Harare, Zimbabwe, 28th November 2014 IP and Finance - Accounting and Valuation of IP Assets and IP-based Financing - – Topic 17 - McLean Sibanda Training of the Trainers Program on Effective Intellectual Property Asset Management by Small and Medium Sized Enterprises (SMEs) Organised by the World Intellectual Property Organisation (WIPO) and the African Regional Intellectual Property Organization (ARIPO) Harare, Zimbabwe, 28th November 2014

Summary Introduction Valuation methods Concluding Remarks

Introduction Different Forms of Finance High Friends Family Fools Angels Venture Capitalists Risk Public Funds (grants, soft loans, etc.) Private Equity Equity markets Commercial banks Low Seed Start-up Early growth Established Stage of development of the Investee

Introduction A Question of Value - “Value must exceed the price." IP valuation is complex Complex interaction of legal and business issues as well as uncertainties What is the value put on table before prospective investors? 4 4

Introduction Importance of valuing IP 5 5

Introduction Importance of valuing IP IP an asset / currency Deal leveraging / cross licence) Collateral / security Sold / disposed of Licenced / leased Basis for a joint venture Competitive advantage / market leadership IP new currency in knowledge based economy 6 6

Introduction Fundamental Questions in Valuation 7 7

What is the value added by IP Assets? Introduction Fundamental Questions in Valuation With IP What is the value added by IP Assets? Without IP When will the company become mature / sustainable, and what are the potential constraints / barriers? What are the cash flows from existing assets? Competition Regulatory Etc. How risky are the cash flows from both existing assets and IP assets? 8 8

Introduction Factors Affecting Valuation Quality of the IP Asset Depth and breath of patent claims Prosecution history Territories granted Distinguishing ability Quality of underlying product Time to market Inherent commercialisation risk Litigation / infringement 9 9

IP Valuation Different Valuation Methods Cost method Market method Income 25% rule (relief from royalty) Discounted Cash Flow Monte Carlo simulations 10 10

IP Valuation Cost Method Recovery of costs incurred – cost to redevelop Does not consider the time value of money / opportunity cost Not equate to value – no link to future revenues Typical in early stage technologies 11 11

IP Valuation Market Method Comparison with similar technologies / products / transactions Access to transactional information In essence a guide 12 12

IP Valuation Market Method Similar to real estate valuations Similar transactions / Assets Market method 13 13

IP Valuation Market Method 14 Use of the 25 Per Cent Rule in Valuing IP by Robert Goldschreider, John Jarosz and Carla Mulhern, Les Nouvelles – December 2002 at p123) Licensed royalty rates (late 1980s to 2000)   Royalty rates and successful licensee profits Industry No licences Median royalty rate Avg operating profits Royalty as a % of profit Automotive 35 4.0% 11.3% 44.1% Chemicals 72 3.6% 12.0% 25.0% Computers 68 8.3% 33.3% Consumer Goods 90 5.0% 18.4% 27.1% Electronics 132 13.1% 34.3% Energy & Environment 86 9.2% 38.1% Food 32 2.8% 14.2% 15.8% Healthcare Products 280 4.8% 18.5% 21.6% Internet 47 7.5% 10.4% 48.0% Machine/Tools 84 4.5% 9.6% 35.0% Media & Entertainment 19 8.0% -13.5% -66.7% Pharma & Biotech 328 5.1% 25.8% 17.4% Semiconductors 78 3.2% 31.9% 7.8% Software 119 6.8% 25.1% 21.4% Telecom 63 4.7% 14.5% 34.5% Total 1533 18.8% 26.6% 14 14

Royalty Rates for Different Industries Source: Dan McGavock of IPC Group, Chicago Based on survey results

Royalty Rates for Different Industries RoyaltySource® from Transaction Analysis Industry Average Median Max Min Count Chemicals 4.7% 4.3% 25.0% 0.1% 78 Internet (incl software) 11.8% 8.8% 50.0% 0.3% 88 Telecom (excl Media) 4.9% 4.5% 15.5% 0.4% 73 Consumer Gds, Rtl & Leis 5.5% 5.0% 28.0% 0.1% 98 Media & Entertainment 9.1% 5.0% 50.0% 2.0% 25 Food Processing 3.2% 2.8% 10.0% 0.3% 38 Medical/Health Products 6.1% 5.0% 77.0% 0.1% 376 Pharma & Biotech 7.0% 5.0% 50.0% 0.0% 458 Energy & Environment 5.0% 5.0% 20.0% 1.0% 107 Machines/Tools 5.2% 4.5% 25.0% 0.5% 90 Automotive 4.3% 3.5% 15.0% 0.5% 59 Electrical & Electronics 4.2% 4.0% 15.0% 0.5% 139 Semiconductors 4.3% 3.0% 30.0% 0.0% 75 Computers & Office Equip 5.3% 4.0% 25.0% 0.2% 73 Software 11.5% 6.8% 70.0% 0.0% 147 Industry Summary 6.40% 4.80% 1,924

IP Valuation Income Method Based on future revenues Generally for more mature technologies 17 17

IP Valuation 25% Rule Royalty = 20% to 33% of PBIT

IP Valuation 25% Rule Value of trademarks used by a company R100m turnover Pays R4m in royalties Generates R24m in profits (before royalties, interest and tax) (PBIT) http://www.snz.co.za/articles/valuation/use-of-the-25-rule/

IP Valuation 25% Rule (cont…) Contrast with inappropriate valuation of same trademarks: R100m turnover Pays R4m in royalties Generates R24m in profits (before royalties, interest and tax) (PBIT) http://www.snz.co.za/articles/valuation/use-of-the-25-rule/

25% Rule - example PBIT example: Sales: R15,000,000 Cost of sales: (R10,000,000) Overheads: (R2,000,000) Interest: (R500,000) Tax: (R600,000) PBIT: R3,000,000 Applying 25% Rule: Royalty = R750,000 pa = 5% of turnover (i.e. R750k/R15m) Q: What if you are already licensing in technology and paying R150,000 royalty?

IP Valuation Discounted Cash-flow Assumes revenues / cash-flows Discount rate for risk NPV

Unsystematic risk premium: Discount rate Discount rate Is a measure of risk Unsystematic risk premium: Relative risk and return Risk free rate 3% Mature product 10% (ie 2% UR) Pre-national launch 15% (ie 7% premium) Technology only is sure 25% (ie 12% premium) Embryonic R&D 50% (ie 42% premium) (US info – 5% SR)

IP Valuation Valuation of Nascent / Early Stage Technologies Risks Transition: laboratory to large scale manufacturing / market adoption Failure to be cost effective to manufacture Stronger and newer competitive technology will emerge Regulatory hurdles (e.g. undesirable side-effects in case of drugs) May not achieve promised benefits Cost approach most used for nascent / early stage IP Cost approach doesn’t consider patent monopoly value Grossly undervalues IP in some cases Other methods - Discounted cash flow, Monte-Carlo, 25% rule

Concluding Remarks

Concluding Remarks Valuation complex and depends on a number of factors Important that employ appropriate valuation method Valuation done for variety of reasons: New investments Capital raising Commercialisation – e.g. licensing or venture creation Tax purposes An art more than a science Don’t let valuation kill the deal!

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