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TECHNOLOGY-BASED�INTELLECTUAL�PROPERTY

DR��RICHARD�RAZGAITIS

Principles, Methods, and Tools

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Valuation and Dealmakingof Technology-BasedIntellectual Property:

Principles, Methods, and Tools

RICHARD RAZGAITIS

John Wiley & Sons, Inc.

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For the late Bill Riley, long time licensing mentor at Battelle.

Copyright C© 2009 by Richard Razgaitis. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.

This book is a completely revised and expanded edition of Richard Razgaitis’s previous book,titled Valuation and Pricing of Technology-Based Intellectual Property (978-0-471-25049-4).

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in anyform or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise,except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, withouteither the prior written permission of the Publisher, or authorization through payment of theappropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers,MA 01923, (978) 750-8400, fax (978) 750-4470, or on the web at www.copyright.com. Requests tothe Publisher for permission should be addressed to the Permissions Department, John Wiley &Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online athttp://www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their bestefforts in preparing this book, they make no representations or warranties with respect to theaccuracy or completeness of the contents of this book and specifically disclaim any impliedwarranties of merchantability or fitness for a particular purpose. No warranty may be created orextended by sales representatives or written sales materials. The advice and strategies containedherein may not be suitable for your situation. You should consult with a professional whereappropriate. Neither the publisher nor author shall be liable for any loss of profit or any othercommercial damages, including but not limited to special, incidental, consequential, or otherdamages.

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ISBN 978-0-470-19333-4

Printed in the United States of America.

10 9 8 7 6 5 4 3 2 1

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Contents

Preface vii

Disclaimer viii

About the Author ix

Acknowledgments xi

CHAPTER 1 Introduction to Opportunity Discovery, Valuation,and Dealmaking 1

Introduction: Technology D-V-D 1Taxonomy of Technology Licensing 5High Significance, High Ambiguity Contexts 7Licensing D-V-D and Innovation 12Going Forward 23Notes 23

CHAPTER 2 Risk and Reward 27

Uncertainty 27Phronesis (Judgment) 31Technology Uncertainty 32More on Risk 35Value and Price 45Two Final Points on Buying and Selling 48Notes 49

APPROACH I OPPORTUNITY DISCOVERY 51

CHAPTER 3 Identifying and Prioritizing Technology Opportunities 53

Seller “Opportunity Space” 53The Technology Box 63Buy-Side Expressions of Value: The Wheelbarrow 69Overview of Valuation Methods 71The Six Valuation Methods 77Conclusion 81Notes 82

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iv Contents

APPROACH II VALUATION 85

CHAPTER 4 Method 1: Use of Industry Standards for Valuation 87

The Concept and Limitations of “Industry Standards” 87Sources of Industry Standard Data and Information 97Survey Results as a Source of Industry Standards Data

and Information 98Proposed or Established Norms 105Shopped Term Sheets and Price Lists 107News Sources of License Agreement Information 109Journals, Proprietary Databases, Reports, and Consultants 118Published License Agreements as a Source of Industry

Standards 119Court Cases/Judgments as a Source of Industry Standards 123Patent Pools 126Lifetime and Organizational Learning 127Average Error 127Concluding Observations and Cautionary Notes 129Appendix 4A: Outline of Agreement between DuPont and

University of Houston 131Notes 134

CHAPTER 5 Method 2: The Rating/Ranking Method, and Tool 139

Ubiquity of Rating/Ranking 141Overview of How Rating/Ranking Can Be Used in Valuation 145Groups and Grouping as a Fundamental Knowledge Forming

Process 148Using Rating/Ranking to Value Technology: Factor

Assessment 155Developing Criteria for Using Rating/Ranking for Valuation of

Technologies 162Illustrations of Applying the Rating/Ranking Method 168Issues in Interpreting Value from a Rating/Ranking Result 171Using Rating/Ranking to Value Technology: Classified Value 174Uses of Rating/Ranking with Approaches and as a General

Tool 176Perspectives on Rating/Ranking as an Approach with

Licensing 182Knowledge, Uncertainty, and Humility 185Conclusion 189Appendix 5A: Factors in Pricing License 190Notes 196

CHAPTER 6 Method 3: Rules of Thumb to Determine Valuation 201

Foundations of Rules of Thumb 203Cost Savings Example of the 25 Percent Rule 205


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Perspectives on the 25 Percent Rule 208Use of the 25 Percent Rule for Apportioning New Profits 209Examples of Applying the 25 Percent Rule to New Profits

Licensing 211A Universal Rule of Thumb Chart 222Other Percent Rule Values 224Some Misuses/Misapplications of the 25 Percent Rule 225Other Valuation Rules of Thumb Used (or Have Been

Proposed) 226Summary Points on the Use of the 25 Percent Rule 229Conclusion 231Notes 232

CHAPTER 7 Method 4: Discounted Cash Flow Method to DetermineValuation 235

Overview of the DCF Method 236Basic Financial Concepts 247Quantification, Classification of Risk 265An Example Cash Flow Projection from a License 277Additional Considerations for Calculating DCF 289Segment and Scenario Analysis 293Cash Flow Projections 299Other Issues to Be Considered with the DCF Method 318Conclusion 330Sources of Information to Develop Business Projections 331Notes 331

CHAPTER 8 Method 5: Advanced Valuation Methods 337

Modified Discounted Cash Flow Method 338Monte Carlo Method 345Real Option Methods 414Conclusion 447Online Resources 448Appendix 8A: Example Crystal Ball Report for Exhibit 8.18 449Appendix 8B: Crystal Ball Report Corresponding to the

Results Presented in Exhibit 8.XX for a Double-HumpedCost Distribution Assumption 456

Notes 464

CHAPTER 9 Method 6: Valuation by Auctions 469

Introduction to Auctions 470When Auctions are Feasible 471Auction Examples 474Auctions as Distinct from Other Types of Dealmaking 479Auction Strategies for Buyers 489Auction Caution 490Conclusion 491


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Appendix 9A: Bidder’s Agreement 491Notes 492

APPROACH III DEALMAKING 495

CHAPTER 10 Approach: Deal Structure 497

Return to the Box and Wheelbarrow 498Cash When Pricing Structures 502Cash As Pricing Structures 507Cash If Pricing Structures 517Cash Maybe: Options 521Consideration Forms Beyond Simple Cash 522Special Form of Cash If: Equity 525Balancing Simplicity with Comprehensiveness 537Conclusion 537Notes 538

CHAPTER 11 People, Process, and Lessons Learned 541

Introduction 541Deal Team 546Deal Targets 552Negotiating Plan 556Plan B 560Concluding Advice from Technology Dealmakers 565Notes 566

CHAPTER 12 In Conclusion 569

Approach of Opportunity Discovery as a Quest 569Approach of Valuation: A Review of the Six Valuation

Methods 572Approach of Dealmaking 583Closing Thoughts 592Website Resources 594Notes 594

Appendix: List of Abbreviations and Trademarks 597

Bibliography 599

Index 603


Preface

This book is the fourth that I have written for John Wiley and Sons. All of themin some way have been about creating value from technology by identifying

opportunities, valuing and pricing those opportunities, and Dealmaking.The 1999 book, Early Stage Technologies: Valuation and Pricing, was my initial

effort that developed the Six Methods of Valuation:

(1) Industry Standards(2) Rating/Ranking(3) Rules of Thumb(4) Discounted Cash Flow(5) Advanced Methods(6) Auctions

In 2003, I updated and expanded the 1999 book as Valuation and Pricing ofTechnology-Based Intellectual Property. In the same year, I wrote a separate bookon Dealmaking: Dealmaking Using Real Options and Monte Carlo Analysis.

In the present book, I have expanded most of the material in the three ear-lier books and cohered it all (I hope) in three core technology commercializationbusiness processes, designated as Approaches. They are: opportunity Discovery,Valuation, and Dealmaking, hence the acronym Technology (or Licensing) D-V-D.In particular I have expanded the use of Monte Carlo as an Advanced ValuationMethod. The text provides a link to my web site—www.razgaitis.com—that in-cludes spreadsheets used in this book, as well as a means to obtain a free trial ofthe Monte Carlo software (Crystal Ball developed by Decisioneering, now a part ofOracle Corporation) to enable the reader to run his or her own simulations, and toprovide a place for the inevitable errata.

My focus throughout has been on “opportunity Dealmaking,” as opposed tolitigation contexts. Accordingly, the subject matter of Dealmaking is typically some-thing other than bare patents in a process of sellers and buyers discovering valueand enhancing deal structures to their mutual benefit. Technology Dealmaking isthat special conjunction of the oldest form of human interaction, trading, with themost modern, technology. The nautical theme of the cover art is intended to besuggestive of this ancient quest for economic benefit through trade in the face ofsignificant risk. The Approaches, Methods, and Tools (A-M-T) here presented arewith the intent of being a kind of lighthouse, overarching business principles, notwith the aspiration of risk removal, but to support risk-based opportunity discovery,valuation, pricing, and Dealmaking.

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viii Preface

Throughout the book, I have made numerous changes and clarifications inthe hope of making the points clearer and more useful and fitting together thecomplete business process of opportunity discovery, valuation, and Dealmaking.Arthur Schopenhauer (1788-1860) in an 1844 edition of his classic book, The Worldas Will and Representation (or Idea) originally published in 1818, wrote: “Now, asregards this second edition, in the first place I am glad that after twenty-five yearsI find nothing to retract; my fundamental convictions have been confirmed, at anyrate as far as I myself am concerned.”* In his final edition of that book, he changednot a word from text he had written 40 years earlier. From this perspective, his 1844edition, and his final 1858 edition included his 1818 text unchanged.

In contrast with that genius, I have tried to change anything and everything inmy previous writing that I could to make it better and more complete, as well asmore interesting, even fun to read. I have made extensive use of everyday termsof art—some might even call it business slang—to be as expressive as possibleat the cost, perhaps, of some textual dignity. But Carl Sandburg, that Chicago bigshoulders/Tool Maker city poet, said it well: “slang is a language that rolls up itssleeves, spits on its hands, and goes to work.” Putting technology to work is whatI’ve tried to do here, using down-to-earth language to do it. I am still not donewith that work, but it is the best I can do at the moment. It does not, however,represent my final views on the subject of technology valuation and pricing. I haveintended it to be an educational contribution to my profession, not as a proof texton some narrowly defined dispute, but as a systematic discussion of tools, methods,and principles, that can be developed and applied to that most challenging task ofdeveloping a model framework for establishing its worth, and reaching agreementwith a Dealmaking partner.

Disclaimer

It may not be necessary, but it is probably prudent, to point out what should beobvious: This is not intended as a proof text in support of litigation. The context ofthe valuation methods considered here and my associated observations and sugges-tions is in support of opportunity licensing, not enforcement. Further, each licensingand valuation opportunity is specific to the given fact situation; so it is unwise andeven misleading to take a passage of static words and assume that it can be appliedwithout consideration of the specific circumstances by the exercise of reasonedjudgment.

*Schopenhauer, Arthur, The World as Will and Representation, translated from the German byE.F.J. Payne, Dover Publications, Vol. 1, 1969, p. xxi. Although his book on epistemologicalphilosophy is generally far afield from our purpose here, Schopenhauer’s core idea that weapprehend not the subject of our consciousness but only a representation of such subject isuseful and applicable to our understanding of any valuation model we may use and develop.We will return to this idea in closing observations in Chapter 12.


About the Author

Dr. Richard Razgaitis began his career in technology on an exact date, May 25,1961, on the occasion of President Kennedy’s pronouncement:

I believe that this nation should commit itself to achieving the goal, before thisdecade is out, of landing a man on the Moon and returning him safely to theEarth. No single space project in this period will be more impressive to mankind,or more important in the long-range exploration of space; and none will be sodifficult or expensive to accomplish.

On that day he selected his undergraduate major, Aeronautical and AstronauticalEngineering. That led to his becoming first a “rocket scientist,” then part of the CapeKennedy launch team from the first Apollo flight in 1966 through the first lunarlanding of Apollo 11 in 1969. He had the unique privilege of loading the fuel intothe Saturn S-IVB that sent the first men to the moon: Apollo 8, December 21, 1968,Frank Borman, James Lovell, and William Anders.

He was a professor for more than 10 years at the University of Portland and OhioState University where he taught more than 20 different undergraduate and graduatelevel classes. He has worked in industry for the past 30 years, including 10 years asVice President of Commercial Development for two billion dollar R&D organizations,Battelle and Bellcore. For the past 11 years he has been a senior consultant withCharles River Associates and predecessor firms IPC Group and InteCap LLC.

He holds a B.Sc. in Aeronautical and Astronautical Engineering from the Uni-versity of Illinois, a M.Sc. in Aerospace Engineering from the University of Florida,a Ph.D. in Mechanical Engineering/Thermal Fluid Sciences from SMU, and an MBAfrom Ohio State University. He has been a registered professional engineer inthree states. He has been a long-time Board Member of the Licensing ExecutivesSociety including holding the chair of Treasurer. He was on the Board of the Li-censing Foundation for six years and for three years its President. He also served athree year term on the Board of the National Inventor’s Hall of Fame, which periodincluded the special induction in 2003 on the 100th year anniversary of flight, in-cluding the Lifetime Achievement Award for John Glenn, the first American to orbitthe earth in Mercury Friendship 7.

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x About the Author

He has written four books published by John Wiley & Sons, four book chapterspublished by the Association of University Technology Managers, the LicensingExecutives Society International (LESI), and by the Centre for the Management ofIntellectual Property in Health Research and Development and the Public IntellectualProperty Resource for Agriculture, and four annual survey articles on the key issuesin the licensing industry in les Nouvelles, the journal of LESI, on behalf of TheLicensing Foundation.


Acknowledgments

One of the themes of this book is the multidisciplinary context for TechnologyD-V-D, and the need for active learning. So the list of people I would like to

acknowledge is long, but by no means exhaustive. Although I have been involved inputting technology to work since 1965 when I joined the Apollo Program as a “rocketscientist,” my work in technology licensing did not begin until the early 1980s whenI worked for Battelle Memorial Institute. When I joined its Battelle DevelopmentCorporation I was mentored by a special group of long time employees,

Much of my life has been spent in learning. Some would say, I still have a longway to go (which is true, but details on that are more appropriate to a confessional).Here I want to offer heartfelt thanks to you many “teachers” that in some meaningfulway contributed to the thinking expressed here.

For 14 years and 2 months, I had the privilege of working for Battelle in Colum-bus, Ohio. During the early years of this period I had the opportunity of working forBattelle Development Corporation (BDC), a wholly owned subsidiary that had beenresponsible for commercializing Battelle and outside inventor technology since 1935.During those years at BDC, I happened to be present during the retirement transitionof an unusually talented group of individuals who took the time and patience to sharewith me over a period of years their insights from an incredible breadth of experi-ence. Although the content of this book is mine, I would be remiss not to acknowl-edge the influences that this unique opportunity afforded me. Bill Riley, to whom thisbook is dedicated, hired me into BDC. Bill was an endless source of experience-filledmarketing and dealmaking stories; many of those stories deserve a string instrumentcomposition to elevate them to more-than-Irish ballads (really more like HomericEpics). Bill’s 29 years with Battelle, long term participation in the Licensing Execu-tives Society (including a term as LES President), and wise memory were, for me,like attending an academy of licensing learning. His recent passing is a loss I feelevery time I hear of a funny moment in licensing that I wish I could share with him.

Ken Shaweker was also a 30-year veteran of licensing experience, mostly atBattelle. He was BDC’s IP Counsel. As our lead attorney, he was a model of reasonedjudgment combined with sagacity in developing solutions to meet worthy businessobjectives and taught me lot about agreements and people.

Steve Dickerson, another 30-year man and head of BDC for many years, wastireless in his enthusiasm and pursuit of opportunities. In negotiations he was bothgracious and quick thinking, a very potent combination.

Dr. Charles Schwartz was, unbelievably, our 50-year man. His breadth andcurrency of technical insight was astounding; and as to kindness and patience, Ihave known only one other that deserves mention in the same breath.

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xii Acknowledgments

Art Westerman (“just” a 40-year man) in addition to his business developmentskills was a great writer and teacher of business writing (sorry that I didn’t learnbetter than I did).

There were many others at Battelle who were not part of the retirement transi-tion but who were part of my licensing and valuation “faculty”: Barry Bissell, BobZieg (who as Ken’s replacement shared the fruits of 26 years of patent/licensingexperience), Bill Huffman, Roland Adoutte, L. Don Williams, Gene Eschbach, andmany others.

I owe a very special debt to four very talented administrative assistants whoseteachings often had to be by the rescue method: Carol Cremeans, Shirley Russell,Shari Dean, and Mary Ann Dillon.

I am likewise indebted to my experiences and opportunities at Bellcore, nowTelcordia Technologies. One of my teammates there, the late Bruce Sidran, was theobject of dedication in my 2003 Dealmaking book. I miss his friendship and greatsense of humor.

For 11 years now I have been associated with a consulting group headquarteredin Chicago, initially under the name IPC Group, then Intecap LLC, which thenbecame part of Charles River Associates. The name keeps changing on the door,but most of the people are still there. I would like to acknowledge the specialclient working relationships I have had with colleagues Dan McGavock and BobGoldman, and in times past with Brian Oliver and Mike Lasinski. In particular Iwant to acknowledge two Charles River Associates colleagues, Lew Koppel and BobGoldman, who made numerous helpful suggestions based on their review of thismanuscript. There is a long list of others with whom I have worked however Icannot name them all.

My association with the Licensing Executive Society (LES) has been a constantsource of learning from many people who have also become friends. If I start men-tioning names, I would never know where to stop. LES is simply an outstandinggroup of individuals who have universally been both gracious and wise, an uncom-mon combination.

The origins of these books can probably be traced to a conversation I hadwith Lou Berneman who, on behalf of the Association of University TechnologyManagers (AUTM), asked me to teach the valuation section of AUTM’s introductionto licensing course. That invitation, and honor, became an annual event for me forsome dozen years and lead to my writing the valuation chapter in AUTM’s LicensePractice Manual, which has now been revised. I owe thanks to Lou, AUTM, and inparticular the two thousand plus students who have participated in that experience;these many interactions have helped me solidify my own thoughts and defog someaspects.

In my 11 years consulting I have done perhaps 200 or more projects, andgiven numerous day and multi-day valuation “workshops” for clients. One of thebenefits of all these experiences is the learning that takes place in every encounter,every question. Thanks to all of you for the opportunities to serve you by theseassignments. Although I have been careful not to disclose anything proprietary fromthese engagements, the inevitable learning that comes from them has been a lifelongbenefit.

Perhaps I owe my greatest learning debt to those many individuals withwhom I negotiated, or attempted to negotiate, licensing agreements, including those


Acknowledgments xiii

necessary negotiations with my own teammates. Your reasoned and articulate ex-planations, of how you viewed the subject opportunities have swirled through mymemories many times and continue to do so even now, many years later. It is anaxiom of negotiation that Dealmaking is a mutual learning experience. I don’t knowhow mutual it has been, but for me it has been the learning laboratory and mythanks goes out to all of you.

This is not the kind of personal book that causes me to focus on the contributionsof my family. But, it has been their encouragement and patience and source of earthlypurpose that has kept me going: So to you, Carol (my loyal wife of now two plusyears and counting) and children of whom I am so proud . . . Rich, Renda, Christy,Jodi, and Leslee, I say “thanks.” These six have all at one time or another asked“What exactly is it that you do?” This book is a long answer.

Lastly, my thanks go to Susan McDermott and Emilie Herman at John Wiley &Sons, and Martha Cooley who welcomed me into the Wiley relationship with thatfirst book. Thanks for encouraging my writing, especially when things were goingslowly.

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