1. Structure of Financial Terms in a License
OPTEON
PTY LTD
Philip Mendes
Director
Level 3, 380 Queen St
Brisbane QLD, Australia Ph
Fax

2. Benchmarking financial terms.
Benchmarking
Financial Terms
In licenses
Amounts
Royalties
Milestone Payments
Structure
What types of
financial terms

3. 1. Royalty on sales by a licensee
X% of sales price
Gross sales price; or
Net sales price
Most common type of royalty provision
Royalty is remuneration for quantity of use
Greater the quantity of use, the greater the royalty
The more sales, the greater the royalty
But more to a license than a royalty on sales
Clever ways for licensors to increase their remuneration
Clever ways for licensees to reduce their royalty overhead

4. Royalty upon sub-license income received by licensee
Licensee grants sub-license
Sub-licensee will pay to Licensee
Royalties on the sub- licensee’s own sales
Milestone payments, etc
All that income is sub-license income
Licensee pays a royalty of Y% to Licensor on all that income .
Licensor
Licensee
Sub-Licensee

5. Royalty upon Last Licensee’s Sales
Royalty on sale price for which the last licensee sells product
Royalty rate remains fixed, e.g. 2% of sale price of last sale – that is all licensor will receive
Licensor might be better off receiving Y% of Sub-license income – might be greater than this 2% - as Licensee will sub-license after value adding and will secure a substantially higher royalty .
Licensor
Licensee
Sub-Licensee
Buyer

6. 4. Ramped Up Royalties
As a product is more successful, and costs reduce, royalty increases
Licensor forgoes royalties in early stages, in return for higher royalties later
Infrequently seen

7. Royalty on sales in countries where patent granted
Expressed as:
“Valid Patent Claim”
Sales in country where but for license product would infringe a granted patent
That is, you only receive a royalty where sales are made in countries where the sale of a product is protected by a granted patent
Traps:
No royalties on sales made while patent pending (e.g., delays in examination, opposition proceedings etc)
No royalties on sales in countries where patent is not sought, nor granted – ie, if patent in US only, you only get royalties on sales in US

8. Royalty on sales in countries where no patent is granted
This royalty often resisted by licensee – “why should I pay a royalty for sales in countries where there is no patent and I have no power to prevent competitors ?
Royalty might still fairly be payable:
Patent is likely to be taken out in 20 – 25 countries and that may represent 90% - 95% of the world market – so why shouldn’t royalty be paid on sales in remaining countries ?
Licensee will select the countries where patent will be sought
Result
pay full / part royalty,
reducing by 50% if a competing product enters the marketplace, if it would have infringed the patent

9. 7. Royalty stacking Can arise in two ways
1. Product to be sold needs license in of complementary technology,
e.g., a delivery system
another active ingredient
a complementary product where both sold together e.g., a vaccine cocktail
Sale price of product sold reflects complementary technology as well
2. Freedom to operate – license in patent that is
infringed
Cannot reduce royalty by whole amount of royalty paid to another person
Alternative: in each case, reduce royalty by X% of royalty paid out, up to max of y% reduction on any royalty payment

10. 8. Royalty Splitting – know how
Split royalties so that they are referable to different parts of the IP that is licensed
Instead of seeking a royalty of 5%:
Royalty of 3% for use of patent
Royalty of 2% for use of know how
Purpose:
If patent is invalidated, license on foot, with a royalty
getting a royalty in countries where there are no patents

11. 9. Reach Through Royalties
Are royalties
Not on a Product derived from your IP
Instead, on a product derived from someone else’s IP, but which your IP validated
Examples:
License of a Mouse Model
Mouse Model validates a drug target
Therapeutic drug developed that acts on that target
Software program – royalties on reagents
Catalyst that reduces manufacturing costs

12. 10. Suspending royalties
Suspend royalties while revocation proceedings are on foot against a patent
Licensee will be concerned that it may be unnecessarily paying royalties if the patent is revoked
Licensor will be concerned to receive royalties if patent stands up
A middle ground is that royalties are
Paid to a trustee
Returned to licensee if revocation proceedings successful
Paid to licensor if revocation proceedings unsuccessful

13. 11. “Most favoured” royalty
Most favoured clause is very common in the case of a non exclusive license
Agree on royalty of 10%
If licensor later grants a license in the same country to a competing licensee for a lower royalty, that lower royalty will apply in lieu of the 10% royalty
Sought by non exclusive licensee to enable it to be better able to compete

14. 12. Royalties on damages
Does Licensor get a royalty of X% on damages ?
Assume:
Cost of Good: $60
Profit Margin: $40
Retail price: $100.00
Royalty: 5%
Damages for lost profits: therefore are: $40.00
Should licensor get:
5% of $40.00 ($2); or
5% of $ ($5) ?

15. 13. Lump Sum License Fees Once Only License Fee
License fee payable by installments
Signing Fee
To offset past patent expenses, expenses of doing the deal (travel, legals etc) some part of R & D costs,

16. 14. Minimum Annual Royalty Alternative to performance obligations
Performance obligations are obligations that a licensee must meet to continue to be licensed
Avoids shelving (non use) of IP
Licensor gets no financial return and wants to be able to license someone else
Avoids inadequate performance (e.g., no commercialisation in a major market, such as US)
Licensor gets inadequate financial return and wants to be able to license someone else

17. 14. Minimum Annual Royalty Examples of performance obligations
Pre market entry milestones to be achieved:
(a) If following completion of research, more research is needed to bring products to a market ready state, the completion of that research
(b) Completion of animal studies
(c) Completion of collection of data for lodging IND in USA
(d) filing IND in USA
(e) Commencement of Phase 1 Clinical Studies
(f) Commencement of Phase 2 Clinical Studies
(g) Commencement of Phase 3 Clinical Studies
(h) Filing of PLA in USA
(i) Approval of PLA. in USA
(j) First sale anywhere in the world
Failure leads to termination

18. 14. Minimum Annual Royalty Examples of performance obligations
Sell X quantity of product worldwide by
Or, sell the following quantities (revenues) in the following Territories in the following Periods:
Failure leads to termination
All motivated by Licensor seeking to maximise commercialisation and therefore revenue

19. 14. Minimum Annual Royalty Alternative to performance obligations
A Pharma / multinational will not accept performance obligations of these type
A large biotech company will not be able to secure those types of performance obligations from a pharma, and so will also not accept them from a licensor
Alternative is Minimum Annual Royalties
A minimum amount of royalties to be paid
Licensee must pay the higher of
Actual royalties, or
Minimum annual stipulated amount
Ramp up the amount year by year
If Licensee elects not to pay, termination

20. 15. Minimum Annual Payments
Similar concept to Minimum Annual Royalties
But refers to all payments payable under the license
For example, credit Milestone payments against the minimum payment amount
May credit other things
Research monies paid
Consultancy fees paid

21. 16. Milestone Payments
Payments made at identifiable points along the development / regulatory pathway

22. Pay royalties on what Definition of “Gross Sale Price”
Gross / Net – only labels - definition that is important
Pay on invoice price
Deduct taxes, duties, VAT, GST etc on sale
Deduct returns
Deduct packaging, freight and insurance
Only if separately invoiced
Or lump sum deduction, maximum of 3-5%
Sales to Related companies – transfer pricing
Licenses to Related Companies (with consent)

23. Royalty Rate Methodologies

24. Arriving at the right royalty rate
Most reliable method to arrive at a royalty rate
Benchmarking combined with DCF
Rules of thumb
Second least reliable method
Statistics and averages
Least reliable method

25. 25% Rule Rule of thumb Rule of Thumb
As with all Rules of Thumb – need to use with caution
May be a starting point only – with justifiable departures
Sam Davis, “Patent Licensing”, Patent Law Institute 1958, see Goldscheilder & Marshall, “The Art of Licensing from a Consultant’s Point of View”, Les Nouvelles No 6, 1971
Licensor should receive 25% of the pre tax profits, and the licensee should receive 75% of the pre tax profits.
Principle is that a royalty should be 25% of an expected profit margin.
Rule used not just to value IP for licensing purposes, but used to assist in determining damages in infringement proceedings.
Rule formulated having regard to a study of numerous worldwide licenses negotiated over many years.

26. 25% Rule Operation Relies on knowing the margin for an industry
If a margin is generally known or accepted, the 25% can work as a rule of thumb
Margin / Profits subject to interpretation

27. 25% Rule Discounting for early stage
Assumes that the IP is market ready
Development costs are therefore not taken into account
Should licensee pay same royalty rate if IP is market ready / still requiring $100m of development / regulatory costs ?

28. 25% Rule How reliable is it ?
A starting point,
A guide
Not an inflexible rule
Royalty Source database table – and new study of applicability of 25% Rule
“Use of the 25% Rule in Valuing IP Les Nouvelles December 2002 p 123

29. 25% Rule A starting point Once you have a starting point
What factors may suggest that the royalty should:
Decrease
IP not market ready
Further R&D
Regulatory and compliance matters
A highly competitive market
High plant production costs
High marketing costs
Extraordinary capital expenditure that has to be incurred
Volatile Margin
Increase
A robust patent position
Access to ongoing know how and trade secrets
R&D Program by licensor and prospect of improvements
Marketing networks and leads
Marketing assistance
Proven track record

30. 25% Rule Don’t make that the royalty rate
Don’t make the royalty rate 25% of pre tax profits
The concept of profit is too easily capable of manipulation
Onerous to keep separate accounting records in relation to different products of a business
25% is a rule of thumb, an approach
Ascertain the margin
Model the revenues and costs
Arrive at an amount that represents 25% of margin
Apply that as a percentage
Adjust upwards or downwards as the circumstances justify

31. Royalties responsive to development costs / risk
The more development costs a licensee will incur, the lower the royalty it is prepared to pay
Put another Way:
The more risk that a licensee takes, the lower the royalty it is prepared to pay
The more development costs a licensor has incurred, the greater return it seeks, the higher the royalty it requires
Put another Way:
The more risk a licensor has taken, the greater the return it seeks

32. Royalties responsive to development costs / risk
Research organisation licensors typically get a low royalty rate:
compared to the licensee, they take comparatively little risk, and pay comparatively little of the development cost
Research organisations may typically pay $500K to $1-2m in research
Pharma / multinational licensee will typically pay $25 m to $300 in
Further research costs
Development costs
Regulatory costs

33. Average financial terms in University Biotech Deals

34. Pathway to Market - Value

35. Pathway to Market - Risk

36. Royalties on Therapeutic Drugs.

37. Clinical Trials .

38. Variables impacting upon royalty rates
who pays development costs
a research organization perceived to be inexperienced will get a comparatively lower rate
a product with a small market will attract a small royalty rate (e.g. a rare disease)
product with lots of competing products (e.g. headache tablet) likely to attract a small royalty rate
product with a large market, and few competitors will attract a very high royalty rate

39. Structure of Milestone Payments

40. Pre-clinical Milestone Payments
Source: Health Advances LLC Analyses of selected Recap reported deals

41. Royalty on Vaccines

42. Royalty on Diagnostic product

43. Royalty rate distribution

45. Royalty Source data

46. Royalty upon sub-license income received by licensee
Sub-licensee will pay to Licensee
Royalties on the sub- licensee’s own sales
Milestone payments, etc
Licensee pays a royalty to Licensor on all that income
Up to 50% non pharma
Pharma deals:
30% a good result
25% a poor/ fair result
20% a poor result
15% a very poor result .
Licensor
Licensee
Sub-Licensee

47. Benchmarking Royalty Rates

48. Benchmarking Nobody wants to get 3% when the benchmark is 10%
Nobody wants to put a deal at risk by demanding 8% when benchmark is 2%
Need to know what is the right royalty rates
Benchmarking or comparables
Something is worth X because something else that is similar to it achieved X in the market place
Challenge is whether it is truly comparable
No two technologies are identical
How similar / different are they ?
The greater the similarities the greater the reliance on the comparable deal
To benchmark need to source information about deals that concerns comparable IP

49. Sources of information Databases
Bioworld Today news archives on
Recap: best biotech source – contains most deal making information
Pharmaventures – mostly press releases
Royalty stat and royalty source – broad cross section of industries – compiled from EDGAR
Knowledgexpress: Accesses pharmaventures and royaltysource

50. Sources of information Professional Reports
Intellectual Property Research Associates issues reports on royalty rates for all industries, - fragmented information
US $ US$ US$1500

51. Sources of information Professional Associations
Licensing Executives Society
“Les Nouvelles” Journal
Members can search journal on line
Wealth of opinions and observations about royalty rates for different types of industries
Techno-L Discussion group
Accessible at
Searchable archive of queries posted and replies with opinions and views onroyalty rates for different types of industries

52. Sources of Information Press releases and web searches
Press releases about deals in a particular industry or dealing with certain categories of products
Sources of press releases
Archived press releases on the web:
And Google

53. Benchmarking Find comparable deals Ascertain their financial terms
Ascertain the things about the deals that are
Similar
Different
Assess the extent to which a deal can be a Comparable
Assembles all the comparable deals and form conclusions
The closer other deals are, the more reliable they are as benchmarks
The further away they are, the less reliable they are