1 intellectual property valuation and finance 2 on 12/31/99, investors said p&g was worth $...

1

Intellectual Property Valuation

andFinance

2

ON 12/31/99, INVESTORS SAID P&G WAS WORTH $ 151.6 BILLION

P&G’s FINANCIAL STATEMENTSSAID IT WAS WORTH $ 32.1 BILLION

WHO WAS RIGHT ??

3

ON 12/31/99, INVESTORS SAID P&G WAS WORTH $ 151.6 BILLION

WHAT HAPPENED TO $ 57.4 BILLION ??

FIVE MONTHS LATER, INVESTORS SAID P&G WAS WORTH $ 94.2 BILLION

4

Course Overview

• Why Valuations are Necessary

• Importance of IP Assets

• Accounting Principles

• Valuation Theory & Practice

• Tax, Litigation & Finance

• Working with a Valuation Expert

• Case Studies

5

Why Valuations are Made

• Transaction Support

• Litigation Support

• Regulatory Requirements

• Accounting Requirements

• Taxes - Federal, State Income - Estate - Gift - ad valorem

• Financial

6

…from “Bricks and Mortar”

to

IP

7

INTANGIBLE ASSETS

• Rights

• Relationships

• Intellectual Property

• Undefined Intangibles

8

Rights

• Leases

• Distribution Agreements

• Employment Contracts, Covenants

• Financing Arrangements

• Supply Contracts

• Licenses, Certifications

• Franchises

9

Relationships

• Trained and Assembled Workforce

• Customer Relationships

• Distribution Relationships

10

Intellectual Property

• Proprietary Technology Trade Secrets Know-how

• Patents

• Copyrights

• Trademarks

• Right of Publicity

11

Proprietary Technology

• Formulas, Recipes, Specifications• Management, Accounting, Mfg. Procedures• Formations, Plays, Training programs• Marketing Strategies• Artistic Techniques• Customer Lists, Routes, Demographic Studies• Job Files, Product test results• Business Knowledge - Suppliers, Lead times,

Cost and pricing data

12

Undefined Intangibles

• Goodwill

• Elements of a Going Concern (“going concern value”)

13

The Business Enterprise andthe Assets That Comprise It

14

Business Enterprise

BUSINESS

ENTERPRISE

VALUE OF EQUITY

VALUE OFLONG-TERM DEBT

MONETARY ASSETS

TANGIBLE ASSETS

INTANGIBLE ASSETS

= =

15

ELEMENTS OF THE BUSINESS ENTERPRISE (monetary assets)

MONETARY ASSETS

Cash, Inventories, Work in Process,Finished Goods, Accounts Receivable LESS:Accounts Payable and other CurrentLiabilities

“Net Working Capital”

16

ELEMENTS OF THE BUSINESS ENTERPRISE

TANGIBLE ASSETS

Land, Land Improvements, BuildingsMachinery and Equipment, Vehicles

“Plant, Property and Equipment”

17

INTANGIBLE ASSETS

Computer Software, Assembled Workforce,Favorable Contracts, Customer Relationships,Intellectual Property

“Goodwill or (ugh!) Going Concern Value”

ELEMENTS OF THE BUSINESSENTERPRISE

18

BUSINESS ENTERPRISEis a PORTFOLIO

T - BILLSMONEY MARKETCORPORATE BONDSEQUITIESLOTTERY TICKETS

=

19

BUSINESS ASSET CHARACTERISTICS

MONETARY TANGIBLE INTANGIBLE

RETURNREQUIREMENT

FINANCING

INVESTMENTQUALITIES

8 - 10 % 10 - 15 % 15 - 40 %

DEBT EQUITY

LIQUID NON-LIQUIDVERSATILE NARROW MARKET

VALUEIN USE

VALUE INLIQUIDATION

CASH RECEIVABLES INVENTORY

GENERAL PURPOSE SPECIAL PURPOSE

20

RELATIONSHIP OF EARNINGS AND VALUE

EARNINGS

VA

LU

E

SCRAP VALUE OF TANGIBLE ASSETS

FORCED LIQUIDATION VALUE

ORDERLY LIQUIDATION VALUE

VALUE IN CONTINUED USE

REPLACEMENT COST

REPLACEMENT COST

BUSINESS ENTERPRISE VALUE

GOODWILL

INTANGIBLES

TANGIBLES

0

0

(-)

(-)

21

Balance Sheet View ofthe Business Enterprise

Current Assets

Plant, Property and Equipment

Other Assets

Intangible Assets andIntellectual Property

Current Liabilities

Long-Term Debt

Stockholder’s Equity

22

Value ofthe Business Enterprise

C.A. less C.L.

Plant, Property and Equipment

Other Assets

Intangible Assets andIntellectual Property

Long-Term Debt

Stockholder’s Equity

VALUE OF: VALUE OF:

23

Basic Accounting Concepts

24

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (“GAAP”)

FASB - Financial Accounting Standards BoardSFAS - Statement of Financial Accounting StandardsAPB - Accounting Principles BoardAPB 99 - Opinions of APBAICPA - American Institute of CPA’sSAP - Statements of PositionGAP - Gordon’s Accounting Principles

25

PUBLIC vs. PRIVATE

PUBLIC PRIVATE

IRS

SEC

STOCKHOLDERS

IRS

STOCKHOLDER

26

AUDITED FINANCIAL STATEMENTS

“These financial statements are the res-ponsibility of the Company’s management.”

“Our responsibility is to express an opinionon these financial statements based on ouraudit.”

“In our opinion, the financial statements…present fairly, in all material respects…thefinancial position of …in conformity withG.A.A.P.”

27

Business Transactions

BUSINESS ENTERPRISE

Employees

Suppliers

Lenders

Investors

Government

Customers

28

Balance Sheet

Current Assets

Plant, Property and Equipment

Other Assets

Current Liabilities

Long-Term Debt

Stockholder’s Equity

ASSETS - what weown

LIABILITIES - how wefinanced what we own

29

THE PROCTER & GAMBLE COMPANY and SUBSIDIARIESConsolidated Balance Sheets

($millions)

Years ended June 30, 1999 1998ASSETSCurrent Assets Cash 2,294$ 1,549$ Investments 506 857 Accounts Receivable 2,940 2,781 Inventories Materials and Supplies 1,176 1,225 Work in Process 375 343 Finished Goods 1,787 1,716 Deferred Income Taxes 621 595 Prepaid Expenses 1,659 1,511

Total Current Assets 11,358 10,577

30

Current Liabilities Accounts Payable 2,300$ 2,051$ Accrued Liabilities 4,083 3,942 Taxes Payable 1,228 976 Debt due within one year 3,150 2,281

Total Current Liabilities 10,761 9,250

Current Assets Cash 2,294$ 1,549$ Investments 506 857 Accounts Receivable 2,940 2,781 Inventories Materials and Supplies 1,176 1,225 Work in Process 375 343 Finished Goods 1,728 1,716 Deferred Income Taxes 621 595 Prepaid Expenses 1,659 1,511

Total Current Assets 11,299 10,577

Net Working Capital = Monetary Assets

+

-

=

31

Property, Plant, and Equipment Buildings 3,885 3,660 Machinery and Equipment 16,953 15,953 Land 562 539

21,400 20,152 Less Accumulated Depreciation 8,774 7,972

Total Property, Plant, and Equipment 12,626 12,180 Goodwill and Other Intangible Assets Goodwill 7,062 7,023 Trademarks and Other Intangible Assets 1,115 1,157

8,177 8,180 Less Accumulated Amortization 1,355 1169

Total Goodwill and Other Intangible Assets 6,822 7,011

32

LIABILITIES and SHAREHOLDERS' EQUITYCurrent Liabilities Accounts Payable 2,300$ 2,051$ Accrued Liabilities 4,083 3,942 Taxes Payable 1,228 976 Debt due within one year 3,150 2,281

Total Current Liabilities 10,761 9,250 Long-Term Debt 6,231 5,765 Deferred Income Taxes 362 428 Other Non-current Liabilities 2,701 3,287

Total Liabilities 20,055 18,730

33

Flow of Funds

CURRENT LIABILITIES

LONG-TERM DEBT

STOCKHOLDER EQUITY

REVENUE

COST OF GOODS

EXPENSES

TAXES

PROFIT

CURRENT ASSETS PLANT, PROP. & EQUIP.

OTHER ASSETS

34

THE PROCTER & GAMBLE COMPANY and SUBSIDIARIESConsolidated Statements of Earnings

($millions)

Years ended June 30, 1999 1998 1997Net Sales $38,125 $37,154 $35,764Cost of Products Sold 21,206 21,064 20,316

Gross Margin 16,919 16,090 15,448

Marketing, Research, Admin. Expenses 10,666 10,035 9,960Operating Income 6,253 6,055 5,488

Interest Expense 650 548 457Other Income, net 235 201 218

Earnings before Income Taxes 5,838 5,708 5,249

Income Taxes 2,075 1,928 1,834Net Earnings $3,763 $3,780 $3,415

35

Years ended June 30, 1997 % 1996 % 1997 %Net Sales $38,125 100.0 $37,154 100.0 $35,764 100.0Cost of Products Sold 21,206 55.6 21,064 56.7 20,316 56.8

Gross Margin 16,919 44.4 16,090 43.3 15,448 43.2

Marketing and Administration Expense 5,402 14.2 4,785 12.9 4,927 13.8Research and Development Expense 1,726 4.5 1,546 4.2 1,282 3.6Advertising Expense 3,538 9.3 3,704 10.0 3,468 9.7

Operating Income 6,253 6,055 5,771

Interest Expense 650 1.7 548 1.5 457 1.3Other Income, net 235 0.6 201 0.5 218 0.6

Earnings before Income Taxes 5,838 5,708 5,532

Income Taxes 2,075 5.4 1,928 5.2 1,834 5.1Net Earnings $3,763 9.9 $3,780 10.2 $3,698 10.3

Depreciation and Amortization 2,148 1,598 1,487Gross Cash Flow $5,911 $5,378 $5,185

Capital Expenditures 2,828 2,559 2,129Net Cash Flow $3,083 $2,819 $3,056

36

THE PROCTER & GAMBLE COMPANY and SUBSIDIARIESConsolidated Statements of Cash Flows

($millions)

Years ended June 30, 1999 1998 1997Cash and Equivalents, Beginning of Year $1,549 $2,028 $2,074

Operating Activities Net Earnings 3,763 3,046 3,415 Depreciation and Amortization 2,148 1,358 1,487 Deferred Income Taxes -60 328 -26 Other -307 -574 1,006

5,544 4,158 5,882

Investing Activities Capital Expenditures -2,828 -2,179 -2,129 Proceeds from Asset Sales 434 402 520 Acquisitions -137 -358 -150 Change in Investment Securities 356 -331 -309

-2,175 -2,466 -2,068Financing Activities Dividends to Shareholders (1,626) (1,462) (1,329) Additions to Long-term Debt 986 1,970 224 Reductions in Long-term Debt (334) (432) (724) Other 921 1,473 (26) Treasury Purchases (2,553) (1,929) (1,652)

-2606 -380 -3507

Effect of Exchange Rate Changes -18 -96 -31

Change in Cash and Cash Equivalents 745 -801 276

Cash and Equivalents, End of Year 2,294$ 1,549$ 2,350$

37

Basic Valuation Principles

38

PREMISE OF VALUE

• Cost of Reproduction

• Cost of Replacement

• Book Value

• Tax Basis

• Fair Market ValueMarket Value, Fair Value, Exchange ValueOrderly / Forced Liquidation Value, Investment Value

39

PREMISE OF VALUE

“The amount at which a property would exchangebetween a willing buyer and seller, neither undercompulsion, each having knowledge of the facts,and with equity to both.”

or

“The present value of the future economic benefitsof ownership.”

FAIR MARKET VALUE

40

PREMISE OF VALUE

“The amount at which a property would exchangebetween a willing buyer and seller, neither undercompulsion, each having knowledge of the facts,and with equity to both.”

or

“The present value of the future economic benefitsof ownership.”

FAIR MARKET VALUE

41

VALUING A BUSINESS

THE BUSINESS ENTERPRISE(PORTFOLIO)

THE UNDERLYING ASSETS

(AS ELEMENTS OF PORTFOLIO)

THE UNDERLYING ASSETS(FOR ALTERNATE USE)

42

VALUATION METHODS

• Cost Approach

• Market Approach

• Income approach

43

COST APPROACH

Cost of Reproduction or Cost of Replacement

Less: Physical DepreciationLess: Functional ObsolescenceEquals: Replacement Cost Less Depreciation

Less: Economic Obsolescence

Equals: FAIR MARKET VALUE

44

MARKET APPROACH

• Comparable Property

• At Arm’s Length

• Contemporaneous to Appraisal

• In an Active, Public Market

Analyze evidence of transactions of:

45

INCOME APPROACH

AMOUNT

DURATION

RISK

46

PRESENT VALUE (direct cap)

DIRECT CAPITALIZATION

Used when we are to receive an unchanging amount in each period into perpetuity

PV =AMOUNT ($)

RATE (%)

47

PRESENT VALUE (direct cap with growth)

DIRECT CAPITALIZATION with GROWTH

Used when we are to receive a constantly growing amount each year into perpetuity

PV =AMOUNT x (1 + Growth Rate)

(Rate - Growth Rate)

48

PRESENT VALUE (discounting)

DISCOUNTING

Used when we are to receive varying amounts in each period for a finite number of periods.

PV =AMOUNT 1 AMOUNT 2 AMOUNT 3

(1 + Rate) (1 + Rate)^2 (1 + Rate)^3

+ + + ….

49

PRESENT VALUE of $ 300,000

@ 4% $288,000 $277,000 $246,000 $201,000

@ 15% 258,000 223,000 142,000 68,000

@ 25% 234,000 183,000 87,000 25,000

1 YEAR 2 YEARS 5 YEARS 10 YEARS

To be received in:

50

INCOME APPROACH (NPV = PV future benefits..)

AMOUNT

DURATION

RISK

=NET PRESENT VALUE

“The present value of the future economic benefitsof ownership.”

51

QUANTIFYING THE ECONOMICADVANTAGE

Enables the use of lower cost materialsEnables the use of less materialReduces the amount of laborIncreases speed of productionImproves quality / Reduces defectsEliminates or reduces environmental and/or safety hazardsResults in premium pricingProvides economies of scaleProvides purchasing powerRelieves the owner of the cost to create

52

INCOME RISK

• WILL WE RECEIVE IT ?• WILL WE RECEIVE IT IN THE EXPECTED

AMOUNT ?• WILL WE RECEIVE IT WHEN EXPECTED ?• MUST WE INVEST TO GET IT ?• MUST WE INVEST IN “BIG LUMPS” ?• HOW LONG MUST WE WAIT FOR INCOME

TO START ?

53

RATES OF RETURN

5.90- 6.7% - CD’s, Treasury Bills6.05% - 30-year Treasury bonds8.00% - 30-year mortgage commitments8.00-10.00% - Corporate bonds9.50% - Prime rate9.00-15.00% - High-yield bonds10.05-11.05% - Large company equities (Treasury plus 4-5%)12.05-15.05% - Small company equities (plus 6-8%)20% - 2nd or 3rd stage venture capital40% - Venture capital, early commercialization50% - Venture capital, early stage

54

INCOME DURATION (economic life vs. legal…)

ECONOMIC LIFE =

MAY OR MAY NOT BE =

the period during whichit is profitable to use anasset

Legal LifePhysical LifeTechnological LifeDepreciable Life

55

TRANSFER OF VALUE BETWEENFORMS OF INTELLECTUAL

PROPERTY

0102030405060708090

100

Trademark

Patent

56

PRIMARY SECONDARY WEAK

Patents and Technology Income Market Cost

Trademarks and Brands Income Market Cost

Copyrights Income Market Cost

Assembled Workforce Cost Income Market

Management Information Software Cost Market Income

Product Software Income Market Cost

Distribution Networks Cost Income Market

Core Deposits Income Market Cost

Customer Relationships Cost Income Market

Franchise Rights Income Market Cost

Corporate Practices and Procedures Cost Income Market

Elements of a Going Concern Cost Income Market

Goodwill Market (1) Income (2) -

(1) Residual based on enterprise market value(2) Capitalization of "excess" income

Figure 11.2 Valuation Method Preferences

57

MERCK & CO., INC. and SUBSIDIARIESValuation of Underlying Assets

($millions)

Years ended December 31, 1999 1998Current Assets Cash 2,021.9$ 2,606.2$ Short-term Investments 1,180.5 749.5 Accounts Receivable 4,089.0 3,374.1 Inventories 2,846.9 2,623.9 Prepaid Expenses and Taxes 1,120.9 874.8

Total Current Assets 11,259.2 10,228.5 Current Liabilities Accounts Payable 4,158.7$ 3,682.1$ Loans and Current Portion of Long-term Debt 2,859.0 624.2 Income Taxes Payable 1,064.1 1,125.1 Dividends Payable 677.0 637.4

Total Current Liabilities 8,758.8 6,068.8

MONETARY ASSETS (net working capital) 2,500.4$ 4,159.7$

Investments 4,761.5 3,607.7

Property, Plant and Equipment Land 259.2 228.8 Buildings 4,465.8 3,664.0 Machinery, Equipment and Office Furnishings 7,385.7 6,211.7 Construction in Progress 2,236.3 1,782.1

14,347.0 11,886.6 Less Allowance for Depreciation 4,670.3 4,042.8

9,676.7 7,843.8 TANGIBLE ASSETS 12,011.9$ 9,865.2$

BUSINESS ENTERPRISE VALUE Common Shares Outstanding (millions) 2,968.0 Year-end Price $67.25 Common Equity Value (millions) $199,598.0 Long-term Debt (millions) 3,143.9

$202,741.9

LESS: Value of Monetary Assets 2,500.4$ Value of Investments 4,761.5 Value of Tangible Assets 12,011.9

EQUALS: Value of Intangible Assets 183,468.2

58

SALES / R & D ADMINISTRATION /

MARKETING MANUFACTURING ENGINEERING PURCHASING FINANCE

TRADEMARKS 1 2

PATENTS 3 4

PROPRIETARY 5 6

TECHNOLOGY

RECORDS AND 7 8 9 10

DRAWINGS

SOFTWARE 11 12 13

COPYRIGHTS 14 15

PROVIDING 16

CONTRACTS

RECEIVING 17

CONTRACTS

CUSTOMER 18

RELATIONSHIPS

Figure 8.10 Sources of Information about Intangible Assets

59

Home Products

HealthFoods

Auto Products

Office Products

Cosmetics

Figure 8.6 Disaggregating the Business Enterprise

60

Home Products

HealthFoods

Auto Products

Office Products

Cosmetics

Figure 8.7 Disaggregating the Business Segment

Product 3

Product 2

Product 1

61Figure 8.8 Disaggregating the Product Line

Tangible

Intangible

Monetary

Brand

Product 1

62

FIGURE 3.4

TOTALEARNINGS

Te

MONETARY ASSETS

TANGIBLE ASSETS

INTANGIBLE ASSETS+ +

DEBTCAPITAL

EQUITYCAPITAL

BUSINESS

ENTERPRISE

PORTFOLIO

Me

Te

Ie

63

TOTALEARNINGS

Te Ie

EARNINGS ATTRIBUTABLE TO INTANGIBLE ASSETS

IDENTIFIEDINTANGIBLES

INTELLECTUAL PROPERTY

TRADEMARKS

PATENTEDTECHNOLOGIES

COPYRIGHTS

SPECIFICTECHNOLOGY

IAe IPe

PTe

STe

FIGURE 3.5

64

TABLE A.1

Business Enterprise Weighted Cost of Capital

WEIGHTEDPERCENT OF AFTER TAX AVERAGE

INVESTED CAPITAL AMOUNT INVESTED COST OF COST OF COST OFCOMPONENT ($ MILLIONS) CAPITAL CAPITAL CAPITAL CAPITAL

EQUITY 75.0 75.0% 14.0% 14.0% 10.5%DEBT 25.0 25.0% 7.0% 4.2% 1.1%

---------------- ---------------- ----------------TOTAL 100.0 100.0% 11.6%

Required Rate of Return Among Assets

PERCENT OF WEIGHTED PERCENT OFASSET CATEGORY AMOUNT INVESTED RETURN RETURN TOTAL

($MILLIONS) CAPITAL REQUIRED REQUIRED RETURN

NET WORKING CAPITAL 20.0 20.0% 5.0% 1.0% 8.6%TANGIBLE ASSETS 30.0 30.0% 7.0% 2.1% 18.1%INTANGIBLE ASSETS 50.0 50.0% 17.0% 8.5% 73.3%

---------------- ---------------- ---------------- ----------------TOTAL 100.0 100.0% 11.6% 100.0%

65

Allocating Income Among Assets

ASSET AMOUNT OFVALUE RETURNS RETURN

ASSET CATEGORY ($ 000's) REQUIRED ($ 000's)

NET WORKING CAPITAL 90,000 6.0% 5,400TANGIBLE ASSETS 125,000 9.0% 11,250

INTANGIBLE ASSETS 35,000 14.0% 4,900

INTELLECTUAL PROPERTY 50,000 17.0% 8,500---------------- ---------------- ----------------

TOTAL 300,000 10.0% 30,050

PATENTS 10,000 14.5% 1,450PROPRIETARY TECHNOLOGY 15,000 20.3% 3,050TRADEMARKS 25,000 16.0% 4,000

---------------- ---------------- ----------------50,000 17.0% 8,500

66

Allocating Weighted Average Cost of Capital Among Assets

WEIGHTEDASSET PERCENT OF AVERAGE

ASSET CATEGORY VALUE ENTERPRISE RETURNS COST OF($MILLIONS) VALUE REQUIRED CAPITAL

NET WORKING CAPITAL 20.0 20.0% 5.0% 1.0%TANGIBLE ASSETS 30.0 30.0% 7.0% 2.1%INTANGIBLE ASSETS Computer Software 5.0 5.0% 10.0% 0.5% Assembled Workforce 8.0 8.0% 15.0% 1.2% Trademarks 37.0 37.0% 18.5% 6.8%

---------------- ---------------- ----------------TOTAL 100.0 100.0% 11.6%

QUANTITATIVE QUALITATIVE

REVIEWFINANCIALS

Disaggregate to Products

Trademarked Product Financials

AnalyzeFeasability Studies

AnalyzeBusiness Plans

ReviewProjections Develop

Cash Flow Forecasts

CorrelateReturns byAsset Class

Correlate Asset Values andBusiness Enterprise Value

CONCLUDETRADEMARK VALUES

CONCLUDE ROYALTY RATES

MarketRoyalty RateInvestigation

AnalyzeMonetary Assets

AnalyzeTangible Assets

AnalyzeOther Intangible Assets

ConcludePreliminary Asset Values

InvestmentRate of Return Analysis

BUSINESSENTERPRISE VALUATION

Comparable Company Analysis

Industry Data

General EconomicConditions

AnalyzeMarketing Data

AnalyzeMarket Research Data

Independent Market Research

DATA GATHERING INTERVIEWS WITH MANAGEMENT

TRADEMARK VALUATION AND ROYALTY RATE DEVELOPMENT

Research ComparableTransactions

68

DISCOUNTED CASH FLOW

YEAR 1 YEAR 2 YEAR 3 YEAR 4

REVENUES REVENUES REVENUES REVENUES

EXPENSES EXPENSES EXPENSES EXPENSES

NET INCOME NET INCOME NET INCOME NET INCOME

CAPITAL +NON-CASH

CAPITAL +NON-CASH

CAPITAL +NON-CASH

CAPITAL +NON-CASH

NET CASHFLOW

NET CASHFLOW

NET CASHFLOW

NET CASHFLOW

PRESENTVALUE

PRESENTVALUE

PRESENTVALUE

PRESENTVALUE

69

DISCOUNTED CASH FLOW MODEL - BASE CASE

SALES $10,000 $11,000 $12,000 $14,000 $15,000

COST OF GOODS SOLD 4,000 4,400 4,800 5,600 6,000

GROSS PROFIT 6,000 6,600 7,200 8,400 9,000

OPERATING EXPENSES 3,000 3,300 3,600 4,200 4,500 GENERAL & ADMINISTRATIVE 1,500 1,650 1,800 2,100 2,250

INCOME BEFORE TAXES 1,500 1,650 1,800 2,100 2,250

INCOME TAXES 600 660 720 840 900

NET INCOME 900$ 990$ 1,080$ 1,260$ 1,350$

DEPRECIATION 200 200 200 300 300ADDITIONS TO NWC 0 50 100 200 50ADDITIONS TO PLANT 50 50 150 75 75

NET CASH FLOW $1,050 $1,090 $1,030 $1,285 $1,525

PRESENT VALUE $979 $884 $726 $788 $813TOTAL PRESENT VALUE $4,190

70

TABLE 4.11 USING MARKET ROYALTY RATES

FANCY COMPANY, INC. 1 2 3 4 5 TOTAL

Sales Revenue 373,500$ 388,440$ 387,754$ 386,391$ 347,448$ 1,883,533$

Trademark Royalty Rate 5% 5% 5% 5% 5%------------ ------------ ------------ ------------ ------------

Income Attributable to Trademark 18,675$ 19,422$ 19,388$ 19,320$ 17,372$ 94,177$

TABLE 6.7

RELIEF FROM ROYALTY VALUATION

FANCY COMPANY, INC. 1 2 3 4 5

Sales Revenue 373,500$ 388,440$ 387,754$ 386,391$ 347,448$

Trademark Royalty Rate 5% 5% 5% 5% 5%------------ ------------ ------------ ------------ ------------

Income Attributable to Trademark 18,675$ 19,422$ 19,388$ 19,320$ 17,372$

INCOME ATTRIBUTABLE TO TRADEMARK 18,675$ 19,422$ 19,388$ 19,320$ 17,372$ Less: Income Taxes 7,470$ 7,769$ 7,755$ 7,728$ 6,949$

------------ ------------ ------------ ------------ ------------After-tax Income Attributable to Trademark 11,205$ 11,653$ 11,633$ 11,592$ 10,423$

Present Value of After-tax Income 10,391$ 9,294$ 7,979$ 6,837$ 5,288$

TOTAL PRESENT VALUE 39,788$

71

TABLE 6.4 VALUATION OF PREMIUM PRICE ADVANTAGE

FANCY COMPANY, INC. 1 2 3 4 5SALES OF PREMIUM PRICED PRODUCT

Unit Sales Forecast 150,000$ 156,000$ 162,240$ 168,730$ 175,479$ Price per Unit 2.49 2.49 2.49 2.49 2.49

------------ ------------ ------------ ------------ ------------ Sales Revenue 373,500$ 388,440$ 403,978$ 420,137$ 436,942$

PLAIN COMPANY, INC.SALES OF GENERIC PRODUCT

Unit Sales Forecast 150,000$ 156,000$ 162,240$ 168,730$ 175,479$ Price per Unit 2$ 2$ 2$ 2$ 2$

------------ ------------ ------------ ------------ ------------ Sales Revenue 328,500$ 341,640$ 355,306$ 369,518$ 384,299$

INCOME ATTRIBUTABLE TO TRADEMARK 45,000$ 46,800$ 48,672$ 50,619$ 52,644$ Less: Income Taxes 18,000$ 18,720$ 19,469$ 20,248$ 21,057$

------------ ------------ ------------ ------------ ------------After-tax Income Attributable to Trademark 27,000$ 28,080$ 29,203$ 30,371$ 31,586$

Present Value of After-tax Income 25,288$ 23,070$ 21,046$ 19,200$ 17,516$

TOTAL PRESENT VALUE 106,119$

72

TABLE 6.5 VALUATION OF GROSS PROFIT ADVANTAGE

PLAIN COMPANY, INC. 1 2 3 4 5 TOTALSALES OF GENERIC PRODUCT

Unit Sales Forecast 150,000$ 156,000$ 162,240$ 168,730$ 175,479$ Price per Unit 2.19 2.19 2.19 2.19 2.19

------------ ------------ ------------ ------------ ------------ Sales Revenue 328,500$ 341,640$ 355,306$ 369,518$ 384,299$ 1,779,262$ Cost of Goods Sold PER UNIT 1.50$ 1.50$ 1.50$ 1.50$ 1.50$ Cost of Goods Sold 225,000$ 234,000$ 243,360$ 253,094$ 263,218$

------------ ------------ ------------ ------------ ------------ Gross Profit 103,500$ 107,640$ 111,946$ 116,423$ 121,080$ 560,589$

31.51%

COMPARABLE COMPANY GROUPSALES OF GENERIC PRODUCT

Unit Sales Forecast 750,000$ 780,000$ 811,200$ 843,648$ 877,394$ Price per Unit 2.19 2.19 2.19 2.19 2.19

------------ ------------ ------------ ------------ ------------ Sales Revenue 1,642,500$ 1,708,200$ 1,776,528$ 1,847,589$ 1,921,493$ 8,896,310$ Cost of Goods Sold PER UNIT 1.65 1.65 1.65 1.65 1.65 Cost of Goods Sold 1,237,500$ 1,287,000$ 1,338,480$ 1,392,019$ 1,447,700$

------------ ------------ ------------ ------------ ------------ Gross Profit 405,000$ 421,200$ 438,048$ 455,570$ 473,793$ 2,193,611$

24.66%GROSS PROFIT ATTRIBUTABLE TO TRADEMARK 22,500$ 23,400$ 24,336$ 25,309$ 26,322$ Less: Income Taxes 9,000$ 9,360$ 9,734$ 10,124$ 10,529$

------------ ------------ ------------ ------------ ------------After-tax Income Attributable to Trademark 13,500$ 14,040$ 14,602$ 15,186$ 15,793$

Present Value of After-tax Income 12,644$ 11,535$ 10,523$ 9,600$ 8,758$

TOTAL PRESENT VALUE 53,059$

73

TABLE 6.6 VALUATION OF OPERATING PROFIT ADVANTAGE

PLAIN COMPANY, INC. 1 2 3 4 5 TOTALSALES OF GENERIC PRODUCT

Unit Sales Forecast 150,000$ 156,000$ 162,240$ 168,730$ 175,479$ Price per Unit 2.19 2.19 2.19 2.19 2.19

------------ ------------ ------------ ------------ ------------ Sales Revenue 328,500$ 341,640$ 355,306$ 369,518$ 384,299$ 1,779,262$ Cost of Goods Sold PER UNIT 1.50 1.50 1.50 1.50 1.50 Cost of Goods Sold 225,000$ 234,000$ 243,360$ 253,094$ 263,218$

------------ ------------ ------------ ------------ ------------ Gross Profit 103,500$ 107,640$ 111,946$ 116,423$ 121,080$

Selling, General and Administrative Expenses 49,275$ 51,246$ 53,296$ 55,428$ 57,645$ ------------ ------------ ------------ ------------ ------------

Operating Profit 54,225$ 56,394$ 58,650$ 60,996$ 63,436$ 293,700$ Operating Profit Percentage of Sales 16.5% 16.5% 16.5% 16.5% 16.5% 16.5%

COMPARABLE COMPANY GROUPSALES OF GENERIC PRODUCT

Unit Sales Forecast 750,000$ 780,000$ 811,200$ 843,648$ 877,394$ Price per Unit 2.19 2.19 2.19 2.19 2.19

------------ ------------ ------------ ------------ ------------ Sales Revenue 1,642,500$ 1,708,200$ 1,776,528$ 1,847,589$ 1,921,493$ 8,896,310$ Cost of Goods Sold PER UNIT 1.65 1.65 1.65 1.65 1.65 Cost of Goods Sold 1,237,500$ 1,287,000$ 1,338,480$ 1,392,019$ 1,447,700$

------------ ------------ ------------ ------------ ------------ Gross Profit 405,000$ 421,200$ 438,048$ 455,570$ 473,793$

Selling, General and Administrative Expenses 295,650$ 307,476$ 319,775$ 332,566$ 345,869$ ------------ ------------ ------------ ------------ ------------

Operating Profit 109,350$ 113,724$ 118,273$ 123,004$ 127,924$ 592,275$ Operating Profit Percentage of Sales 6.7% 6.7% 6.7% 6.7% 6.7% 6.7%

OPERATING PROFIT ATTRIBUTABLE TO TRADEMARK 32,355$ 33,649$ 34,995$ 36,395$ 37,851$ Less: Income Taxes 12,942$ 13,460$ 13,998$ 14,558$ 15,140$

------------ ------------ ------------ ------------ ------------After-tax Revenue Attributable to Trademark 19,413$ 20,190$ 20,997$ 21,837$ 22,710$

Present Value of After-tax Revenue 18,182$ 16,587$ 15,132$ 13,805$ 12,594$

TOTAL PRESENT VALUE 76,299$

74

TABLE 6.10TRADEMARK VALUATION - MULTIPLE EXPLOITATION SCENARIOS

YEAR 1 YEAR 2 YEAR 3 YEAR 4 YEAR 5 REVERSION TOTALPRIMARY EXPLOITATION Net Cash Flow 1,200$ 1,300$ 1,500$ 1,600$ 1,700$

Present Value of Net Cash Flow 16.0% 1,114$ 1,041$ 1,035$ 952$ 872$ 5,781$ 10,794$

SECONDARY EXPLOITATIONS Similar Product Extensions Net Cash Flow 650$ 700$ 800$ 900$ 950$

Present Value of Net Cash Flow 17.0% 601$ 553$ 540$ 520$ 469$ 2,861$ 5,544$

Dissimilar Product Extensions Net Cash Flow 150$ 250$ 400$ 450$ 500$

Present Value of Net Cash Flow 20.0% 137$ 190$ 254$ 238$ 220$ 1,079$ 2,118$

Licensing Income Net Cash Flow 50$ 60$ 70$ 80$ 90$

Present Value of Net Cash Flow 20.0% 46$ 46$ 44$ 42$ 40$ 194$ 412$

Speculative Extensions Net Cash Flow 100$ 300$ 500$ 800$ 1,200$

Present Value of Net Cash Flow 25.0% 89$ 215$ 286$ 366$ 440$ 1,599$ 2,995$ -------------

TOTAL PRESENT VALUE 21,862$

75

TRADEMARK VALUATION by ALLOCATION of INCOME

ASSET EARNINGSASSET CLASS FMV PERCENT RETURN WEIGHTED PERCENT ALLOCATION

($000) (%) RATE RATE (%) ($000)Monetary Assets 50,000$ 4.55% 7.0% 0.32% 2.47% 3,463$

Tangible Assets 750,000 68.18% 12.0% 8.18% 63.60% 89,046

Other Intangibles 200,000 18.18% 15.0% 2.73% 21.20% 29,682

Trademarks 100,000 9.09% 18.0% 1.64% 12.72% 17,809 --------------- --------------- --------------- --------------- ---------------

Business Enterprise Value 1,100,000$ 100.00% 12.86% 100.00% 140,000$

76

ROYALTIES

THE BURNING QUESTION

77

THE LICENSING TRANSACTION

LICENSORLICENSEE

ROYALTY

78

THE LICENSING TRANSACTION

LICENSORLICENSEE

ROYALTYLICENSOR INCOME

LICENSEE INCOME

A

B

C

79

THE LICENSING TRANSACTION

LICENSORLICENSEE

ROYALTY

LICENSEE INCOME

80

THE LICENSING TRANSACTIONIS CONTROLLED BY THE

ECONOMICS OFTHE LICENSEE’S BUSINESS

81

COST APPROACH ROYALTY

What did it cost to develop the IP ?

Set a royalty that will recoup the cost.

NO !!

82

MARKET APPROACH ROYALTY

MAYBE !!

What royalties have others paid orreceived ?

What is the “industry standard” ?

83

INCOME APPROACH ROYALTY

What is the economic benefit to thelicensee ?

What is our proper share ?

YES !!

84

DISCOUNTED CASH FLOW MODEL - BASE CASE

SALES $10,000 $11,000 $12,000 $14,000 $15,000

COST OF GOODS SOLD 4,000 4,400 4,800 5,600 6,000

GROSS PROFIT 6,000 6,600 7,200 8,400 9,000

OPERATING EXPENSES 3,000 3,300 3,600 4,200 4,500 GENERAL & ADMINISTRATIVE 1,500 1,650 1,800 2,100 2,250

INCOME BEFORE TAXES 1,500 1,650 1,800 2,100 2,250

INCOME TAXES 600 660 720 840 900

NET INCOME 900$ 990$ 1,080$ 1,260$ 1,350$

DEPRECIATION 200 200 200 300 300ADDITIONS TO NWC 0 50 100 200 50ADDITIONS TO PLANT 50 50 150 75 75

NET CASH FLOW $1,050 $1,090 $1,030 $1,285 $1,525

PRESENT VALUE $979 $884 $726 $788 $813TOTAL PRESENT VALUE $4,190

85

DISCOUNTED CASH FLOW MODEL - WITH BENEFIT OF IP

SALES $10,000 $11,000 $12,000 $14,000 $15,000

COST OF GOODS SOLD 3,600 3,960 4,320 5,040 5,400

GROSS PROFIT 6,400 7,040 7,680 8,960 9,600

OPERATING EXPENSES 3,000 3,300 3,600 4,200 4,500 GENERAL & ADMINISTRATIVE 1,500 1,650 1,800 2,100 2,250

INCOME BEFORE TAXES 1,900 2,090 2,280 2,660 2,850

INCOME TAXES 760 836 912 1,064 1,140

NET INCOME 1,140$ 1,254$ 1,368$ 1,596$ 1,710$

DEPRECIATION 200 200 200 300 300ADDITIONS TO NWC 0 50 100 200 50ADDITIONS TO PLANT 50 50 150 75 75

NET CASH FLOW $1,290 $1,354 $1,318 $1,621 $1,885

PRESENT VALUE $1,203 $1,098 $929 $994 $1,005TOTAL PRESENT VALUE $5,229

86

DISCOUNTED CASH FLOW MODEL - WITH ROYALTY PAYMENT

SALES $10,000 $11,000 $12,000 $14,000 $15,000

COST OF GOODS SOLD 3,600 3,960 4,320 5,040 5,400

GROSS PROFIT 6,400 7,040 7,680 8,960 9,600

ROYALTY EXPENSE 4.0% 400 440 480 560 600OPERATING EXPENSES 3,000 3,300 3,600 4,200 4,500 GENERAL & ADMINISTRATIVE 1,500 1,650 1,800 2,100 2,250

INCOME BEFORE TAXES 1,500 1,650 1,800 2,100 2,250

INCOME TAXES 600 660 720 840 900

NET INCOME 900$ 990$ 1,080$ 1,260$ 1,350$

DEPRECIATION 200 200 200 300 300ADDITIONS TO NWC 0 50 100 200 50ADDITIONS TO PLANT 50 50 150 75 75

NET CASH FLOW $1,050 $1,090 $1,030 $1,285 $1,525

PRESENT VALUE $979 $884 $726 $788 $813TOTAL PRESENT VALUE $4,190

87

Allocating Income Among Assets to Calculate a Royalty

ASSET AMOUNT OFVALUE RETURNS RETURN

ASSET CATEGORY ($ 000's) REQUIRED ($ 000's)

NET WORKING CAPITAL 90,000 6.0% 5,400TANGIBLE ASSETS 125,000 9.0% 11,250

INTANGIBLE ASSETS 35,000 14.0% 4,900

INTELLECTUAL PROPERTY 50,000 17.0% 8,500---------------- ---------------- ----------------

TOTAL 300,000 10.0% 30,050

PATENTS 10,000 14.5% 1,450PROPRIETARY TECHNOLOGY 15,000 20.3% 3,050TRADEMARKS 25,000 16.0% 4,000

---------------- ---------------- ----------------50,000 17.0% 8,500

SALES REVENUE (from Figure 4.7) 328,500

INCOME ALLOCABLE TO TRADEMARKS 8,500

INDICATED ROYALTY RATE 2.6%

88

UNIFORM STANDARDS ofPROFESSIONAL APPRAISAL

PRACTICE (“USPAP”)

• Ethical Standards

• Minimum Work Standards

• Client Relationships

• Minimum Reporting Standards

89

VALUATION ENGAGEMENT

• Client Arrangements

• Investigation / Data Gathering

• Analysis

• Report Writing

90

EXPLOITATION

KEEP IT ? SELL IT ?

LICENSE IT ?

ENHANCE IT ?

91

EVALUATING EXPLOITATIONS

• Commercialize• Enhance• Sell• License out• License in comp.• Joint venture

0

5

10

15

20

25

30

35

40

45