When a company develops a hot technology, the founders can quickly find themselves courted for mergers and acquisition. While an early exit can be desirable, especially at the right price, it’s incumbent on acquired companies to be clear on all claims to their intellectual property before executing a transaction or they could find themselves liable for damages.
Nevium was contracted as an IP damages expert witness to analyze the contributions of two companies in one such case in the molecular diagnostics and genetic sequencing market and assess damages. With far-reaching implications for individual diagnosis and treatment as well as public health outcomes, DNA sequencing technology is a high-stakes arena for innovation. As often happens with sophisticated technology in a dynamic market, commercialization requires the skills and resources of more than one party, leading to a complex business relationship that must be carefully disentangled in the event of acquisition.
One company—Distribution Partner—provided molecular diagnostic instruments and services for DNA sequencing. A second company—let’s call them Sequencing Systems—held an exclusive license from a university for a sequencing technology developed in academia. With its sole source of revenue resting on research grants, and under the gun to bring a product to market using the patents licensed from the university in order to avoid losing exclusivity, Sequencing Systems entered into an agreement with Distribution Partner—which already had a product successfully in field—to market and distribute products based on the licensed technology.
Timing is Everything
In January Distribution Partner achieved the first installation of an instrument based on Sequencing System’s technology. In March of the same year, Sequencing Systems met a third company—Acquisition Corporation. In June, Acquisition Corporation performed due diligence to purchase Sequencing Systems. In August, Sequencing Systems terminated its relationship with Distribution Partner.
Our discovery showed that Sequencing Systems referenced the relationship with Distribution Partner in several official communications, including a letter to the university demonstrating fulfillment of the licensing agreement, a Small Business Innovation Research (SBIR) application, and a letter to its Board of Directors as late as July. Whereas a letter of intent between Sequencing Systems and Acquirer was dated April and an agreement and plan of merger was dated in June. Distribution Partner was not informed of the acquisition until two months after the acquisition was completed.
At stake in this partnership was an opportunity potentially worth hundreds of millions of dollars, per Sequencing Systems’ SBIR application. Distribution Partner projected it could sell 45 instruments in the first year, achieving total revenues of almost $20 million. For year five, they projected growth to 120 instruments, with more than $50 million total revenue. For its part, Sequencing Systems estimated its revenue would reach almost $100 million during year five, including instruments and consumables. Both parties expected revenue and earnings to accelerate as installations of the product drove demand for higher margin consumables.
Valuation & Damages
In order to calculate damages, we had to first calculate the value of Sequencing Systems’ business. Of the three generally accepted valuation methodologies, we relied on the Income Approach, which assumes the value is the present value of the future earnings capacity available to the owners, since both companies were banking on future profits. Using the income approach, we valued the business at $50 million.
In building our valuation analysis we developed a sales forecast for instruments, consumables, and service contracts related to the technology, as well as a profitability and cash flow forecast for each of the companies. We looked at the value of the business opportunity available to both parties and calculated the portion of the acquisition price achieved by Distribution Partner’s contribution. This apportionment calculation was used to calculate the value each of the parties would have derived had they continued working together.
Since Sequencing Systems’ acquisition by Acquisition Corporation cost Distribution Partner the chance to pursue the opportunity outlined in the forecasts, the present value of the lost business opportunity was equivalent to Distribution Partner’s economic loss. Of the $50 million valuation, the value of the business opportunity for Distribution Partner was $15 million.
Sequencing Systems and Distribution Partner essentially split the duties to bring a product to market, including research, development, testing, manufacturing, distribution, sales and support. In examining the tasks required to bring the product to market, we determined that Distribution Partner performed approximately 30% and Sequencing Systems performed 70%. Therefore, Distribution Partner’s share of the $30 million paid by Acquisition Corporation would have been $10 million.
No technology is created in a bubble; it often takes more than one party to successfully bring a tech product to market. For any party being courted for merger or acquisition, it is imperative to disclose any such discussions or negotiations with relevant business partners so they may be accounted for in any resulting transaction and to avoid post-acquisition litigation and damages claims. Parties that have ever potentially contributed intellectual property included in the sale of a partner company would do well to scrutinize the timing of the transaction in relation to their payout—if any.
Nevium provides C-level executives and IP owners with valuations and IP strategies that leverage IP to enhance financial performance. Nevium uses IP valuation tools to connect IP to financial performance, enabling greater leverage of IP assets.
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Strategy Based on IP Valuation
As IP valuation experts, Nevium develops IP Strategies based on IP valuation tools. We calculate and communicate how patents, trademarks, copyrights, trade secrets and brands contribute to financial performance. Nevium’s IP Strategy services focus on translating how IP and intangibles impact the company’s bottom line, enabling IP owners and managers to identify and develop business strategies that leverage the company’s proprietary assets and enhance financial performance.
IP strategies can include leveraging brands and trademarks to access new markets or new territories, leveraging patents and proprietary technologies to optimize product pricing, and mapping IP portfolios to identify acquisition and divestiture opportunities. A thorough valuation-based review of an IP portfolio often uncovers opportunities to maximize capital investments and identifies business risks.
Using IP Valuation
Valuation of IP assets provides a benchmark and metric allowing Boards, IP Owners, Executives and In-house IP managers to demonstrate how and where their IP is making a difference. In other words, how their IP is influencing profits, impacting enterprise valuation and creating growth opportunities.
Nevium’s IP valuation clients gain a deeper understanding of their IP portfolios, quantify how their IP is contributing to financial performance and know which assets are being leveraged to drive growth and greater valuations.
Our valuation clients often realize some IP assets are contributing more than previously thought, while other asset groups are not generating expected returns and could be leveraged in other ways. We have identified assets that are key to financial performance that lacked sufficient legal protection and identified opportunities to sell or license other assets.
Nevium’s Valuation Tool Kit
Nevium’s valuation toolkit features a range of IP valuation tools, including our apportionment matrix and profit apportionment valuation model. The apportionment analysis is a four-step process that includes a business’ enterprise valuation, identification and grouping of key IP assets, a valuation of each of the business’ primary revenue-generating activities and a valuation of each identified asset bundle. Our valuation reports provide a multi-level view of the activities and assets driving the overall value of the organization.
Our valuation analyses are supported by industry and market research and valuation benchmarks. Our reports and presentations are designed to inform, communicate and provide new insights for business owners, executives and managers.
Nevium Intellectual Property Consultants
Nevium provides the IP industry with a visionary approach to calculating and communicating the financial impact of trademarks, copyrights, patents, brands and intangible assets. Our trailblazing techniques use advanced IP tools that go beyond the numbers. For IP litigators, Nevium provides expert damages testimony that combines our knowledge of Internet and social media analytic tools with accepted methodologies and concise narratives. We also provide C-level executives and IP owners with valuations and IP strategies focused on leveraging IP to enhance financial performance.
Nevium has worked with a wide range of clients across many industries. Often our IP valuation assignments become long-term partnerships where we advise our clients on licensing, business expansion, product pricing and overall business strategy. We work closely with in-house and outside counsel to ensure that IP business strategies work in conjunction with IP legal strategies.
In a world defined by climate change, social inequality, and large-scale conflict, and as idealistic Millennials come of age, companies that can turn a profit while fulfilling a higher mission are on the rise. These so-called “mission-driven companies”—think TOMS helping one person in need for every pair of shoes purchased or Everlane using only ethical, transparent manufacturing processes—capitalize on consumers becoming more informed about the products they consume and how they are sourced.
We recently undertook an intellectual property (IP) valuation for a mission-driven direct-marketing cosmetics company touting the “safety” of their products. The less-than-five-year-old company’s financials showed them beating out competitors on revenue growth and gross profits and they were set to become profitable in two years’ time as they branched out into e-commerce and retail sales. In the IP valuation we sought to assign a dollar amount to the company’s brand which included the trademarks and marketing assets that used the brand name (“brand assets”).
Research Reveals Low Brand Awareness among Likely Customers
Our first finding in the valuation process was friction between the market for the company’s products and its distribution strategy, which relied on consultant sales rather than more traditional personal care product channels. According to our market research, the outlook for safe, healthy, and organic products remained highly favorable with growth in organic cosmetics forecast at 13% over the next five years; tellingly, however, the company’s most relevant competitor with a network distribution strategy had experienced declining sales, earnings, and valuationsin recent years.
While brand awareness and intent to purchase was high among stakeholders (consultants, monthly members, and casual customers), 0% of control group respondents—heavy cosmetics users with a majority indicating safe and natural ingredients as a priority—had unaided awareness of the company’s brand when asked the open-ended question of what brands come to mind for safe and natural ingredients.And when supplied with a list, only less than 20% of participants indicated awareness of the company’s brand.
Brand Score & Apportionment Reveal Disproportionate Role of Consultants in Financial Performance
Using our proprietary Brand Score Tool, in which we assign scores to factors such as licensing, pricing, and differentiation, the company came out with a brand score of 2.0, which is relatively low for a consumer products company.
With our Profit Apportionment Model we seek to determine how certain brand assets contribute to a company’s overall financial performance. Using our model, we found that of the company’s key assets, the consultant network was the one contributing most to financial performance. The brand assets, while somewhat effective in the direct channel, were not pulling their weight in e-commerce and retail channels.
Our Profit Apportionment Model included a cash flow forecast for each distribution channel and each asset. By totaling the charges and assigning discount rates based on the risk level of each asset, we determined the value of each IP asset used by the company. We also conducted a brand valuation using a Relief from Royalty model, which calculates the market cost to license the brand assets. This method yielded a slightly lower valuation but the context of licensing the brand assets was less relevant to this company, so we focused our value opinion on the Profit Apportionment Model result.
When it’s Not Enough to Deliver on the Promise of the Mission
Sustainability, corporate social responsibility (CSR), and values-based behaviors can be important drivers of stakeholder perception. Essentially, a company promising to act in a sustainable or values-based manner is making a promise to its stakeholders that it will back its statements with actions. When a company’s statements and actions are aligned with its stakeholders’ values, and the company delivers on its promises, its brand is perceived more favorably. As more companies embrace missions based on sustainability, CSR, and values-based promises they have the opportunity to prove that their actions are aligned with their promises and build stronger brands.
In the case of our mission-driven brand valuation client, the company delivered on its promise, as reflected by high repurchase rates, however; the low brand name recognition showed the promise was not yet connected to its brand. Therefore, the brand was not yet driving financial performance as much as it could.
Over time, increased brand equity impacts the bottom line by helping a company sell more products, sell them at a higher price, or save money with decreased need to advertise. Although a direct sales model can be incredibly effective for generating revenue, without frequent and consistent use of the brand assets by the consultant network, critical opportunities to garner brand equity are missed.
Regardless of distribution channel, when brand assets are properly leveraged, delivering on the mission translates into brand equity; and when brand equity is properly leveraged, brand valuation captures the resulting return on investment.