TECHNOLOGY TRANSFER AND SUCCESSFUL TECHNOLOGY LICENSING (STL) FOR

R&D NETWORKS IN COLOMBIA

Bogota, April 27 to 30, 2009

Topic 7 : Key Terms in a Licensing Agreement (b) Cluster III: IP Valuation and Accounting

• Value: Total value of the licensed IP in context of the other key terms; and

• Form of payment: How the payments will be made.

• Value: Total value of the licensed IP in context of the other key terms; and

• Form of payment: How the payments will be made.

Cluster 3: Financial Terms in License Agreements

When is IP Valuation Used?

I. Litigation – Lost Profit

II. Strategies and Transactions – Benefit and Risk

• Merger and Acquisition

• IP Audit

• Funding

• Financial Reporting

• Investment Transactions

• IP Commercialization/Licensing

When is IP Valuation Used in Technology Transfer Process ?

UNIVERSITY AND R&D INSTITUTION

Development Commercialization

INDUSTRY

R&D Protection

GOVERNMENTFUNDING / COLLABORATION

Valuation

ValuationValuation

Valuation

Valuation

« Background  » CommercializationP P

1 10 30 50

When is IP Valuation Used ?

When we are decidingat which stage of development the research result should be commercialized? Be aware – the benefit and the risk will be different for the same asset.

DevelopmentResearch Result

When is IP Valuation Used?

• Sell or License?• What is the Right Price?• Royalty Rate?

• In context of other key terms» Subject of the license» Scope of the rights granted» Exclusive – Non Exclusive» Territory» Time» Other financial arrangements

What is IP Valuation?

• Benefit

• Risk

Valuation: The process of identifying and measuring financial benefit and risk from an asset.

How does IP Valuation Work?How does IP Valuation Work?

The Three Classic Methods• Income

– value over time discounted for• risk• time value of money

• Market comparables• Cost to recreate

The Income Method

• Projection of the future net income (“net cash flow”) that the IP asset can be expected to generate over a certain period of time (usually the economic lifetime of the asset), taking into account the time, value of the money and the risk that the income will not be realized.

• Objective - determination of the Net Present Value of the IP asset.

The Income Method

Advantages

• It gives a valuator flexibility to envisage different future options.

• Helps develop future IP asset management strategy.

• Relatively simple to apply.

Disadvantage

• Very subjective

Income Method

• Different approaches• Discounted Cash

Flow

• Monte Carlo

• Real Option

Income Method

• DCF is one of the approaches to the Income Method;

• A projection of a future net cash flow expected from the commercial use of the intangible asset under review;

• over a period of the economic life of the IP;

• “discounted” by the time value of the money and risk (“discounted rate”).

DCF – Basic Elements

• Time - economic life of the asset.

• Usually shorter than the legal life.

• Depends on the type of industry.

• Pharma products - even after the patent expiration - because of trademark or follow- on technology.

DCF – Basic Elements

• Expected Growth - determined by using:

– Past growth rates

– Similar technologies

– Forecast by industry experts

– Management’s own projection

• Growth rate change in relation with technology diffusion

Growth of Technology Diffusion

• Market introduction – “market penetration”• Growth phase• Saturation of maturity

•1 •2 •3

•Revenue of Patented Product

•Time

DCF – Basic Elements

• Risk that the income will not be realized.

• “Discounting” - reducing a projected Net Cash Flow to a present value of the IP asset.

• Discount rate– the real interest rate

– inflation

– risk premium.

How DCF Calculation Works

1. Identify the market for the technology 2. Determine current cash flow from the particular

asset -- distinguish the IP from other elements of value in the product. Use available data – your own for the same or similar technology or sectarian professional data base

2. Subtract any costs (cash outflows) that are required to generate the income (Net Cash Flow)

3. Estimate the expected growth of the net cash flow--over the economic life of the asset (in most cases shorter than the protection

period of IP )

How DCF Calculation Works (continued)

4. Discount projected future net cash flow to a lump sum that is the present value.

5. To do this, you make a judgment to determine a “discount rate” based on:

• Real interest rate• Expected inflation rate• Risk premium• Apply discount rate on the projected net

cash flow over the economic life of the asset = PRESENT VALUE AMOUNT

How DCF Calculation Works (continued)

CF(t)

(1+r)tPV = Σt=1

nCF(t)

(1+r)tPV = Σt=1

CF(t)

(1+r)tPV = Σt=1

n

Example - Smart Turbine

• Identify potential market for Smart Turbine.– New generation of installation? – Smart Turbine compatible with new installation– but

more efficient generator.– Generator – 20% of installation.

• What is the potential value of the targeted market? Cost of the new generation of installation - 1 BE for the production of 1 MW, current production of wind energy ( 52 MW) – potential market for Smart Turbine – 20% of 52 BE – 10,4 BE

Example – Smart Turbine

• What is an expected growth – use the information available – 23% (2001 – 2005)

• To project NET present value of the technology – estimate the profit margin in this area – 10% ( 90% of the cash flow will be needed to cover costs) – NET CASH FLOW – 104 ME

• Apply growth rate (23%) to project expected growth of the cash flow in the period under projection ( 5 years)

• Take into account penetration rate in the market each year under projection – 10%, 30%, 60%, 70%, 70%.

• Calculate the risk – discount rate – 8% • NET PRESENT VALUE

Year 1 2 3 4 5 6 23,8

BE

19,35 BE

15,73 BE

12,79 BE

10,4 BE

Expected economic growth of total turbine market (23%)

Market penetration rate for Smart Turbine tech.

10% 30% 60% 70% 70%

Projected cash flow for Smart Turbine tech

1,04 BE

3,84 BE

9,44 BE

13,55 BE

16,66 BE

Net Cash Flow

104 ME

384 ME

944 ME

1,355 BE

1,66 BE

Discount factor 1

(1.08) 1 _ (1.08)2

1 _ (1.08)3

1 _ (1.08)4

1 (1.08)5

0

Discounted value of 1 E

.925 .846 .779 .716 .659

Discounted Cash Flow

= 95,68 ME

324,86 ME

735,38 ME

970,2 ME

1097,9 ME

Net Present

Value 3,22

4 BE

= 95,68 + 324,86 + 735,38 + 970,2 + 1097,9 ME

*A Note: ME – million Euro

BE – b illion Euro

Market Method• Advantage-simple, if there are appropriate data

• Difficulties • IP market is not developed• Difficult to find pertinent data (contracts are

confidential usually)• Sectarian databases might have useful

information-variations and complexity of each case have to be taken into consideration

• Geographical and market differences• Other terms in contract have to be taken into

account

Cost Method• Replacement (creation) cost-cost of R&D

plus the cost of IP protection;

• Advantages: useful to estimate a competitor’s invent-around costs and understand licensor’s perspective;

• Disadvantages– lost time– difficult to determine– cost of creation is not always representative of

the value of the protected technology.

• 25% Rule of Thumb

- Licensor gets 25% of profit

Other Valuation Methods

• Licensee perspective: how much can it afford to add to its cost of goods sold?

• Licensor perspective: what rate of return on R&D investment does it expect?

Practical approach

• Current financial and accounting system conceptualized to reflect value of tangible assets.

• Traitionally – accounting surve the stakeholders with objective informaton of the companie‘s well being.

• Stakeholders – owners, emplyees, potential investors, tax authorities and society as a whole.

• Dominent accounting rule – not to over-value asset.• Often accounting legislation and norms, in principal local by nature, are strongly

related to taxation practices, thus changes are hard to implement. Prectices and jurisdictions differ.

• .

IP Valuation and Accounting

• Over last 50 years –growth of the significance and contribution of intangible assets to the market capitalization of the firms imposed the need for adjusted accounting system.

• Accounting practices and norms, local by nature, slowly change and differ in how they

• Recognize• Classify• Capitalize Intellectual Property

• Efforts to internationally standardize the accounting system – Internatonal Accounting Standards Board (IASB) issuing International Accounting Standards (IAS) and International Financial reprting Standards (IFRS).

.

IP Valuation and Accounting

• Over last 50 years –growth of the significance and contribution of intangible assets to the market capitalization of the firms imposed the need for adjusted accounting system.

• Accounting practices and norms, local by nature, slowly change and differ in how they

• Recognize• Classify• Capitalize Intellectual Property

• Under existing accounting standards in most jurisdiction• There is a different approach to IP internally developed and purchased.• The cost of the intangible asset purchased fom a third party is capitalized as an

asset – if the asset recognition criteria are met – that it will give a future economic benefit.

• The same rule apply to tangible and financial assets, icluding to most self constructed tangible assets.

• Development of its own IP is prohibited from capitalization of the costs as an asset investment – it is considered as a cost – as it can not be reliably measured and it is less evident if it will give future economic benefit.

.

IP Valuation and Accounting

IP Valuation and Accounting• Efforts to internationally standardize the accounting system – Internatonal Accounting

Standards Board (IASB) issuing International Accounting Standards (IAS) and International Financial Reprting Standards (IFRS).

• International Accounting Standard 38 (IAS 38) – handle most issues in relation with intangible assets. Additional issues – such as impairment of assets and business combinations – are delt with IAS 36 and IFRS 2, respectivly The general rule regarding recognition of intangible assets (IAS38.8-21)

• An intangible asset is:• An Asset• Non- Monetary• Without Physical Substance• Controlled by the Entity• Identifiable ( capable of being separated from entity or arising from contractual

or other legal rights)

• It is only recognized if:• It is probable that the future economic benefits will flow to the entity• The cost can be measured reliably

THANK YOUOlga Spasic

Innovation and Technology Transfer Section, Patent Division

olga.spasic@wipo.int