Doug Bania and Brian Buss provided a webinar entitled “Internet Tools for Intellectual Property Analysis” for the Certified Patent Valuation Analyst (CPVA) designation. The CPVA requires successfully completing courses related to valuation of emerging technologies, negotiating licensing agreements for maximum returns, advanced patent valuation and calculating damages resulting from patent infringement.
To purchase our webinar as a step in becoming a CPVA, please click here.
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.
Intellectual property (IP) is the legal term used to describe creations of the mind. Any work of art, invention, phrase, symbol, design, discovery or work of literature could be referred to as intellectual property. Although the term has been in use for over 200 years, its use did not become common until the 20 century.
In the modern era, the valuation of intellectual property (IP) has become a business issue that is essential to many companies’ financial, business, marketing and branding goals. Intellectual property valuation work is usually done to provide corporations, inventors, manufacturers and artists with a sound appraisal of the intangible properties they own.
The Basics of Intellectual Property Valuation
Whether it is required for a sale, a purchase or a merger, intellectual property valuation is seen as one of the most essential tasks required for strategic management. There are a number of reasons why an intellectual property appraisals may be required, often having to do with issues such as pricing and transactions, tax planning, royalty rates, litigation or financing.
There are several categories of intellectual property, their valuation often depending on both the specific traits of the IP and unique circumstances of their owner:
Patents are some of the oldest forms of intellectual property. Granted by the government to an inventor, a patent essentially prevents anyone else from making, using, selling or importing a specific invention for a certain amount of time.
Trademarks are designs or expressions used by a firm to distinguish itself from similar companies or traders.
Copyright provides an artist or the creator of an original piece of work with the exclusive rights for publishing or modifying it – normally only for a limited time.
2D or 3D design patterns created either for artistic or utilitarian purposes by a certain artist, designer, company or architect, are usually protected under industrial design rights.
Finally, trade secrets can refer to any type of work mostly unknown to the general public. These allow businesses and other entities to earn and maintain an advantage over their competitors, based on the techniques and practices that they are able to develop.
The valuation process for each of these categories requires an in-depth economic understanding and extensive knowledge about each specific type of intellectual property, what it entails and which valuation standards they belong to. There are four main approaches used for intellectual property valuation, each of them using a different method and philosophy to determine the value of the assets.
The Income Approach
Considered the most common and widely used valuation method for IP, the Income Method addresses an item’s ability to generate gains, defining the present value of an intellectual item, while addressing the anticipated economic benefits that it could bring during its estimated life span.
When using this approach, experts pay special attention to five main factors that can help pinpoint the exact value of a piece of intellectual property:
The revenue or income gained from the use of the IP;
The targeted portion of the income that can be attributed to the subject IP;
The estimated amount of time during which that income can be gained;
Risks and estimates related to revenue generation process;
Expected revenue growth or fluctuations.
It is also important to draw a clear line between business enterprise value and the actual value provided by the intellectual property in question to support the business in achieving higher revenue.
Valuation Based on Cost
The cost approach values a piece of intellectual property based on the amount of money it would take to either reproduce it as – for instance, an exact replica of a particular invention – or replace it with a similar item, based on the same principle, and designed for the same goals.
Although this method seems simple, it has to do with far more than just R&D costs. It requires a valuation expert to properly address a variety of factors, such as the changes in the value of a specific component from the time of the IP’s invention to the present date, or the impact that any exterior developments may have had on the manufacturing/development process.
An example of this would be the use of advanced software applets for the recreation or replacement of a specific piece of computer code that needs to be valued as intellectual property.
This valuation approach is most useful in areas where very little financial data exists and where technical information has to be taken more seriously. It is mainly associated with early-stage technology and the establishment of a maximum price for a technological asset as it relates to proposed transactions.
The Market Approach
This is considered one of the most sound and accurate valuation methods in use today. The market approach is meant to ascertain a specific asset’s value based on the principle of competition and equilibrium. The market approach assumes that, when you own a piece of intellectual property in a free and unrestricted market, factors such as supply, demand and pricing comparison will work to create a type of balance that stabilizes the price of an intellectual asset.
Royalty rate databases provide comprehensive data on transactions completed between willing buyers and sellers, allowing IP valuation experts to create a market standard when valuing a particular piece of intellectual property.
Relief from Royalty
The Relief from Royalty method is based on a lesser-known theory called the “deprival theory”. This method takes into account the perceived amount of money that a certain company might be deprived of if it did not own the intellectual property that is put up for valuation.
For instance, if a well-known corporation did not come up with the plans for a new appliance that has achieved resounding success in the months and years prior to its valuation, the firm may have been required to rent the said service or product from a third party, effectively having to invest potentially large sums of money.
Because the market size and the value of market shares are generally common pieces of information that can easily be accessed, the Relief from Royalty method is commonly used even if intuitively for the quick valuation of a wide array of assets despite the fact that, in some cases, it can be somewhat unreliable.
The methods presented above are the four most commonly used methods of intellectual property valuation in existence. Other methods also exist, aiming to facilitate a broader and more accurate attempt for valuation in the case of intellectual properties whose value cannot be correctly ascertained through the valuation techniques mentioned earlier.
Some of these methods can still be quite practical, including the Discounted Cash Flow method – designed to determine the value of IP based on current cash flow values – or the Historic Cost valuation method, which is meant to appraise an IP item based on the amount of money invested into its development from its very inception (as long as the development process was started in the recent past).
There are, of course, plenty of other details one needs to know about intellectual property valuation before being able to fully understand the process. The best way to get any and all of your questions answered is to contact a valuation expert who can educate you while helping to build your intellectual property strategy.