2. 1 Intellectual Property Valuation and Finance

3. 2 ON 12/31/99, INVESTORS SAID P&G WAS WORTH $ 151.6 BILLION P&G’s FINANCIAL STATEMENTS SAID IT WAS WORTH $ 32.1 BILLION WHO WAS RIGHT ??

4. 3 ON 12/31/99, INVESTORS SAID P&G WAS WORTH $ 151.6 BILLION WHAT HAPPENED TO $ 57.4 BILLION ?? FIVE MONTHS LATER, INVESTORS SAID P&G WAS WORTH $ 94.2 BILLION

5. 4 Course Overview Why Valuations are Necessary Importance of IP Assets Accounting Principles Valuation Theory & Practice Tax, Litigation & Finance Working with a Valuation Expert Case Studies

6. 5 Why Valuations are Made Transaction Support Litigation Support Regulatory Requirements Accounting Requirements Taxes - Federal, State Income - Estate - Gift - ad valorem Financial

7. 6 …from “Bricks and Mortar” to IP

8. 7 INTANGIBLE ASSETS Rights Relationships Intellectual Property Undefined Intangibles

9. 8 Rights Leases Distribution Agreements Employment Contracts, Covenants Financing Arrangements Supply Contracts Licenses, Certifications Franchises

10. 9 Relationships Trained and Assembled Workforce Customer Relationships Distribution Relationships

11. 10 Intellectual Property Proprietary Technology Trade Secrets Know-how Patents Copyrights Trademarks Right of Publicity

12. 11 Proprietary Technology Formulas, Recipes, Specifications Management, Accounting, Mfg. Procedures Formations, Plays, Training programs Marketing Strategies Artistic Techniques Customer Lists, Routes, Demographic Studies Job Files, Product test results Business Knowledge - Suppliers, Lead times, Cost and pricing data

13. 12 Undefined Intangibles Goodwill Elements of a Going Concern (“going concern value”)

14. 13 The Business Enterprise and the Assets That Comprise It

15. 14 Business Enterprise BUSINESS ENTERPRISE VALUE OF EQUITY VALUE OF LONG-TERM DEBT MONETARY ASSETS TANGIBLE ASSETS INTANGIBLE ASSETS ==

16. 15 ELEMENTS OF THE BUSINESS ENTERPRISE (monetary assets) MONETARY ASSETS Cash, Inventories, Work in Process, Finished Goods, Accounts Receivable LESS: Accounts Payable and other Current Liabilities “Net Working Capital”

17. 16 ELEMENTS OF THE BUSINESS ENTERPRISE TANGIBLE ASSETS Land, Land Improvements, Buildings Machinery and Equipment, Vehicles “Plant, Property and Equipment”

18. 17 INTANGIBLE ASSETS Computer Software, Assembled Workforce, Favorable Contracts, Customer Relationships, Intellectual Property “Goodwill or (ugh!) Going Concern Value” ELEMENTS OF THE BUSINESS ENTERPRISE

19. 18 BUSINESS ENTERPRISE is a PORTFOLIO T - BILLS MONEY MARKET CORPORATE BONDS EQUITIES LOTTERY TICKETS =

20. 19 BUSINESS ASSET CHARACTERISTICS MONETARY TANGIBLE INTANGIBLE RETURN REQUIREMENT FINANCING INVESTMENT QUALITIES 8 - 10 % 10 - 15 % 15 - 40 % DEBT EQUITY LIQUID NON-LIQUID VERSATILE NARROW MARKET VALUE IN USE VALUE IN LIQUIDATION CASH RECEIVABLES INVENTORY GENERAL PURPOSE SPECIAL PURPOSE

21. 20 RELATIONSHIP OF EARNINGS AND VALUE EARNINGS VALUE SCRAP VALUE OF TANGIBLE ASSETS FORCED LIQUIDATION VALUE ORDERLY LIQUIDATION VALUE VALUE IN CONTINUED USE REPLACEMENT COST BUSINESS ENTERPRISE VALUE GOODWILL INTANGIBLES TANGIBLES 0 0 (-)

22. 21 Balance Sheet View of the Business Enterprise Current Assets Plant, Property and Equipment Other Assets Intangible Assets and Intellectual Property Current Liabilities Long-Term Debt Stockholder’s Equity

23. 22 Value of the Business Enterprise C.A. less C.L. Plant, Property and Equipment Other Assets Intangible Assets and Intellectual Property Long-Term Debt Stockholder’s Equity VALUE OF:

24. 23 Basic Accounting Concepts

25. 24 GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (“GAAP”) FASB - Financial Accounting Standards Board SFAS - Statement of Financial Accounting Standards APB - Accounting Principles Board APB 99 - Opinions of APB AICPA - American Institute of CPA’s SAP - Statements of Position GAP - Gordon’s Accounting Principles

26. 25 PUBLIC vs. PRIVATE PUBLIC PRIVATE IRS SEC STOCKHOLDERS IRS STOCKHOLDER

27. 26 AUDITED FINANCIAL STATEMENTS “These financial statements are the res- ponsibility of the Company’s management.” “Our responsibility is to express an opinion on these financial statements based on our audit.” “In our opinion, the financial statements… present fairly, in all material respects…the financial position of …in conformity with G.A.A.P.”

28. 27 Business Transactions BUSINESS ENTERPRISE Employees Suppliers Lenders Investors Government Customers

29. 28 Balance Sheet Current Assets Plant, Property and Equipment Other Assets Current Liabilities Long-Term Debt Stockholder’s Equity ASSETS - what we own LIABILITIES - how we financed what we own

30. 29

31. 30 Net Working Capital = Monetary Assets +-=+-=

32. 31

33. 32

34. 33 Flow of Funds CURRENT LIABILITIES LONG-TERM DEBT STOCKHOLDER EQUITY REVENUE COST OF GOODS EXPENSES TAXES PROFIT CURRENT ASSETS PLANT, PROP. & EQUIP. OTHER ASSETS

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38. 37 Basic Valuation Principles

39. 38 PREMISE OF VALUE Cost of Reproduction Cost of Replacement Book Value Tax Basis Fair Market Value Market Value, Fair Value, Exchange Value Orderly / Forced Liquidation Value, Investment Value

40. 39 PREMISE OF VALUE “The amount at which a property would exchange between a willing buyer and seller, neither under compulsion, each having knowledge of the facts, and with equity to both.” or “The present value of the future economic benefits of ownership.” FAIR MARKET VALUE

41. 40 PREMISE OF VALUE “The amount at which a property would exchange between a willing buyer and seller, neither under compulsion, each having knowledge of the facts, and with equity to both.” or “The present value of the future economic benefits of ownership.” FAIR MARKET VALUE

42. 41 VALUING A BUSINESS THE BUSINESS ENTERPRISE (PORTFOLIO) THE UNDERLYING ASSETS (AS ELEMENTS OF PORTFOLIO) THE UNDERLYING ASSETS (FOR ALTERNATE USE)

43. 42 VALUATION METHODS Cost Approach Market Approach Income approach

44. 43 COST APPROACH Cost of Reproduction or Cost of Replacement Less: Physical Depreciation Less: Functional Obsolescence Equals: Replacement Cost Less Depreciation Less: Economic Obsolescence Equals: FAIR MARKET VALUE

45. 44 MARKET APPROACH Comparable Property At Arm’s Length Contemporaneous to Appraisal In an Active, Public Market Analyze evidence of transactions of:

46. 45 INCOME APPROACH

47. 46 PRESENT VALUE (direct cap) DIRECT CAPITALIZATION Used when we are to receive an unchanging amount in each period into perpetuity PV = AMOUNT ($) RATE (%)

48. 47 PRESENT VALUE (direct cap with growth) DIRECT CAPITALIZATION with GROWTH Used when we are to receive a constantly growing amount each year into perpetuity PV = AMOUNT x (1 + Growth Rate) (Rate - Growth Rate)

49. 48 PRESENT VALUE (discounting) DISCOUNTING Used when we are to receive varying amounts in each period for a finite number of periods. PV = AMOUNT 1 AMOUNT 2 AMOUNT 3 (1 + Rate) (1 + Rate)^2 (1 + Rate)^3 +++ ….

50. 49 PRESENT VALUE of $ 300,000 @ 4% $288,000 $277,000 $246,000 $201,000 @ 15% 258,000 223,000 142,000 68,000 @ 25% 234,000 183,000 87,000 25,000 1 YEAR 2 YEARS 5 YEARS 10 YEARS To be received in:

51. 50 INCOME APPROACH (NPV = PV future benefits..) = NET PRESENT VALUE “The present value of the future economic benefits of ownership.”

52. 51 QUANTIFYING THE ECONOMIC ADVANTAGE Enables the use of lower cost materials Enables the use of less material Reduces the amount of labor Increases speed of production Improves quality / Reduces defects Eliminates or reduces environmental and/or safety hazards Results in premium pricing Provides economies of scale Provides purchasing power Relieves the owner of the cost to create

53. 52 INCOME RISK WILL WE RECEIVE IT ? WILL WE RECEIVE IT IN THE EXPECTED AMOUNT ? WILL WE RECEIVE IT WHEN EXPECTED ? MUST WE INVEST TO GET IT ? MUST WE INVEST IN “BIG LUMPS” ? HOW LONG MUST WE WAIT FOR INCOME TO START ?

54. 53 RATES OF RETURN 5.90- 6.7% - CD’s, Treasury Bills 6.05% - 30-year Treasury bonds 8.00% - 30-year mortgage commitments 8.00-10.00% - Corporate bonds 9.50% - Prime rate 9.00-15.00% - High-yield bonds 10.05-11.05% - Large company equities (Treasury plus 4-5%) 12.05-15.05% - Small company equities (plus 6-8%) 20% - 2nd or 3rd stage venture capital 40% - Venture capital, early commercialization 50% - Venture capital, early stage

55. 54 INCOME DURATION (economic life vs. legal…) ECONOMIC LIFE = MAY OR MAY NOT BE = the period during which it is profitable to use an asset Legal Life Physical Life Technological Life Depreciable Life

56. 55 TRANSFER OF VALUE BETWEEN FORMS OF INTELLECTUAL PROPERTY

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60. 59 Figure 8.6 Disaggregating the Business Enterprise

61. 60 Figure 8.7 Disaggregating the Business Segment

62. 61 Figure 8.8 Disaggregating the Product Line Product 1

63. 62 FIGURE 3.4 TOTAL EARNINGS TeTe MONETARY ASSETS TANGIBLE ASSETS INTANGIBLE ASSETS ++ DEBT CAPITAL EQUITY CAPITAL BUSINESS ENTERPRISE PORTFOLIO MeMe TeTe IeIe

64. 63 TOTAL EARNINGS TeTe IeIe EARNINGS ATTRIBUTABLE TO INTANGIBLE ASSETS IDENTIFIED INTANGIBLES INTELLECTUAL PROPERTY TRADEMARKS PATENTED TECHNOLOGIES COPYRIGHTS SPECIFIC TECHNOLOGY IA e IP e PT e ST e FIGURE 3.5

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68. QUANTITATIVE QUALITATIVE REVIEW FINANCIALS Disaggregate to Products Trademarked Product Financials Analyze Feasability Studies Analyze Business Plans Review Projections Develop Cash Flow Forecasts Correlate Returns by Asset Class Correlate Asset Values and Business Enterprise Value CONCLUDE TRADEMARK VALUES CONCLUDE ROYALTY RATES Market Royalty Rate Investigation Analyze Monetary Assets Analyze Tangible Assets Analyze Other Intangible Assets Conclude Preliminary Asset Values Investment Rate of Return Analysis BUSINESS ENTERPRISE VALUATION Comparable Company Analysis Industry Data General Economic Conditions Analyze Marketing Data Analyze Market Research Data Independent Market Research DATA GATHERING INTERVIEWS WITH MANAGEMENT TRADEMARK VALUATION AND ROYALTY RATE DEVELOPMENT Research Comparable Transactions

69. 68 DISCOUNTED CASH FLOW

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77. 76 ROYALTIES THE BURNING QUESTION

78. 77 THE LICENSING TRANSACTION LICENSOR LICENSEE ROYALTY

79. 78 THE LICENSING TRANSACTION LICENSOR LICENSEE ROYALTY LICENSOR INCOME LICENSEE INCOME A B C

80. 79 THE LICENSING TRANSACTION LICENSOR LICENSEE ROYALTY LICENSEE INCOME

81. 80 THE LICENSING TRANSACTION IS CONTROLLED BY THE ECONOMICS OF THE LICENSEE’S BUSINESS

82. 81 COST APPROACH ROYALTY What did it cost to develop the IP ? Set a royalty that will recoup the cost. NO !!

83. 82 MARKET APPROACH ROYALTY MAYBE !! What royalties have others paid or received ? What is the “industry standard” ?

84. 83 INCOME APPROACH ROYALTY What is the economic benefit to the licensee ? What is our proper share ? YES !!

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89. 88 UNIFORM STANDARDS of PROFESSIONAL APPRAISAL PRACTICE (“USPAP”) Ethical Standards Minimum Work Standards Client Relationships Minimum Reporting Standards

90. 89 VALUATION ENGAGEMENT Client Arrangements Investigation / Data Gathering Analysis Report Writing

91. 90 EXPLOITATION KEEP IT ? SELL IT ? LICENSE IT ? ENHANCE IT ?

92. 91 EVALUATING EXPLOITATIONS Commercialize Enhance Sell License out License in comp. Joint venture