Technology Valuation Methods

 Environment of TTO valuations
 The key to valuation
 Valuation approaches
› Rules of thumb
› Comparables
› ‘Scientific’ approaches

 Section 9 of IP Handbook
› http://www.iphandbook.org/handbook/ch09/
 Anything written by Richard Razgaitis

 Three examples of technologies:
› US 6,684,702 – Flow Duct Obstruction
› US 6,386,217 – Axillary Crutch
› US 6,048,850 – Method of Inhibiting
Prostaglandin Synthesis in a Human Host
 For each example:
› Patent abstract, diagrams, claims
 Each is a real TTO valuation issue

100.00

90.00

80.00

70.00

60.00

50.00

40.00

30.00

20.00

10.00

0.00

-10.00

McMaster University FY97 to FY06, Net
Revenues/Disclosure over Disclosures, Max revenue=100

 What happened to Pareto?
(80/20)
 More likely:
› Long Tail distribution (98/2)
 Valuation implications
› Do we make any money except
on a home run?
› Most valuations will be wrong
› A lot of money in thin lines
› But watch out for the expenses

 Process control
› Want to concentrate on big winners
 Help with subsequent negotiations
› Knowledge of the market
› Good valuations = Good deals
 Helps set targets
 Classic Definition of Valuation
› Between willing buyer and seller
› Having full possession of all relevant facts

Technology  Patents
Know-how
Expertise
Exclusivity  Yes / No
Confidentiality  Yes / No
Licence Back  Yes / No
What Plan?  Spin-off
Licence
Other

 Key to value: the Market
› The ‘value’ proposition
 Who decides to buy?
 e.g.: who decides on choice of a
specific drug for a condition?
 Q: For an example, what are our
relevant markets?
 Q: Are there other markets we should
consider?

 Before anyone can buy product, what
still needs to be done?
› Regulatory approvals
› System creation
 Q: for an example, which will require
approvals? Will approvals be
maintained?
 Q: what still needs to be done to
generate revenues?

 Very common belief that research $$
spent is the value
 Economics analysis
› Value of sunk costs?
› If there is no recovery on
research costs value is ZERO
 Costs can create a
real expectations
problem

 Start-up Companies
 Internal use
 Traditional licensing:
› Rules of thumb
› Comparables
› ‘Scientific’ or ‘B School’ approaches

 e.g.: VC invests $20M in seed capital in
company based on technology; subsequently
company generates $50M on an initial public
offering (IPO)
 What is value of technology?
 Analysis:
› What does university get out of the company?
› What do inventors get?
› Does university still share with inventors?
› Is there sponsored research coming in from
company?

 Depends on each individual negotiation
› Is there a double dip? (i.e. both shares and a
royalty)
› Only real determinant is post dilution
percentage left
 Some suggestion that technology value
may be as little as 1 or 2% pre-IPO

 Two types:
› Institution wants to sell a product
› Technology to be added to defensive portfolio
 Sales
› Isolated situations
 e.g.: Isotope sales;
Medical instruments
› What to do with sharing
formulae?
 How to calculate expenses

 Technology will be added to portfolio to
enable some other technology or to overcome
‘patent thicket’
 Good situation is ‘patent pooling’
› See: Parish and Jargosch, AUTM Journal 2003
› e.g. of MPEG pool
› Future of bio: Patenting to permit use; e.g. SARS
 Bad situation is where company wants to use it
defensively
› Q: Can university even do this type of deal?
› What is appropriate price?

 Rules of Thumb
› Usually based on specific industries
› May be confused with comparable rates
 Most used Rule of Thumb:
› The Razgaitis Rule aka The Rule of Quarters
 Need to be able to analyze what is the ‘incremental’
margin before G&A
 Rule suggests that ¼ of that increment should be
licensors
 In practice see anywhere from 10 to 50%
 Best suited to clear commercial products

Before After

Sales – $100 $200
CGS – $50 $70
Margin – $50 $130
G&A – $20 $20

Net profit $30 $110

Incremental Margin $80; therefore, royalty would
be $20 or 10% of Sale Price

 Q: of 3 examples, which is (are) suited to
‘Rule of Quarters’ analysis?
 How to price the royalty?
 The realities of the target industry
 More information on this: LES

 The 50% Rule:
› At point of product introduction, 50% of total
risk remains
› IF inventing org brings product to
introduction stage, entitled to 50% of profits
› Therefore, if commercializing org does part
of product introduction entitled to more than
50% of profits
 More a starting position for discussions

 Some industries have ‘standard’ rate
› Shrink-wrap software in 25 to 50% range
› Some types of pharmaceuticals
 What is the base?
› Stacking royalties problem
 How to get information on comparable
rates?
› Colleagues
› Subscriptions to Newsletters

 More similar deals is better
 But are the deals the same?
› Industry segments; Margins; Use of IP
› Licensing terms: exclusive; non; options
 Risk analysis
› What is usual risk profile of our technologies?
Compared to industrially-generated
technologies?
 Certainty analysis
› Similar to risk but one component separate:
certainty of measurement

 Different types of Risk
› Technology: can we develop the
technology as envisaged
› Market: will the market adopt the
technology
› IP issues: will our IP protection hold up
› Societal Norms: will our technology
continue to be accepted?

 Internet: Publicly-filed information like SEC
and SEDAR information
› www.sec.gov (look for EDGAR)
 Court and other public records
› http://pacer.psc.uscourts.gov/
 Specialty information
› www.10kwizard.com
› www.fda.gov
 Company’s own websites and competitors

 Leading Fed Ct decision
 Court established factors to consider in
establishing a ‘reasonable’ royalty
 15 Factors include:
› Existing royalty rates for licensor and licensee
› Exclusivity; territory; field of use
› Practice in licensing; relationship between
parties; potential related sales
› Duration and term of patent

1: Georgia-Pacific Corp. v. U.S. Plywood-Champion Papers, 318 F. Supp. 1116, (S.D.N.Y.
1970), modified, 446 F.2d 295 (2d Cir. 1971).

 Discounted Cash Flow (DCF) and
Net Present Value (NPV)
 Real options theory
 Auctions
 But first some arithmetic!

 What are assumptions that go into a DCF or
NPV calculation?
› Market size
› Percentage of market
› Product price
› Royalty Rate
› Discount (interest rate)
 How precise is any of these five
assumptions?
› The lowest of these is the most precision our
answer can have!

 Using probability distribution, which is
best estimate of discount (interest) rate?

σ = small

 Using probability distribution, which is
best estimate of discount (interest) rate?

σ = large

 How much is 2 ± 3 times 5 ± 5 ?
› -1 x 10 ( -10) to 5 x 10 (+50)
 More importantly, how much is:

times = ??

 More simply: is the result the fat or skinny
distribution?
› Answer: it is an even broader distribution

 If you’re lucky you have maybe 1 digit of
precision in your answer!
 The best you are likely to get in precision is
order of magnitude
› i.e. $106 vs. $107
 Any sensitivity analysis going to result in very
broad spread for the answer
 Put both of these conclusions together:
› Value for just about anything is going to be
somewhere between minus $106 and plus $108!

 Based on possible cash flows during life of
technology
› Usually patent life
 Likely distribution:

 Create Annual Cash Flows
› Market size
› Percentage of market
› Product price
› Royalty rate (or CGS)
 Then need to establish the appropriate
discount rate

 Relationship between rate of return and risk:

0

return

Company Ave Cost of Capital

Risk-free rate – T-bills + Inflation: ~7%

risk

 Need to know appropriate average cost of
capital
 Then add risk factors:
› Technology: can we develop the
technology
› Market: will the market adopt the
technology
› IP issues: will our IP protection hold up
› Societal Norms: will our technology continue
to be accepted?

 Superimpose NPV at, say, 15%

 Sensitivity Analysis at 7%, 15% and 30%

 Cumulation at 15%

 Note break-even point

 Discount rate is market driven
 AUTM TTM (Part X, Ch. 2)
› Low risk rates (known product): 15 to 20%
› New product, known manufacturing ability: 25% to
35%
› New product, new manufacturing, known business:
30% to 40%
› New business, product ready (no R&D): 40% to 50%
› New business, product needs R&D: 50% to 70% and
up
 Q: for three examples, what discount rate?

 Despite name not a ‘bet the bank’
strategy
 Uses probability distributions to create a
new probability distribution
 Hand calculation difficult
 Software implementations:
› Crystal Ball: www.crystalball.com
› @RISK: www.palisade.com

 Based on Black-Merton-Scholes options
analysis
 Best example is stock market options
 Why pay anything for an Oil future at $200
per barrel 12 months from now?

 Actual formula:

 Time sensitive
 Also depends on volatility
› Volatility related to risk
› Risk up  Volatility up  Option value up
 More information: Black-Scholes on
Wikipedia

 Theoretically, the best way to obtain the
highest value
 Depends on exposure to largest number of
potential buyers
 cf. success of eBay
 In patent field:
› Ocean Tomo – Summer 2009 IP Catalogue online
› Results from last auctions not like an Art Auction
 Will grow over time as bidders understand process
 Prediction: will become a larger force as
business understands IP better

 You have prospects for
sales efforts
› From brainstorming markets
› From comparables research
 You’re ready to negotiate
› You have ideas on:
 Field and Territory of Use
 Exclusivity or not
 Comparable rates
 etc. etc.

 Richard has spent $500,000 developing a
new way of arranging an electric steel-
making furnace which increases the
efficiency. R approaches UniSteel about
licensing the technology.
 UniSteel is interested and figures that they
will save about $100,000 per year in costs.
 What issues would you consider in valuing
the technology?

 M University has been asked by a new faculty hire, Professor Roe,
to take on the commercialization of a technology developed by
Professor Roe previously. The technology is currently 100% owned
by R Inc. which is, in turn, 100% owned by Prof. R and his wife. M is
being offered shares in R Inc. to take on the project.
 The technology is a new means of measuring someone’s blood
alcohol level by a skin testing device. A prototype has been
developed by R Inc. at a cost of $50,000. It is expected that it
might cost $2,000 per unit to build a production model. The
current number of units of breathalyzers sold in North America is
4,000 per year at a retail cost of $2,500. There are two major
competitors.
 What is an appropriate percentage of shares in R Inc. that M
Univ. should receive? What other information would you like to
receive? How would you obtain it?

 You have heard that patent law’s ‘first sale doctrine’
does not allow you to collect ongoing royalties from
a machine that you sell outright.
 You have invented a new patented machine for
conducting laser eye surgery. The machine has a
useful life of 10,000 operations which normally sell (by
the eye surgeon) for $900 per operation. The
machine costs you $175,000 to build and $40,000 per
year to maintain for the 10 years useful life of the
machine.
 Discuss an appropriate sales or licensing strategy
and pricing model to maximize your financial returns.

 Valuation is not an exact science!
 Valuation can be a good start in getting
information you will need at various
stages of process
 Remember the ‘long tail’!
 The answer is likely going to be between
-$105 and $108 !

Marcel D. Mongeon
+1 (905) 390 1818
marcel@mongeonconsulting.com

Technology Valuation Methods

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Technology Valuation Methods