1. 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

2. Summary
Introduction
Valuation methods
Concluding Remarks

3. 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

4. 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

5. Introduction
Importance of valuing IP 5 5

6. 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

7. Introduction
Fundamental Questions in Valuation 7 7

8. 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

9. 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

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

11. 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

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

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

14. 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

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

16. Royalty Rates for Different Industries RoyaltySource® from Transaction Analysis
Industry Average Median Max Min Count
Chemicals % 4.3% 25.0% 0.1%
Internet (incl software) 11.8% 8.8% 50.0% 0.3%
Telecom (excl Media) % 4.5% 15.5% 0.4%
Consumer Gds, Rtl & Leis % 5.0% 28.0% 0.1%
Media & Entertainment % 5.0% 50.0% 2.0%
Food Processing % 2.8% 10.0% 0.3%
Medical/Health Products % 5.0% 77.0% 0.1%
Pharma & Biotech % 5.0% 50.0% 0.0%
Energy & Environment % 5.0% 20.0% 1.0%
Machines/Tools % 4.5% 25.0% 0.5%
Automotive % 3.5% 15.0% 0.5%
Electrical & Electronics % 4.0% 15.0% 0.5%
Semiconductors % 3.0% 30.0% 0.0%
Computers & Office Equip % 4.0% 25.0% 0.2%
Software % 6.8% 70.0% 0.0%
Industry Summary % 4.80% 1,924

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

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

19. 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)

20. 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)

21. 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?

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

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

24. 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

25. Concluding Remarks

26. 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!

27. THANK YOU