This document provides an overview of intellectual property valuation for attorneys. It discusses the different types of intellectual property that can be valued, as well as the common valuation approaches of income, market and cost. The income approach values the future cash flows from an IP asset, the market approach uses comparable market transactions, and the cost approach considers costs to recreate the asset. The document emphasizes defining the valuation assignment and performing due diligence on the IP asset being valued.

1. Attorney’s Guide to the
Valuation of Intellectual
Property
Ben Armitage
Rich Billion
Billion & Armitage®
Intellectual Property that Drives Business®
Clyde Hanson, CPVA
Venture Isles, LLC
The business-side of patents & innovation
© 2014 Armitage, Billion, Hanson 1

2. Introduction
Valuation of intellectual property is not the core work
of most attorneys. The goal today is to provide a
working knowledge so you’ll know what questions to
ask and have a better sense of the process.
Intellectual property has become the driver of value
creation in many industries.
80% of the market value of Fortune 500 is attributed to
intangible assets, including IP, up from 40% in 1975
Managing tangible assets is well-established, managing
intangible assets, less so. “You can’t manage what you can’t
measure” --Peter Drucker. Valuing IP is basic to managing it
well.
© 2014 Armitage, Billion, Hanson 2

3. Overview
1. Types of Intellectual Property (IP)
2. Determining the Valuation Assignment
3. IP Valuation Methods
4. Performing Due Diligence
5. Selecting a Valuation Specialist
6. Data & Document Gathering: Analyst Support
7. Reviewing & Interpreting the Valuation Report
© 2014 Armitage, Billion, Hanson 3

4. Types of Intellectual Property
Patents
Utility
Design
Trade Secrets
Trademarks
Copyrights
Domains
Brands
Intangible assets that
can be sold separately
from the entire firm are
intellectual property
Technology-usually pre-commercial
designs,
data, and knowhow.
© 2014 Armitage, Billion, Hanson 4

5. Considerations: Context of Value
What is the context?
 Licensing
 Selling
 Buying
 Litigation
 Gift
 Taxation
 M&A reporting
 Based on the context, the value
might change.
 For example, licensing, buying and
selling involves negotiation. As a
result the royalty rate might not be
indicative of the actual value.
 Litigation involves damages
between two adverse parties, who
were unwilling to come to an
agreement prior to litigation.
© 2014 Armitage, Billion, Hanson 5

6. Purposes of IP Valuations
Transaction pricing & deal structure
Finance collateralization & securitization
Taxation planning & compliance
Management information & strategic planning
IP portfolio management decisions
Bankruptcy & reorganization analysis
Litigation support & dispute resolution
© 2014 Armitage, Billion, Hanson 6

7. Defining the Assignment
What exactly is the property to be valued?
How will the valuation be used?
Value at what date? Current? Historical?
Who is the audience? What is their focus?
What level of documentation?
Does client or analyst select techniques?
When is the work product needed?
Who is to be the analyst’s contact?
Is the existence of the valuation confidential?
© 2014 Armitage, Billion, Hanson 7

8. Defining the Assignment
What definition of value is to be used? Value to whom?
Fair market value
Fair value
Market value
Acquisition value
Use value
Investment value
Owner value
Insurable value
Collateral value
Ad valorem value
© 2014 Armitage, Billion, Hanson 8

9. Defining the Assignment
Premise of Value: How the value will be created
Value in continued use, as part of a going-concern
business enterprise
Value in place, but not in current use in the production
of income
Value in exchange, as part of an orderly disposition
Value in exchange, as part of a forced liquidation
© 2014 Armitage, Billion, Hanson 9

10. Defining the Assignment
Which, if any, certification standards?
 Uniform Standards of Professional Appraisal Practice (USPAP)?, Federal
Court Rule 26?, IRS regulations 197 (Definition and valuation of intangible
assets), 482 (Intra-company transfer prices), & 170 (qualified appraisal &
appraiser)? Non-certified?
What level of precision is desired?
Maximizing−very existence of the enterprise is at stake
Optimizing−cost and value of precision is balanced
Satisfying levels−when lower cost information is “good enough”
An opinion letter states analyst’s judgment of value based
on experience without a bottom-up analysis
Single asset vs. portfolio of related or unrelated assets
Separate calculations for each asset
Sampling/ Key assets
© 2014 Armitage, Billion, Hanson 10

11. Getting the Lay of the Land
Is asset an entire product? Business model? Franchise?
Is it a platform technology?
Is it a component?
Is it a sustainable competitive advantage?
Does it have or justify a premium price?
Is it a new or established market?
Who or what is competition?
Situation of client? Growth? Profitable? Stable?
Who has more power in the hypothetical transaction?
Which side may end up with more of the value?
© 2014 Armitage, Billion, Hanson 11

12. Risk Lowers Value
 Risks—Where handled in the valuation?
 Technology—Will it work? Stay on budget?
 Execution: Quality of management & workforce
 Intellectual Property
 Invalidity risk, claim limitation risk
 Design-around risk
 Freedom-to-operate / blocking patents
 New competition, obsolescence
 Market acceptance
 Environment-economy, interest rates, buyer confidence, regulatory
Risk Adjustments
Discount interest rate
Direct increase or decrease in value by factors
(c) 2014 Armitage, Billion, Hanson 12

13. General Valuation
Approaches
Disaggregate the value question into many smaller
questions which can be answered with public data or
assumptions that are are narrower and can be evaluated
Three traditional approaches like appraising a house
 Income: values the future benefit stream, then discounts back to a present
value. Looking ahead.
Market: uses comparables to establish relative value. Looking around.
 Cost: cost to create the asset. Looking back.
Use multiple approaches & techniques in a single valuation
Reality checks from multiple perspectives
(c) 2014 Armitage, Billion, Hanson 13

14. Cost Approach
Cumulative investment in asset
 Cost is close to value in building construction, but not all IP
 Profit leverage of IP can be significant, so cost ≠ value
Cost Techniques
 Replacement or Historical Cost
 Equal Return Payments-ERP
 “Fair” split of between buyer/seller for more developed assets
 Both parties earn the same rate of return on their investments
 Remaining cost to market, Risk-adjusted NPV EBIT
 Disaggregation of profits by asset class
 SG&A
 Reputational IP
 Technical IP
 Assumes tangible assets are commodities that don’t earn
economic rents
© 2014 Armitage, Billion, Hanson 14

15. Market Approach
Compare to values of similar assets sold in an arms
length transaction in a well-organized market
Auctions ideal arbiter of value
Challenge: Thin and secretive IP marketplace
Adjusting market values to make comparable
Weighted average, score closest assets higher
Sources: News releases, IP Offerings quarterly
newsletter “IP Quotient”, ICAP Auctions (Ocean
Tomo), court filings & published opinions
There may be no comparable transactions
Comparable licenses are more common
© 2014 Armitage, Billion, Hanson 15

16. Other Market Techniques
Rule of Thumb: Poltorak Rule (Base year EBIT * 1.3)
Current brokerage rate—Pay 1-10% of economic
benefits in a lump sum payment
Apply to discount to sum of future royalties
(Comparable royalty rate applied to the forecast flow of
(wholesale) sales over the economic life of asset)
The more predictable & established the royalty flow,
the lower the current brokerage rate
© 2014 Armitage, Billion, Hanson 16

17. Patent Market Technique
Econometrics-Pantros Patent Value Report
Predicts a sale price for a patent that considers a
computer score of the quality of the patent and its
licensing potential as indicated by patent data. Black
box, technique proprietary.
Cumulative economic flows to patent space (size of
technology area’s share of US GDP)
Inventors misinterpret market size value as what they
should get for their patent
Issued US patents only
About $250 per report
© 2014 Armitage, Billion, Hanson 17

18. Income Approach
Data Needed
How big is the market in dollars? Units?
What is the is the asset’s economic life?
How much of potential market is reachable profitably?
What are major segments of the market?
What marketing channels serve each segment?
What prices, gross margins and costs are relevant?
Dealing with Uncertainty
Rating & scoring
Probability trees
Monte Carlo method
© 2014 Armitage, Billion, Hanson 18

19. Income Approach Techniques
Rule of Thumb: 25% Rule (% of EBIT created goes to IP developer)
Discounted cash flow (NPV) of gross margin or cost savings
Economic life of asset
Selecting the discount rate (what risks are covered, cost of capital)
Examples of Specific Techniques
NPV (less R&D and launch costs paid by buyer) of EBIT
NPV with Probabilities Method
 Technical success
 Commercial success
 Cost of failure
Cost Savings NPV*25% (cost saving are a positive economic benefit)
Expected Commercial Value
 Probability of commercial success applies to launch costs
 Probability of technical success applies to R&D costs
 Adjusts the present value of future earnings from the asset
© 2014 Armitage, Billion, Hanson 19

20. Income Forecast Factors
Market share growth of asset owner
Existing solutions will retain some share for some time
Takes time to sell channels, end-buyers
 Except phone apps & games, toys, fashion, etc.
New, non-infringing competitors likely to arise
Technology adoption curve
Market share aside, getting customers to adopt a truly
disruptive innovation is a challenge and takes time.
Published studies of adoption curves are used by
analysts
© 2014 Armitage, Billion, Hanson 20

21. Combining Results of Several
Techniques into Single Value
Analyst judges which techniques are most relevant to
this situation and weights them higher in the
calculation of a combined monetary value.
Written rationale for the weights
Sensitivity analysis
Infringement damages usually one approach
Two Summary Values (Venture Isles practice)
NPV of the flow of economic benefits
Likely sale price of asset with & without multiple offers
© 2014 Armitage, Billion, Hanson 21

22. Adjusting Combined Value
Stage of technology development
Industry openness to innovation
Number of decision-makers for IP
Patent and IP quality and quantity
Litigation tested +15%
Portfolio size (single patent -15 to -30%)
Forward citations +1-3% each
Stature of the inventors
Economic cycle
Emerging competition
Profit flow large enough to justify asserting patent(s)?
Caution not to double discount for risks © 2014 Armitage, Billion, Hanson 22

23. Valuation Opinion
Summary statement of value
Purpose for which valuation was created
Limitations on use of valuation
Value “as of” date
Professional liability boilerplate
Page 24 in ABC Company example valuation report
© 2014 Armitage, Billion, Hanson 23

24. Infringement Damages
Historical sales/cost data gained through discovery
Analyst focus is on:
 Comparable royalty rates; Georgia-Pacific case factors
 Discount rate justification
Higher standards for documentation
Daubert Case Principles for Experts
 Testable
 Peer review and publication
 Acceptable rate of error and maintenance of standards
 Community acceptance
Expert witness experience
Credentials become more important
Trending toward academics, economists
© 2014 Armitage, Billion, Hanson 24

25. Considerations for Marketing IP
Trademarks—Symbol of the brand, can be shared and
licensed to go on products of other firms
Brands—customer perception relative to
competition; premium price, higher market share, or
both
Domain names—ease of use, memorable? Online
estimators (free).
Valuation Issues
Hard to untangle brand & trademark
Few comparables
© 2014 Armitage, Billion, Hanson 25

26. Example: ABC Company
 Actual valuation, used with permission after redactions & modified
demand estimates
 Purpose: Set a reasonable asking price for portfolio and show buyer the
economic benefits (Value-created)
 Primary market research on adoption obstacles
 Value date: calculations going forward till end of patent term (17 years)
 Portfolio: Patent, trademark, hardware system design & software (p. 4)
 Potential buyers with 3 business models valued
 Potential market size—8 market segments sized
 Addressable market-13-50% of potential by biz model
 Cash-flow by type of buyer (3) * 8 segments = 24 estimates
 Valuation by Buyer Type and Market Segments (Field-of-Use) created
© 2014 Armitage, Billion, Hanson 26

27. ABC Example: Income
Approach
Pages 10-15 covers Income Approach
US Patent so US only demand estimated
Other assumptions & comparable royalty results p 11-12
Five techniques, 4 used in Value-created estimate, 1 in Market (sale
price) estimate. 1 rule of thumb, 4 NPV calculations
Excel Workbook model: 9 linked spreadsheets.
 EBIT & royalty forecasts
 Technique calculations
 Industry trend & market segment data and assumptions documented
Technology adoption curve & market share growth adjust demand
Econometric technique also in Value-created estimate
© 2014 Armitage, Billion, Hanson 27

28. ABC Example: Market
Approach
Page 20 of valuation report
Royalty rate weighted average scoring of comparable
licenses, 4.17% used
EBIT based on % of sales in published data for similar
types of business
3 techniques, all used in asking price estimate
Poltorak Rule
Current Brokerage Rate (2 rates)
© 2014 Armitage, Billion, Hanson 28

29. ABC Example: Cost Approach
Page 15-18 of report
Two techniques
Replacement Cost (used in Value-created)
Equal Return Payment (used in asking price)
 Lump sum also shown as annual royalty payments
Calculated by buyer type
© 2014 Armitage, Billion, Hanson 29

30. Selecting a Valuation Analyst
Face-to-face meetings or telecom preference
Budget
Deadlines
Technical/industry expertise
Working relationship
Litigation/non-litigation
IRS/non-IRS audience
Professional certifications
A person, not the firm, does the work
© 2014 Armitage, Billion, Hanson 30

31. IP Asset Due Diligence
Team approach
Patent attorneys
Business evaluators
Industry veterans
Contract attorneys
© 2014 Armitage, Billion, Hanson 31

32. IP Asset Due Diligence
Patent Attorney
File history review
Maintenance fees
Prior art search
Freedom to operate
Litigation search
Docket review
Claim evaluation
 Enforceability, coverage, etc.
Check ownership (assignments, employment
agreements, etc.)
© 2014 Armitage, Billion, Hanson 32

33. IP Asset Due Diligence
Rest of team
Any liens or mortgages on IP
Market/product evaluation
Industry players
 Litigious? Potential partners? etc.
© 2014 Armitage, Billion, Hanson 33

34. Patent File History Review
All relevant art cited and review by Examiner
Limitations disclaimed in prosecution
Admissions by patent attorney
© 2014 Armitage, Billion, Hanson 34

35. Ownership
Correct inventors
Assignments or other transfer of rights
Government rights
Third party challenges
© 2014 Armitage, Billion, Hanson 35

36. Claim Evaluation
Scope
Product coverage
Detectability
Enforceability
© 2014 Armitage, Billion, Hanson 36

37. Best Practices
Talk to your patent attorney
Assignments/Ownership locked up
Employment agreements
Consultant agreements
File continuations
Monitor deadlines, file on outstanding disclosures
Deal with warts head-on
Stalled prosecution, third-party issues
© 2014 Armitage, Billion, Hanson 37

38. Data & Document Gathering
Internal data & interviews with key personnel
Patent, trademark, etc. lists
Encumbrances to IP assets
Past offers for the IP
Litigation history
Product lists, marketing materials, tech manuals, price
lists, customer lists
Product/division/firm financials
Resource people contact information
© 2014 Armitage, Billion, Hanson 38

39. Interpreting Valuation
Reports
What was valued and why?
How was value defined? Value as of when?
What are the sources for market demand data?
What methods & techniques were used?
© 2014 Armitage, Billion, Hanson 39

40. Reviewing Valuation Reports
Was the IP understood by the analyst?
Did the due diligence verify the government
recognition of the IP?
Who was interviewed about the IP?
Are the methods relevant to the situation?
Are assumptions about the future clear? Reasonable?
Did independent legal council review the IP?
Do modeling spreadsheets match the report tables?
Are risks addressed explicitly?
© 2014 Armitage, Billion, Hanson 40

41. IP Valuation: In Conclusion
Valuing IP is key to maximizing its financial return
There is a wide-range of valuation types
Clarification of assignment upfront pays dividends
How important is the decision the valuation will
influence to the sponsor of the valuation?
Better to have a simpler valuation that its users
understand than a complex one understood only by
the analyst.
© 2014 Armitage, Billion, Hanson 41

42. Q & A
© 2014 Armitage, Billion, Hanson 42

43. Special Thanks
Frank Farrell
Frank@fsfarrell.com
Markus Lacis, CPA
Markus.Lacis@McGladrey.com
© 2014 Armitage, Billion, Hanson 43

44. Reference Books
Valuation and Pricing of Technology-Based
Intellectual Property, Richard Razgaitis
Business Valuation Resources (BVR) Guide to
Intellectual Property Valuation, Michael Pellegrino
Valuing Intangible Assets, Robert Reilly, Robert
Schweihs
Fundamentals of Patenting and Licensing for Scientists
and Engineers, Matthew Y. Ma
© 2014 Armitage, Billion, Hanson 44

45. For More Information
Clyde Hanson, CPVA
Clyde.hanson@ventureisles.com
(612) 418-1192 Minneapolis
Richard Billion
rbillion@billionarmitage.com
(952) 697-2633
Ben Armitage
barmitage@billionarmitage.com
(952) 697-2632
© 2014 Armitage, Billion, Hanson 45