Page 1 Boris J. Steffen, CPA, ASA, ABV, CDBV Principal & Director Intellectual Property Valuation & Damages Analysis
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Boris J. Steffen, CPA, ASA, ABV, CDBVPrincipal & Director
Intellectual Property Valuation & Damages Analysis
Overview
» Intellectual property characteristics
» Reasons to value intellectual property
» Valuation considerations
» Methods of valuing intellectual property
» Theory of patent damages
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» Theory of patent damages
» Analysis of intellectual property damages
» Valuation case study
» Expert profile
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Intellectual Property Characteristics
Intellectual property is a unique class of intangible asset different from other intangibles in how it is created, developed and protected
» Intangible assets are economic resources, often created in the normal course of
business, that lack physical presence, but have value due to the rights, benefits,
and privileges they convey to their owner
› Brand names
› Customer lists
› Non-compete agreements
» Intellectual properties comprise a subset of intangible assets that are created» Intellectual properties comprise a subset of intangible assets that are created
consciously through the intellectual effort of specifically identifiable individuals, and
are registered and legally protected by federal and state statute
› Patents
› Copyrights
› Trademarks
› Trade secrets
› Know-how
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The value of intellectual property is a function of the property rights and economic benefits associated with its existence
» Property rights associated with intellectual property include it being subject to
› Private ownership and legal transfer
› Specific identification and description
› Legal existence and protection
› Tangible manifestation
› Coming into, and going out of, existence at a specific time or due to a specific event
» Economic benefits associated with intellectual property ownership, and that » Economic benefits associated with intellectual property ownership, and that are required to quantify value, include:
› Incremental income
› Decremental costs
› Contributory value enhancement
» Economic phenomena lacking these attributes may not qualify as discrete intellectual property or intangible assets
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Intellectual properties can be grouped by category and type based on similarities in development, use, features and legal protection
Marketing Technology Artistic works
Data processing Engineering
Creative • Trademarks
• Trade names
• Service Marks
• Literary
• Musical
• Dramatic
• Artistic
• Computer software
• Integrated circuit masks and masters
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• Logos• Artistic
• Film• Proprietary
databases
Innovative • Product patents
• Process patents
• Patent applications
• Trade secrets
• Designs
• Drawings
• Blueprints
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Reasons to Value Intellectual Property
The demand for intellectual property valuation is driven by a variety of legal, financial, regulatory and commercial needs
Category
LitigationDamages for infringement, breach of contract, business interruption, fraud, property settlements
Accounting, and financing transactions
Enterprise purchase price allocation, IP purchase, collateral value, reorganization, licensing, alliances, SFAS 141 and 142
Reason
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transactions alliances, SFAS 141 and 142
Corporate planningResource allocation, evaluation of returns, management strategy, development, protection, commercialization, monetization
TaxesTransfer pricing, transfer of IP to investment holding company, estate/gift tax, ad valorem property tax
Under ASC 350, acquired intellectual property must be recognized based on fair value separately from goodwill and amortized over its useful life
» Recognizable intangibles are assets that lack physical presence, have a finite life, and
› Have an underlying contractual or legal basis, or
› Can be separately sold, transferred, licensed, rented, or exchanged
» Recognizable intangibles with finite useful lives are accounted for based on fair value, amortized, and tested annually for impairmentvalue, amortized, and tested annually for impairment
» Recognizable intangibles are amortized over their useful lives, no longer limited to 40 years, but subject to any residual value
» Identifiable intangibles with indefinite lives (trademarks and brand names) are not amortized, but must be tested for impairment
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Valuation Considerations
The value of intellectual property will vary based on the standard of value
applied
» Fair market—the value at which a buyer and seller would transact, neither being compelled to do so and both having reasonable knowledge of relevant facts
» Fair—the value to fairly compensate an owner for being involuntarily deprived of the economic benefits of an asset for which there is neither a willing buyer nor seller
» Investment—the value to an individual investor based on investment expectations and requirements
» Acquisition—the price a specific buyer would pay based on the unique benefits to » Acquisition—the price a specific buyer would pay based on the unique benefits to that buyer
» Use—the value of an asset given a specific, defined use
» Owner—the value given the current owner’s field of use application and ability to develop the asset commercially
» Insurable—the amount required to replace an asset with one of comparable utility, function, and income-generating ability
» Collateral—the amount a creditor would loan with the asset serving as collateral
» Ad valorem—the value of an asset for property tax purposes under jurisdictional statutory standards
The value of intellectual property will vary based on the assumptions underlying the premise of value employed
Valuation purpose
�Why performed
� Intended use
�Audience
Highest and best use
•Consistent with applicable laws and regulations
•Physically, functionally,
Valuation objective
•Deal pricing and structure
•Financing
•Tax planning
Premise of value
•Continued use as part of going concern
•In place, but not in current usefunctionally,
technologically possible
•Financially viable
•Results in the highest value
•Tax planning
•Strategic planning
•Reorganization
•Litigation
in current use
•In exchange in an orderly disposition
•In exchange in a forced liquidation
Intellectual property incorporates legal rights that are distinct, separable, transferable, and of varying economic value
Interest Summary terms
Fee simple Total and absolute ownership of all legal rights
Life or estate Rights to ownership of IP for the life of the owner, or the rights to income from IP for the life of the tenant
Term Ownership rights to IP for a specified term or number of years
License/franchise Rights retained by the licenser/franchiser, or granted to the License/franchise Rights retained by the licenser/franchiser, or granted to the licensee/franchisee, for specific term, use, market area, etc.
Reversionary Rights to future ownership of IP owned by another party
Development Rights to develop and commercialize subject IP for transferee benefit
Exploitation Rights to make use of subject IP (natural resources, mining, forest)
Use Rights to derive some manner of benefit from the use of an IP (often related to specific areas, industries, products and/or services)
As the value of intellectual property changes over time, valuations should be qualified “as of”, and relied on only for, a specified date
•The appropriate valuation date is often tied to the intended use of the valuation
Historical Contemporaneous Prospective
•Prior to date of valuation
•At date of valuation •At a date subsequent to valuation
•Requires disclosure
•The appropriate valuation date is often tied to the intended use of the valuation
� Decision making
� Information
•May be a function of statutory or regulatory ruling
� Date of asset transfer, merger, lien, reorganization
•Should be agreed to by analyst and user, together with valuation purpose and objective
The value of intellectual property is in part a function of the time period over which it is expected to contribute to future cash flows
Maintenance
Expected useExpected useful life of related assets
The useful Maintenance expenditures required to obtain future cash flows
Legal limitations
Regulation
Obsolescence, competition, demand, technology
The useful life of an asset is a function
of
The risk inherent to an intellectual property is measured by the cost of capital used to discount economic income generated by the asset
» The cost of capital is the expected rate of return required to compensate for the time value of money (real rate of return plus inflation) and risk of an investment
» Several options are available for estimation purposes
› Buildup, CAPM, MCAPM, WACC, P/E, VC
» In practice, the appropriate cost of capital depends on whether the IP will be valued as part of a going concern or on a standalone basis
› Under going concern assumption, rate is a function of business enterprise› Under going concern assumption, rate is a function of business enterprise
‒ Results in estimate of value in continued use as an integral component of going concern entity
› With stand-alone basis, rate is tied to risks of specific asset
‒ Results in higher rate than going-concern assumption and value of IP as independent asset
» Ultimately, the choice between capitalization scenarios will rest on the
› Valuation objective
› Highest and best use of the IP
› Actual use of the IP
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Methods of Valuing Intellectual Property
The Uniform Standards of Professional Appraisal Practice recognizes three basic approaches to valuation
IP valuationmethodologies
IP valuationmethodologies
IncomeIncome MarketMarket CostCost
Value is equal to the present value of future
Value is inferred from comparable asset
Value is equal to accumulated costspresent value of future
economic benefits
— Discounted cash flow
— Direct capitalization
— Relief from royalty
— Profit split
— Excess earnings
— Loss of income
comparable asset market transactions
— Comparable asset sales
— Relief from royalty
accumulated costs
— Reproduction
— Replacement
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Theory of Patent Damages
The owner of a patent may recover damages equal to lost profits attributable to infringement, but never less than a reasonable royalty
» Lost, “but-for” profits damages are equal to the difference between expected and actual profits absent the infringement› Assumes infringer not licensed to use patent
› Requires showing of causation per the reasonable probability standard of Panduit‒ Existence of demand
‒ Absence of acceptable non-infringing substitutes
‒ Manufacturing and marketing capacity
‒ Supportable estimate of lost profits‒ Supportable estimate of lost profits
» Reasonable royalty damages are equal to the amount that would have been paid by the infringer in an arms-length transaction for the right to use the patent› Assumes infringer licensed to use patent
› Sufficient to show infringing sales actually occurred
› Reasonable royalty based on hypothetical licensing agreement approach and Georgia-Pacific factor analysis
» Statute and case law permit damages of lost profits and reasonable royalties combined along with prejudgment interest; also trebling and attorney’s fees
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Analysis of Intellectual Property Damages
Intellectual property damages can be valued by the “before and after,” “but-for,” and “actual/opportunity cost” techniques
» Under these methods, damages are assessed as the: › Decrease in IP or enterprise value, or
› Value of the damaging event
» Each method can be applied across a variety of situations› Fraud, infringement, lender liability, breach of contract, business interruption, etc.,
» Further, damages under each method can be measured by changes in › Unit volume, price, revenue, market share
› Costs of production, operations, and research and development
› Capital investment and financing costs
» Conceptually and in execution, each method is analogous to one of the three approaches to valuing intellectual property› Before and after » market approach
› But-for » income approach
› Actual/opportunity cost » cost approach
Comparison of intellectual property damages method calculations
Actual/opportunity costBut-forBefore and after
Value of IP/Enterprise before start of damage period
Less:
Restated past cost of developing IP
Plus:
Restated past opportunity cost of not
Value of past but-forincome from start of damage period
Plus:Less:
Value of IP/Enterprise after end of damage period
Equals:
IP/Enterprise value diminution
opportunity cost of not developing IP
Plus:
Future opportunity cost of not commercializing IP
Equals:
Value of damages
Plus:
Value of future but-forincome to end of damage period
Equals:
Value of lost profits
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Valuation Case Study
Acquisition of technology use rights
» Situation
› A large international conglomerate acquired rights, formerly licensed, to technology developed in Europe and Asia together with a joint-venture partner
» Considerations
› Purpose and objective—to value acquired assets for financial and tax reporting purposes
› Premise and standard of value—fair market value in continued use and as part of a › Premise and standard of value—fair market value in continued use and as part of a going concern
› Highest and best use—continued use as part of going concern yielded highest valuation
› Rights subject to appraisal—ownership and use rights to background and foreground technology used in developing and manufacturing products
› Useful life—equal to amortization period
› Cost of capital—WACC based on premise and contributory nature of IP
› Valuation date—beginning of calendar year to conform with fiscal period
Acquisition of technology use rights(cont)
» Valuation
› Relief from royalty—qualifies as both income and market approach‒ Historical royalty rates for licenses for the subject IP
◦ Comparability established
◦ Clear “but-for” standard
‒ Arms-length royalty rates from licenses of comparable IPR‒ Arms-length royalty rates from licenses of comparable IPR
◦ Based on analysis of ownership rights, financing, industry, geographic market, transaction duration, terms, and secondary market conditions
› Reproduction cost‒ Current costs of research, development, and design services required to exactly duplicate IP
› Avoided cost‒ Research, development, and design services costs not incurred due to the benefits of
ownership
Relief from royalty valuation
2003 2004 2005 2006 2010
Revenues (2)
811,720$ 893,250$ 888,000$ 1,036,800$ 1,130,220$
Growth From Prior Year 16.8% 10.0% -0.6% 16.8% 0.0%
Royalty Rate (3)
4.0% 4.0% 4.0% 4.0% 4.0%
Gross Royalty Savings 32,469 35,730 35,520 41,472 45,209
Less:
Amortization 7,398 7,398 7,398 7,398 7,398
Maintenance expense 16,300 16,300 16,300 16,300 16,300
Net Royalty Savings 8,771 12,032 11,822 17,774 21,511
Taxes (3,184) (4,368) (4,291) (6,452) (7,808)
As of January 1, 2003
In-The-Money CorporationIP Technology
Relief from Royalty Method (U .S.$000s) (1)
Taxes (3,184) (4,368) (4,291) (6,452) (7,808)
After-Tax Royalty Savings 5,587 7,664 7,531 11,322 13,702
Plus:
Amortization 7,398 7,398 7,398 7,398 7,398
After-Tax Cash Flow 12,985 15,062 14,929 18,720 21,100
Time Factor 0.5 1.5 2.5 3.5 7.5
Present Value Factor 0.9678 0.9064 0.8489 0.7951 0.6118
Present Value of Royalty Savings 12,567$ 13,653$ 12,673$ 14,884$ 12,910$
Cumulative Present Value of Royalty Savings @ 1/01/03 110,970$
Value (Rounded) 111,000$
Sensitivity analysis based on varying gross royalty rates:
Assumptions: Royalty Rate Value
2.00% 18,000$
6.77% 3.00% 64,000$
4.00% 4.00% 111,000$
Tax Rate 36.30% 5.00% 158,000$
Years amortized 15 6.00% 204,000$
Weighted Average Cost of Capital
Royalty Rate
Avoidable cost valuation
2003 2004 2005 2006 2010
E ng in e U n its 140 ,000 1 50 ,000 1 50 ,000 1 80 ,000 1 80 ,000
P rice R edu c tion fo r IP R T ran sac tion 79$ 7 9$ 7 9$ 7 9$ 7 9$
P rice R edu c tion fo r O ngo in g E ng in ee rin g 116 .43 1 08 .67 1 08 .67 9 0 .5 6 9 0 .5 6
B en e fit F rom P rice R edu c tion 27 ,325 .00 2 8 ,1 12 .50 2 8 ,1 12 .50 3 0 ,4 75 .00 3 0 ,4 75 .00
O ngo in g E ng in ee rin g E xp en se (1 6 ,300 .00 ) (1 6 ,3 00 .00 ) (1 6 ,3 00 .00 ) (1 6 ,3 00 .00 ) (1 6 ,3 00 .00 )
T o ta l o f A vo id ed C o st 11 ,025 .00 1 1 ,8 12 .50 1 1 ,8 12 .50 1 4 ,1 75 .00 1 4 ,1 75 .00
L ess :
Am o rtiza tio n 4 ,066 .67 4 ,0 66 .67 4 ,0 66 .67 4 ,0 66 .67 4 ,0 66 .67
N et A vo id ed C o st 6 ,958 .33 7 ,7 45 .83 7 ,7 45 .83 1 0 ,1 08 .33 1 0 ,1 08 .33
A s o f Janu a ry 1 , 2 003
In -T he -M oney C o rp o ra tion
IPT echno log y
A vo id ed P u rch as in g C o s t V a lu a tion (U .S . $ 000 s )
N et A vo id ed C o st 6 ,958 .33 7 ,7 45 .83 7 ,7 45 .83 1 0 ,1 08 .33 1 0 ,1 08 .33
T axes (2 ,5 25 .88 ) (2 ,8 11 .74 ) (2 ,8 11 .74 ) (3 ,6 69 .33 ) (3 ,6 69 .33 )
A fte r-T ax C o s t S a v in g s 4 ,432 .46 4 ,9 34 .10 4 ,9 34 .10 6 ,4 39 .01 6 ,4 39 .01
P lu s :
Am o rtiz a tion 4 ,066 .67 4 ,0 66 .67 4 ,0 66 .67 4 ,0 66 .67 4 ,0 66 .67
A fte r-T ax C a sh F low 8 ,499$ 9 ,0 01$ 9 ,0 01$ 1 0 ,5 06$ 1 0 ,5 06$
T im e F ac to r 0 .5 1 .5 2 .5 3 .5 7 .5
P resen t V a lu e F ac to r 0 .9678 0 .9064 0 .8489 0 .7951 0 .6118
P resen t V a lu e o f A vo id ed L icen s in g C o st $8 ,225 $8 ,158 $7 ,641 $8 ,353 $6 ,428
C um u la tive P re sen t V a lu e o f A vo id ed L icen s in g C o st @ 1/ 01/ 03 $60 ,819
F a ir M ark e t V a lu e @ 1/ 01/ 03 $60 ,819
V a lu e (R ound ed ) $6 1 ,0 00
6 .77%
T ax R a te 36 .3%
Y ea rs am o rtiz ed 15
W e igh ted A ve rag e C o st o f C ap ita l
Reproduction cost valuation
($ million)
1996 1997 1998 1999 2000 2001 2002 Totals
IP Technology -$ -$ -$ -$ 63.1$ 5.2$ 24.6$ 92.9$
Current Cost Conversion Factor 100 = January 2003 0.9405 0.9560 0.9784 0.9849 0.9971 0.97936 0.96399
Historical Dollar Costs
IP Technology
Current Dollar Conversion Valuation
Factor 100 = January 2003 0.9405 0.9560 0.9784 0.9849 0.9971 0.97936 0.96399
1996 1997 1998 1999 2000 2001 2002 Totals
IP Technology -$ -$ -$ -$ 62.9$ 5.1$ 23.7$ 91.7$
Current Dollar Costs
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Expert profile
» Boris Steffen is an expert in financial and managerial accounting, corporate finance and valuation with significant multi-industry, multi-company and cross-border experience in operations, finance, strategy and litigation. As an advisor in financing, investment and restructuring transactions and claims, matters in which he has consulted or testified include antitrust and competition policy, bankruptcy, restructuring and solvency, contracts, intellectual property, international trade and arbitration, mergers and acquisitions, business valuation, pricing, costs and profitability, securities and taxes.
» As a corporate development executive and consultant, Mr. Steffen has advised in transactions and claims valued in excess of $100 billion. Sectors in which he has consulted include the aerospace,
Boris J. Steffen, CPA, ASA, ABV, CDBV(202) 538 – [email protected]
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claims valued in excess of $100 billion. Sectors in which he has consulted include the aerospace, automotive, beef processing, biotechnology, business services, cable network, chemical, consumer product, defense, document management, electronic imaging, financial services & banking, food & beverage, healthcare, independent power, information technology, insurance, internet, newspaper, magazine, pharmaceutical, oil & gas, printing, pumps & controls, retail, satellite, semiconductor, software, steel, telecom, tobacco and electric utility industries.
» Mr. Steffen has held positions in finance, public policy, corporate development and consulting with Inland Steel Industries, the FTC, Bureau of Competition, U.S. Generating, and LECG. He holds a Master of Management degree with specializations in accounting and finance from the Kellogg School of Management of Northwestern University, and a Bachelor of Science degree in Finance and Bachelor of Music degree in Applied Music from DePaul University. He is an Accredited Senior Appraiser, Certified Public Accountant, Accredited in Business Valuation, Certified Distressed Business Valuation Analyst, and member of the AICPA, ABA, ABI, Insol International, AIRA, ASA and American Finance Association.
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Boris J. Steffen, CPA, ASA, ABV, CDBVPrincipal & Director
Intellectual Property Valuation & Damages Analysis