1. Valuation Consulting 49-50 The Hop Exchange, 24 Southwark Street, London, SE1 1TY Tel: 020 7403 3344 Fax: 0207 499 2266 e-mail: valconsult@valconsulting.co.uk www.valuation-consulting.co.uk

2. VALUATION CONSULTING THE LICENSEE & LICENSOR Four Calculations or Steps – ‘can Kelvin count’ 1.Intrinsic value of Licensor 2.Intrinsic value of Licensee PLUS 1.Intrinsic value of Licensor 2.Intrinsic value of Licensee The capital values calculated are an essential step to calculate a royalty rate or royalty arrangement - discuss

3. VALUATION CONSULTING LICENSING ECONOMICS & ROYALTY RATES Why License Market penetration Market penetration Increase profits Increase profits Access another’s resources Access another’s resources Synergy with another Synergy with another Circumvent infringement situations Circumvent infringement situations Sell related products Sell related products

4. VALUATION CONSULTING REASON FOR LICENSING IN TECHNOLOGY Reducing reliance on in-house R & D Reducing reliance on in-house R & D Specialist R & D companies often more innovative and efficient than larger manufacturing/distribution companies Specialist R & D companies often more innovative and efficient than larger manufacturing/distribution companies Reduced product development time and costs Reduced product development time and costs Cost of acquiring technology may not have to be incurred until revenues commence Cost of acquiring technology may not have to be incurred until revenues commence

5. VALUATION CONSULTING REASON FOR LICENSING OUT TECHNOLOGY Specialist R & D companies can concentrate on what they do best and use others for manufacturing and distribution Specialist R & D companies can concentrate on what they do best and use others for manufacturing and distribution Technology may not be of strategic importance for licensor but may be for licensee Technology may not be of strategic importance for licensor but may be for licensee Use of existing production, marketing and distribution facilities can reduce costs Use of existing production, marketing and distribution facilities can reduce costs Effective method of entering foreign markets Effective method of entering foreign markets Can accelerate cash flow and/or profits Can accelerate cash flow and/or profits

6. VALUATION CONSULTING ROYALTY INCOME Minimum or maximum royalties Minimum or maximum royalties Frequency of payment Frequency of payment Licensor conditions Licensor conditions Licensee conditions Licensee conditions Other considerations Other considerations Currency of payment Currency of payment Duration Duration Cancellation Cancellation

7. VALUATION CONSULTING CLUES FROM CASE LAW AS TO A REASONABLE ROYALTY Exclusivity.Exclusivity. The proportion of the marketable product attributable to the intellectual capital.The proportion of the marketable product attributable to the intellectual capital. The relative risks borne by licensor and licensee.The relative risks borne by licensor and licensee. The impact on the licensor’s business.The impact on the licensor’s business. The rate of technological change within the industry and the state of development of the market.The rate of technological change within the industry and the state of development of the market. The cost of inventing or developing the intellectual capital.The cost of inventing or developing the intellectual capital. Investment rates of return available from alternative forms of investment assessing comparable elements of risk.Investment rates of return available from alternative forms of investment assessing comparable elements of risk. The commercial relationship between the parties and the time frame of the agreement.The commercial relationship between the parties and the time frame of the agreement. How the parties may structure a ‘deal’.How the parties may structure a ‘deal’.

8. VALUATION CONSULTING SETTING A ROYALTY RATE In practice a rate is estimated by reference to some or all of the following: Existing licenses for the intellectual capital (the comparables approach),Existing licenses for the intellectual capital (the comparables approach), Industry norms for licenses for similar inventions (the market approach),Industry norms for licenses for similar inventions (the market approach), Allocation of economic benefits derived from the use of say the patented invention andAllocation of economic benefits derived from the use of say the patented invention and The rule of thumb approach or the 25% rule.The rule of thumb approach or the 25% rule.

9. VALUATION CONSULTING A LICENSOR’S ESTABLISHED PRACTICE: THE COMPARABLES APPROACH In litigation on intellectual capital the courts will examine carefully royalty rates established by the licensor in previous license agreements. This approach examines: How other licences were negotiated.How other licences were negotiated. The intellectual capital and support required to maintain it.The intellectual capital and support required to maintain it. The length of the agreement.The length of the agreement. Exclusivity.Exclusivity. Special terms for special deals.Special terms for special deals. Geography.Geography. The sector in which the intellectual capital is licensed.The sector in which the intellectual capital is licensed. Special RelationshipsSpecial Relationships Even if previous licensing practice is comparable, it can only provide a benchmark. Intellectual capital by its nature is unique and it is often a thankless task making numerous and required adjustments to allow a fair comparison.

10. VALUATION CONSULTING INDUSTRY NORMS AND RULE OF THUMB Many industries have built up a folklore of average royalty rates. It is usual to search for: Obvious comparables in the same or related sectors.Obvious comparables in the same or related sectors. Comparables of closely related intellectual property.Comparables of closely related intellectual property. Transactions of different intellectual capital (typically a brand), but licensing in the same sector e.g. clothing or food.Transactions of different intellectual capital (typically a brand), but licensing in the same sector e.g. clothing or food.

11. VALUATION CONSULTING MARKET PRACTICE MAY NOT BE REPRESENTATIVE OF THE CIRCUMSTANCES OF YOUR APPRAISAL BECAUSE: Royalty information regarding similar intellectual capital is very rare. Seldom can a reasonable comparison be found and still more seldom is third party royalty rate information available.Royalty information regarding similar intellectual capital is very rare. Seldom can a reasonable comparison be found and still more seldom is third party royalty rate information available. The licensor would not have granted a licence to just anybody thus the licence may not be typical.The licensor would not have granted a licence to just anybody thus the licence may not be typical. Special licensees and related party transactions may have an effect.Special licensees and related party transactions may have an effect. The adjustments required to compare a substantial running royalty rate for an exclusive licence will be worthless in evaluating a non- exclusive license on different, but related technology.The adjustments required to compare a substantial running royalty rate for an exclusive licence will be worthless in evaluating a non- exclusive license on different, but related technology.

12. VALUATION CONSULTING The IPR may be important for only part of a product.The IPR may be important for only part of a product. Information about rates that are available may reflect specific licensing clauses that affect the royalty rate that was negotiated.Information about rates that are available may reflect specific licensing clauses that affect the royalty rate that was negotiated. Many rates have been negotiated by legal experts without consideration for business risk and investment rates of return.Many rates have been negotiated by legal experts without consideration for business risk and investment rates of return. Industry rates were often established years ago and reflected economic conditions, business risks, and investment rates of return that are no longer appropriate. Any mistakes made by the initial setting of an industry royalty are passed along.Industry rates were often established years ago and reflected economic conditions, business risks, and investment rates of return that are no longer appropriate. Any mistakes made by the initial setting of an industry royalty are passed along.

13. VALUATION CONSULTING MARKET PRACTICE AND THE ROLE OF INDUSTRY AVERAGES Even though industry averages are suspect as a royalty rate it is an essential exercise in any determination.Even though industry averages are suspect as a royalty rate it is an essential exercise in any determination. Figures typically are based on a net sales price royalty base and a non-exclusive license.Figures typically are based on a net sales price royalty base and a non-exclusive license. A 20% to 50% premium has been discussed as a reasonable average for exclusivity of licence.A 20% to 50% premium has been discussed as a reasonable average for exclusivity of licence. As much as 300% premium for exclusivity has been reported in the pharmaceutical field.As much as 300% premium for exclusivity has been reported in the pharmaceutical field.

14. VALUATION CONSULTING AVAILABLE PROFITS APPROACH (REFERRED TO AS THE ANALYTICAL APPROACH IN THE US) The Licensor Perspective For the licensor there are many ways to determine the minimum he or she is prepared to accept. However a simple profit analysis method often works best. In a growing market where the licensor has established a market share which would not be at risk by the entry of a competitor, his £X value will be determined by estimating the expected future incremental profit increase with and without exclusivity. That differential, discounted to present day value, represents the available incremental profit should exclusivity be lost.

15. VALUATION CONSULTING RULES OF THUMB Over the years a fiction has developed that, in general, a competitor should be willing to pay between 23% and 33% of the gross profit margin before taxes expected to be returned under licence.Over the years a fiction has developed that, in general, a competitor should be willing to pay between 23% and 33% of the gross profit margin before taxes expected to be returned under licence. It may be used as a benchmark to compare a royalty rate arrived at from economic mathematical modelling.It may be used as a benchmark to compare a royalty rate arrived at from economic mathematical modelling. This rule of thumb method allocates incremental profits between parties. The rough allocation of profits reflects the relative risks borne by the parties.This rule of thumb method allocates incremental profits between parties. The rough allocation of profits reflects the relative risks borne by the parties.

16. VALUATION CONSULTING In practice the parties must either agree that each year say 25% of the gross profit is turned over to the licensee or they agree on a value of the expected gross profit over the life of the intellectual capital and convert that amount into a running royalty. Neither is often feasible in the real world. Few with prudence and disposition would allow a licensor sufficient access to its books and records on an annual basis to calculate gross profit even assuming agreement could be reached as to how gross profit is to be calculated.

17. VALUATION CONSULTING THE LICENSEE & LICENSOR Four Calculations or Steps – ‘can Kelvin count’ 1.Intrinsic value of Licensor 2.Intrinsic value of Licensee PLUS 1.Intrinsic value of Licensor 2.Intrinsic value of Licensee The capital values calculated are an essential step to calculate a royalty rate or royalty arrangement - discuss

18. VALUATION CONSULTING STRUCTURING LICENSE AGREEMENTS TO MAXIMISE PROFITS

19. VALUATION CONSULTING STRUCTURING DEALS Case 1 2% of licensee’s sales every year Case 2 1.5% of licensee sales with minimum of £50,000 pa for the first 4 years Case 3 300,000 payable in 4 equal annual instalments

20. VALUATION CONSULTING STRUCTURING DEALS Case 1 Case 2 Case 3 Case 1 Case 2 Case 3 YearSales Cash Profits Cash Profits Cash Profits 1 5m 100 100 75 225 75 300 1 5m 100 100 75 225 75 300 2 10m 200 200 150 100 75 - 2 10m 200 200 150 100 75 - 3 8m 160 160 120 70 75 - 3 8m 160 160 120 70 75 - 4 5m 100 100 75 25 75 - 4 5m 100 100 75 25 75 - 560 560 420 420 300 300 560 560 420 420 300 300 Case 1 2% of licensee’s sales every year Case 2 1.5% of licensee sales with minimum of £50,000 pa for the first 4 years Case 3 300,000 payable in 4 equal annual instalments

21. VALUATION CONSULTING License 1 The royalty rate here is 2% of licensee’s sales every year. License 2 The royalty here is 1.5% of licensee sales with minimum of 50,000 p.a. for the first 4 years. Should the licensor wish to represent it as such this is a profit calculation as follows: Yr (1)4 x 50 + (75 – 50) = 225 Yr (2)150 (1.5% x 10m) – 50 k (taken in Yr 1) = 100 Yr (3)120 – 50 = 70 Yr (4)75 – 50 = 25 License 3 300,000 payable in 4 equal annual instalments