brian buss: valuing ip using an apportionment model bvr october 2015

Valuing IP Using an Apportionment Model

Brian BussNevium Intellectual Property Solutions

www.nevium.com

Business Valuation ResourcesOctober 20, 2015

Today’s CE Codes: 1293, 4057, 7728

2© 2015 Business Valuation Resources, [email protected]

Introduction / Contents

To be discussedWhy apportionment should be in the valuation professional’s “Tool-kit” when

evaluating intellectual properties (IP) and intangible assets (IA)

Review of the model we use to analyze, evaluate and value IP and IA in strategic valuation assignments

Benefits and limitations of adding this model to your analysis tool kit


IP ValuationIP Valuation & Analysis - common contexts Contribution of an asset to the economic benefits achieved by a business involved in a dispute Valuation of assets that would be transferred to, or used by, another business entity Strategic understanding of the IP, IA, Assets and Resources being used by a business

This presentation focuses on contribution of IP to the IP’s current user

DefinitionsIntellectual Property (“IP”)

Legally protected non-tangible properties: Patents, Trademarks, Copyrights

Intangibles (“IA”)

Non-physical assets owned by a business: relationships, trade secrets, processes & procedures, etc.

Assets Tangible assets, IP and IA Resources The Assets and other capabilities or qualities that could contribute to a business

Apportionment Process quantifying the portion of economic benefits derived from use of an Asset or Resource

Allocation Process of assigning expenses incurred by the entire organization to a specific product or service


IP Valuation

Income Approach: Value of any asset or resource is based on the present value of future economic benefits that can be generated from ownership of that asset.

Valuation Approaches & Apportionment

Need to identify and quantify the specific contribution to Economic Benefits made by the IP or IA.

The model shown in this presentation is an income approach, however . . .

In both Cost and Market, need to focus on the Asset or Resource relative to other assets and resources used by the business.

Cost Approach: Value is based on cost and effort to replace / replicate an Asset or Resource

Valuation ContextIf asset isn’t providing a benefit, then there’s no value in its current context

Market Approach: Value based on similar transactions


IP Valuation & Apportionment

Apportionment in Valuation Literature

In determining the value that a patented technology contributes to end products, the analyst must apportion out value associated with contributions made by tangible assets as well as other intangibles. Some of the intangibles that would need to be apportioned out of the analysis include know-how, trade secrets, trademarks, and reputation.

The Four Elements Used in Determining a Patent’s ValueQuickreadbuzz.com; June 30, 2011; NACVA

363 Search Results in BVLibrarySearch for “Apportionment” 10/1/15

Guide to Intellectual Property ValuationBV Resources (p322, Chapter 11)

The contributions that the licensor and licensee bring to the licensing transaction should have a material impact on the magnitude of any royalty rate determination. The licensor naturally owns the IP rights; however, the licensee brings value to the table, usually through execution prowess (e.g., manufacturing capability or expertise), sales and distribution channels, or working capital. Each of these components has value and is an important determinant in ultimate market success. If one party contributes more to the overall success, then that party should reap more of the rewards. Thus, the valuation analyst must identify what both the licensor and licensee bring to the transaction in order to apportion the contributions in an equitable manner.

When prospective financial information is used to determine the fair value of a subject intangible asset it might include contributions from a number of different assets working together as a group. To arrive at the excess earnings solely attributable to the subject intangible asset, the valuation specialist needs to identify other assets that are contributing to the generation of the asset group’s earnings.

Best Practices for Valuations in Financial Reporting: Intangible Asset Working Group – Contributory AssetsThe Appraisal Foundation, May 31, 2010


Example from a Recent Analysis


IP typically requires additional resources in order to generate profits. A patent owner requires physical assets such as machinery and manufacturing facilities, human capital, and other intangible assets in order to manufacture, distribute market and sell products that incorporate the patented innovation. A copyright protects the expression of an idea but not the actual product or process that is provided to customers. In other words, a copyright-protected marketing brochure is rarely the final product sold to customers, and therefore does not contribute 100% of the profits achieved from the sale of products featured in the brochure. Therefore a calculation based on 100% of the achieved profits would overestimate the contribution of IP to the product or service provided by the allegedly infringing user of the IP.


Apportionment in Statute and Precedent

In the Georgia-Pacific case, the district court identified a list of factors that may be relevant to determining a reasonable royalty for patent infringement damages, including factor 13, which provides that courts should consider “[t]he portion of the realizable profit that should be credited to the invention as distinguished from non-patented elements, the manufacturing process, business risks, or significant features or improvements added by the infringer” when apportioning damages. (Comment on the Georgia-Pacific case from: Geradin & Layne-Farrar, Patent Value Apportionment Rules for Complex, Multi-Patent Products; February 2011)


There are many more similar comments . . . Apportionment must be considered – the challenge is how to do the calculations

TILEC Discussion PaperDiscussion of Georgia Pacific Factors

Unless you find that a portion of the profit from the [use] [sale] of a [product] [work] containing or using the copyrighted work is attributable to factors other than use of the copyrighted work, all of the profit is to be attributed to the infringement. The defendant has the burden of proving the [portion] [percentage] of the profit, if any, attributable to factors other than [copying] [infringing] the copyrighted work. In establishing the infringer’s profits, the copyright owner is required to present proof only of the infringer’s gross revenue, and the infringer is required to prove his or her deductible expenses and the elements of profit attributable to factors other than the copyrighted work.

17 U.S.C. § 504(b)


IP Valuation

Business Value > Value of IP Assets owned by the Business

Apportionment: Identify the portion of future benefits derived from use of the IP Assets

Present Value of Expected

Future Benefits

Value of Business

Intangible Assets

Tangible Assets

Copyrights

Patents

Intangible Assets

Tangible Assets

Trademark

IP depends on other assets and resources in order to generate economic benefits


IP Valuation

The Model Described in this Presentation was built to isolate each product offered by the Business, and

Assign Apportionment Rates based on the Product’s dependence on the Business’ Assets and Resources

Same concept, different imageProducts generate profit through use of a Company’s IP and other Resources

TheIntellectual

Property& Products Profits

People Resources

Tangible Assets / Natural Resources

=

Capital Resources

Other IP & IA


Questions?

Review

Looking for an analytical tool to help our strategic clients better understand the contribution of their IP to their own business

Encountering the term “Apportionment” more and more

How we use the term “Apportionment”: Identify the portion of future benefits derived from use of the IP Assets

Key construct: IP depends on other assets and resources in order to generate economic benefits

Today’s CE Codes: 1293, 4057, 7728


The IP Valuation Model

The Model is a procedure for . . .

Identifying all assets used to generate economic benefit at a business

Considers the value of all Assets & Resources used by the business

Considers the different level of performance achieved by the Company’s different products

Identifies and apportions benefits provided by the Assets & Resources, including benefits provided by IP Assets

Values IP in the context of its use by the business


IP Valuation Model & Process

1 Value total operations of the Business

Perform a business valuationForecast future economic benefits, discount to present valueValue of the Business = value of 100% of assets and resources used by the Business

2 Forecast each source of revenue

Most businesses are a portfolio of revenue and benefit-generating products and servicesGroup and bundle similar revenue sources

3 Identify Key Assets and Resources

What assets and resources are used by the Business?Identify and group: Tangibles, IP, IA and other Resources

4 Develop Apportionment Rates

Which assets or resources are most important / least important to each revenue sourceWhich products/services rely on each identified asset

5 Value the Forecast Apportion Rates

Total the forecast period rents calculated for each Asset or ResourceDiscount each Assets’ total rents to a present value

6 Check results Apply the concept of equal values: Total value of Business = Total Value of all Revenue Sources = Total Value of Rents for all Assets and Resources


IP Valuation Apportionment Model

Business Valuation• Known valuation; or• DCF

DCF would be based on “Build-up” product

level forecasts

Product Forecasts• Sales• Earnings • Invested Capital

Cash Flows

For each source of revenue at the

Company

Apportionment Rates• Analysis of how each

Product depends on the Assets and Resources

• Valuation is the Present Value of Apportionment Charges

Concept of Equal Values

Value of Business =

Value of Products=

Value of all Assets & Resources

Also, weighted average rates of return are equal

Assumptions BookRevenue growth (Product / Company)

Earnings Margins

Working Capital and Capital Expenditure

Equal Value DashboardApportionment Rates: Each Product’s dependence on Assets

and Resources

Required Rates of Return: for each Product, and each Asset and Resource

Model Framework

One Model to Value the Business, Value each Product, and Value all Assets & Resources (including IP)


Steps 1 & 2Value of the Business

Business ValuationKnown valuation, or based on a DCF

• Assumes a going concern

• Forecast through the known business cycle / evolution to next generation of products

• Include a perpetual value

• Build-up forecast based on revenue and earnings forecast for each product

Building the ModelBuild an assumptions book - 1 worksheet to drive forecast inputs, including:

• Price• Unit Volume• COGS & margins• Operating Expenses & margins• Capital Expenditures• Working Capital ratios

Reconcile the Business Valuation• Market and Cost Approaches• Comparable company performance ratios• Comparable company trading and acquisition

multiples• Reasonableness tests

Products don’t last forever, assume business will continue


Steps 1 & 2Identify and Forecast Each Source of Revenue

Product ForecastsMost businesses generate revenue from a portfolio of products & services

• Products• Services• Contracts / Licenses• Non-core activities

Building the ModelDifferent product types have different gross profit margins and different contributions to overall profitability

Identifying & Grouping Revenue Sources• Financial reports• Discussions with Management• Promotional and marketing materials

Often can group similar products:• Similar margins• Similar function / target market• Rely on the same assets & resources

If possible, work with Management to develop . . . • List and grouping of products / services /

revenue sources• Forecast for existing, in-development and future

products• Isolating expenses (non-capitalized) related to

IP and IA development, registration and maintenance

• Length of product life cycle and use of perpetual values

• Treatment of non-core activities

Consider the typical product life cycle


Steps 1 & 2Sample: Business Valuation and Revenue Forecast Worksheets

Business ValuationY0 Y1 Y2 Y3 Y4 Y5 Perpetual

Total Net Revenue 1,000.0 1,112.5 1,205.3 1,289.9 1,331.2 1,375.1

Gross Profit 795.5 904.0 967.4 931.9 962.6

Operating Expenses 508.9 555.4 602.3 626.6 652.2IP & IA Expenses 20.0 20.4 20.8 21.2 21.6 22.1

Operating Income 266.2 327.8 343.9 283.6 288.2

Tax Expense 106.5 131.1 137.6 113.4 115.3

Net Income 159.7 196.7 206.4 170.2 172.9

Cash Flow AdjustmentsWC Balance 95.0 111.3 120.5 129.0 133.1 137.5Change in WC (16.3) (9.3) (8.5) (4.1) (4.4)Capital Expenditure (55.6) (60.3) (64.5) (66.6) (68.8)

Invested Capital Cash Flow 87.9 127.1 133.4 99.5 99.8 856.6Discount Period 0.5 1.5 2.5 3.5 4.5 5.0Discount Factor 15% 0.93 0.81 0.71 0.61 0.53 0.50Discounted Forecast CF 81.9 103.1 94.1 61.0 53.2 425.9Valuation 819.2

Product AY0 Y1 Y2 Y3 Y4 Y5

Net Revenue 600.0 690.0 759.0 834.9 876.6 920.5Gross Profit 552.0 569.3 626.2 613.7 644.3Operating Expense 414.0 455.4 500.9 526.0 552.3IP & IA Expenses 10.2 10.4 10.6 10.8 11.0Operating Income 127.8 103.4 114.6 76.8 81.0

Tax Expense 51.1 41.4 45.8 30.7 32.4Contribution to Operating Income 76.7 62.1 68.8 46.1 48.6

Working Capital Balance 42.8 50.1 54.2 58.0 59.9 61.9Change in Working Capital (7.3) (4.2) (3.8) (1.9) (2.0)CapEx (38.9) (42.2) (45.1) (46.6) (48.1)Add: After-tax IP Expenses 6.1 6.2 6.4 6.5 6.6Product Cash Flow 36.6 21.9 26.2 4.1 5.1


Step 3Identify Key Assets and Resources

Building the ModelIdentifying & Grouping Key Assets & Resources

• Discussions with Management• Company’s promotional and marketing materials• Comparison to peers: Competitive advantages; Points of

differentiation; Margins & performance ratios

Identify & Group Assets & ResourcesTechnology: patents, trade secrets, designs,

processes

Marketing: TMs, logos, brands, signage, slogans, reputation, websites & domain names

Physical: location, real estate, buildings, equipment, logistics

Content: databases, customer lists, copyrights, manuals, publications, test results

Relationship: suppliers, customers, distributors, work-force

Working Capital: A/R, inventory, A/P

Identifying & Grouping Key Assets & Resources

• Company language analysis: Reliance on Service, Volume, Location

• Customer surveys• Website traffic data


Step 4Develop & Apply Apportionment Rates

Apportion the Forecast Cash Flow Calculated for Each Product

• 100% of the Earnings / Cash Flow / Economic Benefits to one of the identified Assets & Resources

• Apportionment Rate is the amount of Product earnings derived specifically from each Asset or Resource

• Apply a consistent, qualitative analysis

• Relies on analyst’s judgement and opinion – requiring clear communication of the support and rationale

Building the ModelDeveloping Apportionment Rates

• Assess relative importance to each Product to estimate an apportionment rate

• Use the Equal Value Dashboard to organize rates for each Asset type and Product

Apportionment Math

Each Revenue Source Relies the Organization’s Assets and Resources in a Unique Way

Build a logic/rationale worksheet that . . . • Describes each Asset & Resource group

• Lists observations about Asset’s use and importance to each Product

• Cite source documents and reference materials


Step 4Sample: Apportionment Rate Support Worksheet

Description, Observations & Opinions

Description of Identified Asset

Observations SourceDoc 2d

_____.com

AdWords - Schedule XX

Schedule __ and Schedule __

USPTO (Doc 6a)

Apportionment FactorsRevenue/Earnings Source Apportionment Observations Source RateK&T MARCOM 15%CRO Cabinets 15%

Cabinets (Home) Complementary products. Use other brand elements in addition to Subject Marks MARCOM 10%

Anesthesia Cabinet Complementary products. Use other brand elements in addition to Subject Marks MARCOM 10%

ADC Implants Dental Cabinet follow-on products. Use other brand elements Management 5%

ADC Implants Hospital Cabinet follow-on products. Use other brand elements Management 5%

Data Mining No relation: different branding and service-oriented marketing Management 0%

Relative RiskObservation Implication

LowerLowerLower

Required Rate of Return 17.5%

Company's core products. Subject Marks are the brand name used with these products

TM assets typically have similar or lower required rates of return compared to the corporation's WACCTM assets have the longest legal l ives of IP assetsNo legal issues or disputes related to the names and marks

The term and name related to the firm's line of ____________ products. These are the Company's core products.

Design and word mark are registered at the USPTONamed used to identify ______ designed and manufactured by COMPANY90 average monthly Google searches in the USA (higher than other brand assets at the Company)

Loosly similar marks exist such as "_______Systems"Margin achieved by products using the Subject Marks > other products. Margins on Complementary products are higher


Step 5Value the Forecast Apportionment Rates

To calculate a value for each Asset / Resource . . .• Sum the calculated Apportionment Charges• Deduct asset-specific expenses• Discount calculated Benefits to present value using the

required rate of return for each asset

Equal Valuations Require Equal Weighted Average Returns


Steps 4 & 5Sample: Apportionment Charges & Product Valuation

Product BY0 Y1 Y2 Y3 Y4 Y5 Perpetual

Product Cash Flow 34.4 89.0 89.0 79.0 76.9

Apportionment ChargesWorking Capital 2% 0.7 1.7 1.7 1.6 1.5PP&E 5% 1.7 4.5 4.4 3.9 3.8Company Marks 12% 4.1 10.7 10.7 9.5 9.2Patented Technologies 10% 3.4 8.9 8.9 7.9 7.7Marketing Content 25% 8.6 22.3 22.2 19.7 19.2Trade Secrets 5% 1.7 4.5 4.4 3.9 3.8Relations with Customers 15% 5.2 13.4 13.3 11.8 11.5Relations with Suppliers 10% 3.4 8.9 8.9 7.9 7.7Workforce 16% 5.5 14.3 14.3 12.7 12.3Total Charges 34.4 89.0 89.0 79.0 76.9

Less: After-tax IP/IA Expense 3.7 3.7 3.8 3.9 4.0Cash Flow After IP Costs 30.7 85.3 85.1 75.1 72.9 683.0

0.5 1.5 2.5 3.5 4.5 5.0Present Value Factor 14% 0.94 0.82 0.72 0.63 0.55 0.52Discounted Future Value 28.8 70.1 61.4 47.5 40.4 354.7Valuation 602.8


Steps 4 & 5Sample: Sample Asset / Resource Valuation Calculations

Company MarksY1 Y2 Y3 Y4 Y5 Perpetual

Apportionment Charges from:Product A 2.9 1.8 2.1 0.3 0.4Product B 4.1 10.7 10.7 9.5 9.2Service C 8.8 8.6 9.3 8.8 9.3

Total Charges to Asset 15.8 21.0 22.1 18.6 18.9

Directly Related Expenses After-Tax 4.3 4.4 4.5 4.5 4.6Economic Benefit 11.5 16.7 17.6 14.1 14.3 163.7

0.5 1.5 2.5 3.5 4.5 5.0Present Value Factor 12% 0.9 0.8 0.8 0.7 0.6 0.6Discounted Benefit 10.9 14.1 13.3 9.5 8.6 92.9Valuation 149.1

Patented TechnologiesY1 Y2 Y3 Y4 Y5 Perpetual

Apportionment Charges from:Product A 9.1 5.5 6.5 1.0 1.3 Product B 3.4 8.9 8.9 7.9 7.7 Service C 8.8 8.6 9.3 8.8 9.3

Total Charges to Asset 21.3 23.0 24.7 17.7 18.3

Directly Related Expenses After-Tax 3.7 3.7 3.8 3.9 4.0 Economic Benefit 17.7 19.2 20.9 13.8 14.3 133.9

0.5 1.5 2.5 3.5 4.5 5.0 Present Value Factor 14% 0.9 0.8 0.7 0.6 0.6 0.5 Discounted Benefit 16.5 15.8 15.1 8.7 7.9 69.5 Valuation 133.6


Step 6Check Results

Apply Concept of Equal Values• Value of Business = Value of All Revenue Sources = Value

of All Assets & Resources

• WACC = WARA = WARP (returns for Product valuations)

• “Unidentified” is the value of the Business less sum of valuations of all identified assets & resources

Check for 100% Allocations• Each revenue source must have 100% apportionment

across assets

• All expenses & charges must be allocated 100% across products

Reasonableness Checks• Fit with Company Language Analysis and Key

Competitive Advantages• Rationale for each required rate of return

input• Would / Could an outside party purchase at

the calculated price?• Specific Asset Valuation Approaches:

• RfR• Workforce• Customer Relationships• Excess Earnings

Value of Business

Operations

Value of Products

Value of Assets &

Resources Intangibles

Tangibles

Intellectual Properties

= ==


Step 6Sample: Equal Value Dashboard

Value of Business Value of Assets & Resources Value of Revenue Sources

Asset / ResourceRate of Return Valuation

Value Contribution

Rate of Return Valuation

Value Contribution

Working Capital 5% 100 12% Product A 20% 46.7 6%PP&E 8% 105 13% Product B 14% 602.8 74%Company Marks 12% 149 18% Service C 19% 169.0 21%Patented Technologies 14% 134 16%Marketing Content 17% 74 9%Trade Secrets 20% 11 1%Relations with Customers 21% 100 12%Relations with Suppliers 20% 49 6%Workforce 23% 52 6%Unidentified / Synergies 29% 45 6%

WACC 15% Weighted Return 15% Weighted Return 15%Business Value 819 Total Value 819 Total Value 819

Apportionment Rates IP Expense AllocationAsset / Resource Product A Product B Service C Asset / Resource IP Expense

Working Capital 2% 2% 2%PP&E 5% 5% 5%Company Marks 8% 12% 30% Company Marks 35%Patented Technologies 25% 10% 30% Patented Technologies 30%Marketing Content 20% 25% 2% Marketing Content 10%Trade Secrets 10% 5% 2% Trade Secrets 25%Relations with Customers 10% 15% 20%Relations with Suppliers 5% 10% 2%Workforce 15% 16% 7%

100% 100% 100% 100%


Using the Model

Limitations• Multiple DCF calculations introduce many opportunities

for mechanical error

• Analyst must develop and support rationale for the Apportionment Rates

• More difficult to employ without access to company’s Management

Advantages• Yields an in depth analysis of

Company’s operations

• Identifies out-performing and under-performing product lines

• Often identifies under utilized assets and resources

• Valuations based on current use of the IP (rather than a transaction where the use may be somewhat similar)


Review

The model we’ve presented is best suited for use with strategic clients when addressing issues of business valuation, contribution of products and the Company’s IP assets

The process of forecasting product performance and then apportioning the economic benefit yielded by each product to Assets and Resources helps managers and owners identify strengths, weaknesses and opportunities.

The Model requires a qualitative assessment of the contribution of IP to each product group – this step relies on sound judgement and review of the available information

The Model has helped our clients better understand their businesses, but has its limits and may not be appropriate in all valuation contexts.

Questions?


Nevium Intellectual Property SolutionsNevium provides solutions for managing and maximizing the value of intellectual properties and intangible assets. We work with entrepreneurs, corporations, legal counsel, for-profit and not-for-profit IP owners to value and maximize the value of trademarks, copyrights, patents, brands, domain names, endorsements, and other intangible assets.

Nevium’s principals have worked with a diverse range of large and small organizations to build, identify and monetize their intellectual property assets. From brand licensing and endorsement programs, to infringement and mis-use disputes, to valuation and transaction negotiation; we enable organizations to achieve additional benefits from their proprietary assets.

The Firm’s experience includes:

• Valuation of businesses, brands, trademarks, copyrights, celebrity rights, patents, new technologies, endorsements, and other intangible and marketing assets

• Valuation of IP and intangible assets for strategic decisions, transfer pricing, tax planning, litigation support, bankruptcy, due diligence, and acquisition advisory

• Economic damages calculations and expert testimony in IP-related litigation and infringement disputes

• Developing and executing IP licensing and management strategies

• Revenue model and pricing strategies for IP-based businesses

• Managing business and IP asset transactions for buyers, sellers, licensors and licensees

Today’s CE Codes: 1293, 4057, 7728