PAYMENTS AND ROYALTY RATES February 2008 Christi Mitchell, IP Director, Highbury Ltd

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PAYMENTS AND ROYALTY RATES

February 2008

Christi Mitchell, IP Director, Highbury Ltd

christi@highburyltd.com 2

Christi MitchellIP Director

• Human Genetics, Molecular Biology, Marketing and Business Degrees

• Past President Licensing Executive Society (LES) Britain &Ireland; current Board Director

• International Chairman, Life Sciences LESI• International licensing experience over 25 years• International Biotechnology and Healthcare start

up and university spin-out company experience • Venture Capital experience

VALUATION

• KNOWLEDGE BASED INDUSTRY – CENTRAL TO THE UK ECONOMY

– Innovative ideas leading to IP rights and wealth creation:

• Improved products

• New brands

• Creative expressions

This process is being increased by the erosion of Global trade barriers

Outline.

Valuing technology

Some valuation methods

Key financial terms

–royalties

Market due diligence

• Establishing the market potential– potential for viable revenue streams,

– cost of independent development

– costs of commercialization

– impact of previous attempts to commercialize

• Market sector review including macro factors and market trends – consumer awareness

– government constraints

Build Financial Model

• Forecast market size and growth• Forecast sales – value & volume• Forecast market share (competitor due diligence)• Review price structures across all territories• Review take to market costs, including:

– sales & marketing– IP implementation– Further R&D– Regulatory requirements & hurdles

• Review distribution chain – risks & costs

Other Due Diligence

• Due Diligence leads to Financial Data– IP due diligence

– Product due diligence• Forecasts, markets, timeframes, need, take to market route

– Partnering costs (legal, other support, time factors, deal implementation)

– Corporate due diligence• Stability, margins, ethics, reputation

Organisation/inventor with

Protecting theinvention

Planningcommercialisation

Implementation

Manage andenhance the

inventionprotection

Developbusinessstrategy

Developcommercialisation

strategy

Undertake duediligence and

market research

Identify suitablepartners

Manage dealconstruction andimplementation

Project Process OverviewDiagram indicates how Highbury adds value to, and manages the

technology/Intellectual Asset commercialisation lifecycle; from idea through to deal implementation.

Financial assessment

• valuation of products / technologies

• simple financial models

• risk assessment

• financial impact of different deal structures

• royalties

Some valuation methods

• REMEMBER: Agreement on IP valuation is the most difficult hurdle in the negotiation.– Seller focuses on reward

– Buyer focuses on the risk

• Generally made up of lump sum plus royalty ( lump sum/milestone payment scheduling varies across the world)

Valuation Insecurity

• Value depends on

1. Ability of licensee to successfully implement it as a process or product

2. Dependant on a specific market that may be seen differently by the 2 parties

3. The ability to prevent infringement

4. Ability to access licensors know how

Simple financial models

Valuation methods are based on:

–for early technology

Potential income

–when application is evident

Market data

– when the technology is developed

Cash Flow Analysis

• what will the investment cost?

• how much cash will it generate each year?

• To calculate Cash Flow:– Define the value of the investment

– Calculate the size of the benefits

– Determine the timing of the benefits

– Quantify the uncertainty of the benefits

– Do the benefits justify the investment ??• Remember – cash flow is not profit

Risk Adjusted Discount Rate

• This is an adjustment for the time value of money and the inherent risk

• Calculated risk : – Cost Of Capital + a fudge factor = The Hurdle rate – used to discount future cash flows back to today.

• The result of summing the Discounted current and future cash flows = The Net Present Value (NPV)

• +ve NPV = likely good investment (it adds value to the company)

Risk assessment/sensitivity

analysisMethods to assess risk:• Add risk factor to discount rate or create ‘hurdle’

rate e.g.20%• Determine sensitivity of model to various

unknowns by calculating different scenarios, e.g. - lower price or market share - development costs are higher - development takes longer - cost of goods are higher than forecast

Other valuation methods

• DCF (Discounted Cash Flow)– Problem,“The future cash flows of raw technology are

uncertain”

• Monte Carlo– A mean estimate of cash flows, and statistically modelled

range of expected cash flows.– Produces an unbiased distribution of present values where the

mean can be taken. (objective method)

• Capital Asset Pricing Model (CAPM)– Adjust the “Hurdle Rate” based on the amount of “systemic

risk” = Risk Adjusted Discount Rate (RADR)– This allows degrees of risk to be incorporated

Key financial terms

• Equity investment– control

• Upfront payments– commitment

• Milestone payments– risk sharing

• Other payments– e.g. manufacturing facility, research, patent or clinical costs

• Royalties– profit sharing

Most important factors affecting Royalty Rates

o Strength of IP

o Market sector (expected norms)

o Degree of exclusivity (field of use restrictions)

o Licensor/Licensee characteristics

o Economic factors

o Phase of development

o Duration and scope of license

o Commitment to ongoing research

o Negotiating skills

o Degree of need

Generic IA Biotech Value Drivers

• Value Drivers– Market

• Reached peak?• Growth rate• Market share

– Cost• Operating• development

– Time• Patent life• Proof of concept

– Option• Strategic• operating

• Risk Drivers– Internal risk

• Strategic fit or dilution

– Substance risk• Safety

• Efficacy

• availability

– Competitor risk• In class

• Out of class

– Commercial risk• Image

• Economics

Royalty rates: Industry Norms

• What are they?

• What don’t they tell us?

• Are they useful?

• How can we use them?

Royalty rates: Industry Norms Franklin Pierce Law Centre

Industry Royalty Norm

Chemical 1-5%

Computers 3-5%

Consumer Products 2%

Electronics <1-5%

Pharmaceuticals 4-15%

Industry NormsWhat don’t they tell us?

• the range of royalty values• the stage of development• to what the royalty rate relates• what other financial components exist

– Down payments– Milestone payments– Equity etc.

• any other aspects of the deal– Exclusivity – Timing of payments etc.

Financial negotiation

• market estimates – establish a baseline

– share market data

– agree top line figures

• openly discuss key assumptions

• identify corporate drivers– fixed hurdles - NPV / IRR

– turnover of £ X m

Risk verses Reward

• Licensee prefers royalty– Allows them to limit the consequence of uncertainty

• Licensor prefers (dp) downpayment– Quicker rate of return

– Will not share licensees implementation risk

– Avoids royalty mismanagement by licensee

– Requires less enforcement/monitoring than royalty

– Dp raises negotiation cost (requires greater due diligence to get the price right)

Timing

• early payments– carry high risk to the licensee

– have high impact on NPV

• late stage payments– are paid on specific target achievements

– carry lower impact on NPV

Agreement provisions

• clear payment terms – timing and delivery

– currency exchange provisions

– late payment

– CIF/FOB

• manufacturing / QC

• royalty audit provisions

Conclusions

• Relating risk to reward is difficult

• There are many valuation methods

• IP values are not static

• Industry norms only tell part of the story

• Patents lapse, value may not hold into perpetuity

• Use a mix of valuation methods

Contact

• Christi Mitchell: – Intellectual Property Director

• Direct Tel: +44(0)1462436894• christi@highburyltd.com

• Elizabeth McNabb:– International Business Development Director

• Direct Tel: +44(0)20835556989• elizabeth@highburyltd.com

• Anne Wight:– Business Development Director Highbury Pacific

• Direct Tel: +64(0) 21432424 • anne@highburyltd.com

PAYMENTS AND ROYALTY RATES February 2008 Christi Mitchell, IP Director, Highbury Ltd

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