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IP Valuation
          September, 2011



    CONSOR Intellectual Asset Management




                   © CONSOR 2011
1
Why IP Valuation?
                     Beyond specialized IP law practices,
              business, commercial, tax and estate practitioners
      Increasingly involved in identifying, protecting, applying, and
              defending intangible assets owned by clients.


    Context                                  Purpose
    • Value to whom?                         • Buy, sell or transfer
    • How much value?                        • Disputed ownership
    • How and when does value                • Improve performance
      change?
                                             • Collateralization

                                    © CONSOR 2011
2
What is IP?



    Intellectual Property vs. Intangible Assets
           Bundles of IP and IA Assets




                       © CONSOR 2011
3
Context: Property Types
                         Intangible Assets



        Intellectual Properties

                                                         Customer &
                                                           Vendor
     Patents      Trademarks           Data Bases       Relationships

                     Trade                Internet       Proprietary
    Copyrights
                    Secrets                Assets         Systems


          IA vs. IP: Commercialized Separate from Other Assets
                                 © CONSOR 2011
4
IP Property Types
                    Bundles of Intangible Assets (IA),
                 each contains Intellectual Properties (IP)
    Marketing                              Relationship (Customer / Supplier)
     Marks, brands, names, domains                    Customer / Supplier
                                                         relationships
     Trade-dress, packaging, logos
                                                     Distribution networks
       Non-competes, key-person
                                                         Order backlog

    Technology                             Contract
        Technologies, know-how,                      License / royalty, lease,
           systems, methods                                franchise
       Patents, software, recipes,           Permits, use rights, broadcast
          content, databases                             rights


                                     © CONSOR 2011
5
Valuation Methodologies
                      Cost                      Income                     Market
              Economic principal of      Present value of future    Value based on price of
                  substitution             economic benefit             similar assets
Description




               Measures expense           Requires projections         Requires suitable
               required to replace       and a risk assessment        comparable assets

              Neglects future benefit     Requires allocation of
                                          benefit specific to the
                                                   asset


                   Replication /                   DCF                   Comparable
Application




               replacement feasible                                      transactions
                                           Relief from Royalty
                  Benchmarking                                          Benchmarking


                                     Valuation as Art and Science

                                                © CONSOR 2011
6
Valuation Tools of the Trade
           The “Science” of Valuation

      Discounted Cash Flow Models
      Comparable Valuation Ratios
           Replacement Cost
           Relief from Royalty
       Allocation / Excess Earnings
             Option Models
        Proprietary Approaches

                     © CONSOR 2011
7
Changing Valuation Terminology
             Level of Value                                   Value Definitions


                                                              Fair Market Value
                                                                 Fair Value
      MVIC                                                     Strategic Value
                    MVE
    = Assets +                                               Liquidation Value
    Liabilities    = Equity
                  Ownership
                               Minority
                              Interests                   Who’s Setting Standards?

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


                       Defining the Assignment to Avoid “Bad Art”

                                          © CONSOR 2011
8
Case: Improper Use of a Character
    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


                             © CONSOR 2011
9
Case: Improper Use of a Character
Methodology               Approach   Results ($millions)
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




                           Case Take-away: Context is Key

                                       © CONSOR 2011
10
A more complex case showing
     the importance of Context, and
     the importance of identifying IP




                   © CONSOR 2011
11
Case: Identifying IP
• 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?




                             © CONSOR 2011
12
Case: Identifying IP
 Can see its there . . .
 Net Revenue                                                        20,000,000
                                                           Comps Average      Subject
 Earnings Margin                                               10%                 25%
 Operating Income                                             2,000,000           5,000,000
 Market Earnings Multiple       Comp. pub lic                  6.0x                6.0x
                            financial companies

 Implied MVIC                                                12,000,000       30,000,000
 Value of Tangible Assets     Book value per                   (500,000)          (500,000)
                              Balance Sheet

 Value of Goodwill                                          11,500,000       29,500,000
 Subject's Excess Earnings                                           3,000,000
 Subject's Proprietary Intangible Assets                             18,000,000



                                           © CONSOR 2011
13
Case: Identifying IP
• We can see IP exists . . .
• What are the key types
  of IP Assets?              IA at the CLIENT
                             Proprietary systems (some could
                                       be commercialized)
                                  Proprietary methods
                                  Relationships / key people
                                       (can’t be commercialized)
                                  History / Longevity / 1st to
                                    Market (can’t be commercialized)

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

                                   © CONSOR 2011
14
Value Constraints

                                                                                  Brand / Trade
                                                                                     Names
       Value of Business



                                                             Intangible             Intellectual
                               Present Value of                Assets               Properties
                               Expected Future
                           =       Benefit        =                          =
                                                                                 Intangible Assets


                                                           Tangible Assets        Tangible Assets




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


                                                      © CONSOR 2011
15
Case: Impact of Context
Could a company’s IP assets exceed the market value of the business?

• 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?
        Sources of Funds       Use of Funds                  Allocation
        Cash              50   Buy Equity              400   A/R           25
        Stock            275   Repay Debt              100   Inventory     50
        New Debt         200   Costs                    25   PP&E         100
                                                             Goodwill     350
        Total           525    Total                   525   Total        525
                                       © CONSOR 2011
16
Can Value of IP > MVIC?
                                Allocation              Goodwill Acquired
Context Drives the Science      A/R                25   Brands          150
• Value of IP cannot            Inventory          50   Patents           65
  exceed MVIC in a              PP&E              100   Databases       115
  purchase price                Goodwill          350   Other IA             20
  allocation
                                Total             525   Total                350
• Value of each IP = PV of
  future benefit each IP
                               Tools / Science
  provides to Company’s
                               • Forecast cash flows by product
  cash flow
                               • Quantify the interaction of IP Assets and
                                 their contribution to earnings

                             Case Take-away:
        Context is key / Context Can Be Forced on the Value Analyst
                                  © CONSOR 2011
17
What if the Context Changes?
        What if we don’t have a completed transaction between
                  a wiling buyer and a willing seller?

 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)

                                      © CONSOR 2011
18
What if the Context Changes?
         What if we don’t have a completed transaction between
                   a wiling buyer and a willing seller?




 IP Valuation Methodologies                         All these approaches
 •   Comparable Transactions                              construct a
 •   Relief from Royalty                                 hypothetical
 •   Discount Future Benefit                       agreement between IP
 •   Replacement Cost                                Owner and IP User




        Crafting the Hypothetical Agreement Requires Art and Science
                                   © CONSOR 2011
19
Hypothetical Agreements
No More Rules of Thumb                         Replacing Rules of Thumb
• Uniloc USA v. Microsoft Corp:          • Licensing agreement =
  applicable specifically to IP analysis   contractual financial
                                           agreement
• End of the 25% rule = “End of the
  unsupported conclusion”                • Commitments can and do
                                           take many forms
• Averages & Surveys as the
  lemming’s rule of thumb                • Hypothetical agreements
                                           must reflect their real-
• If it’s a universal norm, it can’t       world counterparts
  meet the criteria for comparables



                         This Shouldn’t be Shocking

                                   © CONSOR 2011
20
Reflecting Real-world Complexity?
        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


Did Consider . . .                       Assumed . . .
• Forecast benefit (sales, term)         • Constant sales
• Industry dynamics (rate)               • Industry average royalty rate
• Risk assessment                        • No changes during term
                                   © CONSOR 2011
21
Case: Alternative Royalty Rate Analyses
• 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


                           © CONSOR 2011
22
Case: Alternative Royalty Rate Analyses
Royalty Rate Build-up Method: BVEq

                 BVEQ= CBV + (IVE1 + IVE2 + …. + IVEN)

      Brand Value Components                          Range (%)
      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
     Surveys and Comparable Transactions are not The Only Tools Available

                                    © CONSOR 2011
23
Case: Reflecting Reality
      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 Benefits
       Up-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 Benefits
       Up-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

        Take-away: “Hypothetical Negotiation” Drives Greater Analytical Burden
                                              © CONSOR 2011
24
When Valuation Issues Arise?
 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.



                                    © CONSOR 2011
25
The Valuation Answer


     Reconcile results from multiple approaches
      Reconcile the calculations to the context




           Context + Time = Value




      There Are No Valuation Answers: Only Good Choices

                            © CONSOR 2011
26
Handouts
             Law 360 on Rules of Thumb
     Considerations for Hypothetical Negotiations
         20 Licensing Structure Alternatives
        Criteria for Comparable Transactions




                        © CONSOR 2011
27
Discussion




        © CONSOR 2011
28
CONSOR’s Services
             www.consor.com                                               858 454 9091

                  IP Valuation                                       IP Litigation Support
 • Valuing patents, trademarks, copyrights, trade         • Assisting attorneys with damage calculation
   secrets, celebrity rights, and technology                parameters & case strategy
 • Helping businesses understand the value of             • Proven success as expert witnesses
   their IP
                                                          • Economic damages in litigation
 • Valuation for transactions, tax purposes,
                                                          • Federal, state & international experience
   litigation, licensing deals, and more
                                                          • Arbitration, and mediation


            Licensing Consulting                                        IP Transactions
 • Assisting clients in maximizing the licensing          • Maximize the value of bankrupt assets
   value of their IP assets
                                                          • Identify valuable IP in bankruptcy
 • Develop licensing strategies, execute, negotiate
                                                          • Market and sale of bankrupt IP assets
   license agreements
                                                          • Value and dispose of intellectual property
 • Licensing experts in litigation
 • Evaluate financial and economic commitments
   of a potential transaction


                                                    © CONSOR 2011
29

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Intellecual Property Valuation

  • 1. IP Valuation September, 2011 CONSOR Intellectual Asset Management © CONSOR 2011 1
  • 2. Why IP Valuation? Beyond specialized IP law practices, business, commercial, tax and estate practitioners Increasingly involved in identifying, protecting, applying, and defending intangible assets owned by clients. Context Purpose • Value to whom? • Buy, sell or transfer • How much value? • Disputed ownership • How and when does value • Improve performance change? • Collateralization © CONSOR 2011 2
  • 3. What is IP? Intellectual Property vs. Intangible Assets Bundles of IP and IA Assets © CONSOR 2011 3
  • 4. Context: Property Types Intangible Assets Intellectual Properties Customer & Vendor Patents Trademarks Data Bases Relationships Trade Internet Proprietary Copyrights Secrets Assets Systems IA vs. IP: Commercialized Separate from Other Assets © CONSOR 2011 4
  • 5. IP Property Types Bundles of Intangible Assets (IA), each contains Intellectual Properties (IP) Marketing Relationship (Customer / Supplier) Marks, brands, names, domains Customer / Supplier relationships Trade-dress, packaging, logos Distribution networks Non-competes, key-person Order backlog Technology Contract Technologies, know-how, License / royalty, lease, systems, methods franchise Patents, software, recipes, Permits, use rights, broadcast content, databases rights © CONSOR 2011 5
  • 6. Valuation Methodologies Cost Income Market Economic principal of Present value of future Value based on price of substitution economic benefit similar assets Description Measures expense Requires projections Requires suitable required to replace and a risk assessment comparable assets Neglects future benefit Requires allocation of benefit specific to the asset Replication / DCF Comparable Application replacement feasible transactions Relief from Royalty Benchmarking Benchmarking Valuation as Art and Science © CONSOR 2011 6
  • 7. Valuation Tools of the Trade The “Science” of Valuation Discounted Cash Flow Models Comparable Valuation Ratios Replacement Cost Relief from Royalty Allocation / Excess Earnings Option Models Proprietary Approaches © CONSOR 2011 7
  • 8. Changing Valuation Terminology Level of Value Value Definitions Fair Market Value Fair Value MVIC Strategic Value MVE = Assets + Liquidation Value Liabilities = Equity Ownership Minority Interests Who’s Setting Standards? AICPA, ASA, ISO, NACVA, IRS, Courts, FASB, LESI, and more Defining the Assignment to Avoid “Bad Art” © CONSOR 2011 8
  • 9. Case: Improper Use of a Character 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 © CONSOR 2011 9
  • 10. Case: Improper Use of a Character Methodology Approach Results ($millions) 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 Case Take-away: Context is Key © CONSOR 2011 10
  • 11. A more complex case showing the importance of Context, and the importance of identifying IP © CONSOR 2011 11
  • 12. Case: Identifying IP • 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? © CONSOR 2011 12
  • 13. Case: Identifying IP Can see its there . . . Net Revenue 20,000,000 Comps Average Subject Earnings Margin 10% 25% Operating Income 2,000,000 5,000,000 Market Earnings Multiple Comp. pub lic 6.0x 6.0x financial companies Implied MVIC 12,000,000 30,000,000 Value of Tangible Assets Book value per (500,000) (500,000) Balance Sheet Value of Goodwill 11,500,000 29,500,000 Subject's Excess Earnings 3,000,000 Subject's Proprietary Intangible Assets 18,000,000 © CONSOR 2011 13
  • 14. Case: Identifying IP • We can see IP exists . . . • What are the key types of IP Assets? IA at the CLIENT Proprietary systems (some could be commercialized) Proprietary methods Relationships / key people (can’t be commercialized) History / Longevity / 1st to Market (can’t be commercialized) Case Take-away: Both IP and IA Contribute to Value © CONSOR 2011 14
  • 15. Value Constraints Brand / Trade Names Value of Business Intangible Intellectual Present Value of Assets Properties Expected Future = Benefit = = Intangible Assets Tangible Assets Tangible Assets 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 © CONSOR 2011 15
  • 16. Case: Impact of Context Could a company’s IP assets exceed the market value of the business? • 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? Sources of Funds Use of Funds Allocation Cash 50 Buy Equity 400 A/R 25 Stock 275 Repay Debt 100 Inventory 50 New Debt 200 Costs 25 PP&E 100 Goodwill 350 Total 525 Total 525 Total 525 © CONSOR 2011 16
  • 17. Can Value of IP > MVIC? Allocation Goodwill Acquired Context Drives the Science A/R 25 Brands 150 • Value of IP cannot Inventory 50 Patents 65 exceed MVIC in a PP&E 100 Databases 115 purchase price Goodwill 350 Other IA 20 allocation Total 525 Total 350 • Value of each IP = PV of future benefit each IP Tools / Science provides to Company’s • Forecast cash flows by product cash flow • Quantify the interaction of IP Assets and their contribution to earnings Case Take-away: Context is key / Context Can Be Forced on the Value Analyst © CONSOR 2011 17
  • 18. What if the Context Changes? What if we don’t have a completed transaction between a wiling buyer and a willing seller? 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) © CONSOR 2011 18
  • 19. What if the Context Changes? What if we don’t have a completed transaction between a wiling buyer and a willing seller? IP Valuation Methodologies All these approaches • Comparable Transactions construct a • Relief from Royalty hypothetical • Discount Future Benefit agreement between IP • Replacement Cost Owner and IP User Crafting the Hypothetical Agreement Requires Art and Science © CONSOR 2011 19
  • 20. Hypothetical Agreements No More Rules of Thumb Replacing Rules of Thumb • Uniloc USA v. Microsoft Corp: • Licensing agreement = applicable specifically to IP analysis contractual financial agreement • End of the 25% rule = “End of the unsupported conclusion” • Commitments can and do take many forms • Averages & Surveys as the lemming’s rule of thumb • Hypothetical agreements must reflect their real- • If it’s a universal norm, it can’t world counterparts meet the criteria for comparables This Shouldn’t be Shocking © CONSOR 2011 20
  • 21. Reflecting Real-world Complexity? 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 Did Consider . . . Assumed . . . • Forecast benefit (sales, term) • Constant sales • Industry dynamics (rate) • Industry average royalty rate • Risk assessment • No changes during term © CONSOR 2011 21
  • 22. Case: Alternative Royalty Rate Analyses • 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 © CONSOR 2011 22
  • 23. Case: Alternative Royalty Rate Analyses Royalty Rate Build-up Method: BVEq BVEQ= CBV + (IVE1 + IVE2 + …. + IVEN) Brand Value Components Range (%) 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 Surveys and Comparable Transactions are not The Only Tools Available © CONSOR 2011 23
  • 24. Case: Reflecting Reality 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 Benefits Up-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 Benefits Up-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 Take-away: “Hypothetical Negotiation” Drives Greater Analytical Burden © CONSOR 2011 24
  • 25. When Valuation Issues Arise? 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. © CONSOR 2011 25
  • 26. The Valuation Answer Reconcile results from multiple approaches Reconcile the calculations to the context Context + Time = Value There Are No Valuation Answers: Only Good Choices © CONSOR 2011 26
  • 27. Handouts Law 360 on Rules of Thumb Considerations for Hypothetical Negotiations 20 Licensing Structure Alternatives Criteria for Comparable Transactions © CONSOR 2011 27
  • 28. Discussion © CONSOR 2011 28
  • 29. CONSOR’s Services www.consor.com 858 454 9091 IP Valuation IP Litigation Support • Valuing patents, trademarks, copyrights, trade • Assisting attorneys with damage calculation secrets, celebrity rights, and technology parameters & case strategy • Helping businesses understand the value of • Proven success as expert witnesses their IP • Economic damages in litigation • Valuation for transactions, tax purposes, • Federal, state & international experience litigation, licensing deals, and more • Arbitration, and mediation Licensing Consulting IP Transactions • Assisting clients in maximizing the licensing • Maximize the value of bankrupt assets value of their IP assets • Identify valuable IP in bankruptcy • Develop licensing strategies, execute, negotiate • Market and sale of bankrupt IP assets license agreements • Value and dispose of intellectual property • Licensing experts in litigation • Evaluate financial and economic commitments of a potential transaction © CONSOR 2011 29