IPR VALUATION STUDY MATERIAL 1.

INTRODUCTION AND SIGNIFICANCE The last decade has witnessed a tremendous growth in the recognition of the importance of legal protection of intellectual property and the value of intellectual property assets all over the world. It is foreseeable from the current developing trend that intellectual property will become a very important factor in the development of national economy of various countries and of international trade in the new millennium. Therefore, assessment of the value of intellectual property assets will play a role of ever-increasing importance in promoting these developments. This issue has become even more important with the recent issuance of Statement of Financial Accounting Standard 142, Goodwill and Other Intangible Assets, which changed the accounting treatment of certain intangibles during acquisitions of companies or assets. Instead of a more-or-less blanket treatment of acquired intangibles that featured a stated amortization period, many of these assets will now be carried on the balance sheet at cost and subjected to an annual impairment test. Similarly, the tax authorities will be very interested in understanding how the value of any donated property, including patents and related intangibles, was calculated. Financing and bankruptcy are other situations where a third party will have a valid need to know the value of your intellectual property. There are many situations where accurate value information is required for internal purposes as well. The purchase or sale of these kinds of assets obligates management to have an idea of its value before entering into negotiations. Similarly, negotiating a fair royalty rate or other compensation when licensing IP necessitates understanding the value of the assets. When calculating intellectual property value, there is a difference between the overall value provided by the IP and what is known as its fair market value. The appropriate definition to use under the circumstances will have a significant impact on the conclusion reached. The definition recognized by the Internal Revenue Service and most courts is essentially as follows: Fair market value is the price at which an asset exchanges between a willing buyer and a willing seller, neither being under compulsion to act and both having reasonable knowledge of all relevant fats. A simple example will serve to illustrate the difference between value and fair market value as outlined herein. Suppose an inventor has developed a process that would allow a manufacturer to save $1 million when compared to the expense currently incurred during his manufacturing process. The benefit of the technology is therefore in the form of a cost saving and the value of the development amounts to the $1 million in savings. However, $1 million is not likely to be considered the fair market value. According to the definition, fair market value is the price at which the asset

would change hands. There is no incentive for the manufacturer to pay the inventor $1 million for the development when his benefit also equals $1 million. The true fair market value will likely be somewhere between $0 and $1 million, and will be determined by the various inputs that have an impact on a true negotiation. These will include items such as the competitive environment and the existence of alternative methodologies that provide the same benefit. Finding the value of an IP asset is not like finding the price of a standardized product, like a car or a bicycle, which can be easily located in a newspaper or at a local dealer. The values in IP assets lie not in the standardization of the asset, but in the uniqueness of the image that a trademark is the carrier of, or the technological solutions that the patent is protecting. Important steps in IP Valuations are; Establishing Parameter,Making Assessments and Estimations, Adapting Appropriate Methodology and completing Calculations

2. PARAMETERS FOR ASSISTING VALUATION Thus far we have been equating price with value. Whilst value may represent an estimation of price there are a range of circumstances that will have a bearing on the nature of the price or the price assumption: Competitiveness The fact that an idea is capable of achieving unique recognition through the IP registration process does not make it immune to competition. Alternative ways of achieving the same result may well exist in the are of a patent; brands will have competitors and even strong brands will experience competition from generic manufacturers, as is the case in the pharmaceutical industry. Quality of Provenance The source of the IP has a bearing upon its ultimate value. Example: 1) A device that enabled computers to be directly controlled by thought would have very considerable market value. A company with an established manufacturing and market presence would have the resources to undertake production development and introduce the invention to the market in a short time frame. Both profits and cash flow would be generated relatively soon. Example: 2) If the same device were invented by an individual in his small work shop he/she would need to raise sufficient capital to develop not only the product but the necessary manufacturing and distribution structure. There is also the risk that in the time it takes to bring a product to market from scratch, competitors have been able to develop competing technology. It would therefore be reasonable to attribute a higher value to the IP in the case of 1) than in the case of 2).

Transactional Example: 3) The inventor in 2) decides to sell or license to the manufacturer in 1). Depending on the relative negotiating astuteness of the two parties, the price obtained would probably be higher than the return if the inventor decided to market the product him/herself, but lower thatn the value to the purchasing company. Even then the terms of the licensing contract will have a bearing on the value of the IP to the licensor. To take a real-life case, if Bill Gates had been persuaded to license the DOS operating system to IBM on an exclusive basis, IBM would undoubtedly have made more money and Microsoft less. But also we have to consider that the market in such circumstances might have taken on a different shape with a number of competitor operating systems emerging and consequently the possibility of lower profits being generated by the DOS and Windows operating systems. Were this the case the aggregate worth of DOS/Windows IP would have been lower than the case today. Intent - Certain categories of IP, most particularly, patents can be retained for reasons other than the intention of exploiting them directly in the market place. Exploitation of a patent for replacement technology can be withheld to extend the working life of established production capacity. An alternative technology cab be prevented from entering the market place to restrict competition. Where the owner is a substantial organization, unlikely to be forced into a sale of its IP and under no commercial strategy to change its policy, a valuation on an open market (willing buyer/willing seller) basis would not be appropriate. Function A patent, or in certain circumstances, other forms of IP can be used to protect a central concept. Peripheral patents may not be central to the basic technology, but form part of a broad technological matrix thereby making it more difficult for competitors to replicate a product by other means. Such items of IP have a limited value on their own and therefore any value they have is derived from the core item of IP.

Surely a valuation is a valuation? How is it that the purpose of a valuation can determine its outcome? Let us briefly examine some of the areas and situations in which IP valuations may be required and some of the factors that can give rise to divergent valuations: Purchase and sale traditional buyer / seller price divergence Licensing buyer/seller price divergence combined with the influence of different financial and taxation profiles; differences in corporate philosophies and objectives; Corporate Finance merger and acquisition valuations will incorporate the buyer/seller price divergence but also existence of competitive IP within the combined businesses; taxation profiles; differences of perception in market profiles; differences in corporate philosophies and objectives. Also corporate finance funding operations will also have to

take into account the different risk perceptions between investor and the raiser of capital, variances of optimism in the business plan. The following factors are also relevant; company policy towards maintaining IP marketing expenditure, patent protection measures and expenditure; industry IP life-cycle; company market share; financial resources in relation to peer group competitors etc. Litigation by definition there is a wide discrepancy between the plaintiffs and the defendants positions. Where IP is a subsidiary component of a broader dispute involving the value of assets generally, a relatively conventional willing buyer/willing seller approach may be appropriate. Where the litigation relates directly to IP infringement, assessments will not only have to take into account present value of the IP but also wheat it might have been had the infringement had not occurred, loss of past value/revenue and the costs of restoring the position. Transfer Pricing a contentious area where governments, taxation authorities, insolvency practitioners and even policemen in the case of suspected money laundering are frequently highly suspicious of the values placed on IP. Within the valuation framework there are legitimate reasons for seeing a divergence in price between what might be expected, based on broad knowledge of companies activities in other regions, and the calculated transfer price. For example there will be variances in the strength of brand or patent between one market and another. Poor IP protection enforcement in a given market may lead to an IP owner requiring a high level of return in exchange for putting his IP at risk. The pricing of IP transfer may be part of a larger transaction and the pricing may be a legitimate reflection of its role in the overall consideration package. Financial Reporting for the purpose of management information, providing shareholders and employees with additional information and to the extent that it can be incorporated in published accounts (e.g. part of an exercise to verify the accuracy of a goodwill item) valuations of IP are required. A range of issues will influence the outcome. These include inter alia; company policy towards maintaining IP marketing expenditure; patent protection measures and expenditure; industry IP life cycle; company market share; financial resources in relation to peer group competitors.

Although thus far we seemed to have discussed a long list of potential variable and combinations of variables, they enable us to determine why it is, for example, that just because the trademark Coca Cola is estimated to be worth $35 billion, it does not mean that Pepsi Cola is worth the same, despite the fact that they both are trademarks for very similar products. We are in the position of having established the parameters of the valuation process and we can apply these in the context of an actual valuation.

3. DIFFERENT METHODOLOGIES Once the assets to be valued have been identified, the context of the valuation including the appropriate timeframe has been determined, the proper measurement of value has been selected and the purpose for performing the valuation has been identified, it is time to consider which valuation methodologies to utilize. The most widely recognized valuation methodologies fall into one of three categories: the Cost Approach, the Market Approach and the income Approach. Each of these has strengths and limitations that make them more or less appropriate depending on the specific circumstances of each analysis. The Cost Approach The cost approach seeks to determine the value of IP by aggregating the costs involved in its development. This may seem fairly simple. However, there is more to it than merely adding up all of the receipts for expenditures associated with the R&D. indeed, there are two distinct Cost Approach methods: Reproduction Cost and Replacement Cost. Reproduction Cost is the level of expenditures needed to reproduce the exact same asset. It is appropriate in situations such as litigation involving the specific intangibles in question. The Replacement Cost method measures the expenditures necessary to develop an asset with similar utility and is appropriate in situations such as determining a target price prior to negotiations or calculating a basis for suitable royalty rates or transfer pricing. An important requirement for both methods is that the measurement of the costs be performed as of the valuation date as opposed to when the historical expenditures actually took place. Only the expenditures necessary to reproduce or replace the intangibles in the environment in existence on that date should be included. The appropriate date may be current or it may be a historical date. The impact of this requirement is twofold. If the cost of any of the relevant components has changed since the initial expenditure, the current cost needs to be utilized in the calculations. Also, any developments taking place in the interim that would materially impact the development process need to be factored in as well. An example of this would be the utilization of software applets in writing code. Software code developed prior to the widespread use of this technique could conceivably be developed in a far shorter time and at far less cost now than in the past, when each piece of code was written from scratch. Not all costs encountered during the time period an intangible was developed should be included, only those that would be required to duplicate the asset or an asset of similar utility. These will consist of both direct expenditures and opportunity costs. The direct expenditures will consist of items such as materials needed in the development process, labor costs, and some overhead items. Again, these costs

should be considered as of the date of valuation looking forward, not in their historical terms. If the available literature has progressed to the point where, say, a developmental process for a patented technology that took twenty researchers three years to develop could now be accomplished by four researchers working for one year, the latter structure is the template to use when estimating these costs. Also, make sure that the salaries, benefits, and other employment costs being attributed to those hypothetical researchers are based on current practices, not on the specifics in place historically. Overhead and management costs, such as project supervision, utilities and administrative costs should be pro-rated to reflect their true involvement with the direct development process. When projecting the timetable needed to develop the IP in question based on the current environment of prices, knowledge and available inputs consideration must be given to the probability of success, which will act as a necessary discounting factor. The opportunity costs consist of the other courses of action and investment opportunities that have been ignored in order to pursue the development of this intangible. If structured properly, this element will recognize the required return on investment being made by the assets owner. Other opportunity costs include the lost profits resulting from delays in commercializing the product. The possibility of obsolescence also needs to be addressed. If someone develops a better technology, it may not matter what the other factors are. When the objective of your analysis is to determine the value of the IP in the marketplace, whether via the reproduction method or the replacement method, any elements of the IP that are obsolete in the current environment need to be acknowledged. The cost approach is most useful in cases where there is no economic activity to review, such as early-stage technology. It also is effective at establishing a maximum price for the asset if the context is a proposed transaction. This situation exists when there are many candidates for substitution available. The relevant theory is that an investor will pay no more for an asset than the cost to develop or obtain and asset of similar utility. The main drawback associated with the cost approach is that it does not recognize any economic benefits associated with marketplace activity. There is no mechanism to incorporate revenue or profit data and therefore it ignores an important standard of value by which many assets are measured. When using the Cost Approach, an accurate valuation is one in which all relevant costs, including opportunity costs, have been factored into the analysis; that they have all been treated appropriately; that the probability of success has been considered; and that the issue of obsolescence has been addressed. Market Approach The Market Approach to IP valuation is similar to valuation techniques used for assets such as real estate and paintings. With real estate, the value of a four-bedroom

house close to good schools can be accurately estimated by researching recent transactions featuring comparable homes in the same neighborhood. Similarly, intellectual property value is determined by comparing the IP to comparable assets that have recently exchanged under similar circumstances. Because the indication of value is based on comparable transactions and there is a high degree of familiarity with the intrinsic concepts established through other asset valuation experience, this method is usually preferred by finders of fact, tax authorities and other third parties. This approach is best if an active market exists that includes many recent examples of arms length transactions for comparable intangible assets. Since IP is unique by definition, it is sometimes difficult to establish that assets are indeed comparable. Before making this claim, it must be verified that the transactions contain adequate information on terms and conditions. Information necessary to establish comparability includes the type of asset, the relevant industry, geographical constraints, exclusivity, payment mechanisms and timeframe, among others. It is important to know if there are extenuating circumstances such as a bankruptcy filing or forced divestiture. These will likely have had an impact on the terms contained within a potentially comparable transaction and thus may render it unsuitable for the analysis. Also, the conditions of the market at the time a transaction takes place will influence the sales or license terms for intangible assets. These are the kinds of relevant factors that need to be considered when using this method. When using the Market Approach, accurate and complete data analysis is of vital importance. Once empirical sales and licensing transactions have been selected based on circumstantial comparability such as timeframe, type of asset, geographical use and other factors, it must be determined whether the financial characteristics of the underlying operations are comparable. The price information contained in these comparables will frequently have to be adjusted using a common reference point such as sales of branded products or some type of margin analysis. An advantage of this approach is that it can be applied to a wide variety of intangible assets in a wide variety of circumstances. It is equally valid when applied to an established trademark or an early stage technology. As long as there is transactional data for comparable assets, the Market Approach will prove to be effective. Unfortunately, transactional data on intangible assets is rarely published and therefore it is difficult to gather enough data to provide a significant number of comparable transactions. The bottom line is that market information can be very useful in analyzing and valuing intellectual property, but it seldom is comprehensive enough to provide the basis for a satisfactory conclusion of the value on its own.

Income Approach
The Income Approach utilizes the ability to the intellectual property to generate cash flow. While the Cost Approach has specific applications in certain situations and

with certain types of intangibles and the Market Approach has its own limitations, the Income Approach is generally applicable to most situations and intangible assets. This approach is based on discounted cash flow theory and defines the value of the subject property as the pre sent value of the anticipated net economic benefits to be achieved over the duration of the propertys useful life. When using the Income Approach to value intellectual property, future income or cash flow related to the business, business segment or product line under consideration is estimated. The forecasted cash flow is then discounted via present value calculations to determine the current value of the operation. At this point, it is necessary to ascertain the portion of this value that is attributable to the intellectual property. When using the Income Approach, particular attention is paid to five main parameters that determine value: revenue or income associated with the use of the IP; expected growth characteristics of the identified revenue or income; expected duration of the revenue or income; risk associated with generating the estimates of revenue or income; and the proportion of the revenue or income that is attributable to the subject IP. These parameters are based on observations of relevant markets, including size, growth trends, market share dynamics among participants and overall market risk characteristics. Comprehensive knowledge of the attributes of the specific intangibles is also important, including stage of development, unique characteristics such as bankruptcy or market leadership, and relevant pricing information associated with the products that feature the subject IP. Producing an accurate forecast of revenue is dependent upon accurate knowledge of the competitive and economic environment in place during the appropriate timeframe for the valuation. It will also need to accurately depict an appropriate estimate of the propertys remaining economic life. The estimation of a propertys useful economic life must incorporate a variety of factors such as potential obsolescence, historical usage, expiration of parents etc. For example, a forecast of future revenue should not extend beyond the protection offered by a patent. On the other hand, a two or threeyear expected lifespan may be too conservative when analyzing a trademark with a 25 year history of success in the marketplace. Keep in mind that the estimate for the remaining economic life of the assets is dependent on the projected prospects of the property and the history of the assets. The discount rate used in the calculations must incorporate all the risks that have an impact on the generation of the future income or cash flow. Risks to consider when determining the discount rate to use in the calculations include the overall market risk, specific industry risk and risks associated with the specific intangibles and operation being analyzed. Several methods are available to calculate an appropriate discount rate including the capital asset pricing model (CAPM), the weighted average cost of capital (WACC) and the Arbitrage Pricing Theory Model. As stated above, it is important to differentiate between the business enterprise value and the value of the intellectual property that supports the business. Two of the more

effective techniques for separating these two elements are Relief from Royalty and Technology Factor. Used effectively, these techniques can provide the kind of accurate information that is necessary to make correct decisions. As long as the analysis has been designed correctly, it is possible to provide a calculated answer to any question associated with the value of intellectual property, whether it has to do with the level of damages related to patent infringement or the price to pay for a trademark. 4. INTERNATIONAL VALUATION STANDARDS

The valuation process necessitates gathering much more information as well as indepth understanding of economy, industry, and specific business that directly affect the value of the intellectual property. Therefore, such information may be gathered from external and / or internal sources. Finally, the information is devoted to be turned into financial models to estimate the fundamental value of a particular type of intellectual property based on such adapted International Valuation Standards.

Uniform Standards of Professional Appraisal Practice (USPAP) International Valuation Standard Committee (IVSC) (50 Countries) US Generally Accepted Accounting Principal (GAAP) International Financial Reporting Standards (IFRS) Financial Accounting Standards board (FASB)

5. LIMITATIONS OF IPR VALUATION The valuation of IP depends upon the use of an interlocking series of estimates, assumptions and judgments. It is highly limited as regards the accuracy of its results. Also, no sooner do we become more comfortable with our abilities to exercise accurate assessment in one field of IP property, than human ingenuity and technology present us with new areas; be they database copyrights, biogenetic materials or website addresses. For these reasons there continues to be a level of discomfort and reluctance to accept IP valuations in some quarters.

References 1) David Drews, IP Metrics LLC, Intellectual Property Valuation Techniques, I P Metrics. 2) VALUATION OF INTELLECTUAL PROPERTY ASSETS, WIPO/INN/DDK/00/5(B) 3) VALUATION OF INTELLECTUAL PROPERTY ASSETS, WIPO/INN/DDK/98/4(b) ***