the valuation of patent-granted medical devices...
TRANSCRIPT
THE TECHNOLOGY TRANSFER VALUATION OF INTELLECTUAL
PROPERTY: VALUING PATENT-GRANTED MEDICAL DEVICES
TRANSFERRED OUT OF UNIVERSITIES
A Thesis
Presented to the
Department of Business Administration
and the
Faculty of the Graduate College
University of Nebraska
In Partial Fulfillment
of the Requirements for the Degree
Masters of Business Administration
University of Nebraska at Omaha
by
Danielle A. P. Allen
November, 2000
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THESIS ACCEPTANCE
Acceptance for the faculty of the Graduate College, University of Nebraska, in partial fulfillment of the
Requirements for the Masters of Business Administration University of Nebraska at Omaha
Committee
Dr. Michael J. O’Hara ____________________________________ Chair, Supervisory Committee Finance, Banking, and Law Department College of Business Administration Dr. Graham R. Mitenko ____________________________________ Finance, Banking, and Law Department College of Business Administration Dr. Richard G. File ____________________________________ Accounting Department College of Business Administration Date: ___________________________________________
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PREFACE
First and foremost, I would like to thank the members of my thesis
committee, including Dr. O’Hara, Dr. Mitenko, and Dr. File, for all of their
invaluable comments and the time that they spent reading and rereading this
work. To Dr. O’Hara, I whole-heartedly apologize for my tendency toward split
infinitives. You have an incredible amount of patience.
I also would like to thank Dr. DeGeteer at http://medlaunch.com and Dr.
Dick Huston, the Director of the University of Nebraska Medical Center’s
Intellectual Property Office for their comments and other contributions to this
work. In addition, I would like to thank Dr. DeGeeter for allowing me access to
his Technology Pricing Model.
I must thank Dr. Randy Jones for spending precious time with me and
helping me understand the market for MRI coils, and allowing me to use
ScanMed’s financial and marketing information as an example of the
methodology developed in this thesis.
Finally, I would like to thank Gordon McGee, my senior manager at
Ameritrade, for being so understanding and flexible during the time that I spent
creating this thesis.
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ABSTRACT
THE TECHNOLOGY TRANSFER VALUATION OF INTELLECTUAL
PROPERTY: VALUING PATENT-GRANTED MEDICAL DEVICES
TRANSFERRED OUT OF UNIVERSITIES
Danielle A. P. Allen (M.B.A.)
University of Nebraska, 2000
Thesis Committee: Dr. Michael J. O’Hara Dr. Graham R. Mitenko Dr. Richard G. File This thesis explores the necessary functions and process required to
complete a successful technology transfer. The focus is placed on valuing a
university created, patent-granted medical device. The valuation is conducted at
one transaction point, after the device has been patented, but prior to identifying
a specific licensee. The methodology includes the use of a discounted cash flow
analysis and decision tree analysis. The valuation is structured to calculate a
risk-adjusted net present value, according to three distinct probability scenarios
(best-case, most-likely-case, and worst-case). The valuation is designed to be
used by a technology transfer office during the search for a potential licensee, as
well as during the licensor-licensee negotiation phase of the technology transfer.
In order to demonstrate the methodology, a previous medical device
patented by ScanMed is analyzed. ScanMed is a private firm, which operates in
the medical device industry in conjunction with the University of Nebraska
Medical Center. ScanMed is one of UNMC’s technology transfer successes.
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TABLE OF CONTENTS
THE TECHNOLOGY TRANSFER VALUATION OF INTELLECTUAL
PROPERTY: VALUING PATENT-GRANTED MEDICAL DEVICES
TRANSFERRED OUT OF UNIVERSITIES
by Danielle A. P. Allen
THESIS ACCEPTANCE 2
PREFACE 3
ABSTRACT 4
TABLE OF CONTENTS 5
CHAPTER I: INTRODUCTION 11
I.A. What is Technology Transfer? 11 I.A.1. Definition 11 I.A.2. Example 12
I.B. What is Intellectual Property? 13 I.B.1. Patents 13 I.B.2. Trademarks 14 I.B.3. Copyrights 14 I.B.4. Trade Secrets 15
I.C. Who Participates in Technology Transfer? 17 I.C.1. Private buyer 17 I.C.2. Private seller 17 I.C.3. Public buyer 18 I.C.4. Public seller 18
I.D. General Considerations in Technology Transfer 20 I.D.1. Legal 20 I.D.2. Scientific 21 I.D.3. Financial 21
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I.D.4. Marketing 23 I.D.5. Accounting 24 I.D.6. Social 25 I.D.7. Managerial 26
I.E. The Impact of Technology Transfers on the Economy 27 I.E.1. Patent Growth 27 I.E.2. Financial Contributions 28 I.E.3. Social Contributions 28
I.F. The Advantages and Disadvantages of Technology Transfer 29 I.F.1. Advantages 29 I.F.2. Disadvantages 30 I.F.3. Ethical issues 32
I.G. Focus 34
CHAPTER II: LITERATURE REVIEW 35
II.A. The Bayh-Dole Act 35 II.A.1. Prior to the Adoption of the Federal Bayh-Dole Act in 1980 35 II.A.2. Provisions of the Bayh-Dole Act 36 II.A.3. Results of the Bayh-Dole Act 38
II.B. The University Technology Transfer Process 39 II.B.1. General Role of a University Technology Transfer Office 39 II.B.2. Disclosure 41 II.B.3. Evaluation 42 II.B.4. Patent 43 II.B.5. Marketing 43
Figure 1. Percentage Range of Sources 45 II.B.6. Licensing 47 II.B.7. Auditing 48 II.B.8. Distribution of Royalties and other Cash Compensations 49
Figure 2. Stanford’s Distribution of Royalties 50 Figure 3. Harvard’s Distribution of Royalties 50 Figure 4. A Comparison of Stanford and Harvard’s Distribution Policy, when royalties equal $100,000 51
II.B.9. Performance Measures 52
II.C. Variables that Affect the Value of Patents and Licenses 54 II.C.1. Factors of Technology 54 II.C.2. Patents 55
II.C.2.a. Patent Strength and Quality 55
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II.C.2.b. Stage of Development 56 II.C.2.c. Market Size 57 II.C.2.d. Success of Related Technology 58 II.C.2.e. Competition 58 II.C.2.f. Profit Margin 59 II.C.2.g. Remaining Life 59 II.C.2.h. Certainty of Success 60
II.C.3. License 61 II.C.3.a. Cost of Commercialization 61 II.C.3.b. Geographic Territory 62 II.C.3.c. Field of use 62 II.C.3.d. Exclusivity 63 II.C.3.e. Technical Assistance 64 II.C.3.f. Length of Agreement 64 II.C.3.g. Sub-license provisions 65 II.C.3.h. Improvements 66 II.C.3.i. Licensee Risk 66
II.C.4. Unknown Risk 67 II.C.5. Insurance 67
II.D. Valuation Methods 69 II.D.1. What is Value? 69 II.D.2. Market Approach 70 II.D.3. Cost Approach 72 II.D.4. Income Approach 74
II.E. Royalty Rates and other Cash Compensations 76 II.E.1 A Reasonable Rate of Return 76 II.E.2. Calculating a Reasonable Compensation 77 II.E.3. Types of Compensation 78 II.E.4. Alternative Forms of Compensation 82
II.F. Electronic Tools for Valuing Patents 83 II.F.1. Valuate by Martha Luehrmann 83 II.F.2 TOP Index by Dr. Albert S. Rubenstein 84 II.F.3. Technology Pricing Model by Dr. Melvin J. DeGeeter and Mr. Jon C. Outland 85
CHAPTER III: METHODOLOGY 87
III.A. Financial Analysis Tools 87 III.A.I. Technology Pricing Model 87 III.A.2. Decision Tree Analysis 88
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III.B. Discount Rate 91 III.B.1. Standard Discount Rates 91 III.B.2. Proxy of the Industry Return on Equity 92
III.C. Discounted Cash Flow Analysis 94 III.C.1. Required Royalty Rate and other forms of Compensation 94 III.C.2. Sales and Expense Projections 95 III.C.3. Net Present Value 97
III.D. Decision Tree Analysis 98 III.D.1. First Branch – Claims and Field of Use 98 III.D.2. Second Branch – Risk Factors 98
III.D.2.a. Patent Strength and Quality 99 III.D.2.b. Stage of Development 100 III.D.2.c. Market Size 100 III.D.2.d. Remaining Life 101 III.D.2.e. Success of Related Technology 101 III.D.2.f. Competition 102 III.D.2.g. Profit Margin 103 III.D.2.h. Product and Process Liability 104 III.D.2.i. Political, Inflationary, and Economic Risk 104
III.D.3. Third Branch – Best-Case, Most-Likely-Case, and Worst-Case Scenario 105
III.E. Final Net Present Value 107
III.F. Review of Applicable Formulas 108
CHAPTER IV: ANALYSIS 110
IV.A. ScanMed 110 IV.A.1. Medical Device Industry 110 IV.A.2. The Specific ScanMed Medical Device 114
IV.B. Choosing the Appropriate Discount Rate 116 IV.B.1. Proxy of the Industry Return on Equity 116
Figure 5. Medical Supplies Industry Return on Equity – 2000 117 Figure 6. Medical Supplies Industry Return on Equity – 1994 120
IV.C Calculating the Discounted Cash Flows 122 IV.C.1. Required Royalty Rate and other forms of Compensation 122
Figure 7. Royalty Rates for In-Licensing by Industry 124 Figure 8. Royalty Rates for Out-Licensing by Industry 124
IV.C.2. Sales and Expense Projections 126 IV.C.3. Net Present Value 128
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Figure 9. Estimated Sales and Expense Projections 129
IV.D. Decision Tree Analysis 130 IV.D.1. First Branch – Claims and Field of Use 130
IV.D.1.a. Methodology Not Applied 130 IV.D.1.b. Methodology Applied 130
IV.D.2. Second Branch – Risk Factors 131 IV.D.2.a. Methodology Not Applied 131 IV.D.2.b Methodology Applied 132 Figure 10. Decision Tree Analysis 133
IV.D.3. Third Branch – Best-Case, Most-Likely-Case, and Worst-Case Scenarios 134 IV.D.3.a. Methodology Not Applied 134 IV.D.3.b. Methodology Applied 135 Figure 11. Decision Tree Analysis 136
IV.E. End Result and Suggested Decisions 140 IV.E.1. Net Present Value for each Scenario 140 IV.E.2. Calculation 142
CHAPTER V: CONCLUSION 145
V.A Technology Transfer 145
V.B. Valuation Methods 146
V.C. Methodology 148
V.D. Analysis 149
V.E. Final Suggestions 149
V.F. Further Research 150
APPENDICES 152
Appendix A 152 The Constitution of the United States of America 152
Appendix B 154 U.S. Code: Title 15,Commerce and Trade 154
Appendix C 156 U.S. Code: Title 17, Copyrights 156
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Appendix D 158 U.S. Code: Title 35, Patents 158
Appendix E 161 Uniform Trade Secrets Act 161
Appendix F 165 List of Top Patenting Organizations in 1999 165
Appendix G 166 Contact Information 166
Appendix H 168 Patent Abandonment 168
Appendix I 169 The Time Value of Money 169
Appendix J 170 The Formula used to Value a Patent According to Perchorowicz (1995) 170
Appendix K 171 Discounted Cash Flow Analysis 171
Appendix L 172 Weighted Average Cost of Capital 172
Appendix M 173 The 25 Percent “Rule of Thumb” to Determine a Royalty Rate 173
ACRONYMS 174
BIBLIOGRAPHY 176
Law 176
Books 177
Journals 179
Internet 181
Newspapers, Monographs, and Interviews 185
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CHAPTER I: INTRODUCTION
I.A. What is Technology Transfer?
Technology transfer has become a prominent business function in the last
20 years. Technology transfer has a wide array of applications and can be used
in virtually all business organizations. As the number and size of knowledge-
based economies continues to grow, and the global market’s ability and
willingness to trade knowledge increases, it is not coincidence that the number of
technology transfers also is growing at a fast pace. More and more firms are
using intellectual property not only to create a strategic advantage, but also to
actually create a barrier to entry by competitors (Parr, 1996).
I.A.1. Definition
Technology transfer is the formal process of transferring ownership or the
right to use a discovery or innovation that has been created or acquired by one
party, to another party (Survey – Q&A About Technology Transfer, AUTM).
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I.A.2. Example
Technology transfer can be accomplished in any number of ways. For
example, a university has developed and patented a new medical device and
seeks to market this new technology. By working with an outside firm, the
university has created a licensing agreement, which gives the firm the right to
use or commercialize the device under the terms of the license. In return, the
university will receive a mutually agreed upon cash or cash-equivalent
compensation. The scope of this thesis will involve the valuation of a patented
medical device by the university as it enters licensing negotiations, as well as a
financial analysis of the transaction.
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I.B. What is Intellectual Property?
There are four basic forms of intellectual property: patents, copyrights,
trademarks, and trade secrets.1 It is extremely important to determine the type of
intellectual property a firm possesses, as the intellectual property’s field of use
and available protection will vary accordingly.
I.B.1. Patents
Patents are created by the U.S. federal government, and can be further
categorized as: utility patents2, design patents3, and plant patents.4 This thesis
will focus on the most common of these three types of patent, that is, a utility
patent. All patents are designed to reward inventors by giving, for a specific
number of years, exclusive rights to the owner of the patent and thus preventing
the public from exploiting the patented technology. In order to qualify as a
patent, the technology must satisfy a statutory definition5, which includes the
requirements of useful, novel, and non-obvious.
1 Intellectual property descriptions are limited to U.S. domestic law. Foreign law definitions of each type of intellectual property may vary in material respects. Foreign law is often similar to U.S. domestic law, in that patent and copyrights almost always are issues for the national governments, while trademarks and trade secrets often are subject to shared jurisdiction by the more local governments and the national government. 2 A utility patent is focused on the application and functionality of a technology. 3 A design patent is focused on the appearance of a technology rather than the functional aspects of the technology. 4 A plant patent is focused on asexual plant reproduction innovations. 5 35 U.S.C. Sections 101 – 103. See Appendix D.
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I.B.2. Trademarks
A trademark identifies, for consumers, a unique source of a good or
service6. Trademarks are created and regulated at both the U.S. State and
federal levels. Marks can be categorized as generic, descriptive, suggestive, or
arbitrary. Generic marks are not protected and arbitrary marks receive the
greatest protection. Trademarks are designed to protect consumers from
reasonably confusingly similar marks identifying different sources of similar
goods or services. A trademark, which is generic or is descriptive of a product,
service, geographic location, or an industry, would not be eligible for federal
registration and protection.7
I.B.3. Copyrights
Copyrights, like patents, are created and regulated by the U.S. federal
government. Copyrights are designed to protect various forms of expression
from being duplicated or distributed without authorization from the copyright
holder. In order to be eligible for a copyright, the work must be original and it
must be fixed or documented in some form.8
6 This thesis will use the term trademark to indicate both trademarks and service marks. In fact, trademarks on products are more easily defined and receive more protection than service marks on services. 7 15 U.S.C. Section 1052. See Appendix B. 8 17 U.S.C. Section 102. See Appendix C.
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I.B.4. Trade Secrets
Trade secrets are the fourth general form of intellectual property. A trade
secrets is defined by the Uniform Trade Secrets Act9 as:
“Trade secret means information, including, but not limited to a formula, pattern, compilation, program, device, method, technique, or process that:
i) Derives independent economic value, actual or potential,
from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and
ii) Is the subject of efforts that are reasonable under the
circumstances to maintain secrecy.”
Information protected by trade secret may or may not be eligible for the
copyright, trademark, or patent protection depending upon whether the
information in question satisfies the requirements of those other laws.10 Trade
secrets are primarily created and regulated at the State level.11 There is no
federal civil cause of action in trade secret law (Hill, 1999). In order to qualify for
protection, the owner of the trade secret must take reasonable steps to maintain
9 The Uniform Trade Secrets Act (UTSA) is a model legislation drafted by the National Conference of Commissioners on Uniform State Laws. See Appendix E. Note that devices are included in the definition. 10 For example, the Walt Disney Corporation’s (NYSE: DIS, http://www.disney.go.com) Mickey Mouse could be protected by overlapping protections. The Mouse’s head and ears silhouette are protected by trademark as well as copyrighted. In addition, the three-dimensional mouse hat can be protected by a design patent. Finally, there can be trade secrets involved in how to make an animal appear friendly and happy when in real life it often generates fear and avoidance. 11The U.S. federal government is a government of powers granted in the U.S. Constitution. The Constitution grants the federal government the power to promote science and the useful arts – by – exclusive rights for limited times. Trade secrets are neither exclusive nor limited in duration. Thus, the federal government has very limited authority (e.g., national security, and foreign commerce rather than interstate commerce) over trade secrets. U.S. Constitution, Article I, Section 8, clause 3, and clause 8. See Appendix A.
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secrecy (DeGeeter, 1999). What is “reasonable,” increases with the anticipated
value of the trade secret. Prior to applying for and receiving a patent, many
forms of technological innovation are first protected as trade secrets. Since trade
secret protection is broader (but weaker) than patent protection, even after a
patent is awarded, the owner of the technology may still rely on trade secret
protection for those portions of the technology that fall outside the bounds of
patent protection.
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I.C. Who Participates in Technology Transfer?
In general, technology transfer occurs between two or more of four
parties. The four parties are public versus private and seller versus buyer.12
I.C.1. Private buyer
First, private organizations such as corporations may transfer technology
into the firm to enhance the firm’s business structure. For example, the goal may
be to use the new technology to enhance an existing product or service, or to
commercialize the new technology. The cost of research and design, timing, and
patent issues may make technology transfer into the firm more attractive than
attempting to reinvent the wheel internally.
I.C.2. Private seller
Second, private organizations may transfer technology out of the firm to
other parties. In this scenario, the firm attempts to realize the greatest profit by
transferring the technology out to another organization, rather than attempting to
independently exploit the technology internally. For example, a firm may own
patented rights, which do not coincide with the organization’s business strategy,
or the firm may not possess the necessary assets, such as cash or
complementary technologies, to bring the technology to market.
12 For the purposes of this thesis, all entities, including private firms and public institutions will be referred to as “firms.”
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I.C.3. Public buyer
Third, a public institution such as a university or a medical center may
choose to transfer technology into the institution. In a recent discussion on
Techno-L13, a university staff member explained how the university’s technology
transfer officials were attempting to transfer technology into the university in
order to further its research agenda as well as develop the technology (“Valuing
Unrealized Patents”, September 14, 2000).
I.C.4. Public seller
Lastly, public institutions may transfer technology out. This has become
increasingly popular over the last twenty years, since the Bayh-Dole Act was
enacted in 1980. As university technology costs have increased faster than
inflation and university revenues have not increased as fast as inflation,
universities confront significant budget constraints. As these budget constraints
have increased, technology transfers out of the university also have been sought
out and used as a critical new source of revenue. Universities use federal grants
and research funds for the academic enterprise. Thus the university may not be
the sole owner of the resulting new technologies, especially for some of the best
technologies developed at the university. Typically, universities lack the financial
and strategic assets for commercialization of their new technologies. New
13 Techno_L is an Internet list service primarily used by technology transfer professionals. Subscriptions are available online at http://www.uventures.com.
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university technologies often are transferred out to private firms, which are
capable and focused toward commercialization, and who can then transfer back
into the university much needed cash or other forms of research support.
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I.D. General Considerations in Technology Transfer
In order to be successful, technology transfer requires the application of a
number of broad business and science skills. The general process of technology
transfer incorporates law, science, finance, management, marketing, accounting,
and, just as invariably, social considerations.
I.D.1. Legal
Legal consultation is necessary in order to choose between available
protections based upon evaluation of the appropriateness and relative strength of
those legal protections, of a technology. Often the key question is patentability of
a technology. Legal consultation is required to obtain, maintain, and enforce the
various protections that are afforded to a technology, as well as ensure
compliance with the additional legal requirements of regulatory bodies such as
the FDA.14 The FDA has jurisdiction over the medical devices arena, and the
FDA is responsible for assuring the safety of such devices15 (Center for Devices
and Radiological Health, http://www.fda.gov/cdrh/index.html).
14 21 U.S.C. 321 et seq.; 21 C.F.R. 1 et seq. The Food and Drug Administration is responsible for the safety and sometimes effectiveness of food, drug, and cosmetic products. The Center for Devices and Radiological Health (a division of the FDA) is responsible for providing a reasonable assurance of the safety of medical devices. Medical devices do not need a finding of “effective” by the CDRH prior to lawful sale. The managed care industry may insist upon effectiveness judged from the perspective of benefits exceed costs, however. 15 Devices are categorized as Class I, II, or III. Class I devices include low risk items such as bandages, and can be marketed immediately. Class II devices include devices such as syringes, or blood pressure monitors, and require the commercializing firm to file a 510k form, 90 days prior to marketing the product. Class III devices include life-saving or life-supporting devices such as stents. Class III devices must receive premarket authorization (PMA), which generally takes 180 days (Sutton, 2000).
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In addition to seeking legal counsel at the creation of governmental
protection for intellectual property, it also is critical to seek legal counsel when
creating private protection in a transfer agreement. Note that patents are one of
the few areas that attorneys are permitted to claim a specialization. This is due
to the separate federal licensure by the Patent and Trademark Office (PTO) in
addition to the State licensure. PTO licensure of Patent Agents16 is based on the
scientific knowledge required during a patent process, such as the initial patent
search and review of prior art.17
I.D.2. Scientific
A new technology also should undergo a review of its scientific merit, prior
to incurring all of the expenses of the patent process. A scientific review is
multifaceted. First, is the new technology “good” science, or are its results
supportable by known science? Second, how new is this new technology?
Patent law, particularly, sets a high threshold of non-obviousness. A well done
scientific review should eliminate the possibility of proceeding with a technology
that lacks the necessary scientific or legal proof, does not follow generally
accepted research standards, or is an obvious invention in that field.
I.D.3. Financial
16 A patent attorney is a PTO licensed Patent Agent who also is licensed by a State or the District of Columbia as an attorney to practice law. 17 “Prior art” is any previous work, by the inventor or any other person, that has been conducted in the patent’s area of focus.
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At the juncture of technology transfer a new set of goals and
consequences are added to a scientific discovery. Although the starting point is
scientifically based, the end result of any technology transfer is the actual
business transaction. Therefore, business knowledge is equally important. An
initial financial analysis should be conducted prior to the patent process in order
to determine the probability of recovering the cost of patenting the technology.
This should be a general Go-No Go decision. The structure of this analysis will
not change substantially at later stages of the technology transfer process.
However, vastly different valuations are possible, even likely, at later stages as
new information is added to the same analysis structure. Once the Go decision
has been made to patent the technology and prior to the actual transfer
transaction, the patent should be valued again in order to equip the transfer out
firm with new information that will be vital during negotiation. Lastly, a financial
analysis will be necessary to evaluate the time line of cash flows, such as royalty,
up front, and milestone payments that may be made under the agreement.
At subsequent transaction points, new financial valuations will need to be
completed, but those are beyond the scope of this thesis. This thesis will focus
on one transaction point, at the post-Go and post-patent, but pre-license
negotiation transaction point in the technology transfer process.
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I.D.4. Marketing
As industries involved in biotechnology continue to gain public interest, the
concepts behind old clichés such as “It’s not what you know, but who you know.”
and “Sell the sizzle, not the steak.” are becoming increasingly important. In order
to maximize the benefits of the transaction, the university must seek out the most
strategic partner available to the university. The university must have a captive
audience to present the technology to and this requires building and maintaining
relationships with potential buyers, licensees, or partners. The manner, in which
the patent is presented to the potential buyer, licensee, or partner, is an equally
important step in the marketing process. Often, this area is overlooked, but
should receive the same level of attention as other steps in the technology
transfer process. Ideally, the inventor will be able to and inclined to play a crucial
role in the presentation.
Finally, the firm must decide which type of commercialization vehicle is
most beneficial. Some of the transfer alternatives include: joint venture, license,
and sale. Other alternatives include the use of bailment18 (Simpson, 1998),
18 Bailment is used to transfer possession, but not ownership, of a physical asset or property. Since intellectual property is intangible property, by the narrow definition of the law, IP can not be bailed. Legal relationships equivalent to bailment can be created by a licensing contract for IP, however. Bailment is an ideal alternative in scenarios where the intellectual property is not eligible for, or is in the process of patent protection, or the patent process is not a feasible alternative due to the speed of industry developments and the length of time required to patent a technology.
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options19, pay-per-use arrangements20 (Johnson, Nirenberg, 1999), and the
incubator approach21 (Thorner, 1998). However, this list is not exhaustive.
I.D.5. Accounting
Regardless of whether a firm has one patent or possesses a portfolio of
patents on related technologies, accounting issues also must be addressed. An
example of such a firm is IBM,22 which was ranked as the top patenting
organization in both 1998 and 199923 (List of Top Patenting Organizations, U.S.
Patent Offices). The accounting valuation is dependent upon whether the patent
is developed internally or purchased. As a buyer, a firm would use the
purchasing price as the patent’s value. If the patent is developed internally, the
accounting valuation can be much more ambiguous. Potentially, a firm could
reap considerable tax benefits24 from the patent portfolio it possesses. However,
19 An “option” is a contract that guarantees one party a legally enforceable choice in the future. Options generally are offered to an external party on a short-term basis and often are bundled with the right to license the technology at a later date. This allows the external party to obtain new information on a number of variables such as the market demand for the technology, prior to committing to a commercialization contract. 20 A pay-per-use arrangement allows the external party to pay an agreed upon price each time the external party uses the covered technology. 21 The incubator approach is a cooperative effort between an academic institution and government agency to further develop or research a new technology and commercialize the technology in the future. The incubator approach offers a distinct advantage, as it allows each party to input their expertise. 22 International Business Machines, NYSE: IBM. http://www.ibm.com 23 In 1998, IBM received 2,657 patents. In 1999, IBM received 2756 patents. See Appendix F. 24 Tax issues can be critical. However, tax issues are beyond the scope of this thesis.
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any tax benefits are dependent upon the values that are assigned to the patent.
A firm should develop internal guidelines for valuing its patents. The firm should
be consistent in its approach to increase the comparability of its valuations.
I.D.6. Social
For all firms, social considerations play a role in the technology transfer
process. Especially for non-profit firms, social considerations are an express
element of their mission that needs to be reflected. Universities, both public and
private, have a social responsibility to serve the general public. Although
arguments have been made that universities should conduct their business
transactions similar to for-profit firms, their purpose, spelled out in their mission
statement, will compel universities to act in ways that for-profit firms would not.
For example, when choosing between two potential licensors, one offering a
more financially attractive license via a limited dissemination of a beneficial
technology, as contrasted with a licensee who is better equipped to broadly
commercialize the patent, the university may choose the latter, as it would better
serve the general public.
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I.D.7. Managerial
Regardless of whether the firm conducts one transaction per year or
hundreds, the process must be managed in order to be consistently successful.
Technology transfer requires cross-functional decision-making and a system
should be implemented that is centrally managed and allows for the different
functions to collaborate, share knowledge, and ultimately create the most
beneficial technology transfer. The entire process should be designed to
maximize the goals of the organization. For the non-profit firm, the quantity and
dollar value of transactions, as well as the quality and social benefits of
transactions, may be in competition. Perhaps surprisingly, for the non-profit firm,
the timing of cash flows may be of greater importance than for many for-profit
firms due to both immediate budgetary constraints as well as a lack of a profit
motive.
It is important to note that a lack of knowledge of or a lack of sufficient
evaluation of the legal, scientific, financial, marketing, accounting, social, or
managerial considerations of a technology transfer could potentially lead to an
unsuccessful transaction, regardless of the strength25 of the technology.
25Strength of intellectual property is important, difficult to quantify, and is a major reason why valuation is so difficult to quantify. Strength can be quantified according to the potential risks to and probable success of the technology. The strength of a technology will change based both on legal and market factors. For example, strength increases when a patent is issued and strength decreases when a new technology enters the market.
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I.E. The Impact of Technology Transfers on the Economy
The increased use of technology transfer has impacted the U.S. in a
variety of ways. The most prominent impacts are the contributions technology
transfer has made on the country financially and socially.
I.E.1. Patent Growth
Radical changes in the global market and technology transfer’s role in that
change is best summarized by a quote from George Gilder (1989).26 It states:
“Wealth and power came mainly to the possessor of material things or to the ruler of military forces capable of conquering the physical means of production: land, labor, and capital. Today, the ascendant nations and corporations are masters not of land and material sources but of ideas and technologies.”
Since the inception of the Bayh-Dole Act,27 the number of patents and
technology transfer transactions in the U.S. has increased drastically. This
growth has been primarily concentrated in the university sector. Between 1991
and 1995, U.S. patents increased 120% and licenses increased 68%
(http://www.tekes.fi/jalkaisut/transbio/uni_uni_tech_offices.html).
26 Smith and Parr, 2000, p. 10. 27 35 U.S.C. Sections 200-212, P.L. 96-517, 1980, Sponsored by Democratic Senator Birch Bayh from Indiana, and Republican Senator Robert Dole from Kansas; signed into law by Democratic President Jimmy Carter. The Bayh-Dole Act permitted non-profit organizations to retain title to inventions created through federally funded programs and seek out profits from commercialization. Refer to http://www4.law.cornell.edu/uscode/35/ch18.html for a copy of the Bayh-Dole Act.
28
I.E.2. Financial Contributions
The public sector has contributed a large portion of the growth and
revenue to the economy. University technology transfer alone, in 1998
contributed $33.5 billion in economic activity (Survey – Q&A About Technology
Transfer, AUTM). Between 1980 and 1993, royalty income from this sector rose
from $7.3 million to $344.4 million (Etzkowitz and Stevens, 1998). It also is
estimated that technology transfer supports between 180,000 jobs and 280,000
jobs (http://www.tekes.fi/jalkaisut/transbio/uni_uni_tech_officees.html; Survey –
Q&A About Technology Transfer, AUTM).
I.E.3. Social Contributions
Technology transfer has been primarily responsible for some, and at least
has contributed to the development of other, new business ideas. It has led to
new products and services which have not only had a positive impact on the
economy, but also have improved the public’s health and quality of life which can
not be as easily quantified.
29
I.F. The Advantages and Disadvantages of Technology Transfer
Although at this point it may appear that technology transfer offers a win-
win proposition, both pro and con arguments easily can be made. In addition,
there are a number of ethical issues, which must be considered when conducting
a technology transfer.
I.F.1. Advantages
Patenting, which is one of the first steps in most technology transfer, offers
a number of advantages. The advantages can be categorized as external or
internal to the creating firm. Externally, patents provide protection for the
technology to induce and reward both research and development. However,
patents also can be an offensive competitive weapon and be used by a firm as
retaliatory power and to strengthen the competitive position of the firm (Whelan,
2000). Portfolios of patents allow some actions to be legal that otherwise would
be feloniously anti-competitive. Portfolios offer firms the ability to license out and
cross license technology, as well as participate in cooperative research and
development. Patents also aid in setting standards in an industry. Standards are
a double-edged sword, both easing entry and retarding innovation.28
28 Although standards provide a foundation upon which all firms can operate, standards also can diminish the market opportunity for new ideas because of the “network effect”. The network effect is the reduction in transaction costs if, a critical mass of users adopt the same technology. The network effect is one reason why an objectively inferior Windows was able to springboard off of DOS and overtake Macintosh.
30
Internally, patents can increase a firm’s corporate image, motivate
employees to invent, and, if done properly, can be used as a measure of
research and design productivity (Granstrand, 1999). In a university setting,
technology transfer generates revenues that then can be reinvested in the
organization (Survey – Q&A About Technology Transfer, AUTM)) and generate
other assets such as equipment, and future consulting opportunities (Slaughter
and Leslie, 1997). It builds relations with external parties, which the universities
desire for a multitude of purposes, including placing graduates and soliciting
donations. Technology transfer increases the prestige of the university, which
has the potential to positively affect both faculty and student recruitment, and
again create employment opportunities for graduate and undergraduate students.
Successful research at this level has the ability to spillover into other areas of
research and into the classroom (Slaughter et al., 1997). Finally, university
technology transfer and commercialization through local small businesses, has
the potential to positively impact local job opportunities.
I.F.2. Disadvantages
Technology transfer and the patent process also raise concerns. In order
to patent a technology, the firm must disclose technical information, which a
number of firms attempting commercialization are reluctant to do (Whelan,
31
2000).29 In addition, the cost of patenting a technology can be a considerable
amount30 (Granstrand, 1999).
Specifically in a university setting, several arguments have been made
against technology transfer. The university has traditionally been tasked with the
creation and free distribution of new knowledge. Universities and their faculty
have been afforded a great deal of autonomy and academic freedom. The most
serious argument made against technology transfer is that business values will
stifle the university’s freedom to research and share knowledge, because of the
conflict between social value and business value.31 For example, commercial
secrecy may preclude publication of research results, which is the essence of
academic discourse and may be necessary for the faculty member’s continued
employment. In addition to limitations on speech, academic resources, such as
space and administrative support are limited. Commercialization demands many
resources, and shortages can be created in the drive to commercialize. A loss of
time for basic research, as well as teaching and teaching preparation time also
29 By disclosing technical information, firms fear that competitors will either 1) learn the firm’s research direction, or 2) use the information to create a non-infringing, but competing patent or product. Firms, which hold this fear, generally prefer trade secrets. Such firms prefer to preserve asymmetric information that is in their favor so as to increase the value of their IP both in the market and for themselves. 30 The average cost of filing a standard patent in the U.S. is $10,000. This does not include maintenance fees or additional office actions, which will vary according to the patent. 31 The American Association of University Professors (AAUP) made a commitment in 2000, to “insulate intellectual work from commercial concerns and to maintain the distinction between intellectual content and commercial content” (http://www.aaup.org/intelst.htm). A major concern of AAUP is to maintain the right to communicate research findings in a timely manner. This often is a point of major conflict with commercialization that demands secrecy both for trade secrets as the sole means of protecting the IP or for preserving a trade secret prior to the USPTO decision on a patent application.
32
may be created by commercialization. Another common fear is that universities
will experience an unsustainable high turnover of faculty, staff, and students as
they are recruited by firms involved in technology transfer. Science respects the
unbiased observer. Commercialization has placed monetary pressures on
academic authors that may, objectively, rise to the level bias. During 2000, the
Journal of the American Medical Association (JAMA) wrestled both with the form
of disclosure required of compensated authors and whether any magnitude of
compensation presumptively disqualifies an author due to bias.32 Lastly, by
participating in the commercialization process, universities may be forced to
assume product or process liability (Slaughter, et al, 1997). It is one thing to
create gifts for society, it is quite another to seek profit from innovation.
I.F.3. Ethical issues
Closely tied to the pros and cons of technology transfer in a university
setting, are ethical considerations. Once again, in a university setting,
technology transfer presents a number of conflicts of interest of different degrees
and kind. The most prominent ethical issues include the use of faculty and staff
time as well as their professional commitment, the misuse of university
resources, technology ownership disputes, and the conflicts which can arise
when faculty and staff are permitted to hold equity in the receiving company,
32 http://www.jama.ama-assn.org/issues.
33
particularly in a start-up company scenario (COGR’s University Technology
Transfer – Questions and Answers).33
The potential for conflict also arises when large corporations build long-
term relations with a university via joint research efforts and corporate funding or
grants. For example, Microsoft made a $25 million grant to MIT. The MIT
arrangement states that Microsoft will have the first rights to licenses created with
the grant, without paying royalties, and will be given the first right to patent
technologies that are developed through joint research efforts (Kloess, v. 7, no.
9, 1999). The chronically cash short university will be sorely tempted to
surrender too much long term autonomy in exchange for short term budgetary
solutions.
Universities are ethically committed to the creation, application, and
dissemination of knowledge. Traditionally, teaching and publications have been
the primary means of dissemination. However, technology transfer is another
means of dissemination and may be the most appropriate means for some forms
of knowledge. A university that completely avoids all technology transfer does
not thereby avoid all ethical conflicts and unethical actions.
33 The Council on Government Regulations serves as a liaison for universities and federal agencies, attempting to ensure that each party’s interests are fairly represented as new regulation is introduced. (http://www.cogr.edu).
34
I.G. Focus
Technology transfer involves a wide range of studies and issues, impacts
a large portion of the economy, and can be used in a number of ways. For the
purpose of this paper, the focus will be valuation of patents, transferred out, from
a university setting. More specifically, it will focus on the valuation of patent-
granted medical devices, to be licensed to for-profit corporations in return for
cash compensation.
35
CHAPTER II: LITERATURE REVIEW
II.A. The Bayh-Dole Act
Although the Bayh-Dole Act has only been in place for 20 years, the
effects have been outstanding. The Act has had a drastic impact on our ability to
market new technologies and compete as a nation, and has had an even greater
impact on the alternatives sources of research funding and revenues available to
universities.
II.A.1. Prior to the Adoption of the Federal Bayh-Dole Act in 1980
Prior to the Bayh-Dole Act,34 any federal government agency that funded
the development of an invention, either partially or fully, was the legal owner of
that invention. Unfortunately, this policy was unsuccessful for a number of
reasons. First, these federal agencies were neither skilled in the art of
technology transfer and commercialization nor were these federal agencies
motivated to commercialize. The agencies often lacked the resources, such as
time and staff, to focus on commercialization. Second, private firms were not
interested in dealing with the federal agencies. The amount of administrative
work, or red tape, involved in negotiating a license agreement with a government
agency, created large disincentives for private companies to pursue a technology
34 35 U.S.C. Sections 200-212, P.L. 96-517, enacted in 1980, was sponsored by Democratic Senator Birch Bayh from Indiana and Republican Senator Robert Dole from Kansas.
36
transfer. Therefore, most technologies developed with federal funding never
were brought to market, and the general public, as well as private firms lost the
benefits the technologies may have held (Bremer, 1993).
In the late 1970’s and early 1980’s, the federal government began to
realize the shortcomings of its policy. Members of Congress recognized the
growing importance of intellectual property and technology transfer on both the
national and international level. In addition, Members of Congress recognized
the significant impact that the inventor of a technology can have on the
technology transfer process (Bremer, 1993).
II.A.2. Provisions of the Bayh-Dole Act
On December 12, 1980, the Bayh-Dole Act was signed into law by
President Jimmy Carter. The Act created a uniform policy that allowed small
businesses and non-profit organizations to retain ownership to inventions
developed under federally funded programs.
The Bayh-Dole Act contains six major provisions:
Ownership by federal grantee Shared proceeds with inventors Extended license duration Domestic manufacturing preference Small business preference Federal non-exclusive license march-in rights
First, small businesses and non-profit firms were permitted to retain title to
inventions funded by federal agencies. Second, in order to create an incentive
37
for individuals within firms, such as university faculty to continue to research,
federally funded firms were required to share the proceeds of an invention with
an inventor. Third, previous time restrictions on licenses, were removed, except
in the case of licenses to large corporations where ten years remained as the set
time limit. Although the federal government surrendered direct license
compensation, the Act’s fourth requirement is that all products, which would be
sold in the U.S., must be manufactured in the U.S. The manufacturing
requirement was to ensure benefit to the U.S. economy. In addition, the Act’s
sponsors intended indirect federal compensation through domestic taxation.
Closely related to the manufacturing requirement, was the fifth requirement,
which stated that small businesses would receive preference in the technology
transfer process. Although the small business preference was controversial, and
is difficult to measure on a case-by-case basis, even today, the purpose was to
give small businesses the same opportunities to exploit new technologies, as
larger firms. Finally, the sixth part of the Act permitted the government to retain a
non-exclusive license to the technology, as well as exercise “march-in rights” to
enforce that non-exclusive license (Etzkowitz et al., 1998; Survey – Bayh-Dole
Act, AUTM).
38
II.A.3. Results of the Bayh-Dole Act
The Bayh-Dole Act provided firms with a great deal of freedom, not only to
license, but also to publish research information and results. However, Members
of Congress also had the foresight to create exceptions to the Act. For example,
to ensure that our nation’s national security is maintained the government is still
guaranteed non-exclusive licenses. In addition, the government is permitted to
exercise “march-in rights” to ensure that significant inventions reach the market
in a competitive manner and benefit the public. As a whole, the Bayh-Dole Act
has created a system, which has proven itself to benefit firms of all types,
whether non-profit,35 small businesses,36 whole industries,37 the government,38
and general public39 (Bremer, 1993).
35 Technology transfer allows universities an additional capability for generating significant revenues. Unrelated Business Income Tax (UBIT) is an example of a tax issue beyond the scope of this thesis. 36 Through the ability to retain title to inventions created in federally funded programs and through the Act’s small business preference provision. Often, faculty inventors form small businesses to commercialize their inventions. The U.S. Small Business Administration (http://www.sba.gov) has a specific funding program for this purpose the Small Business Innovation Research Program (SBIR) (http://www.sba.gov/SBIR/sbir.html). 37 University technology transfer has often been credited with the development of the biotechnology industry. For example, Taxol (paclitaxel) was patented by Florida State University and exclusively licensed to Bristol-Meyers Squibb, NYSE: BMY (http://www.bms.com). The National Cancer Institute described the drug in 1998 as “the most important cancer drug in 15 years”. (http://www.autm.net). 38 The federal and State governments gain as technology transfer spurs growth in the domestic economy, thereby increasing the tax base and the tax revenues. 39 The public benefits through the availability of improved technologies, often this translates into cheaper, or better goods and services delivered in a more efficient manner.
39
II.B. The University Technology Transfer Process
Since technology transfer has only been an alternative for universities for
the last twenty years, and has only become popular in the last decade, most
universities are relatively inexperienced in the art of technology transfer.
However, there are a number of critical steps involved in the technology transfer
process, which are quickly being learned across the U.S.
II.B.1. General Role of a University Technology Transfer Office
Since the enactment of the Bayh-Dole Act, universities across the U.S.
have developed systems to promote, develop, and complete technology
transfers. Proceeds from license agreements have been reinvested in the
university, and it is therefore beneficial for the university to complete the
technology transfer process in the most effective and efficient manner possible,
while still maintaining the goals of the Act and the university’s mission statement.
Most universities that are involved in technology transfer, have at this
point, created a technology transfer office (TTO). According to Gordon V. Smith
and Russell L. Parr (2000), the role of the university TTO is to:
1. “Provide oversight of intellectual property management and technology transfer to ensure adherence to university policies.
2. “Assist university research departments in establishing and maintaining
effective technology transfer mechanisms. 3. “Provide legal services and cooperate with university research
departments in promoting and licensing intellectual property.
40
4. “Take appropriate actions to protect university’s intellectual property. 5. “Promote and negotiate technology transfer to for-profit entities. 6. “Establish policies and procedures to avoid conflicts of interest. 7. “Review and approve all agreements that convey or affect the
university’s right to intellectual property.”40
The most recent AUTM41 survey categorizes the university technology
transfer process into three steps: disclosure, patent, and licensing for
commercial development. Michael Kloess (1999, v.7, no. 11/12) describes the
process as a two-headed process, including the recognition and evaluation of
intentions, as well as filing for a patent, and the marketing of inventions.
Certainly, a significant amount of work has been published regarding this area,
and although each author takes a slightly different approach, it appears to the
author of this thesis that a combination of these works provides the most
accurate view.
In a for-profit setting, technology transfer and patent portfolio policies are
focused on creating competitive advantages and generating profits. Often, gap
analysis42 is used to identify potentially successful technologies that the firm
owns, as well as technologies that the firm should, but does not own.
40 Smith and Parr, 2000, p. 536. 41 The Association of University Technology Managers. AUTM currently has more than 2300 members, including over 300 universities, research institutions, and teaching hospitals (http://www.autm.net). 42 Gap analysis is a management tool used to identify the difference between the corporation’s performance and objectives.
41
(O’Shaughnessy and Germeraad, 2000). However, in a university environment,
the technology transfer process is dictated by the academic values held by the
members of that institution, the potential benefits of the technology to the public,
and of course the institution’s financial interests (Smith et al., 2000). In addition,
the university must still adhere to the requirements established in the Bayh-Dole
Act.
II.B.2. Disclosure
Any technology transfer from a university begins with a disclosure made
by the university inventor; typically a faculty member, but not necessarily. The
disclosure generally includes a list of information43 such as:
The claimed title of the invention Identification of the inventor or inventors A report of any financial support received by the inventors A list of prior art discovered by the inventors The history of the invention A detailed description of the invention All research results An invention agreement44
43 The Association of University Technology Managers provides has a selection of sample agreements and policies available at their website (http://www.autm.net). 44 An invention agreement binds the inventors to the accuracy of the disclosure as well as identifies the ownership of the invention.
42
II.B.3. Evaluation
Once the disclosure has been received, the TTO must begin the process
of evaluating the technology. Unfortunately, technology transfer involves the
allocation of scarce resources, and is dominated by time constraints. Watson
and Fordham-Meier (1995) suggest using an invention triage system to manage
this constrained environment. According to their study45 most universities protect
all inventions and skip the evaluation process when confronted with a deadline.46
Instead, they suggest that the decision to proceed should be based upon three
factors. The three factors are patentability, novelty and market size of the
invention, and the potential technology transfer’s consistency with the institution’s
mission. Perchorowicz (1995) elaborates on the evaluation of the technology
and insists that a technical, patent, market, and financial assessment are
necessary, before making a decision to proceed with a technology.
45 The study was conducted during workshops at the Eastern Regional 1993 and Annual 1994 meetings of the AUTM, therefore, the sample is not random. 46 While patent deadlines are common in a university technology transfer office, most faculty do not fully understand the implications of and requirements for patent protection, and faculty may not present the technology to the TTO until just prior (sometimes just days or even hours) to making the technology public via a conference or other similar medium. The U.S., unlike the rest of the world, allows a technology to be patented, up to one year after publication. In general, other countries only permit publication during the first year for provisional patents. Faculty is usually not aware of this requirement, which can pose a problem when attempting to patent the technology. See I.B.1 Patents.
43
II.B.4. Patent
The TTO must determine what type of patent is appropriate for each
technology or whether other forms of intellectual property protection are most
appropriate. The patent alternatives available to the TTO include a traditional full
patent application, a provisional patent application, and a host of various
international patents such as a PCT47 application. The cost of each patent type
varies, and could potentially affect the licensing process, and the university’s
ability to recover costs. For example, a recent study suggests that a PCT
application can lead to a more timely and less expensive patent due to the
regulatory process and fees involved (Oppedahl, 1999).
II.B.5. Marketing
If an invention does not warrant technology transfer, then the technology
should be made available via publication or other method of public disclosure to
allow the general public access to the knowledge (Watson et al., 1995). If the
invention has been chosen to move toward licensing, then the technology
transfer office must next concentrate on marketing the technology.
Numerous methods can be used to market an intellectual property. More
common forms are cold calls made to potentially viable licensees,48 letters to
47 35 U.S.C. Sections 351 – 376. The Patent Cooperation Treaty is an application that provides multiple international patent application filings simultaneously. 48 Cold calls are direct phone calls made to potential buyers that are not made at the buyer’s request.
44
potentially viable licensees, lists of inventions made available on a website,49 and
lists of inventions made available to firms involved in the invention’s related field.
49 The TTOs generally maintain their own website which can be accessed by interested parties, but third party websites also are available to post new inventions. Related newsletters and journals, such as Technology Access Report also provide this service.
45
Figure 1. Percentage Range of Sources50
50 This table is quoted from Jansen and Dillon (1999).
46
A recent study of 1,140 licenses signed by 6 institutions indicates that
these marketing efforts only contributed 19 percent of licenses and options.
Companies that initiated contact with a TTO contributed 10 percent of technology
transfers, leads from research sponsors contributed 7 percent, and 7 percent
were unknown. According to the study, the most significant leads come from
inventors, which contribute 56 percent (Jansen and Dillon, 1999). The preceding
Figure 1, quoted by the Jansen and Dillon study, graphically demonstrates the
results.
In the study, the range for marketing contributions was rather large and
could be due to variables such as staffing constraints or the reputation of an
institution. However, the inventor contribution range was noticeably close,
across the 6 institutions. Jansen and Dillon (1999) also suggest that mere lists of
inventions, have historically not generated licenses and suggests that marketing
studies for individual technologies usually are an unnecessary cost, as most
purchasing firms51 are only interested in their own studies.52
51 Notably, venture capital firms rely on their own studies so that the valuations from different projects are comparably based on similar assumptions. 52 Different methodologies used in an analysis will produce varying results. Identical methodologies also will produce varying results if the user supplies different assumptions. Purchasing firms have different objectives than universities, which can affect both the methodology used and the assumptions applied.
47
II.B.6. Licensing
Due to time constraints and disclosure issues, most universities seek a
qualified licensee (i.e., financially and technologically capable of commercializing
the technology). It is important to note that the licensee chosen may not be the
best party, but is the optimal choice53 (Jansen et al., 1999; COGR’s University
Technology Transfer – Questions and Answers). Universities often strive toward
non-exclusive licensees as well, believing that it creates more rapid
commercialization and competition, both of which positively reflect the
university’s mission in technology transfer (Smith et al., 2000).
Once a qualified licensee has been identified, option agreements are often
used to allow the firm additional time to further research the technology prior to
committing to commercialization of the technology. Once the firm’s research is
complete, and if they are still interested in pursuing commercialization, then
licensing negotiations can begin. This is the focal point of this thesis. The entire
process (from disclosure to license) will consume a fundamentally unpredictable
amount of time. Typically, the entire process consumes anywhere from as little
as two weeks or well over 100 weeks, although successful licenses are generally
completed within one year (Jansen et al., 1999).
53 Identifying the very best licensor requires evaluating every potential licensor. In theory, this process would be infinite. Therefore, operating under time constraints, the optimal choice is made.
48
II.B.7. Auditing
Unfortunately, even though there is a signing celebration, the technology
transfer process is not complete when the license is signed. The university must,
through auditing, continue to monitor the licensee’s adherence to the license.
Although auditing can be a contentious provision, there are three prominent
benefits, which can be derived from establishing an auditing procedure. First, the
university is able to discover any (a) under-payments caused by miscalculations,
(b) technology uses not reported or permitted in the license, or (c) any number of
other scenarios, such as inappropriate use of non-licensed university intellectual
property (e.g., trademark). Second, by establishing an auditing procedure, the
university makes its compliance expectations clear to licensees. This can greatly
reduce the temptation for dishonesty. Third, an auditing policy creates a greater
level of confidence in the licensee’s reporting, as all parties will be using the
same foundation for reporting.
With appropriate auditing, universities can more easily identify licensing
issues and avoid under-payment. For example, prior to implementing an auditing
process, Stanford had licensed Phycobiliproteins to several firms. By applying a
random auditing procedure, Stanford found that all three licensees chosen had
underpaid a total of $322,000. The cost of the audit was $27,000 (Burns and
Sandelin, 1997).
49
II.B.8. Distribution of Royalties and other Cash Compensations
Universities also must agree in the license to a formula for assessing and
distributing royalties as well as other cash compensation (e.g., upfront license
fees). This is a critical step, since budgetary constraints are forcing more
universities to become involved in technology transfer, as a source of additional
near-term and long-term revenues. Typically, any costs incurred through the
technology transfer process are recovered first; therefore, the TTO receives the
first priority in the distribution formula. Any remaining royalties are then
distributed on either a straight or sliding scale between the inventor, inventor’s
department, inventor’s college, university, and various research funds (Land,
1996).
50
Figure 2. Stanford’s Distribution of Royalties
Party Distribution of Royalties
Technology Transfer Office 15%
Patent Costs Deducted
Inventor Equal
Inventor’s Department Equal
Inventor’s College Equal
Figure 3. Harvard’s Distribution of Royalties
Party Distribution of Royalties
First $50,000 Above $50,000
Inventor 35% 25%
Inventor’s Department 30% 40%
University 20% 20%
President and Fellows 15% 15%
51
Figure 4. A Comparison of Stanford and Harvard’s Distribution Policy, when
royalties equal $100,000
Party Stanford’s Distribution Harvard’s Distribution
TTO $15,000
Patent Costs $10,00054
Inventor $25,000 $25,000
Inventor’s Department $25,000 $40,000
Inventor’s College $25,000
University $20,000
President and Fellows $15,000
54 Assumption made by thesis author in order to provide a comparison of actual dollar amounts.
52
At Stanford, 15 percent of royalties are deducted for technology transfer
costs. Then, patents costs are deducted from the royalties received. The
remaining royalties are distributed evenly between the inventor, inventor’s
department, and inventor’s college.
(http://www.tekes.fi/jalkaisut/transbio/uni_uni_tech_offices.html.)
Harvard’s royalty distribution policy is different from Stanford’s. Instead of
distributing royalties to the technology transfer office, a portion of royalties are
paid to the university. In addition, the President and Fellows also receive a
portion of royalties. At Harvard, royalties below $50,000 are distributed as 35
percent to the inventor, 30 percent to the inventor’s department, 20 percent to the
university, and 15 percent to the President and Fellows. Royalties above
$50,000 are distributed as 25 percent to the inventor, 40 percent to the inventor’s
department, 20 percent to the university, and 15 percent to the President and
Fellows (Smith et al., 2000).
II.B.9. Performance Measures
Section II.B. “The University Technology Transfer Process”, began with a
discussion of the purpose and goals of a technology transfer office and the
benefits that can be realized by a university. In order to determine a technology
transfer office’s effectiveness and efficiency, performance measures must be set.
Kloess, 1999, v. 7, no. 11/12) proposes six factors. These include:
53
The number of start-ups Number of licensees executed Number of new patent applications Amount of research funding per license Amount of industry funding Amount of licensing income
Past AUTM surveys use the same statistics but present the results in a
ratio format so that different institutions and year-to-year comparisons can be
made, which appears to the author of this thesis to be more appropriate.
Finally, Hsu and Bernstein (1997), offer several suggestions, which appear to
summarize the discussion of creating time and cost efficiencies and effective
licenses. They suggest drawing upon the expertise of previous licensees and
university faculty and staff, as well as utilizing the inventor’s contacts and
knowledge to increase marketing effectiveness. They also highlight the cost
efficiencies of using interns whenever possible.
54
II.C. Variables that Affect the Value of Patents and Licenses
When attempting to commercialize a new technology, valuation analysis is
crucial. Both the patent and license must be valued, in order to create a
successful technology transfer.
II.C.1. Factors of Technology
According to S. Radosevic (1999), there are four aspects of technology
that influence technology pricing and policy: rising complexity, transferability,
knowledge intensity, and organizational receptiveness. The first aspect is the
rising complexity of technological changes. This includes the move toward mass
customization and consumer choices, which increase the value of technology.
Second, the transferability of technology is increasing as intellectual property
rights are defined in more detail. The ease in which technology can now be
transferred across firms increases the value of technology. The third aspect is
the increasing knowledge intensity of new technology. This is exceptionally true
in the biotechnology industry, which includes medical devices. The demand for
such technology increases the value of the technology. Finally, the significance
of organizational changes and the role that technology plays in organizational
changes can increase the value of technology. Firms recognize the advantages
that technology can create and are willing to pay for the advantages. The use of
technology in various scenarios is becoming more common and appropriate and
55
firms now are continuously searching for new efficiencies, which can be created
in technology.
II.C.2. Patents
Several variables affect the value of a patented technology. These
include patent strength, patent quality, stage of development, market size,
success of related technologies, competition, profit margin, remaining life, and
certainty of success. Each variable must be carefully evaluated in order to
determine the most accurate value possible. Each variable must be carefully
evaluated in order to determine the most accurate value possible.
II.C.2.a. Patent Strength and Quality
In a legal context, patent strength can be defined as the patent’s ability to
protect the technology in question as well as the reasonable assurance that the
firm will be successful in potential infringement cases. Strength is derived from a
thorough patent search and review of prior art, as well as the content of the
patent application. The sources of strength may not be immediately obvious, but
become more so in the case of litigation. As a patent’s strength increases, the
value of the patent increases (Yau-Young and Ziemer, 1992; COGR’s University
Technology Transfer – Questions and Answers).
Patent quality, which differs from patent strength in that it measures
whether patent protection is an appropriate protection vehicle, has been a
56
subject of recent debate. Between 1991 and 1996, the U.S. Patent and
Trademark Office (USPTO), issued a total of approximately 100,000 patents. In
stark contrast, for the year 2000, the USPTO is expected to issue approximately
200,000 patents. In addition to the surge in patent applications, the USPTO has
experienced a 20 percent turnover in examiners, resulting in more than 50
percent of all examiners with less than two years of USPTO experience. These
statistics suggest that the USPTO is overwhelmed, which can affect the
USPTO’s ability to properly process patent applications. Consequently, more
applications are processed without a full review of prior art (some say without any
review of prior art). Unfortunately, the review of prior art can significantly affect
not only the quality, but also the strength of patents. The USPTO also has been
unable to keep pace with the speed of technological changes. Without guidance
from the USPTO, firms are attempting to patent intellectual property, which may
or may not be upheld (under PTO) as new regulation is introduced, and also can
affect a patent’s quality and strength (Aharonian, 2000, September 15).
II.C.2.b. Stage of Development
The stage of development describes the level of research and design that
has been completed at the time of patent application or grant. As the patent
reaches higher stages of development, risk and uncertainty involved with the
patent, such as laboratory results or regulatory issues, decrease. In general, as
a patent’s stage of development increases, the patent’s value increases
57
(DeGeeter, 1999; Merwin and Warner, 1996; COGR’s University Technology
Transfer – Questions and Answers). For example, a medical device that exists
only in an individual’s mind may be worth less than a medical device that has a
prototype. However, the prototype may reveal that the device just does not work.
In either event, the elimination of uncertainty55 improves the university’s position
because it can either go forward with greater confidence of success or can cut its
losses and stop.
II.C.2.c. Market Size
Market size describes the patent’s potential demand, once
commercialized. In order to determine the market size, all of the patent’s
possible fields of use must be explored. Estimates can be derived from the
historical performance of comparable products. However, an exact value may be
extremely difficult to obtain when the patent is a truly new technology. Market
size represents a portion of a valuation formula. Market size can be used to
calculate future positive cash flows for a technology. As the market size
increases, the projected future positive cash flows for a technology increase.
Especially if there are economies of size associated with greater production, as
the market size for a patent increases, the patent’s value increases (Yau-Young
et al., 1992; COGR’s University Technology Transfer – Questions and Answers).
55 In statistics, certainty is the knowledge of all possible outcomes. Certainty is not a 100 percent probability, but rather is a known probability. Flipping a coin is statistically certain.
58
II.C.2.d. Success of Related Technology
The success of related technologies also can affect the value of a patent
(DeGeeter, 1999). A comparable previous technology that was welcomed by the
public may indicate that the new patent also will perform well. A previous
technology also may pave the way and create the demand for a new patent and
increase the new patent’s performance. This would be common when the new
patent is an enhancement or improvement of the previous technology. This
factor also may not be applicable in all patent valuations. In general, the success
of related technologies will increase the value of a patent.
II.C.2.e. Competition
Competition is a critical factor in the value of a patent. Although a
technology may be protected as a patent, competition may exist through similar
or substitutable technologies. As competition for a technology increases,
(assuming that the market size remains constant) the market must be divided
among more firms. As this occurs, market share becomes increasingly
important, as it plays a role in the projected future cash flows of the patent. A
risk related to competition is that the firm using the patent will have a lower
market share than other competing firms. In addition, competition generally
leads to reduced-pricing strategies in order to gain market share, which also
affects projected future cash flows. Hence, as competition increases, the value
of a patent decreases (Yau-Young et al., 1992). Although not related to medical
59
devices, an appropriate example is the extreme competition occurring in the
personal computer industry.
II.C.2.f. Profit Margin
A patent’s profit margin is the difference between the cost of producing the
technology and the sale price of the technology in the market. Some industries
typically receive higher profit margins than others. For example, high-end
products generally demand a higher profit margin than products, which are mass-
produced and sold at lower prices (e.g., BMW versus Honda). A patent may
have several different profit margins, if it is applied to several fields of use. As
the profit margin for a patent increases, the patent’s value increases (Yau-Young
et al., 1992).
II.C.2.g. Remaining Life
The remaining life can refer to two different factors. First, every product
has a product life cycle, which varies. For example, the life cycle of a personal
computer product is significantly shorter (e.g., about 12 months) than the product
life cycle of a pharmaceutical product (e.g., about 120 months). The product’s
position in the product life cycle affects projected future cash flows. Therefore, a
patent in the initial stages may have a higher value than a similar patent in the
later stages. In addition, with identical per period positive cash flows a patent
60
with a longer product life cycle will have a higher value than one with a shorter
life cycle.
Second, every patent has a time limit.56 Once the time limit has expired,
other firms are permitted to use the patent. Consequently, patents that can be
commercialized early in the patent’s life have a greater period of time in which to
generate revenues. Patents that are introduced later in the patent’s life have less
time in which to generate revenues. This directly affects the projected future
cash flows of a patent and the patent’s value (Smith et al., 2000).
II.C.2.h. Certainty of Success
Yau-Young and Ziemer (1992) include certainty of success as a factor,
which also can affect the value of a patent. This factor, although it is closely tied
to the stage of development, is designed to represent the belief that the patent
will be successful, regardless of the stage of development or other factors such
as preliminary market size estimates. Although valuing a patent can be a
subjective task, it appears to the author of this thesis that the certainty of success
factor is even more subjective than others and does not qualify as a
measurement of value in this thesis.
56 Patents have a time limit of 20 years, with maintenance fees due at 3 ½, 7 ½, and 11 ½ years from the date the patent is granted. If maintenance fees are not paid, the patented technology is deemed “abandoned” and passes into the public domain. See Appendix H for data that show most patents are abandoned prior to the full 20 years.
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II.C.3. License
All of the factors included in valuing a patent, will affect the value of a
license. However, the details of a license agreement will influence the amount of
money that the licensee is willing to pay for the license as well. Factors
associated with the license agreement include: the cost of commercialization,
geographic territory, field of use, exclusivity, technical assistance, length of
agreement, sublicense provisions, and improvements that are made to the
patented technology.
II.C.3.a. Cost of Commercialization
The licensee pays the cost of commercialization to bring the patent to the
market. The licensee may bear many costs. For example, the licensee may face
additional costs for research and (especially) development, as well as the cost of
a marketing campaign to generate awareness of and demand for the product.
Commercialization also includes the cost of complimentary assets,57 which are
necessary to exploit a technology, such as equipment. As the cost of
commercialization increases, the value of the license decreases (COGR’s
University Technology Transfer – Questions and Answers).
57 Complimentary assets focus on unique and financially significant items that are necessary to exploit the patent, but generally exclude common items that are necessary for any type of production.
62
II.C.3.b. Geographic Territory
A well-drafted license agreement will specifically state the geographic
territory that the licensee is permitted to exploit.58 The market size associated
with each territory will vary. The number of potential customers as well as their
relative desire and ability to pay for the patent will vary by territory. As the size of
the geographic territory increases, the value of the license typically increases, in
relation to the market size of the territory (Merwin et al., 1996; Yau-Young et al.,
1992). However, the value of a license can decrease as the geographic territory
increases, if the number of potential customers per territory (or potential revenue)
does not cover the expense of exploiting the territory.
II.C.3.c. Field of use
A license agreement will typically define the fields of use59 that the
licensee is permitted to exploit. This should reduce the potential revenues a
licensee may earn, as some patents have more than one field of use, assuming
that the licensee is capable of exploiting all fields of use. Therefore, a limited
field of use provision generally decreases the value of a license.60 However, it is
58 Recall that the patent itself has a limited geographic territory: it is only valid in the country granting the patent. Absent patent applications to other patent authorities, an owner of a U.S. patent does not have any patent rights in other countries. See II.B.4. Patent. 59 Broad patents, or patents that involve a fundamental process rather than merely a specific object, in particular, may have more than one potential use. Each method of using the patent is referred to as a field of use. 60 Technological change may challenge the license’s definition of a field of use (O’Hara, 1996).
63
important for the licensor to explore all fields of use, in order to ensure that all of
the patent’s uses are exploited to the fullest extent. The licensor should avoid
licensing all fields of use with a licensee who is capable of only using a portion of
the patent’s uses. In this scenario, the licensor would reap the greatest financial
rewards by licensing the patent to more than one firm, according to the field of
use. This strategy would also coincide with the university’s mission to make the
technology available to and benefit the public (Yau-Young et al., 1992).
II.C.3.d. Exclusivity
A license agreement can be either exclusive61 or non-exclusive.62
Exclusivity provides greater potential returns to the licensee, since it eliminates
the possibility of competing with other firms using the same, patented technology
in the same field of use. However, a non-exclusive agreement may not
necessarily adversely affect the value of a license to a specific licensee. If the
licensee desires to reach only one field of use, then an exclusive license for that
field of use will be sufficient. In which case, the university can issue multiple,
non-exclusive licenses each of which is exclusive within a specific field of use.
In addition, patents in the early stages of development may need to be licensed
61 The patent is licensed to only one firm. 62 The patent may be licensed to more than one firm. A university may grant an exclusive license on technology created with federal funding, however, the federal government still has the ability to exercise march-in rights. The most recent and celebrated case of march-in rights occurred between John Hopkins University, CellPro, and the National Institute of Health (Stephenson, 1997).
64
exclusively, in order to provide a firm an incentive to complete the necessary
research and development. Without considering the field of use provision or
stage of development, an exclusive agreement generally increases the value of
the license (Merwin et al., 1996; Yau-Young et al., 1992).
II.C.3.e. Technical Assistance
It is common in a license agreement, particularly between a firm and
university, for the university also to offer technical assistance from either the
inventor of the technology or other members of the university. By offering
technical assistance, the time to complete research and development can be
greatly reduced, thus moving the technology to the market faster. When the
inventor is interested in the research and development associated with
commercialization, technology transfer can be a win-win-win transaction.
Consequently, the patent will begin to generate revenues earlier. As the amount
of technical assistance available to the licensee increases, the value of the
license also increases (Merwin et al., 1996).
II.C.3.f. Length of Agreement
The length of a license agreement can vary from a specific number of
years, to the life of the patent. The longer the agreement is in effect, the more
time that the licensee has to generate revenues through the patent. The length
of agreement is positively correlated to the value of the license (Merwin et al.,
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1996). However, the time value of money quickly erodes the value of revenue
streams in the out-years.63 Increasing risks in the out-years further erode value,
thus creating a bias on both sides of the technology transfer transaction for swift
and sure payouts.
II.C.3.g. Sub-license provisions
A license agreement also may contain a sub-license provision. A sub-
license provision grants the licensee the legal authority to license the patent, that
is, to create a sub-license. This would be common when the original licensee
completes the research and development in a patent portfolio context, where
other firms have contributed other patents to the jointly managed portfolio. A
sub-license agreement is also common when just one firm is not capable of
supplying the entire market. A sub-license can not be broader than the license in
duration, territory, or field of use. If a sub-license provision is included in a
license agreement, then the licensee can potentially receive additional returns
through the authorized uses of the sub-licensees. Therefore, a sub-license
provision also increases the value of a license.64 In the case of a broad
technology, licensed exclusively, it may even be appropriate for the licensor or
63 64 Sub-licensing may make the patent so ubiquitous that any competitive advantage is extinguished. However, a network effect is sometimes feasible and pronounced, in which case the value lost by extinguishments of the competitive advantage may be more than off-set by a patent portfolio network effect. A broad patent, which could support multiple exclusive sub-licenses, is equivalent to a min-patent portfolio. The interactions of sub-licensing, are beyond the scope of this thesis. This thesis will examine an exclusive license for a single field of use medical device.
66
the licensee to require a sub-license provision (Merwin et al., 1996; Yau-Young
et al., 1992).
II.C.3.h. Improvements
Improvements are technical enhancements made to the patent, after the
licensing process is completed. It is common for any improvements to be
included in the licensing agreement, or for the licensee to at the very least have
the right of first refusal or the right or options on the improvements. Since
improvements made to the patent will ultimately benefit the licensee,
improvement provisions generally increase the value of a license (Yau-Young et
al., 1992; Smith et al., 2000).
II.C.3.i. Licensee Risk
Lastly, it is possible for the licensee to pose a certain amount of risk to the
business transaction. Adjustments should be made for any foreseeable risk
involved with the licensee either defaulting on payments, filing for bankruptcy, or
canceling the contract. Start-up companies generally pay a higher fee than
would an established company, due to this risk (Smith et al., 2000).
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II.C.4. Unknown Risk
As the valuation of a patent is completed, and adjustments are made to
account for the uncertainty involved with a patent, the individual conducting the
valuation may feel more confident about some estimates and less confident
about others. In addition, the individual may want to measure such factors in
order to account for his or her belief in the patent. It is the author’s opinion that
the values, which would be assigned to such beliefs, may be subjective that the
contribution to the value analysis is suspect. This is not to say that the
individual’s opinions are not worthwhile, as an individual’s experience can be
invaluable in the licensing process. Rather, that the risk adjustments made
should be based on the categories described, which can be calculated at an
objective level. In addition, other forms of risk, which can be associated with any
type of business transaction such as political risk, inflationary risk, or economic
risk, all are beyond the scope of this work.
II.C.5. Insurance
As the number of patent applications and technology transfers has
increased over the last two decades, insurance companies have found a new
niche of risk management. Several insurance companies now offer patent
insurance. For example, firms such as The Chubb Group of Insurance65 offer
insurance against intellectual property infringement suits, covering patents,
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trademarks, copyrights, and trade dress. Other firms offer a variety of forms of
insurance such as patent validity insurance as well as many others (Kloess,
1999, May).
Using insurance potentially could provide a method of reducing a firm’s
risk associated with patent strength and patent quality. However, the
effectiveness of this risk management would depend upon the specific details of
the insurance policy relative to the purchaser’s situation, as well as the premiums
that would be paid for the policy. The use of insurance in this scenario should be
evaluated on a risk/reward basis.66
65 NYSE: CB. http://www.chubb.com 66 The use and evaluation of patent insurance is beyond the scope of this thesis.
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II.D. Valuation Methods
In a recent discussion on Techno_L, an individual in a private firm asked
other subscribers what percentage of a start-up firm’s value can be attributed to
the firm’s patent portfolio. The individual used 50 percent as an estimate, but
admitted that it was more a guess, than it was an estimate (“Startup Company
Valuation based on Patents, August 29, 2000). Unfortunately, this scenario is
not uncommon. Individuals in all types of firms are becoming involved in
technology transfer without any knowledge of or guidance in the art of technology
transfer. However, there are a number of simple approaches that can be used to
objectively measure a patent’s value.
II.D.1. What is Value?
Value can be categorized either as social value or business value (Sinden
and Worrell, 1979). This thesis will focus on business value, as it applies to the
cash flow analysis. Hindley (1999) suggests that value is based on the specific
place, time, and circumstances. Hindley also identifies three main value
concepts: owner value, market value, and fair value. Smith and Parr (2000),
define the value of intellectual property as the physical value of the IP, in addition
to the value of the rights to use it, or the future economic benefits of the IP.
Sullivan (1996), also identifies three points at which a patent can be valued: pre-
commercialization, pre-negotiation, and during litigation. This thesis will focus on
the value of a medical device, post-patent, and pre-negotiation.
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II.D.2. Market Approach
There are three accepted valuation methodologies: the market approach,
cost approach, and income approach. The market approach offers a value,
created by comparing the patent to similar transactions in order to calculate a fair
market value. However, it is extremely difficult to find an appropriate comparison
with which to use as a basis for the valuation.
The fair market value is the hypothetical amount at which a patent would
be exchanged between a buyer and seller. Fair market value makes several
assumptions. It assumes that both parties are willing, have knowledge of all
relevant information, and that the transaction is equitable to both parties. The
market approach measures the value of a patent, including the physical value as
well as the present value of future economic benefits, by comparing the
transaction to similar historical transactions.
There are several requirements when using the market approach. First,
there must be an active public market for the patent. Second, the historical
transaction, which is used for comparison, must be of a comparable property.
Third, the parties conducting the valuation must have access to the historical
transaction’s price and exchange information. Fourth, the historical and current
transaction must occur between independent parties. Even if these requirements
are met, there are several factors, which may affect comparability, using the
market approach. Smith and Parr (2000), identify these factors as:
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Industry differences Market share differences Profit margin differences New technologies Barriers to entry Legal protection Remaining economic life
Due to the unique requirements of the market approach, there are specific
products, which can be valued more effectively than others, using the market
approach. For example, real estate, general machinery and equipment, and
vehicles are normally valued according to a market approach, because of the
wide availability of similar products. On the other hand, special purpose
machinery and equipment, and most intangible assets and intellectual property
are difficult to value using this approach, due to a lack of comparisons.
When adopting the market approach, the individual conducting the
valuation must be aware of any unique conditions surrounding transactions that
may initially seem comparable, the timing of transactions, and the market forces,
which drive transactions67 (Smith et al., 2000). Once again, the focus of this
thesis is the valuation of patented medical devices, which are a form of
intellectual property. In a number of circumstances, comparable transactions will
not be available. Therefore, the market approach may not always be the
appropriate method to use. However, if comparable transactions are available,
the market can be used effectively.
67 For example, in recent years, Initial Public Offerings (IPOs) have received considerable attention and often begin trading in the secondary market at several times the initial price due to market forces.
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II.D.3. Cost Approach
The cost approach seeks to calculate the value of a patent by measuring
the cost of replacing the patent. The advantage of the cost approach is its ease
of use. However, the cost approach does not consider the time value of money,
which is a serious disadvantage.
As stated previously, patents have a life span, both for legal protection
and commercialization purposes. When attempting to value a patent according
to the cost approach, depreciation adjustments must be made. There are three
primary sources of depreciation, which include: physical wear and tear (this
would not apply to a patent), functional obsolescence (caused by advanced
technology), and economic obsolescence (caused by reduced market demand).
The cost approach assumes that the remaining economic benefits derived from
the patent, are sufficient to justify the cost of development.
In order to calculate the costs of a patent, historical cost trending of the
patent can be used. Some of the costs which should be considered are: the
salaries and benefits of those involved in the patent, overhead costs (including
administrative support and building space), the cost of raw materials, testing and
prototype expenses, and contracted service expenses. It is important to note
that all relevant costs must be included. Once the costs have been identified and
included in the total cost, the value must be adjusted for depreciation.
Historical cost trending relies on accurate record keeping, which may not
always be available. In this case, it is more appropriate to calculate the re-
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creation costs, which are estimates of the costs associated with creating a similar
patent. The same types of costs, which are included in historical cost trending,
also apply to re-creation costs. Again, once all costs have been calculated,
adjustments must be made for depreciation.
It is important to note that cost does not equal value. Value goes beyond
just dollars. Both the benefits (e.g., competitive synergies) and the costs (e.g.,
use of scarce inventive potential) of a patent’s value will include non-cash
aspects. However, the focus of this thesis will be limited to the cash flow
analysis of a patent. If a patent is not expected to generate revenues equal to
the costs of creating the patent, (ignoring depreciation) then the patent can not
be valued as the cost of creating the patent (Smith et al., 2000).
The focus of this thesis occurs in a university setting, where research is
often conducted, and patents are created, under federally funded programs.68
The university assumes the responsibility to make new technologies available to
the public, either through commercialization or publication. Therefore, cost,
although it is an important factor, is not the primary focus within the university,
and consequently is not appropriate in the methodology of this thesis.
68 See Section II.A. The Bayh-Dole Act.
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II.D.4. Income Approach
The income approach measures the value of a patent, by calculating the
net present value of the patent.69 Smith and Parr (2000), suggest several
methods of applying the income approach. However, these methods pertain to
realizing the benefits of a patent within a firm, or at least being capable of
calculating the benefits of a patent to a specific firm. This thesis is not concerned
with internally using or commercializing a patent, but rather is focused on
technology transfer. In addition, the valuation used in this thesis occurs prior to
identifying a specific licensee. This thesis will generate a value used by a
university TTO to identify potential optimal licensees. In addition, the value will
be used by the TTO just prior to entering into negotiation with a potential
licensee, but prior to gaining access to firm specific data from the potential
licensee. Therefore, income approach methods, which require firm specific data,
would be inappropriate.
When attempting to value a patent, Smith and Parr (2000), recognize the
flexibility of the discounted cash flows method, and the need to identify future
cash flows, and risks associated with future cash flows.70 Smith and Parr
69 Net present value (NPV) is the net expected cash flows (cash receipts – cash outlays) adjusted using a discount rate, to the present time. 70 Risks associated with future cash flows, according to Smith and Parr (p. 258-278), include the economic climate, profitability, competition, cash flow duration, and product life cycle as well as many others.
75
suggest using ranges of scenarios and an appropriate discount rate to
acknowledge and account for risk factors.71
Perchorowicz (1995) suggests projecting cash flows for the life of the
patent and discounting the cash flows as well. However, he then multiplies the
net present value by the probability that each risk will not occur.72 For example, if
a patent’s net present value equals $10,000 and the probability that the patent
will clear all regulatory requirements is 90%, then the patent would be valued at
$9,000. This continues until all risk factors have been exhausted. Perchorowicz
also makes a warning about common estimation errors such as the inclusion of
the same risk in more than one factor.
The income approach is able to calculate a patent’s value according to the
net cash flows of a patent, the risks associated with commercializing a patent,
and the time value of money. It is best suited for intellectual property and
contract valuation. The valuation conducted in this thesis will use the income
approach.
71Ranges of scenarios can be categorized as probability percentages, or best-case, most-likely-case, and worst-case scenarios. This thesis will assume a 25 percent best-case scenario, 50 percent most-likely-case scenario, and 25 percent worst-case scenario. 72 See Appendix J.
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II.E. Royalty Rates and other Cash Compensations
The timing and form of cash compensation for a patent is critical. This is
especially true for the cash-short university. Therefore, the TTO must determine
what types of compensations are available and appropriate for each patent.
II.E.1 A Reasonable Rate of Return
Parr (1996) suggests that intellectual property should be treated as an
investment asset, and that royalties and other forms of compensation should
reflect the same factors that drive the rate of return (RoR) requirements
associated with all other business assets. In addition he identifies three factors,
which should drive the rate of return. These are the economic benefits derived
from the patent, the duration of those benefits, and the risk of receiving the
benefits. The exchange conditions also will affect the rate of return. An
exchange can either be an orderly liquidation, forced liquidation, or an auction.73
In an orderly liquidation, the key is to identify the point of indifference for both
buyer and seller (Smith et al., 2000). Often this is not the case. Instead,
compensation often is determined according to “what the market can bear” or by
“the size of the licensee and what it can afford” (Better, 2000). However, in order
73 This thesis assumes that the exchange is an orderly liquidation, between a willing and able buyer and willing and able seller. Different exchange conditions will affect the methodology and assumptions used to value a patent.
77
for the university to create long-term, sustainable relationships,74 the license
should create a win-win situation, in which the licensee is provided the incentive
to successfully develop and commercialize the patent, and the licensor earns a
rate of return which justifies the technology transfer (Dabek, 1999).
II.E.2. Calculating a Reasonable Compensation
A federal court of appeals exists for the sole purpose of determining
intellectual property cases: it is the Federal Circuit. Here, professionals struggle
to answer the same question that the university struggles to answer prior to a
license agreement. What is a reasonable compensation or rate of return? In
litigation, there is a Panduit75 test, under which the firm must prove that 1) a
demand existed for a patented product, 2) there were no non-infringing
substitutes, 3) the patent holder has the manufacturing and marketing
capabilities to exploit the demand, and 4) the amount of lost profits can be
quantified (Sullivan, 1996). In some litigation cases,76 an analytical approach has
been applied in order to determine the reasonable compensation. The analytical
approach operates by identifying the expected profit margin for the patented
technology, and subtracting the normal profit margin of a non-infringing patented
74 See I.D.4 Marketing. Note the importance placed on creating and maintaining a long-term relationships with potential licensees. Although this adds value to a patent, it is a non-cash form of value, and therefore beyond the scope of this work. 75 The name is derived from an infringement case. Panduit Corp. v. Stahlin Bros. Fibre Workers Inc., 575 F.2d 1152, 197 USPQ 726 (6th. Cir 1978). 76 TWM Mfg Co. Inc. v. Dura Corp., 789 F.2d 895, 899 (Fed Cir. 1986).
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technology or non-patented technology. The resulting answer is the profit, which
has been derived specifically from using the patented technology (Parr, 1996). In
addition to being rewarded a reasonable compensation for infringement, firms
have periodically received what is known as a “Panduit kicker.” This additional
dollar amount, or kicker, is generally awarded for costs, which can not be valued,
or may not be included in the calculation for compensation, such as the lost
profits of complementary products or the cost of litigation (Rosenblum, 1998).
Parr (1996) suggests a number of income approach methods, which can
be used to determine an appropriate compensation. However, in this thesis
author’s opinion a discounted cash flow analysis77 is still the most effective
method available for a non-profit firm, and will be used in this thesis.
II.E.3. Types of Compensation
There are a number of ways in which a licensor can receive monetary
compensation under a license. These include (but are not limited to) upfront
fees, milestone or benchmark payments, yearly fees, royalties, and lump sums.
However, the license payments should reflect the allocation of risk, under the
license agreement (DeGeeter, 1999).
Royalty rates are the most direct method of compensating the licensor for
the patent’s success. Therefore, unlike other forms of compensation, which may
77 See Appendix K.
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be directed towards overheard or other specific lump sum purposes, royalty rates
should be distributed according to each party’s contribution to the patent.
There is an often-cited “25 percent rule of thumb” for royalty distributions
giving the licensor 25 percent. Applying this rule is fraught with problems. For
example, 25 percent of what goes to the licensor? Firms often commit an error in
applying the 25 percent rule. The 25 percent rule states that a licensor should
receive at least 25 percent of the licensee’s pre-tax gross profits, or roughly 5
percent of the product’s selling price. Unfortunately, this method does not
consider any specific details of the patent, nor does it define the costs, which
should be included in the gross profit calculation. For example, are selling and
administrative expenses included? Another common method used by firms is the
application of an industry standard royalty rate, or a weighted average royalty
rate. Again the specific strengths and risks of the patent are not considered. In
addition, changing market and economic conditions are ignored. Finally, industry
standards are usually published in ranges (e.g., between 2.5 percent and 5.0
percent, or between 5 percent and 10 percent, etc.), which means that the
ranges still must be refined (Sullivan, 1996; Smith et al., 2000).
Determining the appropriate royalty rate is important, and in many
scenarios, a difference of just 0.05 percent can be substantial. It is the author’s
opinion that general rules of thumb or industry standards (pertaining to royalty
rate determination) should very rarely be the sole source of information, when
establishing a royalty rate.
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It also is common for royalty rates to be based on an accounting figure
such as the cost of research and development, or sales. A return on R & D is not
as effective, because the cost of a patent does not equal the value of a patent.78
However, the return on R & D method is widely used because it is easy to use
and is relatively inexpensive. Another common method uses a return on sales.
In this scenario, royalty rates are based upon net profit, as a percentage of net
revenues. Again this method is relatively easy and inexpensive, but may not
reflect the actual value of the patent (Sullivan, 1996; Smith et al., 2000).
However, royalty rates can be adjusted for uncertainties by establishing a
minimum and maximum royalty payment (Yau-Young et al., 1992).
Milestone payments are used to compensate the licensor of a patent for a
variety of reasons. Milestone payments may be used when a technology has not
yet been proven, or to fund the continuing development, or to provide incentives
to the parties for timely performance. Milestone payments should be triggered at
mutually agreed upon points, which unmistakably indicate an increase in value
for the licensee. For example, a milestone payment may be made once the
technology generates a predetermined amount of sales, or once the technology
reaches a specific stage of development. Milestone payments also can be used
to compensate the licensor for the decreasing value of a license, should the
78 See Section II.D.3. Cost Approach.
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licensee default, and the licensor must find a new licensee (Yau-Young et al.,
1992).
Yearly payments or pay-per-use agreements can be used to compensate
the licensor for a patent that it not commercialized, but rather is used as part of a
process, distant from the final product. The size of such payments should be
dependent upon the novelty and knowledge intensity of the patent (Yau-Young et
al., 1992).
The licensee may be required by the license to pay the original patent
costs as well as the patent maintenance fees. This is especially common when
the licensor is a university or other non-profit firm. If the license is non-exclusive,
each licensee should only be responsible for a portion of the patent and
maintenance costs. Adjustments also can be made as new licensees are added
(Yau-Young et al., 1992).
Upfront fees are fees that are paid at the creation of the license
agreement. Once again, payments made upfront are critical to the budget-
constrained university. Developed, narrow, exclusive patents call for high upfront
fees. On the other hand, moderate fees can be charged for undeveloped, broad,
non-exclusive patents, in order to encourage development and experimentation,
thereby increasing the likelihood of higher compensation (i.e., royalties) in the
future (Yau-Young et al., 1992).
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Paul Better (2000) suggests determining an appropriate upfront fee by
calculating the modified replacement cost (MRC). In order to calculate the MRC,
the inventor is asked three questions:
1. “Knowing what you know now, how much time would you need to rediscover or create this technology?
2. “What equipment would you need?
3. “Can you invent around this technology?”
Based on the answers given, a dollar figure (MRC) can be calculated.79
According to Better’s study,80 a typical upfront fee should be 15 percent of the
MRC.81
II.E.4. Alternative Forms of Compensation
Compensation for a license or a patent’s success does not have to be in
the form of cash payments. Universities are often receptive to alternatives, such
as equipment, donated patents, corporate sponsored research programs, or
cooperative research efforts. However, the valuation of this method of
compensation is beyond the scope of this thesis.
79 Paul Better did not demonstrate the calculation in his work. 80 The Better study consisted of 11 previously negotiated license agreements. 81 The range for the study was between 5 and 30 percent and Better acknowledged that some upfront fees may be intentionally lower to accommodate start-up firms, or other similar scenarios. The type of fees and the relative contribution of each of the fees to the probability adjusted net discounted present value create many opportunities for advantageous choices from the perspective of tax law. However, tax law, while often critical, is beyond the scope of this thesis.
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II.F. Electronic Tools for Valuing Patents
There are three prominent electronic tools for valuing patents: Valuate, by
Martha Luehrmann, TOP Index by Dr. Albert S. Rubenstein, and finally, the
Technology Pricing Model by Dr. Melvin J. DeGeeter and Mr. Jon C. Outland.82
All three attempt to guide the user through the process of calculating the net
present value of a patent’s83 future cash flows, while simultaneously accounting
for the risk and uncertainty associated with commercializing a patent. However,
each model uses a slightly different approach.
II.F.1. Valuate by Martha Luehrmann
Valuate assumes a university technology transfer-out transaction. It is
based on a Microsoft Excel spreadsheet. Valuate accounts for risk and
uncertainty by allowing the user to input an appropriate discount rate. Next, the
required royalty rate and minimum royalty base are input by the user. Finally, the
user must input the estimated sales and expenses for the commercializing firm.
Based on these figures, Valuate calculates the financial results for both
the private firm and the university, up to 16 years into the future. This is most
likely an assumption made by Martha Luehrmann. Since patents have a 20-year
82 See Appendix G for more detailed information on each author. 83 All three models can be applied to a wide range of property, intellectual property such as patents being just one of the possibilities. Although the focus of this thesis is the valuation of patents, in order to fairly reflect the capabilities of each model, the word “project” will be used instead to describe the object of valuation.
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life, the model assumes that either a) the patent will not be licensed until after
year 4, or b) the patent will not continue to generate revenue after 16 years.
Modifications can be made to project cash flows and financial results for
additional years. It also calculates the net present value and return on
investment (ROI) for the private firm and university and offers variations or
ranges.
II.F.2 TOP Index by Dr. Albert S. Rubenstein
TOP Index (Technology Opportunity Potential Index) is a Microsoft Access
based software program. It is capable of managing or evaluating several
projects simultaneously. To begin the process, the user must enter basic project
information (i.e., descriptive information). Then, a number of questions are
presented to quantify the technology according to the following attributes:84
Technical merit Proprietary position Competitive environment Market attractiveness Technical hurdles Manufacturability Regulatory issues Time to market Organizational needs Return on Investment (ROI)
The user is asked to assign an integer value to each question, by ranking
each question or factor between 0 and 10 (with 0 having no value, and 10
84 These attributes are designed to account for the risk and uncertainty of commercializing a patent.
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offering the greatest value). The user also can assign a “no information” ranking,
if no information regarding that factor is available. The factors are then weighted
according to industry data. However, the user can manually adjust weights. The
final factor values are combined to create an attribute value. Likewise, the
attribute values are combined to create a TOP Index value. The TOP Index
software conducts a financial analysis by projecting future cash flows, and
calculating the NPV and ROI. TOP Index also is capable of graphically charting
values. In addition, it is capable of comparing multiple projects, based upon the
same criteria.
II.F.3. Technology Pricing Model by Dr. Melvin J. DeGeeter and Mr. Jon C. Outland
The Technology Pricing Model is a Microsoft Excel spreadsheet,
categorized into steps. First, the Weighted Average Cost of Capital (WACC) is
calculated based upon the user’s input.
Second, the risk premium is calculated by identifying and quantifying the
possibility of any events, which could occur and affect the project. In addition to
project specific events, the user also is asked to identify and quantify the
possibility of average events for the firm, during an average project. If both the
project specific and firm average risk values are equal, the WACC is appropriate
to use as a discount rate. However, if they are different, the WACC must be
adjusted (either up or down) to create an appropriate discount rate.
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Third, the user is asked to estimate the project’s cash flows, as well as the
estimated royalty rate and other licensing fees. By applying the information from
steps 1 and 2, to step 3, the net present value of the project is calculated. In
addition, the Technology Pricing Model generates a range of variations from the
estimates provided.
Finally, the model provides a worksheet, in which to evaluate 2 projects by
asking the user to identify the critical factors for success, weighting each, and
assigning a value between 1 and 5 (1 having the lowest value, and 5 having the
highest value). According to the model, the project with the highest value should
be chosen.
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CHAPTER III: METHODOLOGY
III.A. Financial Analysis Tools
The methodology used will combine one of the three electronic valuation
tools and a decision tree analysis. By using both of these financial analysis tools,
a final patent value will be calculated. This value will be limited to a dollar value
of the cash flows. However, since some non-cash variables are so closely
related to cash-variables, non-cash variables will be used to arrive at the cash
value of the patent.
III.A.I. Technology Pricing Model
As discussed in II.F Electronic Tools for Valuing Patents, there are three
primary electronic valuation tools available. These include Valuate by Martha
Luehrmann, TOP Index by Dr. Albert Rubenstein, and Technology Pricing Model
by Dr. Melvin J. DeGeeter and Mr. Jon C. Outland. All three tools provide a
valuation analysis. However, only one will be used for this thesis.
The Technology Pricing Model allows the university’s TTO to first define
the appropriate discount rate, identify the required royalty rate as well as other
forms of compensation, and calculate the NPV of the patent’s projected cash
flows. Additional risk analysis will be conducted later in this chapter, during the
decision tree analysis discussion. Finally, the Technology Pricing Model
calculates the NPV based upon the information given by the user, and creates a
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range of scenarios based upon the estimates. This range of scenarios will be
key as this thesis defines the best-case, most-likely-case, and worst-case
scenarios for the specific patent-granted medical device that is analyzed. The
Technology Pricing Model85 was made available free of charge to this thesis
author, in its entirety, and it will be used extensively in this analysis.
III.A.2. Decision Tree Analysis
A patent derives its value from the individual claims86, which compose the
patent. As the breadth and the number of claims increase, the strength and
value of a patent generally increases. More specifically, the estimated cash
flows of a patent are derived from the license specified and patent claim
protected fields of use. The decision tree analysis will allow the patent to be
categorized into the individual claims and the individual fields of use. This will be
the first layer of three layers of branches in this decision tree.
Risk factors associated with each claim and field of use will create the
second layer of branches. There are many different risk factors, however
included among some of the most important are:
85 DeGeeter and Outland (2000), see Appendix G. 86 Claims are the heart of a patent. The grant of a patent is a grant of a legal (but not necessarily an economic) monopoly over the claims allowed by the USPTO. A patent applicant purports in the claims what the patent is capable of doing. A claim may be narrower than, or equal to, or broader than a field of use. Each claim may indicate one or several fields of use. Valuation is more closely tied to the field of use than to patent claim. This thesis will analyze a single patent with a single field of use. For the sake of simplicity, that single patent will be assumed to contain a single claim.
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Patent strength and quality Stage of development Market size Remaining life (of patent, license, and technology) Success of related technology Competition Profit margin Product and process liability Political risk Inflationary risk Economic risk
Of these risk factors, the most significant for our purposes are the first
four: patent strength and quality, stage of development, market size, and
remaining life. The middle three (i.e., success of related technology, competition,
and profit margin) also play a key role in commercialization, and as such these
three will be included in this analysis. Each risk factor, which is applied, will be
assigned a probability of 10 percent.87 The last four risk factors, which include
product and process liability, political risk, inflationary risk, and economic risk,
while important for the commercialization of any product or service, will be
excluded from this analysis. That is, each of the last four risk factors will be
assigned a zero percent probability, during this analysis. This has been done so
that the focus may rest upon the factors, which are critical for the specific medical
device to reach commercialization.
87 The 10 percent number is an arbitrary number. If all ten of the listed variables were included in this analysis, and if each of the ten was of equal importance, then the 10 percent could be justified. However, only seven of the ten will be used in this analysis. Also, these seven are not of equal importance. The 10 percent number has been selected to make the analysis more transparent because the weights are equal and the multiplication simple.
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The third layer of branches will be composed of the probability of success
for each of the seven factors. The best-case scenario, the most-likely-case
scenario, and the worst-case scenario, each will be assigned probabilities,
according to a 25 percent, 50 percent, and 25 percent scale.88 These
probabilities need not be static. These probabilities will shift as additional
information is available and the uncertainty of commercialization decreases.
Value need not be static. At the same time as the probabilities shift, the value of
a patent also may shift. The patent’s value will move towards zero, as the
patent’s remaining life (whether that be based on the patent life cycle, product life
cycle, or patent abandonment) decreases. The patent’s value will increase as
the stage of development advances and the size of market increases.
It is important to note that the probabilities and the required rate of return,
which are used in this thesis, are not fixed. Both are subject to change.
Fluctuations may be caused by the time period that the valuation occurs, the
information that is available at that time, as well as other technology transfer
specific information.
88 In a decision tree all of the twigs off of a branch must sum to 100 percent probability. Flipping a coin is a decision tree branch with two twigs, with each twig carrying a 50 percent probability. (Although, after the Bush – Gore election in 2000, one must always remember that it is possible to flip a coin on edge.) In addition, to probabilities, decision branches and twigs may have other weightings (e.g., dollar values) that do not need to sum to 100 percent.
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III.B. Discount Rate
In order to calculate the net present value of the projected cash flows, an
appropriate discount rate must be chosen. A number of methods can be applied,
but the most appropriate rate must be used, in order for the university to realize
an appropriate return.89
III.B.1. Standard Discount Rates
The most common discount rate used during a discounted cash flow
(DCF) analysis is the weighted average cost of capital (WACC).90 The WACC is
generally the most accurate rate because it reflects the firm’s cost of providing
funds for a project. By applying the WACC rate to the DCF, the firm is requiring
that the project at the very least, return the funds that the firm has invested in the
project, at the rate that it cost the firm (at the time) to invest the funds in the
project. It is important to note that each firm will have a different WACC, which
complicates the technology transfer even further. A university almost certainly
will not have a WACC, similar to the WACC of a for-profit firm that seeks to
license the university’s technology. So, how does a TTO choose a discount
rate? The licensee’s WACC could be used in a technology transfer. However,
89 Each party to the transaction will view the transaction through the lens of a different discount rate. Since this thesis is focused on the university, the discount rate used by the university is the “appropriate” discount rate. The licensing document may contain a different discount rate. The licensing document may use the discount rate of the university, or of the buyer, or some compromised discount rate motivated by other concerns (e.g., tax treatment). 90 See Appendix L.
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the valuation conducted in this thesis occurs prior to identifying a specific
licensee.
Absent a specific licensee, the university should seek a market return for
the license agreement. Many times, historical cost information is used by the
TTO, for lack of better information. However, the cost of researching and
designing a technology does not equal the value of the technology. In addition,
the cost of research and design conducted by a university is often is entangled in
byzantine accounting practices related to federal grants and other sponsored
programs. The university TTO must focus on the value of the technology. The
TTO should focus on earning a market return on the licensing of that technology,
and treat the historical cost of creating the technology, as a sunk cost.
III.B.2. Proxy of the Industry Return on Equity
The focus of this thesis is the valuation, of a patent-granted medical
device, that occurs in a university setting, prior to identifying a specific licensee.
Since, in this thesis, the university TTO can not use a WACC or base the return
on the historical cost of the patent, the TTO must find a different discount rate.
The discount rate should reflect the purchasing firm’s required rate of
return. That purchasing firm will be drawn from a specific industry based upon
the field of use that the license will cover. Even though the WACC of a specific
external, for-profit firm can not be used, the proxy of the industry’s return on
equity is available. The assumption (when using an industry equity rate) is that
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the average in the industry firm is conducting similar projects, with similar risks.
A proxy of the industry return on equity will reflect the industry’s average cost of
capital, and the industry’s market return.91
91 Once a potential licensee is identified, then the WACC will need to be adjusted. That adjustment in the WACC may be up or down.
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III.C. Discounted Cash Flow Analysis
A discounted cash flow analysis is conducted by projecting the future net
cash flows from the license of the patent, including sales and expenses. The
cash flows are discounted according to the assigned discount rate. The final
result is the estimated net present value of the patent.92
III.C.1. Required Royalty Rate and other forms of Compensation
A university TTO must determine what types of compensation and rates of
compensation are appropriate for a technology transfer. Royalty rates are a
frequent form of compensation, but upfront fees, milestone payments, and
maintenance fees also can compensate a university. Also, the royalty rate may
fluctuate and the basis (e.g., units sold or gross revenues) for earning the royalty
payments may change. The cash-short university has historically manifested a
preference for front-loaded license compensation agreements. Unfortunately this
means that the TTO may be forfeiting much larger future compensations, for
immediate gratification.93 In order to maximize the benefits of technology
transfers, TTOs will eventually have to move from short-term to long-term
92 See Appendix K for a review of the formula used to derive NPV. 93 “Much larger” here has two meanings. Cash-strapped sellers may knowingly surrender “much larger” dollar transfers at a future date assuming the DCF value of the small, but present payments is larger. “Much larger” here means both DCF value today and cash value at the time of future payment. The error arises when the cash-strapped firm surrenders both the larger cash value in the future and the larger DCF value today. It is not an error to have a different time preference or a different WACC, and thus a different preference for a specific type of compensation.
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compensation. Upfront fees may be appropriate.94 However, upfront fees should
be used in coordination with all forms of compensation to maximize the DCF
value. In addition, a TTO should establish a minimum royalty rate requirement.95
When establishing a compensation package, the TTO also must consider
the time value of money. Different time preferences and costs of capital can
often lead negotiators toward different compensation packages. For example, a
university may suggest a specific set of milestone payments. However, the
licensor may argue that although the milestone is correct, it also correlates with
higher expenses for the firm at that time, which would not allow the firm to make
the milestone payment. In this scenario, the university could offer to allow the
firm to pay interest on the milestone payment (at a rate below the licensor’s cost
of capital, but above the university’s cost of capital) until payment can be made.
Again, alternative forms of compensation such as that described above, or
sponsored research programs, are beyond the scope of this thesis. The focus
will only rely on cash flow valuation analysis.
III.C.2. Sales and Expense Projections
94 Upfront fees may motivate the licensee to commercialize the technology more quickly, in order to recover the costs of the upfront fee. This would indirectly benefit the university TTO as well, through royalties paid to the TTO as well as serve the TTOs mission to make the technology available to the public. In addition, upfront fees also provide the university TTO a way in which to recover technology transfer costs, (i.e., patent or administrative costs) as soon as possible. 95 By establishing a minimum royalty rate, the licensee will be motivated to commercialize the technology as efficiently as possible, knowing that whether the technology is successfully commercialized or not, the licensee will still be required to make a royalty payment.
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A significant amount of valuation analysis time should be invested in
exploring the possible market for a patent. The university TTO can not fairly
license the patent without an estimate of the patent’s future cash flows, as these
future cash flows represent the potential economic benefits, which the licensee
may derive from the technology transfer. It is important to note that this
calculation is not the value of the patent, but rather the profits,96 which can be
derived from the patent. In addition, the cash flow projections should not include
any non-dollar costs or benefits. For example, a patent may potentially create or
strengthen a firm’s strategic position or strategic alliances, but as a non-dollar
benefit, it must be excluded from this calculation.
Cash flow projections are a key element in deriving the profit available
from a patent. For this reason, the TTO tasks need to be divided into two
discrete task sets: first, the business valuation task sets, and second the
scientific and legal task sets.97 The latter task set would be responsible for
evaluating the technology according to its scientific merit, and assuring the
technology’s legal protection. The former would be responsible for estimating the
market potential for the patent, and estimating the projected cash flows of the
96 Profit equals total revenue minus total cost (i.e., Π = TR – TC). Many writers use “value” and “profit” interchangeably, but they should not do so. Profit is far more cash focused than value. This thesis will use “profit” since it will only examine the dollar value of a patent. 97 A successful technology transfer depends upon the TTO’s knowledge and expertise in a broad range of studies. In general, each professional in the TTO will be focused (have the knowledge and expertise) on either the scientific aspects or legal aspects or business aspects of the technology, but rarely all three. For this reason, it is wise to capitalize on the strengths of each professional and create a cross-functional process, during the technology transfer process.
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patent, once it is commercialized. Cash flows projections also should be limited
to the specific field of use, expected in the future license.
III.C.3. Net Present Value
The NPV of the patent must then be calculated, using the determined
discount rate and projected cash flows. The cash flows will include both
projected sales and expenses of the patent, as well as the cost of obtaining and
maintaining patent protection. It will be assumed that all cash flows are paid at
the end of the time period.
However, the NPV does not consider the various risk factors and possible
scenarios, which may occur while attempting to commercialize the patent. In
order to quantify the effects of each risk factor, a decision tree analysis should be
applied.
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III.D. Decision Tree Analysis
A decision tree analysis provides the TTO with a tool. Decision trees are
used to evaluate multiple scenarios and assign a probability to each. This tool
will be especially useful, when attempting to license patents, which present a
variety of risks, such as a patented medical device in the early stages of
development presents.
III.D.1. First Branch – Claims and Field of Use
The first branch of the decision tree requires that the patent be
categorized according to the claims and correlating field of use. This is important
because different claims and fields of use will represent different risk scenarios in
different branches of the decision tree.
III.D.2. Second Branch – Risk Factors
The second branch is the most complex branch. The second branch of
the decision tree will explore the various factors that affect commercialization of a
patent. A significant amount of time should be spent identifying all possible
scenarios. The methodology of this thesis identifies the risk factors below, as
they apply to a medical device. Additional risk factors may be possible for other
types of patents. Since each factor can significantly impact the
commercialization of a patent, each will be assigned a 10 percent weighting.
99
Several of the risk factors, already identified, (i.e., product and process
liability, political risk, inflationary risk, and economic risk) apply to any type of
commercialized product or service, and will be weighted at zero percent in the
analysis, in order to maintain the focus of this thesis on those factors which
specifically apply to the commercialization of a medical device. The analysis will
focus on the following risk factors.98
Patent strength and quality Stage of development Market size Remaining Life Success of related technologies Competition Profit margin
III.D.2.a. Patent Strength and Quality
First, this factor evaluates the patent’s ability to protect the technology
(patent strength) against any possible future infringement. Second, it evaluates
the patent according to quality, which measures whether patenting the
technology is an appropriate protection vehicle.99
98 Additional information regarding each risk factor is available in II.C. Variables that Affect the Value of Patents and Licenses. 99 For example, a patent would be an appropriate protection vehicle for a pharmaceutical product, but trade secret protection would be more appropriate for an internal process used by a firm, based on the disclosure requirements for both.
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III.D.2.b. Stage of Development
The stage of development factor considers several scenarios. First, it
assesses the regulatory risk. For example, a technology, in the early stages of
development, faces the risk of not receiving proper regulatory approval. For a
medical device, this is FDA approval.100
Second, this risk factor evaluates the functionality of the technology.
Once again, a technology, in the early stages of development, faces a greater
risk, if the technology has not yet been significantly proven to have the effect or
work as it claims.
III.D.2.c. Market Size
This factor evaluates the risk associated with market size. During the
discounted cash flow analysis, sales projections were given. The sales
projections were based on the estimated market size and the determined field of
use. The field of use dictates the market for the technology and therefore, the
field of use and market size operate interdependently. Sales projections are
subject to change, and this factor considers different scenarios, which can result
from the fluctuation of market size. This is important, because the market size of
a new product can be extremely difficult to estimate. This is especially true,
100 In the pharmaceutical industry, this is a very large risk, because the firm seeking FDA approval must prove both the safety and efficacy of the product. However, the medical device industry must only prove the safety of the product, which greatly reduces the risk associated with regulation. The FDA categorizes devices according to Class I, II, and III. Each class of devices must follow different requirements for proving the safety of the device.
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when estimating the gains in market share in a stagnate market where quality,
rather than price, is the advantage of the newly patented medical device.
III.D.2.d. Remaining Life
The remaining life of a technology is the shorter of both the product life
cycle and the patent life cycle. In general, a technology will be limited to the
product life cycle, as the patent life cycle is generally longer than the product
cycle. However, the patent life cycle may be critical, if the technology is not
introduced to the market until later, thus moving the product life cycle past the
patent life cycle. In addition, a product life cycle may be unexpectedly shortened
or lengthened by the market, or the patent may be abandoned entirely.101 The
remaining life, risk factor will consider various scenarios that could result from the
remaining life. Based on the patent abandonment rate, this analysis will assume
that the product life cycle ends just after the first maintenance fee, or 3 ½ years
after the patent is granted. The analysis will assume that the maintenance fee is
paid, but that the technology does not generate revenues past 3 ½ years.
III.D.2.e. Success of Related Technology
The success of related technology can both positively and negatively
impact the commercialization of a technology. This risk factor allows the
calculation to consider both the positive and negative impacts or scenarios that
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could result from the success or failure of related technologies. In order to do so,
related technologies must be identified as complementary products, or products
that are related through industry or field of use association. The success of
complementary products will positively impact the success of the new
technology, as the increased demand in the complementary products would
likewise encourage demand in the new technology. The opposite is also true. A
product in a similar field of use, which fails and creates a negative connotation for
that field of use, would negatively impact the new technology as well.
III.D.2.f. Competition
Again, competition can positively or negatively impact the
commercialization of a technology. If strong competition for similar products
exists, then commercialization will become more difficult. If little or no
competition exists, then commercialization may be easier. Competitive forces
constrain the options and profit opportunities of firms in the market and in related
markets. The “competition” risk factor will consider the possible scenarios, which
can result from competition. Competition is distinct from the “success of related
technology” risk factor, which only evaluated complementary products and
products, which are not directly competitive. The “competition” risk factor
evaluates the success and failure of substitute products and their impact on the
success of the new technology. In a market filled with substitute products,
101 See Appendix H for an analysis of patent abandonment.
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demand would be shifted among substitute products, and the new technology
would become just one of a number of product choices. The risk of substitute
products could force the price of the new technology to be lowered, force the
commercializing firm to spend more in marketing, so that the general public
identifies the new technology, or force additional services or enhancements to
the technology (i.e., 24-hour customer service) which would increase the cost of
the technology, but also distinguish the technology from substitute products.
III.D.2.g. Profit Margin
The “profit margin” risk factor explores the effect of profit margin on
commercialization, given a consistent volume. A higher profit margin need not
mean greater cash flows. Profit margins are dependent upon price elasticity in
the market, which is a function of what the customers are willing and able to pay
for the patented technology,102 as well as the costs associated with producing the
technology. The cost of complimentary assets needed for production is closely
related to the cost of production and profit margins. Although complimentary
assets will not be directly addressed in this thesis, complementary assets are
indirectly reflected in the profit margin.
102 The use of managed health care or insurance firms has both increased and decreased the number of medical device customers, which are willing and able to pay. As the number of insured individuals increases, the ability to pay increases. However, increases in the use of managed health care also decreases the willingness to pay for non-cost effective treatments.
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III.D.2.h. Product and Process Liability
When a patent is commercialized through a university technology transfer,
the university may assume (either in part or in full) liability for the product. This
will depend upon the details of the license agreement and liability laws.103 A
liability suit may or may not occur in the future. This risk factor considers the
possible scenarios involved with liability. As this risk factor applies to virtually all
types of commercialization, and is particularly difficult to estimate in a TT context,
the “product and process liability” risk factor will be excluded from the analysis in
this thesis.
III.D.2.i. Political, Inflationary, and Economic Risk
Political, inflationary, and economic risk must be considered when
attempting to commercialize any type of product or service. Political risk for U.S.
103 All too often, the 11th Amendment to the U.S. Constitution is forgotten (until it is too late to address it with a contract provision). The 11th Amendment restores sovereign immunity for the individual U.S. States by striping the U.S. federal courts of jurisdiction over lawsuits initiated by a person who is not a citizen of the State that is being sued. In effect, each State’s legislature decides under what circumstances that State will consent to be sued. Most States have waived sovereign immunity for many routine bases for suit. However, product liability in the absence of privity of contract often is not identified as a routine basis of suit. A separate question is whether a State university is “the State.” If the university in question is a State university, then the university may or may not have any product liability. A clause in a license contract usually can resolve this issue; but, not always, since some States do not empower employees to waive the immunity. Since many TTO’s are part of State universities, and since this legal question is particularly thorny, and since the answers to these legal questions are currently in flux, product and process liability will be excluded from the analysis or risk in this thesis (Crews, 1998).
105
domestic products tends to be minimal.104 Inflationary risk has a particularly
large impact on DCF analysis since inflation immediately influences the discount
rate. Economic risk is a far broader variable and is of more relevance for
discretionary expenditure industries and for high capital expenditure industries.
These scenarios may or may not be predictable, but nonetheless must be
considered. This risk factor explores the possible positive and negative affects or
possible scenarios of each. Again, the analysis will exclude this risk factor.
III.D.3. Third Branch – Best-Case, Most-Likely-Case, and Worst-Case Scenario
The third branch will explore the possibility of each scenario, and how
each could positively or negatively affect the projected cash flow of the patent. A
decision tree, which explores every possible scenario and the degree of each
possibility, would quickly become unmanageable. In order to simplify the
process, while still considering all significant scenarios, a best-case, most-likely-
case, and worst-case scenario will be applied. Probabilities will be assigned to
the three scenarios as 25 percent, 50 percent, and 25 percent accordingly.
For example, when evaluating the market size of a new technology, the
TTO may estimate a demand for 100 products per year. This is the most-likely-
104 Political risk can become a major factor in some circumstances. The price of Microsoft stock, due to the outstanding antitrust lawsuit, gyrated with the relative fortunes of the Republican and Democratic candidates in the year 2000 presidential election. Medical technology can get caught up in political risk (e.g., the RU 486 aborticide prescription drug), but this is rarely a problem for medical devices. Also political risk is greatest for international exposures because import and export laws come into play. However, this thesis is focused on a non-controversial medical device for sale in the U.S. domestic market.
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case scenario, and will be weighted at 50 percent. However, the TTO also must
recognize the possibility that demand may only be 75 products per year, in a
worst-case scenario, and 125 products per year, in a best-case scenario. The
best-case and worst-case scenarios each will be weighted at 25 percent
probability.
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III.E. Final Net Present Value
The final risk-adjusted net present value will be calculated by comparing
the NPV found in the discounted cash flow analysis to the NPV found in the
decision tree analysis. The final risk-adjusted NPV should be used to guide the
financial aspects of the technology transfer process.
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III.F. Review of Applicable Formulas
The valuation analysis can be defined as a two-step process. First the
NPV is calculated, using the DCF formula.105 The NPV is based upon the
projected sales and expense projections, estimated life of the technology, and
the determined discount rate. The assumption is made that all payments occur
at the end of each time period.
Second, the decision tree analysis is conducted. The first layer of
branches consists of the patent’s claims and related fields of use. For the
purpose of this thesis, the medical device in question has one field of use, and
therefore the single patent will be assumed to contain a single claim. The
second layer of branches consists of the risk factors associated with
commercialization. There are 7 branches in the second layer, and each branch
will be assigned a 10 percent weighting. In an actual technology transfer, the
weights of this branch would be assigned according to importance, and would
total 100 percent. However, the 10 percent number has been selected to make
the analysis more transparent. The third layer of branches consists of the
possible scenarios, which may occur for each risk factor. In order to simplify the
decision tree analysis, the best-case, most-likely-case, and worst-case scenario
will be used and assigned weightings according to a 25 percent, 50 percent, and
25 percent scale. These weightings are dynamic and subject to change in a
105 See Appendix K for a description of the formula.
109
technology transfer as more information becomes available. A NPV will be
assigned to each scenario.
Finally, the probabilities will be multiplied and summed by the NPVs. The
NPV for each scenario will be multiplied by the probability of each scenario and
their results will be summed.
NPV1 = (0.25)NPVb + (0.50)NPVm + (0.25) NPVw
Where:
NPV1 = NPV of the first risk factor NPVb = NPV of the best-case scenario
NPVm = NPV of the most-likely-case scenario NPVw = NPV of the worst-case scenario
Next, the NPVs of each risk factor will be multiplied by the probability assigned to
each risk factor and their results will be summed.
NPVf = (0.10)NPV1 + (0.10)NPV2 + (0.10)NPV3 + (0.10) NPV4
Where:
NPVf = Final risk-adjusted NPV NPV1 = NPV of the first risk factor NPV2 = NPV of the second risk factor NPV3 = NPV of the third risk factor NPV4 = NPV of the fourth risk factor, etc.
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CHAPTER IV: ANALYSIS
IV.A. ScanMed
ScanMed is a private for-profit firm, based in Omaha, Nebraska.106
ScanMed is a medical device, manufacturing firm, which offers MRI
enhancement products to OEMs,107 such as GE Medical Systems108 as well as
consumers, such as hospitals and clinics, which own MRI systems. The firm was
founded in 1993, and technologically supported through exclusive licenses with
the University of Nebraska Medical Center (UNMC) and UneMed.109 One of the
previous technology transfers, conducted between ScanMed and UNMC, will be
used to demonstrate the methodology of this thesis.
IV.A.1. Medical Device Industry
The medical device industry is one of the most dynamic industries in the
U.S., as it uses advances in other fields such as microelectronics,
telecommunications, biotechnology, and pharmaceuticals, to create innovations
in the medical device industry. The U.S. market for medical devices was
estimated as $51 billion in 1998, or 37 percent of the global market, at that time.
106 See Appendix G for contact information. 107 OEM is an acronym for original equipment manufacturer. 108 GE Medical Systems is a division of General Electric (NYSE: GE). http://www.ge.com 109 UneMed is a for-profit corporation, dedicated to technology transfer from UNMC and wholly owned by the University of Nebraska Board of Regents. Refer to Appendix G for contact information.
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There are approximately 8,000 medical device firms in the U.S. These firms are
generally small and medium-size, and are usually located near clusters of firms
in the same technology industry. The medical device industry is distinctive
because it is self-sustaining. New medical discoveries demand new medical
devices to serve those advances. In addition, the average life expectancy is
increasing, which means that more people have more years in which they may
require medical treatment. However, several trends will change the industry in
the near future. These trends include health care reimbursement, consolidation,
demographics, and regulation (Hansbury, 2000). The impact of each is reflected
in the specified risk factors. For example, the impacts of health care
reimbursement and consolidation are reflected in the “profit margin” risk factor.
Trends in regulation are considered in the “stage of development” risk factor, and
demographics are reflected in the “market size” risk factor.
As managed health care firms earn a larger portion of the U.S. health
insurance market, these firms seek out profits through cost containment and
lower reimbursement schedules. Often times, firms are required to prove the
outcome-based benefits of a device, before the managed health care firm will
agree to accept the device as a reimbursable product.110 The burden of proof is
110 Managed health care approval is different from FDA approval, in that the FDA is merely confirming the safety of the device, whereas the managed health care firm is confirming the cost/benefit relationship.
112
often placed on the medical device, manufacturing firm.111 Since these
manufacturing firms are typically small and medium-sized112, the cost of
providing the necessary proof can be financially devastating (Hansbury, 2000).
In addition, managed health care firms rely on high volume, low reimbursement
schedules. A recent Wall Street Journal article cited the closure of numerous
clinics, which specialize in breast imaging, or mammograms. These clinics have
been forced to close their businesses because of the low reimbursement
schedules, offered by managed health care firms, which are sometimes even
lower than the cost of providing the test. For example, one Boston clinic official
claims that the cost of each mammogram is $90, but that the clinic is reimbursed
less than $35 per test, by an unnamed managed health care firm. This trend
may continue in the future. If so, then it is not sustainable for either the medical
device industry or the managed health care industry. It is important to note that
this Wall Street Journal article also cited that MRIs generally follow a more
lucrative reimbursement schedule (Martinez, October 30, 2000, page A-1,
column 6).
Consolidation is another trend, which will affect the medical device
industry. The 1980s and 1990s were well known for large mergers and
111 In order to ensure reimbursement, hospitals will seek out those medical device, manufacturing firms, which are able to provide the proof (i.e., cost/benefit relationship) required by the managed health care firms. 112 According to the Advanced Medical Technology Association, more than 80 percent of medical device manufacturers have 50 or fewer employees (The Promise of Medical Technology, http://www.himanet.com/publicdocs/promise4500.html).
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acquisitions in many industries, and the medical device industry was not an
exception. The majority of the medical device industry still consists of small and
medium size firms, therefore making the industry a prime target for mergers and
acquisitions. The author of this thesis believes that the trend will become even
more pronounced in the future. First, the cost of research and design, as well as
the cost of providing proof of a medical device’s benefits (to the managed health
care industry) encourages efficiencies, which can be found in mergers and
acquisitions. Second, hospitals, insurance firms, and other medical equipment
purchasers, are able to leverage their purchasing power and negotiate lower
prices by forming Group Purchasing Organizations (GPO). Mergers and
acquisitions offer firms the ability to survive in this type of environment, through
economies of scale (Hansbury, 2000).
Demographics play a crucial role in the medical device industry. As the
average life expectancy of both men and women increase, so does the number
of years that these individuals may require medical treatment (Hansbury, 2000).
While this may not affect all medical devices, it certainly will have a positive
impact on the MRI market, and consequently, the market for MRI enhancement
products.113
Finally, regulation can have a huge impact on the medical device industry.
According to the Center for Device and Radiological Health’s (CDRH) 1998
113 Medical devices, which are only intended for a specific age group, would not greatly benefit from this trend. However, MRIs are used across a large range of age groups, and would thus benefit from the increased life expectancy of the general public.
114
annual report, the approval time for premarket authorization was reduced by 25
percent and 510(k) clearance was reduced by 12 percent.114 This means that
medical device firms in general, are able to commercialize new products faster
and easier, which can be an enormous financial opportunity for firms (Hansbury,
2000). Assuming, of course, that the medical device firm can demonstrate that
benefits exceed cost experienced by the managed care industry.
IV.A.2. The Specific ScanMed Medical Device
In 1994, the University of Nebraska Medical Center was issued a patent
for NMR (Nuclear Magnetic Resonance) Quadrature Detection Coils. The patent
was exclusively licensed to ScanMed. The coils are used to enhance the MRI of
older units, according to the specific region of the body (i.e., head and spine,
knee, shoulder, or wrist). In 1996, there were an estimated 4,500 MRI machines
in the U.S. The MRI machine replacement schedule is estimated between 5 and
15 years, depending on the level of use. This thesis will assume that MRI
machine replacement occurs at 10 years. Once the MRI machine reaches the
point of replacement, the MRI machine is no longer to produce the images that it
114 Premarket authorization is an FDA requirement for Class III devices, and is used to prove the safety of a medical device. The process generally takes 180 days. The 510(k) clearance applies to Class II devices, and is intended to prove the same level of safety. This clearance generally takes 90 days (Sutton, 2000).
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once did as a new machine. At this point, the MRI customer115 will have to
choose whether to purchase a new MRI machine or purchase image enhance
coils, such as those sold by ScanMed. The coils are expected to extend the MRI
machines useful life between 3 and 5 years, depending upon the level of use. It
is important to note that this does not mean that the coils have reached their
useful life at this point, but rather that the MRI machine will no longer be able to
produce quality images, even in conjunction with the coils.
115 Customers include OEMs, such as GE Medical Systems, hospitals, and managed health care firms. Hospitals are a shrinking part of the medical device market as more and more services are moved off-campus motivated by accounting and reimbursement realities. From an accounting perspective, the off-campus site is more modular, allowing for swifter start-up and shut down. More importantly, from an accounting perspective, the off-campus site does not need to contribute a fraction of its revenue stream to the hospital’s overhead, which includes a much higher average fixed cost. At the same time, especially if the off-campus site is the only medical service of its type located in its zip code, the off-campus site gets reimbursed under a different schedule. If the off-campus site is the only provider in its zip code, then the managed care induced competitive pressures are minimized.
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IV.B. Choosing the Appropriate Discount Rate
At the time that a valuation analysis occurred, UNMC’s TTO would not
have identified ScanMed as the licensee, and therefore would not have been
able to use ScanMed’s WACC as a discount rate in the discounted cash flow
analysis. Unfortunately, the discount rate that was used during the actual
valuation also is unknown. However, according to the methodology of this thesis,
the industry’s return on equity should be used in this scenario.
IV.B.1. Proxy of the Industry Return on Equity
According to the most recent Value Line Investment Survey (September 8,
2000), the medical supplies industry has historically earned the return on equity
as listed in the figure below. In addition, Value Line also provides estimates of
the industry’s return on equity for the years 2000, 2001, and 2003 – 2005.
117
Figure 5. Medical Supplies Industry Return on Equity – 2000116
Year Return on Equity
1996 23.0%
1997 23.4%
1998 24.5%
1999 22.3%
2000117 23.0%
2001 23.0%
2003-2005 21.5%
116 Source: Value Line (September 8, 2000). It is assumed that the Return on Equity (ROE) is calculated in the same manner each year. 117 Those figures, which are in bold, represent estimates provided by Value Line.
118
According to the information in Figure 5, the TTO must now decide which
rate of return to apply to the valuation. If the valuation were conducted today, are
the historical (and factual) figures most appropriate? The historical percentages
are the most accurate. Should the estimates for the year 2000 or 2001 be used,
as they are timelier? Finally, should the rates of return for the years between
2003 and 2005 be used, as those years more fairly represent the returns, at the
time that a technology will be commercialized?118
In a more static industry, historical information may be appropriate.
However, the medical device industry is a very dynamic industry. Value Line is a
relatively reliable source, even for estimated information; there, the historical
rates of return should not be used. That limits the TTO’s RoR choices to either
estimated present rates of return (i.e., 2000 and 2001), or estimated future rates
of return (between 2003 and 2005).119 If the technology, which is being
commercialized, has a rather short remaining life and is near the final stages of
development, then present year RoR estimates (i.e., year 2000 and 2001) should
be used, depending on the time of the valuation, as well as the expected
commercialization date. In contrast, if the technology still requires several years
of development, or has a longer expected remaining life, then the future RoR
estimates (i.e., RoR for the aggregated years 2003 through 2005) are most
appropriate.
118 The ROEs, which are provided by Value Line are annual rates. 119 The ROE, estimated for a range of years, is the estimated annual ROE.
119
In the case of this analysis, the valuation would have occurred in 1994.
Therefore, the TTO would have used information that was available at that time.
In 1994, Value Line (March 18, 1994) published the ROE statistics in Figure 6.
120
Figure 6. Medical Supplies Industry Return on Equity – 1994120
Year Return on Equity
1990 19.0%
1991 19.7%
1992 21.4%
1993 20.0%
1994121 20.0%
1995 20.0%
1997 – 1999 19.5%
120 Source: Value Line (March 18, 1994). 121 Those figures, which are in bold, represent estimates provided by Value Line.
121
Based on Figure 6, the medical supplies industry earned a 20 percent
ROE in 1993. The same ROE was expected in 1994 and 1995. In addition, the
ROE was estimated by Value Line, to decrease slightly between 1997 and 1999.
It is important to note that the estimated ROE, provided in Value Line’s 1994
journal, (Figure 6) differs from the factual ROE, which is reported in the 2000
journal (Figure 5). For example, Value Line estimated a 19.5 percent ROE in
1997. However, the actual ROE was 23.4 percent. This disparity is caused by
unpredicted growth in the industry, and serves as a great example of the
uncertainty, which has been discussed in this thesis.
In 1994, the TTO would not have had the luxury of knowing the actual
future ROE’s, which are provided in Figure 5. Instead, the TTO would have had
to base the discount rate on the estimated future ROE in 1994, 1995, and 1997
through 1999, which is provided in Figure 6. Based on the patent abandonment
rate, the DCF analysis assumes that the technology will not generate revenues
past the first maintenance fee, which is 3 ½ years from the date that the patent is
granted. Therefore, the discount rate must be appropriate for 1994, 1995, 1996,
and the first six months of 1997. Based on the information provided in Figure
6122 and the time line, which will be used in the discounted cash flow (DCF)
analysis a 20 percent discount rate appears appropriate. Therefore, a 20 percent
discount rate will be used in the DCF analysis.
122 In Figure 6, Value Line estimates that the industry will earn a 20 percent ROE in 1994 and 1995, and estimates that the ROE will decrease slightly for the years 1997 through 1999, to 19.5 percent.
122
IV.C Calculating the Discounted Cash Flows
In order to calculate the NPV of a patent, the positive and negative cash
flows must be estimated and discounted according to the pre-determined
discount rate. In addition, the TTO also must determine the compensation
package of royalties, upfront fees, and milestone payments.
IV.C.1. Required Royalty Rate and other forms of Compensation
According to the time value of money, in order for a university TTO to
maximize the benefits of a technology transfer, they must optimize the duration of
their internal cash flow time line. For many TTOs extending the cash flow time
line may require some learning. It is irrelevant, but understandable that a TTO
may wish to recover the costs of patenting the technology and conducting the
actual technology transfer through upfront fees (assuming that the patent fees
are not a cost that is specifically addressed and paid by the licensee). On
average, the cost of filing an obtaining patent protection is $10,000. The
overhead costs of a TTO will vary according to the specific TTO. For a TTO,
similar to that operating under UNMC, overhead costs could be as high as
$2,500123 per technology transfer. Therefore, the TTO should use the sum
$12,500 (= $10,000 + $2,500) as the foundation for the initial upfront fee offer.
123 This cost assumes a 4-step phase, including an initial patent search conducted by a graduate student or similar individual, a more in-depth patent search conducted by an internal patent attorney, additional consultation with an external patent attorney, and an additional patent agent search. The estimate was provided by the UNMC Intellectual Property Office (IPO).
123
Upfront fees that are paid in addition to the sum listed above may be appropriate
for unique and advanced technologies.
Milestone payments are balloon payments triggered by a mutually
agreeable definition of when significant risk of failure is eliminated. For example,
a milestone payment may be triggered once the FDA approves the technology.
Next, the TTO must determine an appropriate royalty rate. The following
Figure 7 and Figure 8 represent applicable royalty rates according to industry,
and according to whether the firm is in-licensing or out-licensing. Unfortunately,
the medical device industry is not specified, but a group of similar and
comparable industries are available. Figure 7 and Figure 8 categorize the royalty
rates according to ranges (i.e., between 2 and 5 percent) and according to
industry (i.e., general manufacturing, university, etc.) The percentage of licenses
which use each range of royalties are listed across from the industry and below
the percentage range. For example, 45 percent of general manufacturing (in-
licensing) royalties, in Figure 7, are between 0 and 2 percent. The royalty rate is
not the same as the discount rate. The discount rate is the rate of return that the
TTO seeks for the technology transfer,124 whereas the royalty rate is simply the
percentage (typically of net sales, but other base numbers can be used) that the
licensee will pay to the licensor on a yearly basis. Royalty payments are only a
portion of the entire technology transfer return.
124 In this case, the TTO will seek a return equal to the return on equity (ROE) for the medical device industry.
124
Figure 7. Royalty Rates for In-Licensing by Industry125
Industry 0-2% 2-5% 5-10% 10-15% 15-20% 20-25% >25%
General Mfg. 45% 28.6% 12.1% 14.3%
University 25% 25% 50%
Health Care 3.3% 51.7% 45%
Pharmaceuticals 23.6% 32.1% 29.3% 12.5% 1.1% 0.7% 0.7%
Figure 8. Royalty Rates for Out-Licensing by Industry126
Industry 0-2% 2-5% 5-10% 10-15% 15-20% 20-25% >25%
General Mfg. 21.3% 51.5% 20.3% 2.6% 0.8% 0.8% 2.6%
University 7.9% 38.9% 36.4% 16.2% 0.4% 0.6%
Health Care 10% 10% 80%
Pharmaceuticals 1.3% 20.7% 67% 8.7% 1.3% 0.7% 0.3%
125 Source: Dabek (2000). 126 Source: Dabek (2000).
125
Dabek (2000) attributes the differences between in-licensing and out-
licensing to the industry’s reliance on detailed profit analysis, or lack thereof.
Based on this information, focus should be placed on in-licensing royalty rates,
rather than out-licensing royalty rates. Since royalty rates are given in ranges
(i.e., between 2 and 5 percent), it is difficult to calculate a weighted average
royalty rate per industry. According to the ranges of royalties presented, it
appears that the majority of licenses in these industries occur between 2 and 5
percent. The medical device is more similar to the pharmaceutical industry.
None of the industry rates in Figures 7 and Figure 8 are equally comparable to
the medical device industry. However, a proxy of the industries provided,
combines the relevant factors associated with the medical device industry and
provides a guide to the royalty rates of the medical device industry.
The TTO also should review the results of applying the “25 percent rule of
thumb.” This rule states that royalties should be set at 25 percent of the
technology’s profit margin.127 The 25 percent formula generally applies to
technologies which are ready for commercialization, but adjustments can be
made, either upward or downward to for accommodate technologies which are
not at that stage of development. There is no single rule, which TTOs can use to
establish the royalty rate or other forms of compensation. However, by
127 See Appendix M for a detailed formula of the “25 percent rule of thumb.”
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calculating a number of compensation rates and comparing and contrasting the
results, the most accurate rate can be determined.
IV.C.2. Sales and Expense Projections
In order to calculate the DCF of the patent, the market size, market price,
and cost of goods sold, must be calculated. As stated previously, in the year
1996, in the U.S., there were 4,500 MRI machines were in use. In addition, the
average life expectancy of an MRI is between 5 and 15 years. This analysis will
assume a 10-year average life expectancy. At this point, the MRI machine
(through normal wear and tear) is no longer capable of producing the images that
it did when it was new. It is important to note that there may be a lapse in time,
from when the machine is manufactured, when the machine is sold and when the
machine is put into place, which would lengthen the estimated market. However,
for the purposes of this thesis, it is assumed that the MRI machine is
manufactured, sold, and put into use on the same day. In addition, the
methodology will also exclude the sale of used MRI machines.128
Based on the known 4,500 MRI machines in 1996, and a 6 percent growth
rate for the medical device industry as a whole (Hansbury, 2000), approximately
4,000 MRI machines would have been in use, in the U.S., in 1994. Making the
assumption that MRI machines were purchased on a consistent basis,129 then 10
128 The valuation, which conducted once a potential licensee has been identified, would be more detailed and explore these assumptions further, in order to gain a more accurate value of the patent. 129 This assumption is made due to a lack of information regarding the pattern of historical MRI machine purchases.
127
percent of all MRI machines would be technologically ready for replacement or
would benefit from the enhancement MRI coils, such as those produced by
ScanMed, in 1994.130 According to ScanMed, the price per lower extremity coil is
$9,880. Ultimately, these estimates create a potential sales estimate of
$3,952,000 (= 0.10(4,000) x $9,880) per year for the lower extremity coil product.
The projected sales and expense estimates, used in the DCF, will be based upon
a 6 percent growth rate, which is consistent with the medical device industry
growth rate, according to Hansbury (2000).
The cost per MRI coil product estimated from historical ScanMed income
statement information, is 16% of sales. Finally, the DCF analysis, also will
assume that the patent is not renewed after the first maintenance fee131 (3 ½
years from the date that the patent is granted) but will assume that the
maintenance fee is paid.132
130 A firm will create either a cash or non-cash sinking fund for the MRI machine for accounting purposes. It is possible that the firm may have a cash-based sinking fund or cash flow, sufficient enough to allow the firm to purchase a new MRI, thereby bypassing the MRI enhancement coil market completely. On the other hand, a firm, which does not have a sufficient cash-based sinking fund, or has used a non-cash-based sinking and does not have sufficient cash flow to allow the firm to purchase a new MRI, will attempt to lengthen the life of the MRI. However, this thesis assumes that any firm, regardless of their financial ability, would best interested in using the MRI enhancement coils. 131 According to the United States Patent and Trademark Office (http://www.uspto.gov), the schedule for maintenance fees is as follows: $850 due at year 3 ½, $1,950 due at year 7 ½, and $2,990 due at year 11 ½. 132 This assumption is made, based upon the patent abandonment rate, illustrated in Appendix H. Based on the rapid growth patterns in the medical device industry, the possibility for technological obsolescence, which in the case of this specific medical device could be caused by either advances in MRI machines, or in enhancement products. The DCF will be calculated pessimistically by including the patent maintenance fee due at 3 ½ years.
128
IV.C.3. Net Present Value
Figure 9 below represents the sales and expenses, gross profit, and
NPV.133 The discounted cash flow analysis is based upon 3 1/2 years, with year
1 starting in 1994, and year 3 ½ occurring at the end of the first six months of
1997. The payments are discounted, assuming that the payments are made at
the end of each time period.
133 See Appendix K for the formula used to calculate the NPV.
129
Figure 9. Estimated Sales and Expense Projections134
1994 1995 1996 1997
Sales 3,952,000 4,189,120 4,440,467 2,353,448
COGS 671,840 712,150 754,879 400,086
Gross Profit 3,270,160 3,476,970 3,685,588 1,952,512
PV 2,725,133 2,414,562 2,132,863 941,605
NPV 8,214,163
134 Source: Allen (2000).
130
IV.D. Decision Tree Analysis
The decision tree analysis is based on three steps. The patent’s individual
claims and fields of use are first identified. Next, the risk factors associated with
commercializing the patent are identified. Finally, the best-case, most-likely-
case, and worst-case scenarios are identified for each risk factor.
IV.D.1. First Branch – Claims and Field of Use
The first branch of the decision tree analysis identifies a patent’s separate
claims and fields of use. A claim may indicate one or several fields of use. Each
set of claims and correlating field of use will indicate a separate set of risk factors
and possibility scenarios.
IV.D.1.a. Methodology Not Applied
The ScanMed lower extremity coil patent, while it may have several
claims, has only one relative field of use. Therefore, the first branch will be
truncated and limited to the one field of use.
IV.D.1.b. Methodology Applied
The lower extremity MRI coil’s field of use is as an image enhancement
product. The product is intended for older MRIs, which through routine use (wear
and tear) are not producing images as clearly as a new MRI would. When using
an older MRI, in conjunction with the MRI coils, the MRI is capable of creating
131
images equivalent to images, which can be created with a newer MRI machine.
Eventually, however, the MRI machine becomes sufficiently physically
depreciated that even the coils can not generate an image of acceptable quality.
IV.D.2. Second Branch – Risk Factors
The second branch of the decision tree analysis identifies those risk
factors, which are specific to the patent in question. These are risk factors, which
are assumed by the licensee, but also will affect the licensor’s flow of cash
compensation.
IV.D.2.a. Methodology Not Applied
The methodology of this thesis named several potential risk factors,
specifically associated with the MRI coils patent. However, the methodology also
mentioned that several risk factors would be excluded in the analysis. In order to
maintain the focus of this thesis, the following risk factors, while critical in any
form of commercialization, will be excluded.
Product and process liability Political risk Inflationary risk Economic Risk
These risk factors have been excluded because they apply to all forms of
commercialization, and by limiting the second branches of the decision tree
132
analysis to those factors that only apply to the patent-granted medical device in
question, an isolated value can be calculated.135
IV.D.2.b Methodology Applied
The decision tree analysis will include the following risk factors, as they
apply to the medical device in question.
Patent strength and quality Stage of development Market size Remaining life Success of related technology Competition Profit margin
Each risk factor plays a crucial role in assessing the risk of the medical device’s
ability to generate future cash flows. Consequently, each will be assigned a 10
percent ranking in the decision tree analysis. The probabilities of a decision tree
must always sum to 100. However, dollar values or weightings, which may be
used in a decision tree analysis, are not required to sum to 100. In order to
increase the transparency of the methodology, a 10 percent weighting has been
assigned to each risk factor. In an actual analysis, each risk factor would be
weighted according to its importance.136 At this point, the decision tree analysis
appears similar to Figure 10, below.
135 Note that a more detailed valuation will be conducted once a potential licensee has been identified. 136 A 10 percent weighting was chosen to increase the ease of reader’s ability to calculate numbers quickly (i.e., it is far easier to multiply any given number by 10 percent rather than 1/7th).
133
Figure 10. Decision Tree Analysis137
Patent strength and quality (0.10)
Stage of development (0.10)
Market size (0.10)
Claim/Field Remaining life (0.10) Of Use Success of related technology (0.10) Competition (0.10) Profit margin (0.10)
137 Source: Allen (2000).
134
IV.D.3. Third Branch – Best-Case, Most-Likely-Case, and Worst-Case Scenarios
The third branch identifies the possible scenarios correlated to each risk
factor, which could occur during the process of commercialization. These
potential scenarios vary according to the degree of impact that each would make
on the projected cash flows of the patent, as well as the likelihood of each
scenario actually occurring. Again, the probabilities assigned to the branches of
a decision tree, must sum to 100.
IV.D.3.a. Methodology Not Applied
The potential scenarios for any given valuation will vary according to the
specific patent, which is being valued. The likelihood of each scenario occurring
is not fixed. As more information becomes available, and the uncertainty
involved with commercialization decreases, the probabilities used in the third
branch of the decision tree analysis will change in relation to the new information.
However, the valuation demonstrated in this thesis, is conducted during a
specific time period. Therefore, only one set of probabilities will be assigned. In
addition, the degrees of impact (i.e., best-case, most-likely-case, and worst-case
scenario) may be expanded.
135
IV.D.3.b. Methodology Applied
The third branch of the decision tree analysis, which will be applied in the
analysis, is categorized into three degrees of impact: best-case, most-likely-
case, and worst-case scenario. This is done to simplify the decision tree
analysis, while still providing the most crucial data necessary to clearly evaluate
the patent. The best-case scenario will be assigned a 25 percent probability, the
most-likely-case scenario will be assigned a 50 percent probability, and the
worst-case scenario will be assigned a 25 percent probability.
At this point, all three branches of the decision tree analysis have been
identified. The analysis now appears similar to Figure 11, below.
136
Figure 11. Decision Tree Analysis138
Best (0.25)
Patent strength and quality (0.10) Most Likely (0.50)
Worst (0.25)
Stage of development (0.10)
Market size (0.10)
Claim/Field Remaining life (0.10) Of Use Success of related technology (0.10) Competition (0.10)
Profit margin (0.10)
138 Source: Allen (2000).
137
In regards to patent strength and quality, the best-case scenario is that the
patent, based on its strength, eliminates any possible infringement or is capable
of defending any possible infringement. In addition, patent protection is also the
most effective protection vehicle. The most-likely-case scenario is that strength
and quality, as discussed above, are mediocre. The worst-case scenario is that
the patent can not be defended from infringement, and is one of the least
effective means to protect the technology.
For the stage of development, the best-case scenario is that the MRI coils
are, or without any uncertainty will be, approved by the FDA. In addition, the
best-case scenario also means that the MRI coil’s technical ability has been
proven (i.e., the MRI coils work are they are designed to work). The most-likely-
case scenario is that there is a reasonable probability that the FDA will approve
the MRI coils, and that the technical ability has been reasonably, but not
completely proven. The worst-case scenario is that the FDA does not approve
the MRI coils, or that the MRI coils will fail based on its technical merits.
In regards to market size, the best-case scenario is that actual market size
will be even greater than estimated.139 The most-likely-case scenario is that the
market size will be equal to the estimated market size. The worst-case scenario
is that the market size has been overstated and will actually be much less than
estimated.
139 See III.C.2. Sales and Expense Projections, for a description of the estimated market size.
138
The best-case scenario of the remaining life is that the MRI coils will
continue to generate revenues after the first maintenance fee, or 3 ½ years after
the patent is granted. The most-likely-case scenario is that the MRI coils will
generate revenues until the first maintenance fee has been paid. The worst-case
scenario is that the MRI coils will discontinue generating revenues very quickly,
and the decision to abandon the patent will be made before the first maintenance
fee is paid.
In regards to the success of related technology, the best-case scenario is
that the medical device industry will continue to find new fields of use for MRI
machines, and that MRI machines will continue to grow in popularity at a rate not
predicted in this thesis. The most-likely-case scenario is that the use of MRI
machines will grow at or near the medical device industry standard. The worst-
case scenario is that a new technology will replace MRI machine applications
used in conjunction with a MRI coil, or that the use of MRI machines will
decrease.
The primary competitors for MRI coils are GE Medical Systems,140
Toshiba,141 Hitachi,142 and Siemens.143 The best-case scenario, in terms of
competition, is that the potential licensee is either one of the above-mentioned
140 GE Medical Systems is a division of General Electric (NYSE: GE). http://www.ge.com 141 Other OTC: TOSBF. http://www.toshiba.co.ip/index.htm 142 NYSE: HIT. http://www.hitachi.co.ip 143 Other OTC: SMAWY. http://www.siemens.de/de2/flash
139
firms, or that the potential licensee is capable of creating an agreement with one
or all of these firms to supply MRI coils. The most-likely-case scenario is that the
potential licensee is not one of the above-mentioned firms, but that the licensee
does create supply agreements with one or more of these firms. The worst-case
scenario is that the licensee is not one of the above-mentioned firms, and that no
supply agreements are created.
In terms of profit margin, the best-case scenario is that profit margin is
higher than estimated, meaning that either the MRI coils are sold for more than
expected, or that the licensee is capable of producing the product at a cost,
which is lower than estimated, thus increasing the profit margin. The most-likely-
case scenario is that the profit margin will be consistent with the estimates
already provided in the discounted cash flow analysis.144 The worst-case
scenario is that the profit margin is much lower than estimated.
144 See IV.C. Calculating the Discounted Cash Flows, and Figure 9. Estimated Sales and Expense Projections.
140
IV.E. End Result and Suggested Decisions
Once each scenario is defined, a NPV must be assigned to each. Then,
the NPV is multiplied by the weighting of each scenario and summed. The sum
of each group of scenarios is then multiplied by the weighting of each risk factor
and again summed, to finally reach the final risk-adjusted NPV.
IV.E.1. Net Present Value for each Scenario
The NPV for each scenario will be assigned as follows:
Patent strength and quality
Best-case $8,214,163145
Most-likely-case $8,190,050146
Worst-case $4,107,081147
Stage of development
Best-case $8,214,163148
Most-likely-case $6,847,430149
Worst-case ($8,743)150
145 This estimate is based upon the DCF estimate. See IV.C. Calculating the Discounted Cash Flows. 146 This estimate is based upon $50,000 litigation cost in year 3. 147 This estimate is based upon sales of only ½ of the market, caused by unrecoverable infringement. 148 This estimate is based upon the DCF estimate. See IV.C. Calculating the Discounted Cash Flows. 149 This estimate is based upon no sales in the first six months of the first year, due to regulatory and development issues. 150 This estimate is based upon the technology never being commercialized.
141
Market Size
Best-case $10,269,890151
Most-likely-case $8,214,163152
Worst-case $6,158,436153
Remaining Life
Best-case $9,998,291154
Most-likely-case $8,214,163155
Worst-case $6,205,635156
Success of Related Technology
Best-case $8,768,316157
Most-likely-case $8,214,163158
Worst-case $7,084,792159
151 This estimate is based upon the market being 25 percent larger than estimated. 152 This estimate is based upon the DCF estimate. See IV.C. Calculating the Discounted Cash Flows. 153 This estimate is based upon the market being 25 percent less than estimated. 154 This estimate is based upon the technology generating revenues one year longer than expected. 155 This estimate is based upon the DCF estimate. See IV.C. Calculating the Discounted Cash Flows. 156 This estimate is based upon the technology generating revenues for one year less than estimated. 157 This estimate is based upon a 12 percent growth rate, rather than the industry’s 6 percent. 158 This estimate is based upon the DCF estimate. See IV.C. Calculating the Discounted Cash Flows. 159 This estimate is based upon a 3 percent growth rate, rather than the industry’s 6 percent. In addition, it is based upon the technology generating revenues until year 3.
142
Competition
Best-case $8,214,163160
Most-likely-case $4,107,081161
Worst-case $2,053,540162
Profit Margin
Best-case $8,808,590163
Most-likely-case $8,214,163164
Worst-case $7,817,878165
IV.E.2. Calculation
Each NPV must now be multiplied by their respective probability weighting
(i.e., 25 percent, 50 percent, or 25 percent) and summed according to each risk
factor. The totals for each group of scenarios are as follows:
160 This estimate is based upon the DCF estimate. See IV.C. Calculating the Discounted Cash Flows. 161 This estimate is based upon gaining only 50 percent of the market. 162 This estimate is based upon gaining only 25 percent of the market. 163 This estimate is based upon a 5 percent decrease in the cost of goods sold. 164 This estimate is based upon the DCF estimate. See IV.C. Calculating the Discounted Cash Flows. 165 This estimate is based upon a 5 percent increase in the cost of goods sold.
143
Patent strength and quality $7,175,335166
Stage of development $5,475,070
Market size $8,214,162
Remaining life $8,158,061
Success of related technology $8,070,358
Competition $4,620,465
Profit margin $8,236,697
These totals must then be multiplied by the weighting that has been
assigned to each risk factor. This appears as below:
Patent strength and quality $717,533167
Stage of development $547,507
Market size $821,416
Remaining life $815,806
Success of related technology $807,035
Competition $462,046
Profit margin $826,369
166 = 0.25($8,2214,163) + 0.50($8,190,050) + 0.25(4,107,081) 167 = 0.10($7,175,335)
144
Finally, these totals must be summed in order to calculate the NPV of the
MRI coils, according to the decision tree analysis. The sum of the weighted
NPVs of the risk factors is $4,997,712. This sum represents the NPV of the
estimated cash flows for the technology, once risk adjustments have been made.
The risk adjustments were made by estimating the NPV of the best-case, most-
likely-case, and worst-case scenario, according to each risk factor, and then
multiplying and summing those results according to the probabilities and
weightings, which were assigned in the decision tree analysis. The difference
between the NPV found in the original discounted cash flow analysis168 and the
NPV found in the decision tree analysis can be contributed to the inclusion of risk
adjustments in the decision tree analysis. The final, risk-adjusted net present
value should be used by the TTO to evaluate the technology and enter into
license negotiations. Additional valuations will be necessary once a potential
licensee has been identified, but are beyond the scope of this thesis.
168 See IV.C. Calculating the Discounted Cash Flows.
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CHAPTER V: CONCLUSION
V.A Technology Transfer
Technology transfers (TT) can be used to transfer a variety of forms of
intellectual property including patents, trademarks, copyrights, and trade
secrets.169 These forms of intellectual property can be transferred between any
combination of private buyers, private sellers, public buyers, and public sellers.170
In order to complete a successful TT, a technology transfer office (TTO) must
incorporate a number of functions in the process. These functions171 include:
Legal Scientific Financial Marketing Accounting Social Managerial
While each step in the technology transfer process is equally important,
this thesis focused on the financial analysis used in a TT. Other functions, (i.e.,
legal, marketing, accounting, etc.) were discussed, but excluded from the
methodology. This thesis focused on the financial analysis of patents, and
excluded other forms of intellectual property. In addition, the financial analysis is
conducted from the viewpoint of a public seller. The buy-side of the TT is
169 See I.B. What is Intellectual Property? 170 See I.C. Who Participates in Technology Transfer? 171 See I.D. General Considerations in Technology Transfer.
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discussed, but the methodology excludes private buyers and sellers, as well as
public buyers.
V.B. Valuation Methods
There are several methods and points in time in which to value a patent-
granted medical device. A technology can be valued a) prior to a patent
application, b) after receiving a patent, but before identifying a licensee, c) once a
potential licensee has been identified, or d) in an infringement case. There are
three broadly accepted methods in which to value a patent. These methods
include the market approach, cost approach, and income approach.172 There are
also a number of factors, which can affect the value of a patent or license, which
must be considered, when attempting to conduct a valuation analysis. For a
patent, these factors173 include:
Patent strength and quality Stage of development Market size Success of related technology Competition Profit margin Remaining life
For a license, the risk factors174 include those listed for a patent, in addition to:
172 See II.D. Valuation Methods. 173 See II.C.2. Patents 174 See II.C.3. License.
147
Cost of commercialization Geographic territory Field of use Exclusivity Technical assistance Length of agreement Sub-license provisions Improvements Licensee
The valuation analysis conducted in this thesis, was set at the post-patent,
but pre-licensee point in time. The valuation analysis used the income approach
and decision tree analysis, and focused on the factors, which affect the value of a
patent, excluding those, which affect a license. In addition, the valuation was
limited to a cash-flow analysis, and excluded any non-cash values.
Several forms of compensation, such as royalties, upfront fees, milestone
payments, and yearly payments were identified.175 Alternative forms of
compensation such as sponsored research programs, or equipment donations
were excluded from the compensation analysis.176 In addition, this thesis
explored several methods in which to determine the appropriate amount and ratio
of each type of compensation.177
Three primary tools used for technology transfer valuation were
introduced. These tools include: Valuate by Martha Luehrmann, TOP Index by
175 See II.E.3. Types of Compensation. 176 See II.E.4. Alternative Forms of Compensation. 177 See II.E.2. Calculating a Reasonable Compensation.
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Dr. Albert Rubenstein, and Technology Pricing Model by Dr. Melvin J. DeGeeter
and Mr. Jon C. Outland.178
V.C. Methodology
The methodology of this thesis projected the cash flows of the patented
technology,179 and discounted the cash flows according to a proxy of the
industry’s return one equity,180 finally arriving at a net present value (NPV).181
Next, a decision tree analysis was conducted. The first layer of branches
categorized the patented technology according to its claims and fields of use.182
The second layer of branches identified the various risk factors that applied to the
technology.183 Each risk factor was assigned a weighting.184 The third layer of
branches identified the possible scenarios for each risk factor.185 The scenarios
were limited to best-case, most-likely-case, and worst-case. In order to simplify
the process, these scenarios were assigned probabilities according to a 25
178 See II.F. Electronic Tools for Valuing Patents. Also see Appendix G for contact information. 179 See III.C.2. Sales and Expense Projections. 180 See III.B. Discount Rate. 181 See III.C.3. Net Present Value. 182 See III.D.1. First Branch – Claims and Field of Use. 183 See III.D.2. Second Branch – Risk Factors. 184 In the case of this thesis, each risk factor was equally weighted at 10 percent, however weightings are subject to change, according to the impact of each risk factor on a specific technology. 185 See III.D.3. Third Branch – Best-Case, Most-Likely-Case, and Worst-Case Scenario.
149
percent, 50 percent, and 25 percent scale, accordingly.186 A NPV was calculated
for each scenario, and then multiplied by the probability of the scenario and
summed. These sums were then multiplied by the weighting of the risk factor
and summed again.187 The end result is a risk-adjusted NPV, which can be used
to property evaluate the technology on its financial merits.
V.D. Analysis
In order to demonstrate the methodology, a specific medical device was
chosen. In 1994, the University of Nebraska Medical Center (UNMC) licensed a
patent for lower extremity MRI coils to ScanMed (an Omaha based medical
device firm).188 This patent was valued according to the methodology introduced.
V.E. Final Suggestions
Technology transfers today, are not given the full attention that they
deserve, during the process. All too often, technology transfer professionals are
expected to be fully qualified in each step of the process (e.g., scientific, legal,
financial, marketing, etc.) when that is not usually the case. In order to resolve
this issue, TTOs should be divided into two separate task units. These task units
186 The probabilities, which are assigned to each scenario, also are subject to change, as more information becomes available about the technology, and the level of certainty increases. 187 See III.F. Review of Applicable Formulas. 188 See IV.A. ScanMed. Also see Appendix G for contact information for both ScanMed and UNMC.
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include a legal and scientific unit (to evaluate the legal and scientific merits of a
technology) and a business development unit (to evaluate the financial and
marketing merits of the technology). These task units would work in conjunction
with each other, in order to ensure that the potential benefits of the technology
transfer (TT) are maximized.
In addition, a post-evaluation of each TT should be conducted by the TTO.
This evaluation should be conducted after sufficient actual results are available.
Actual results should be compared to the TTOs earlier projections. The purpose
of the evaluation is to provide the TTO with a tool in which to evaluate their
performance and create a continuous learning program for the office.
V.F. Further Research
In order to fully understand technology transfer, and to understand the
impact that the other functions (e.g., legal, scientific, marketing, etc.) have on the
financial analysis of a TT, more research must be conducted. For example, a
significant portion of a financially successful technology transfer can be
contributed to the marketing efforts of the TTO. Further research should be
conducted to evaluate and identify the most efficient marketing programs for
TTOs. In addition, infringement litigation and patent quality have recently
become prominent issues in the technology transfer profession. From a legal
standpoint, invention and disclosure agreements, as well as the inventor’s
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compensation have become extremely important issues for both public and
private firms.
As stated previously, there also is a lack of standard managerial practices.
This thesis author suggests that the TTO should be divided into task units, which
specialize in a specific task of the technology transfer, and work in conjunction
with each other to create a more knowledgeable and successful technology
transfer. However, even more efficient practices may be identified, after
additional research. TTOs must also search out ways to motivate employees or
faculty to invent and pursue commercialization with the TTO, which should be
explored through additional research. In addition, non-cash forms of licensing
compensation (i.e., donated equipment, sponsored research programs, etc.) are
becoming increasingly common, and therefore additional research should be
conducted so that a TTO can fairly evaluate non-cash offers of compensation.
Finally, this thesis focused on the valuation of patents, created in a university.
Further research should be conducted to explore the valuation of other forms of
intellectual property such as copyrights, trademarks, and trade secrets.
Additional research should also explore the other parties, which may be involved
in technology transfer, such as private buyers, private sellers, and public buyers.
The University of Nebraska at Omaha hopes to continue this research and offer
addition works, which address these issues.
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APPENDICES
Appendix A
The Constitution of the United States of America
Article 1, Legislative Powers, Section 8
[Clause 1] The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defense and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States;
[Clause 2] To borrow Money on the credit of the United States; [Clause 3] To regulate Commerce with foreign Nations, and among the
several States, and with the Indian Tribes; [Clause 4] To establish an uniform Rule of Naturalization, and uniform
Laws on the subject of Bankruptcies throughout the United States; [Clause 5] To coin Money, regulate the Value thereof, and of foreign Coin,
and fix the Standard of Weights and Measures; [Clause 6]To provide for the Punishment of counterfeiting the Securities
and current Coin of the United States; [Clause 7] To establish Post Offices and post Roads; [Clause 8] To promote the Progress of Science and use Arts, by securing
for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries;
[Clause 9] To constitute Tribunals inferior to the Supreme Court; [Clause 10] To define and punish Piracies and Felonies committed on the
high Seas, and Offences against the Law of Nations; [Clause 11] To declare War, grant Letters of Marque and Reprisal, and
make Rules concerning Captures on Land and Water; [Clause 12] To raise and support Armies, but no Appropriate of Money to
that Use shall be for a longer Term than two Years; [Clause 13] To provide and maintain a Navy; [Clause 14] To make Rules for the Government and Regulation of the land and naval Forces; [Clause 15] To provide for calling forth the Militia to execute the Laws of the Union, suppress Insurrections and repeal Invasions; [Clause 16] To provide for organizing, arming, and disciplining, the Militia, and for governing such Part of them as may be employed in the Service of the
153
United States, reserving to the States respectively, the Appointment of the Officers, and the Authority of training the Militia according to the discipline prescribed by Congress; [Clause 17] To exercise exclusive Legislation in all Cases whatsoever, over such District (not exceeding ten Miles square) as may, by Cession of Particular States, and the Acceptance of Congress, become the Seat of the Government of the United States, and to exercise like Authority over all Places purchased by the Consent of the Legislature of the State in which the Same shall be, for the Erection of Forts, Magazines, Arsenals, dock-Yards and other needful Buildings; And [Clause 18] To make all Laws which shall be necessary and proper for carrying into Execution the foregoing Powers and all other Powers vested by this Constitution in the Government of the United States, or in any Department or Officer thereof. Amendment XI The judicial power of the United States shall not be construed to extend to any suit in law or equity, commenced or prosecuted against one of the United States by citizens of another State, or by citizens or subjects of any foreign state.
154
Appendix B
U.S. Code: Title 15,Commerce and Trade
Section 1051 et seq.
Trademark Law Treaty Implementation Act Public Law 105-330-October 30, 1998
Section 1052. Trademarks registrable on principal register; concurrent registration No trade by which the goods of the applicant may be distinguished from the goods of others shall be refused registration on the principal register on account of its nature unless it –
(a) Consists of or comprises immoral, deceptive, or scandalous matter; or matter which may disparage of falsely suggest a connection with persons, living or dead, institutions, beliefs, or national symbols, or bring them into contempt, or disrepute; or a geographical indication which when used on or in connection with wines or spirits, identifies a place other than the origin of the goods and is first used on or in connection with wines or spirits by the applicant on or after on year after the date on which the WTO Agreement (as defined in section 3501 of title 19) enters into force with respect to the United States.
(b) Consists of or comprises the flag or coat of arms or other insignia of the United States, or of any State or municipality, or of any foreign nation, or any simulation thereof.
(c) Consists of or comprises a name, portrait, or signature identifying a particular living individual except by his written consent, or the name, signature, or portrait of a deceased President of the United States during the life of his widow, if any except by the written consent of the widow. (d) Consists of or comprises a mark which so resembles a mark registered in the Patent and Trademark Office, or a mark or trade name previously used in the United States by another and not abandoned, as to be likely, when used on or in connection with the goods of the applicant to cause confusion, or to cause mistake, or to deceive: Provided, That if the Commissioner determines
155
that confusion, mistake, or deception is not likely to result from the continued use by more than one person of the same or similar marks under conditions and limitations as to the mode or lace of use of the marks or the goods on or in connection with which such marks are used, concurrent registrations may be issued to such persons when they have become entitled to use such marks as a result of their concurrent lawful use in commerce prior to (1) the earliest of the filing dates of the applications pending or of any registration issued under this chapter; (2) July 5, 1947, in the case of registrations previously issued under the Act of March 3, 1881, or February 20, 1905, and continuing in full force and effect on that date; or (3) July 5, 1947 in the case of applications filed under the Act of February 20, 1905, and registered after July 5, 1947. Use prior to the filing date of any pending application or a registration shall not be required when the owner of such application or registration consents to the grant of a concurrent registration to the applicant. Concurrent registrations may also be issued by the Commissioner when a court of competent jurisdiction has finally determined that more than one person is entitled to use the same or similar marks in commerce. In issuing concurrent registrations, the Commissioner shall prescribe conditions and limitations as to the mode or place of use of the mark or the goods on or in connection with which such mark is registered to the respective persons.
(e) Consists of a mark which (1) when used on or in connection with the goods of the applicant is merely descriptive or deceptively misdescriptive of them, (2) when used on or in connection with the goods of the applicant is primarily geographically descriptive of them, except as indications of regional original may be registrable under section 1054 of this title, (3) when used on or in connection with the goods of the applicant is primarily geographically deceptively misdescriptive of them, (4) is primarily merely a surname, or (5) comprises any matter that as a whole, is functional.
(f) Except as expressly excluded in subsections (a), (b), (c), shall prevent the registration of a mark used by the applicant which has become distinctive of the applicant’s gods in commerce. The Commissioner may accept as prima facie evidence that the mark has become distinctive, as used on or in connection with the applicant’s goods in commerce, proof of substantially exclusive and continuous use thereof as a mark by the applicant in commerce for the five years before the date on which the claim of distinctiveness is made. Nothing in this section shall prevent the registration of a mark, which when used on or in connection with the goods of the applicant, is primarily geographically deceptively misdescriptive of them, and which became distinctive of the applicant’s goods in commerce before December 8, 1993.
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Appendix C
U.S. Code: Title 17, Copyrights
Section 102 et seq. Section 102. Subject matter of copyright: In general
(a) Copyright protection subsists in accordance with this title, in original works of authorship fixed in any tangible medium of expression, now known or later developed, from which they can be perceived, reproduced, or otherwise communicated, either directly or with the aid of a machine or device. Works of authorship include the following categories:
(1) literary works; (2) musical works, including any accompanying words; (3) dramatic works, including any accompanying music; (4) pantomimes and choreographic works; (5) pictorial, graphic, and sculptural works; (6) motion pictures and other audiovisual works; (7) sound recordings; and (8) architectural works.
In no case does copyright protection for an original work of authorship extend to any idea, procedure, process, system, method of operation, concept, principle, or discovery, regardless of the form in which it is described, explained, illustrated, or embodied in such work. Section 107. Limitations on exclusive rights: Fair use Notwithstanding the provisions of sections 106 and 106A, the fair use of a copyrighted work, including such use by reproduction in copies or phonorecords or by any other means specified by that section, for purposes such as criticism, comment, news reporting, teaching (including multiple copies for classroom use), scholarship, or research, is not an infringement of copyright. In determining whether the use made of a work in any particular case is a fair use the factors to be considered shall include:
157
(1) the purpose and character of the use, including whether such use is of a commercial nature or is for nonprofit educational purposes;
(2) the nature of the copyrighted work; (3) the amount of substantiality of the portion used in relation to the
copyrighted work as a whole; and (4) the effect of the use upon the potential market for or value of the
copyrighted work. The fact that a work is unpublished shall not itself bar a finding of fair use if such finding is made upon consideration of all the above factors.
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Appendix D
U.S. Code: Title 35, Patents
Section 101 et seq.
Section 101. Inventions patentable Whoever invents or discovers any new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof, may obtain a patent therefore, subject to the conditions and requirements of this title. Section 102. Conditions for patentability; novelty and loss of right to patent. A person shall be entitled to a patent unless—
(a) the invention was known or used by others in this country, or patented or described in a printed publication in this or a foreign country, before the invention thereof by the applicant for patent, or
(b) the invention was patented or described in a printed publication in this or a foreign country or in pubic use or on sale in this country, more than one year prior to the date of the application for patent in the United States, or
(c) he has abandoned the invention, or
(d) the invention was first patented or caused to be patented, or was the subject of an inventor’s certificate, by the applicant or his legal representatives or assigns in a foreign country prior to the date of the application for patent in this country on an application for patent or inventor’s certificate filed more than twelve months before the filing of the application in the United States, or
(e) the invention was described in a patent granted on an application for patent by another filed in the United States before the invention thereof by the applicant for patent, or on an international application by another who has fulfilled the requirements of paragraphs (1), (2), and (4) of section 371(c) of this title before the invention thereof by applicant for patent, or
(f) he did not himself invent the subject matter sought to be patented, or
159
(g) (1) during the course of an interference conducted under section 135 or section 291, another inventor involved therein establishes, to the extent permitted in section 104, that before such person’s invention thereof the invention was made by such other inventor and not abandoned, suppressed, or concealed, or (2) before such person’s invention thereof, the invention was made in this country by another inventor who had not abandoned, suppressed, or concealed it. In determining priority of invention under this subsection, there shall be considered not only the respective dates of conception and reduction to practice of the invention, but also the reasonable diligence of one who was first to conceive and last to reduce to practice, from a time prior to conception by the other.
Section 103. Conditions for patentability; non-obvious subject matter
(a) A patent may not be obtained though the invention is not identically disclosed or described as set forth in section 102 of this title, if the differences between the subject matter sought to be patented and the prior art are such that the subject matter as a whole would have been obvious at the time the invention was made to a person having ordinary skill in the art to which said subject matter pertains. Patentability shall not be negatived by the manner in which the invention was made. (b) (1) Notwithstanding subsection (a), and upon timely election by the applicant for patent to proceed under this subsection, a biotechnological process using or resulting in a composition of matter that is novel under section 102 and nonobvious under subsection (a) of this section shall be considered nonobvious if –
(A) claims to the process and composition of matter are contained in either the same application for patent or in separate applications having the same effective filing date; and
(B) the composition of matter, and the process at the time it was invented were owned by the same person or subject to an obligation of assignment to the same person.
(b) (2) A patent issued on a process under paragraph (1) –
(A) shall also contain the claims to the composition of matter used in or made by that process, or
160
(B) shall, if such composition of matter is claimed in another patent, be set to expire on the same date as such other patent, notwithstanding section 154.
(b) (3) For purposes of paragraph (1), the term “biotechnological process” means –
(A) a process or genetically altering or otherwise inducing a single or multi-celled organism to-
(i) express an exogeneous nucleotide sequence,
(ii) inhibit, eliminate, augment, or alter expression of an endogeneous nucleotide sequence, or
(iii) express a specific physiological characteristic not naturally associated with said organism;
(B) cell fusion procedures yielding a cell line that expresses a specific
protein such as a monoclonal antibody; and
(C) Method of using a product produced by a process defined by subparagraph (A) or (B), or a combination of subparagraphs (A) and (B).
(c) subject matter developed by another person, which qualifies as prior art only under one or more of subsections (e), (f), and (g) of section 102 of this title, shall not preclude patentability under this section where the subject matter and the claimed invention were, at the time the invention was made, owned by the same person or subject to an obligation of assignment to the same person.
161
Appendix E
Uniform Trade Secrets Act
Drafted by the National Conference of Commissioners on Uniform State Laws, as amended 1985. http://www.ms.cc.ntu.edu.tw/r621110/laws/tradelaw-us-usta.htm As of 1996, the Uniform Trade Secrets Act has been enacted by 40 states. Section 1. Definitions
As used in this Act, unless the context requires otherwise:
(1) “Improper means” includes theft, bribery, misrepresentation, breach or
inducement of a breach of duty to maintain secrecy, or espionage through electronic or other means.
(2) “Misappropriation” means:
(i) acquisition of a trade secret of another by a person who knows or has reason to know that the trade secret was acquired by improper means; or
(ii) disclosure or use of a trade secret of another without express or implied consent by a person who
(A) used improper means to acquire knowledge of the trade secret; or
(B) at the time of disclosure or use knew or had reason to know that his knowledge of the trade secret was
(I) derived fro or through a person who has utilized improper means to acquire it;
(II) acquired under circumstances giving rise to a duty to maintain its secrecy or limit its use; or
(III) derived fro or through a person who owed a duty to the person seeking relief to maintain its secrecy or limit its use; or
(C) before a material change of his position, knew or had reason to know that it was a trade secret and that knowledge of it had been acquired by accident or mistake.
(3) “Person” means a natural person, corporation, business trust, estate, trust,
partnership, association, joint venture, government, governmental subdivision or agency, or any other legal or commercial entity.
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(4) “Trade secret” means information, including a formula, pattern, compilation,
program, device, method, technique, or process that:
(i) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and
(ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.
Section 2. Injunctive Relief
(a) Actual or threatened misappropriation may be enjoined. Upon application to
the court, an injunction shall be terminated when the trade secret has ceased to exist, but the injunction may be continued for an additional reasonable period of time in order to eliminate commercial advantage that otherwise would be derived from the misappropriation.
(b) In exceptional circumstances, an injunction may condition future use upon payment of a reasonable royalty for no longer than the period of time for which use could have been prohibited. Exceptional circumstances include, but are not limited to, a material and prejudicial change of position prior to acquiring knowledge or reason to know of misappropriation that renders a prohibitive injunction inequitable.
(c) In appropriate circumstances, affirmative acts to protect a trade secret may be compelled b court order.
Section 3. Damages
(a) Damages can include both the actual loss caused by misappropriation and the unjust enrichment caused by misappropriation that is not taken into account in computing actual loss. (b) If willful and malicious misappropriation exists, the court may award exemplary damages in the amount not exceeding twice any award made under subsection (a).
Section 4. Attorney’s Fees
If (i) a claim of misappropriation is made in bad faith, (ii) a motion to termination an injunction is made or resisted in bad faith, or (iii) willful and malicious misappropriation exists, the court may award reasonable attorney’s fees to the prevailing party.
163
Section 5. Preservation of Secrecy
In an action under this Act, a court shall preserve the secrecy of an alleged trade secret by reasonable means, which may include granting protective orders in connection with discovery proceedings, holding in-camera hearings, sealing the records of the action, and ordering any person involved in the litigation not to disclose an alleged trade secret without prior court approval.
Section 6. State of Limitations
An action for misappropriation must be brought within 3 years after the misappropriation is discovered or by the exercise of reasonable diligence should have been discovered. For the purposes of this section, a continuing misappropriation constitutes a single claim.
Section 7. Effect on Other Law
(a) Except as provided in subsection (b) this displaces conflicting tort,
restitutionary, and other law of this State providing civil remedies for misappropriation of a trade secret.
(b) This does not affect: (1) contractual remedies, whether or not based upon misappropriation of a trade secret; (2) other civil remedies that are not based upon misappropriation of a trade secret; or (3) criminal remedies, whether or not based upon misappropriation of a trade secret.
Section 8. Uniformity of Application and Construction
This act shall be applied and construed to effectuate its general purpose to make uniform the law with respect to the subject of this Act among states enacting it.
Section 9. Short Title
This Act may be cited as the Uniform Trade Secrets Act.
Section 10. Severability
If any provision of this Act or its application to any person or circumstances is held invalid, the invalidity does not affect other provisions or applications of the Act which can be given effect without the invalid provision or application, and to this end the provisions of this Act are severable.
Section 11. Time of Taking Effect
164
This takes effect on ____________, and does not apply to misappropriation occurring prior to the effective date.
Section 12. Repeal
The following Acts and parts of Acts are repealed:
165
Appendix F
List of Top Patenting Organizations in 1999189
1999
Rank
1999
Patents
Organization 1998
Rank
1998
Patents
1 2756 International Business Machines 1 2657
2 1842 NEC Corporation 3 1627
3 1795 Canon Kabushiki Kaisha 2 1928
4 1545 Samsung Electronics Co. Ltd. 6 1304
5 1409 Sony Corporation 5 1316
6 1200 Toshiba Corporation 8 1170
7 1193 Fujitsu Limited 7 1189
8 1192 Motorola Inc. 4 1406
9 1153 Lucent Technologies Inc. 13 928
10 1054 Mitsubishi Denki Kabushiki Kaisha 11 1080
189 Source: List of Top Patenting Organizations. U.S. Patent Offices.
166
Appendix G
Contact Information
Valuate Martha Luehrmann EECS/ERL Industrial Relations Program University of California at Berkeley 1466 Grizzly Peak Boulevard Berkeley, CA 94708-2202 Telephone (510) 548-7239 Fax (510) 845-0322 E-mail [email protected]
TOP Index Dr. Albert Rubenstein TAMCOR International Inc. 5038 St. Charles Place Carmel, IN 46033 Telephone (317) 575-8728 Or National Technology Transfer Center (NTTC) Telephone 1-800-678-6882
Technology Pricing Model (TPM) Dr. Melvin J. DeGeeter and Mr. Jon C. Outland 2813 Woodhaven Dr. Champaign, IL 61822 Telephone (217) 355-2579 Fax (217) 355-9892 E-mail [email protected] or [email protected] http://www.medlaunch.com
167
ScanMed Dr. Randall Jones President and CEO 6916 N. 97th Circle, Suite B Omaha, NE 68122 Telephone (402) 571-3271 Fax (402) 571-3340 E-mail [email protected] University of Nebraska Medical Center, Intellectual Property Office Dr. Richard L. Huston Assistant Dean for Research/Director, Intellectual Property Office 986099 Nebraska Medical Center Omaha, NE 68198-6099 Telephone (402) 559-2170 Fax (402) 559-2182 E-mail [email protected]
168
Appendix H
Patent Abandonment190
1992 – 185,446 patents filed 1996 – 206,276 patents filed
After the first actions:
Utility 189,979 Plant 564 Design 15,160 Utility and Plant Reissue 179,391 Design Reissue 15,465 PCT Chapter 1 11,224
Issued: Utility 104,900 Plant 338 Design 11,346 Reissue 291
Abandoned: Utility 58,358 Plant 226 Design 3,461 Reissue 194,565
190 Source: DeGeeter, Melvin J. (2000, October 23). Personal E-mail. “Patent Abandonment”.
169
Appendix I
The Time Value of Money
Present Value of an Ordinary Annuity Formula:
P0 =R 1 1- __________
(1 + i)n i
Where: P0 = present value of an ordinary annuity R = amount of each cash flow
n = number of periods i = interest rate
Comparison (using 10% interest rate):
Firm 1 receives $10,000 in royalties at the end of 1 year. Firm 2 receives $10,000 in royalties at the end of 2 years.
Firm 1 P0 = $9,917.36 Firm 2 P0 = $9,835.39
170
Appendix J
The Formula used to Value a Patent According to Perchorowicz (1995)
Value of a patent = NPV x Probability
Example: NPV = $10,000 Probability of an occurrence = 90% Value of a patent = 10,000 x .90 Value of a patent = $9,000
171
Appendix K
Discounted Cash Flow Analysis
n
NPV = Σ CFt t = 0 ___________
(1 + r)t
Where: NPV = Net Present Value t = the time period n = the number of time periods CFt = the net cash flow at time t r = the discount rate
172
Appendix L
Weighted Average Cost of Capital
rwacc = rd x (1 - Tc) x D + re x E _______ _______ D + E D + E Where: rwacc = Weighted average cost of capital rate rd = Debt rate Tc = Tax rate of the firm D = Amount of debt re = Equity rate E = Amount of equity
173
Appendix M
The 25 Percent “Rule of Thumb” to Determine a Royalty Rate
Royalty Rate = .25 Sale price – Cost to produce Sale price
174
ACRONYMS
AAUP American Association of University Professors
AUTM Association of University Technology Managers
CDRH Center for Devices and Radiological Health
COGR Council on Government Regulation
DCF Discounted Cash Flows, see Appendix K
DPV Discounted Present Value, see Appendix K
FASB Financial Accounting Standards Board
FDA Food and Drug Administration
GAAP Generally Accepted Accounting Principals
GATT General Agreement on Tariffs and Trade
GPO Group Purchasing Organization
IBM International Business Machines
IP Intellectual Property
IPO Initial Public Offering (of a federally registered security)
IPO Intellectual Property Office, see also TTO
JAMA Journal of the American Medical Association
MIT Massachusetts Institute of Technology
MRC Modified Replacement Cost
MRI Magnetic Resonance Imaging
NCCUSL National Conference of Commissioners on Uniform State Laws
175
NMR Nuclear Magnetic Resonance
NPV Net Present Value, see Appendix K
OEM Original Equipment Manufacturer
PCT Patent Cooperation Treaty
PTO Patent and Trademark Office, see USPTO
R & D Research and Development
ROE Return on Equity
ROI Return on Investment
RoR Rate of Return
SBA Small Business Administration
SBIR Small Business Innovation Research Program
TOP Technology Opportunity Potential
TPM Technology Pricing Model
TT Technology Transfer
TTO Technology Transfer Office, see also IPO
UBIT Unrelated Business Income Tax
UNMC University of Nebraska Medical Center
US United States of America
USA United States of America
USPTO United States Patent and Trademark Office
USTA Uniform Trade Secrets Act
WACC Weighted Average Cost of Capital, see Appendix L
176
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