How Much are my Intellectual Assets Worth?
Presented by:
Aron Levko
ARON LEVKO LLC
Intellectual Property Management & Markets
Illinois Institute of Technology, Chicago - Kent College of Law
The implied value of intellectual assets has grown relative
to tangible assets
Components of S&P 500 Market Value
100.0%
20.3%
31.6%
80.0%
67.6%
60.0%
83.2%
79.7%
40.0%
68.4%
20.0%
32.4%
16.8%
0.0%
1975
Source: Ned Davis Research
1985
1995
Intangible Assets
Tangible Assets
Slide 2
2005
What are Intellectual Assets (IA)?
Intellectual Assets
Intellectual Property
Patents
Trademarks
Copyrights
Proprietary Know-How
Information
Business Processes
Data Sources
Trade Secrets
Other Intellectual Assets:
•Labor Skills
•Distributor/Supplier Relationships
•Goodwill
Slide 3
Why do we value IA?
Transactions
Financing
• License or sale
• Commercial lending
• Mergers & acquisitions
• Securitizations
Tax Planning
• Debt or equity fundraising
• IP holdco
Compliance
• Transfer pricing
• Internal controls testing
Strategy
• FAS 141 & 142
• R&D direction
Litigation Support
• IP portfolio management
• Damages analysis
Slide 4
The appropriate basis of value is critical and depends on
the reason for valuation

Fair Market Value
-
•
Fair Value
-

The value an asset would be worth, when considering its specific intended use.
Intrinsic Value
-
•
Generally, a legally created standard value that applies to certain business transactions.
Investment Value
-
•
“The price at which an asset would change hands between a willing buyer and a willing
seller when the former is not under any compulsion to buy and the latter is not under any
compulsion to sell, both parties having reasonable knowledge of relevant facts.” [1]
“The value an investor considers to be “true” or “real,” based upon an assessment of
available facts, which will become the fair market value when other investors reach the
same conclusion.” [1]
Other
[1] American Society of Appraisers, Business Valuation Standards - Definitions
Slide 5
Common Valuation Methods
• Cost Approach
- Value based upon reproduction or replacement costs of an
asset, considering market acceptance and timing needs.
- Often yields lowest value for an IA.
• Market Approach
- Value based upon guideline companies or transactions of
similar assets.
- Often difficult to find comparable companies or relevant
transactions adequately matching the technology, product,
and industry application of an IA.
Slide 6
Common Valuation Methods (cont.)
• Income Approach
- Most common method for valuing an IA.
- Value based upon expected future cash flows and related
risk during the useful life of an IA.
- Types of income approaches include:
• Relief from Royalty Method
• Profit Split Method
• Excess/Incremental Profit Method
Slide 7
Comparison of Valuation Methodologies
Cost
Market
Income
Strengths
Strengths
Strengths
• Ease of Use
• Ease of Use
• Specific Product
• Applicability
• Market
• Future Cash
Considerations
Flows
Issues
Issues
Issues
• Future Benefits
• Comparables
• Impact of
• Market
• Special
Considerations
Adjustments
Discount Rates
• Accuracy of
Revenue F/C
Relief from Royalty Method: Overview
• Values an IA by calculating the licensor’s relief from payment
to a third party for accessing rights to the IA.
- By already having access to the IA, the licensor has value
from not being required to make these payments.
• Generally derived by applying a “reasonable royalty rate” to
the appropriate “royalty base.”
• Present values future royalty payments using appropriate risk
factors that are both technology and industry related.
Slide 9
Relief from Royalty Method: Forecasting Revenues
• Projected market conditions for the economy, industry, and
market segment will assist in evaluating:
- Potential size of the market
- Growth opportunities
- Competitive threats
- Expectations of market acceptance and market share
- Expectations of price
• Useful life expectancy of the IA is the time horizon of the
forecast period.
Slide 10
Relief from Royalty Method: Example (Pharmaceutical Product)
($ Millions)
Revenue
Royalty Rate
Royalty Earned
Administrative Costs
Pre-Tax Cash Flow
Income Taxes
After Tax Cash Flow
Discount Factor
Discounted Cash Flow
Net Present Value
2007
$1,000
2008
$1,400
2009
$2,000
2010
$2,500
2011
$2,600
$50.0
$5.0
$45.0
18.0
$27.0
$70.0
$7.0
$63.0
25.2
$37.8
$100.0
$10.0
$90.0
36.0
$54.0
$125.0
$12.5
$112.5
45.0
$67.5
$130.0
$13.0
$117.0
46.8
$70.2
0.9091
0.8264
0.7513
0.6830
0.6209
$24.5
$31.2
$40.6
$46.1
$43.6
5%
10%
40%
10%
$186.0
Slide 11
The Profit Split Method: Overview
• Allocates a portion of profit a licensee can expect from the use
of an IA, to cover the licensee’s risks and provide reasonable
compensation to a licensor.
• Must consider:
- Forecasted revenues
- Variable costs
- Incremental fixed costs
• Incremental profit must be allocated to the IA, addressing:
- Why allocate profit?
- What is a reasonable profit split?
Slide 12
Why allocate profits?
Business Value
Patent Value
• Portion of total market
• Entire profits from business
• Entire market
• Portion of total product profit
Total Industry Profits
Labor
Labor
Distribution
Distribution
Components of Profit
Components of Profit
Total Industry Profits
Patents
Manufacturing
Mgt. Talent
Location
A
B
C
D
Patents
Manufacturing
Mgt. Talent
Location
A
E
B
C
D
Businesses in the Industry
Businesses in the Industry
Profits Due to
Subject Patents
Slide 13
E
The Profit Split Method: Estimating Commercialization Costs
• What are the anticipated variable costs and incremental fixed
costs for producing and selling each unit of product
encompassing the IA being valued?
• Variable costs may include:
- Direct material
- Direct labor
- Variable overhead (e.g. indirect labor, perishable tools, etc.)
- Sales commissions
- Product warranty expenses
- Profit sharing/ executive bonuses
Slide 14
The Profit Split Method: Estimating Commercialization Costs
(cont’d)
• Considerations for incremental fixed costs may be:
• Does excess capacity exist?
• What is the time frame needed to add capacity?
• What incremental capital expenditures are required?
• Will the patented products replace existing products?
• Other incremental fixed costs may include salaries and
benefits for additional sales and office personnel.
Slide 15
Profit Split Method: Example (Pharmaceutical Product)
($ Millions)
2007
2008
2009
2010
2011
Revenue
$1,000
$1,400
$2,000
$2,500
$2,600
Variable Costs
65%
Incremental Fixed Costs
Total Incremental Costs
(650.0)
(200.0)
(850.0)
(910.0)
(200.0)
(1,110.0)
(1,300.0)
(300.0)
(1,600.0)
(1,625.0)
(300.0)
(1,925.0)
(1,690.0)
(300.0)
(1,990.0)
Incremental Profit
$150.0
$290.0
$400.0
$575.0
$610.0
Profit Split Factor
Royalty Earned
25%
$37.5
25%
$72.5
25%
$100.0
25%
$143.8
25%
$152.5
3.8
$33.8
13.5
$20.3
7.3
$65.3
26.1
$39.2
10.0
$90.0
36.0
$54.0
14.4
$129.4
51.8
$77.6
15.3
$137.3
54.9
$82.4
0.9091
0.8264
0.7513
0.6830
0.6209
$18.4
$195.5
$32.4
$40.6
$53.0
$51.1
Admin Costs
Pre-Tax Cash Flow
Income Taxes
After Tax Cash Flow
10%
Discount Factor
10%
Discounted Cash Flow
Net Present Value
40%
Slide 16
Excess/Incremental Profit Method: Overview
• Identifies excess profit generated by:
- Entities utilizing the IA over similar entities without the IA
- Products encompassing the IA over similar products without
the IA
- Warning: Comparable entities and products may have
unique intangibles that taint the analysis
• Appropriate comparisons can be difficult to perform
• Excess profits may need to be allocable to the IA
- How do you allocate the profits?
Slide 17
Excess/Incremental Profit Method: Variations
• Premium Pricing Method
- Typically used in brand valuation for consumer products
- Consists of incremental revenue over life of the brand less
related marketing costs, then discounted to present value
- Warning: Hard to find unbranded comparable products
• Cost Savings Method
- Calculates cost savings from utilizing the asset
- Typically used in evaluating the efficiency of an innovative
business method or process
- Warning: Must carefully attribute cost savings specifically
to the IA
Slide 18
Excess/Incremental Profit Method: Example (Pharmaceutical
Product)
($ Millions)
Revenue
2007
$1,000
2008
$1,400
2009
$2,000
2010
$2,500
2011
$2,600
Operating Margin
Licensed Technology
Existing Technology
Excess Margin
23.0%
15.0%
8.0%
23.0%
15.0%
8.0%
23.0%
15.0%
8.0%
23.0%
15.0%
8.0%
23.0%
15.0%
8.0%
Excess Earnings
$80.0
$112.0
$160.0
$200.0
$208.0
Profit Split Factor
Royalty Earned
50%
$40.0
50%
$56.0
50%
$80.0
50%
$100.0
50%
$104.0
4.0
$36.0
14.4
$21.6
5.6
$50.4
20.2
$30.2
8.0
$72.0
28.8
$43.2
10.0
$90.0
36.0
$54.0
10.4
$93.6
37.4
$56.2
0.9091
0.8264
0.7513
0.6830
0.6209
$19.6
$148.8
$25.0
$32.5
$36.9
$34.9
Admin Costs
Pre-Tax Cash Flow
Taxes
After Tax Cash Flow
10%
Discount Factor
10%
Discounted Cash Flow
Net Present Value
40%
Slide 19
Valuation Methods Summary
Valuation Method
Amount
($Millions)
Relief from Royalty
$186.0
Profit Split
195.5
Excess/ Incremental Profit
148.8
Average Value
$176.8
Slide 20
Discount Factors: Define the Risk
• Less developed IA have higher risk
- Popular office software program v. new product
- Established drug brand v. generic drug
- Coca Cola brand at $58 billion (Source: Interbrand's Best
Global Brands report, 9/09)
• Risk can be reflected in an IA valuation either by:
- Using a probabilistic approach for each technology-related
risk, then applying a discount rate for the cost of capital:
• Technology-related risks: patent validity & infringement,
obsolescence, commercialization, and regulatory
• Industry-related risk: cost of capital, or
- Applying an overall discount rate for all risk factors
Slide 21
Discount Factors: Technology-Related Risks
Risk of Intellectual Property - Relates to the uncertainty of competitive strength,
scope of claims, freedom to practice, and enforceability of the intellectual property,
along with the ability to detect infringers and enforce such IP rights.
Risk of Technology - Addresses the probability that the underlying Subject
Technology will work as envisioned once scaled for commercialization purposes.
Risk of Commercialization - Addresses the uncertainty regarding the several markets
associated with the Subject Technology (e.g., customer acceptance, market
penetration, price, and profitability) that might impact the value of the Subject
Technology.
Risk of Regulation - Reflects the uncertainty that further laws and directives might
affect the Subject Technology’s commercial status.
Slide 22
Discount Factors: Probabilistic Approach Example
Slide 23
Discount Factors: Industry-Related Risks
Cost of Capital – Reflects inflation and enterprise risks for reducing the value of future
benefits to current available cash by adding a premium, because of this uncertainty, to
a risk-free interest rate. This is described as the Capital Asset Pricing Model (CAPM)*
for determining a discount rate, where:
Discount Rate =
Risk Free Rate + Equity Risk Premium
+ Enterprise size + Investment Specific Risk
Weighted-average cost of capital (WACC) can substitute for the risk-free rate and
equity risk premium in the above formula, where:
WACC =
(Debt Portion of Invested Capital x After-tax Cost of Debt)
+ Beta (Equity Portion of Invested Capital x Cost of Equity)
* Valuing a Business; Pratt, Reilly, and Schweihs; McGraw-Hill
Slide 24
Discount Factors: Using Overall Discount Rate
Required Rate of Return
Concept
Basic Research
Applied Research
Development
Prototype
Commercialization
0
20
40
60
Percent
Slide 25
80
100
Ways to Enhance Value
1. Develop a Comprehensive IAM Strategy and Execute it
2. Integrate IA into Own Products and Services
3. Establish Track Record of Successful IA Integrations
4. Reduce Time to Market for IA Innovations
5. Employ IA as Guardian for Own Products and Services
6. Utilize IA as Value Contributor within Business Transactions
7. Discover Licensing Opportunities for IA in Others’ Products or Services
8. Perform Periodic Maintenance on Obsolete IA
9. Keep Good Relations with Competitors/Suppliers/Regulators/Customers
Slide 26
Therefore,
IF YOU CAN VISUALIZE IT, YOU CAN
MEASURE IT, . . . AND IF YOU CAN
MEASURE IT, THEN YOU CAN
MANAGE IT AND DERIVE VALUE
FROM IT.
Slide 27
Q&A