1. 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, 28 th November 2014

2.  Introduction  Valuation methods  Concluding Remarks Summary

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

4. 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?

5. 5 Introduction Importance of valuing IP

6. 6 Introduction Importance of valuing IP  IP an asset / currency  IP an asset  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

7. 7 Introduction Fundamental Questions in Valuation

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

9. 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

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

11. 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

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

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

14. 14 IP Valuation Market Method 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 licenc es Median royalty rate Avg operating profits Royalty as a % of profit Automotive354.0%11.3%44.1% Chemicals723.6%12.0%25.0% Computers684.0%8.3%33.3% Consumer Goods905.0%18.4%27.1% Electronics1324.0%13.1%34.3% Energy & Environment865.0%9.2%38.1% Food322.8%14.2%15.8% Healthcare Products2804.8%18.5%21.6% Internet477.5%10.4%48.0% Machine/Tools844.5%9.6%35.0% Media & Entertainment198.0%-13.5%-66.7% Pharma & Biotech3285.1%25.8%17.4% Semiconductors783.2%31.9%7.8% Software1196.8%25.1%21.4% Telecom634.7%14.5%34.5% Total1533 18.8%26.6%

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

16. IndustryAverageMedianMaxMinCount 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 Royalty Rates for Different Industries RoyaltySource ® from Transaction Analysis

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

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

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

20.  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/ IP Valuation 25% Rule (cont…)

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

23. Discount rate 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) Discount rate Is a measure of risk

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.  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! Concluding Remarks

27. THANK YOU