools.
Intergovernmental Development Banks& National Governments
PRIVATE
Private and public investors are available.
IP Finance
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Source:R.Ghafele
Investors by risk and stage
Types of investors differ by business maturity stage and perceived risk.
HighperceivedRisk
Lowperceived Risk
Seed Start-Up Early Growth
Established
FounderFriendsFamily Venture
Capital Firms
Governments, Development Banks,Research Foundations
Commercial Banks
Business Angels
Stock Exchange
Private Equity Firms
Joint Ventures, Licensing
IP Finance
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Source:R.Ghafele
Who is ready to invest on the basis of IP?
Family, Friends/Business Angels
+ + + Use of common sense, guts feeling, IP canmatter if lenders are (made) IP aware.
Venture Capital + + + + Look at IP potential and actual IP of earlystage business. In biotech and lifesciences owning a patent can be key
Private Equity/StockExchange (IPO)
+ + + + In late stage business IP can beevaluated: The value of licensingagreements, royalty fees or thecompetitive advantage of owning IP.
Commercial Banks + + Conservative investors, rather look athistorical data. Tend to ignore IP invaluation mainly due to lack of awareness.Recently started to take IP as collateral.
IntergovernmentalDevelopment Banks/NationalGovernments
+ + + Look at promotion of an innovative culture.In early stage projects look rather at IPpotential than existence of formal IP.
ResearchFoundations
+ + + + Innovation, Creativity, Originality ofresearch are key.
Degree of readiness to invest on the basis of IP
Role of IP in valuation
++++ready+++rather ready-rather not ready
IP Finance
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Source:R.Ghafele
Main financing methods don’t give enough credit to IP
Financing methods split in debt and equity financing.
Debt Financing Equity Financing
Venture Capital
BusinessAngelsCapital
PrivateEquityCapital
Loans Leasing Factoring
IP securitization
IP as collateral IP in the business plan
IP Licensing
IP Finance
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Source:R.Ghafele
Description of financing methods
Debt financing differs significantly from equity financing.
Equity financeDebt finance
The investor borrows money at the cost of the borrower’s rated risk (is above the risk free rate, meaning money investor would earn e.g. by buying US treasury bonds).
The money has to be repaid within a certain time horizon. The cost of borrowing that money is the “interest rate”. According to how rating agencies (e.g. Standard and Poor’s) judge the quality of the borrower’s willingness and ability to pay back the money, the cost of borrowing (interest rate) will be high or low.
Profit lies in the interest s/he earns on lending the money. Collateral is asked for as a guarantee and legal recourse in case of bankruptcy.
The investor has no involvement in the management of the company.
“less risks, but less profits”
The investor “buys” parts of the company, usually for a time horizon of 5-10 years.
S/he makes a profit on the spread between the price at which s/he bought the companyand sold it. (historically aim at 20-30% of investment)
It is possible to have several “rounds” of investment.
The borrower does not have to pay any interests for the money, but gives up part of his/her self determination on running the business.
“high risks, but high profits”
Equity investors are VC, Business Angels, Investment Banks, Private Equity Firms
IP Finance
Chart 13
Source:R.Ghafele
Hypothesis: IP is crucial for Innovation
However most investors lack the IP view
Why? Inadequate IP Accounting
Confusion with IP Valuation
Lack of IP strategies among borrowers
What are possible solutions?
AGENDA
IP Finance
Chart 14
Source:R.Ghafele
Accounting finds it difficult to grasp IP
Impact on Type of Language developed for IP
• Silence about a lot of a firm’s IP due to inherent definitions and assumptions in accounting
• Internally and externallygenerated IP is treated differently
• Goodwill
• Historically evolved to report tangible assets/liabilities
• Quantitative stock of performance
• Documentation of past financial position
• Factual, precise, objective, comparable information
• Determines perception of a firm’s management and other market participants
Rationale behind Accounting
IP Finance
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Source:R.Ghafele
Concept Impact
Internally Generated IP is immediately expensed, Acquired IP is valued at its acquisition cost, amortized or subject to an impairment test
Fair value: “Amount at which an asset couldbe bought or sold in a current transactionbetween 2 willing parties, other than a liquidation.”
Intangible Asset: “… identifiable, controlled byan enterprise as result of past events & shouldgenerate future economic benefits for the firm.”
Goodwill: “price a market participant is ready to pay in excess of the value of a firm’s tangible assets.”
The same IP may beperceived to beworth nothing or 100 Mn $
Implies a benchmark, yet worth of IP depends also on context & background
Much IP won’t qualify since it has an indirect impact on cash flows
Difficult to makeworth of IP explicit & compare Goodwill of different firms
This Seriously Impacts Business...
IP Finance
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Source:R.Ghafele
… However Explicit IP accounting gains Momentum — Comparison of different Accounting Standards —
Recognition of IP
US-GAAP German HGB
• Forbidden: § 248/2 HGB
• Exception: acquired IP
IAS/IFRS
• Recognition of IP if IAS criteria are met: IAS 38
• Recognition of IP: Novel approach under FAS 141 &142
Trend towards the explicit recognition of IP increases
InternallyGenerated
IP
• Immediately expensed • Immediately expensed • Immediately expensed
• Recognition of acquired IP:
§ 255/4 HGBAcquired IP
• Recognition of acquired IP if IAS criteria are met: IAS 38
• Purchase Price distributed across all items: FAS 141
• Impairment Test of Goodwill: FAS 142
IP Finance
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Source:R.Ghafele
IP valuation criteria
Management Skills• expertise in managing IP• experience in managing IP• prior investments in the IP protected business segment (“sweat equity”)• motivation to enhance value of the IP
Business Viability • product differentiation through IP• is IP protected product/service viable in the marketplace• competitive advantage through IP• clear development plan/financials for generation of IP
Market • market share/growth for IP protected business segments• market opportunity for IP• competitive threat through IPownership of competitors• entry barriers through IP
Potential Returns• expected returns of IP protected business segments• expected risks of IP protected business segments• size of investment needed to generate IP
Legal Scope of the IP• level of protection granted by the IP• possibility to invent around the IP• possibility of infringing the IP of others• legal viability of the IP• duplication of IP due to inadequate patent search done by the IP office
IPVALUE
IP Finance
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Source:R.Ghafele
IP valuation in relation to overall business valuation
Source:Roya Ghafele
Different valuation emphasis for different investors.
Venture Capital/Private Equity FirmExit possibilities are key. This is how the VC/PE makes money. Often no “science” available to assess early stage business since no historical company performance available. Quality of management team, benchmarking with what is already in the market matters. “Gut feeling”. IP is an important factor in the valuation. VCs look at the legal viability of the IP & how it relates to the business strategy.
Business AngelsConfidence in management is key.Angels invest in “what they know” & often seek to boost the local economy ( “hometown loyalty”). Informal valuation, no systematic approach.IP may matter if Angel has personal interest or the borrower can communicate the value of the IP. IP will be valued according to its potential to generate future cash flows.
Research FoundationsAcademic track record, references, innovation, originality, societal impact, fit in foundation's research portfolio and orientation. Want innovative research does not necessarily have to have practical relevance. Company funded research can be biased by the sponsor’s interest.IP plays a marginal role in the valuation process. Even early stage technology funds do not value explicitly IP. The connection between IP and technology is not sufficiently made.
Inter/Governmental InvestorsLook at macroeconomic, social and cultural spillovers. May show more tolerance towards profitability since are not under the same market pressure as private investors. Funding has a “development” touch. IP plays a marginal role in the valuation process. Early stage technology funds do not value explicitly at IP. The connection between IP and technology is not sufficiently made.
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IP Finance
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Source:R.Ghafele
Approaches to IP Management
• Key QuestionsHow does IP relate to the bottom line of your business?How do you make money and what role does the IP play in it?
• Relate your income streams to IPWhat were the returns from IP protected business segments?Does the IP help you to gain market share or profits?
• Relate IP to your position in the MarketHow did IP give you an advantage over competitors?Do you have freedom to operate & exclusivity in the market?
• Demonstrate your managerial skillsHow determined are you to extract revenue from IP?What experience do you have in managing IP?
• Understand the legal scope of the IP rightsWhat level of protection does your IP guarantee you?Is there a risk that you infringe the IP of competitors or that competitors (legally) steal your IP?
IP Finance
Chart 20
Source:R.Ghafele
Hypothesis: IP is crucial for Innovation
However most investors lack the IP view
Why? Inadequate IP Accounting
Confusion with IP Valuation
Lack of IP strategies among borrowers
What are possible solutions?
AGENDA
IP Finance
Chart 21
Source:R.Ghafele
IP Management improves a firm’s position in the market
• Communicates the value of IP to investors • Shows what IP the company owns• Puts a value to the IP• Explains how the IP relates to business segments
INVESTORS
FOR
FOR
MANAGERS
• Get information on how IP drives growth • Receive adequate inputs for earnings/sales forecasts• Can better estimate risks/revenues of an investment• Can better understand the nature of a business• Increases predictability while decreasing volatility
IP Finance
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Source:R.Ghafele
IP investor communication
Successful investor communication on IP bridges information asymmetry.
What investors look for in a business plan
What’s in it for me?Can I sell it profitably?What’s the financial potential?
Is the management capable of growing the business?Have they done it before?Does the team understand how to penetrate the market?
Is the product unique?Will it meet consumers’ demand?Is the market potential huge enough?Are there entrance barriers?
How much money is needed?What are the exit possibilities?
Executive SummaryWhat’s the growth and profit potential and the management’s capability to achieve the target? How does the IP help to achieve to that target? Body of the Plan• Company Overview :How a do you want to make money? • Management Team: Why are you the right people?
• Products/Services: How does the IP enhance the value?
• Market Analysis: How does the landscape look like?What IP have competitors?
• Funds requested: How much money do you need?
• 5 Year financial projections: What’s the growth potential?
Business plan
Grab readers attention,make him/her curious of the business.
IP Finance
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Source:R.Ghafele
Public Policy Choices
Human capacity building • Need for a Master Program providing IP training from a legal, business
and technological point of view.
Awareness Raising, Training at the Business Level• Fully integrate the IP view in policies aiming at increasing the overall
level of innovation, e.g. the Lisbon Agenda
Harmonize Regulatory Guidelines on IP valuation• Recommendations on standardized approaches would help
Standardize the Reporting of IP• Important steps have been made, but more needs to be done
Integrate the IP dimension in publicly funded projects• Where appropriate IP should be part of the selection process