You Think Your IP Is Worth Something? Prove It

Michele M. Riley and Lynton Markham

Corporate Counsel

01-23-2013

Intellectual property has become a major topic even in the mainstream media as companies like Google Inc., Microsoft Corporation, Apple Inc., and Samsung Electronics Co. Ltd. wage bitter battles over patented technology. In the C-suite, strategic and tactical decisions are being made about acquiring and selling sizable IP portfolios.

The stakes are high. In 2011, an industry consortium paid $4.5 billion to acquire 6,000 patents from the bankrupt Canadian telecom equipment maker Nortel Networks Corporation. Outbid by the consortium, Google went on to acquire Motorola Mobility Holdings Inc. for $12.5 billion and although not explicitly stated, it was widely believed that a major motivation for this transaction was Motorola's portfolio of 17,000 patents — patents that could help Google defend itself and its partners against lawsuits relating to its Android software. Believing Motorola's patent portfolio was actually an undervalued asset, iconic investor Carl Icahn observed that Google is "getting the patent portfolio relatively cheaply."

These strategic patent purchases raise interesting questions about the value of IP and its role in corporate strategy. How are patent portfolio values calculated and how do consortium participants determine their contribution amounts? How should consortiums split the benefits? If litigation ensues, how will the value of these patents be determined?

To definitively prove the value of IP, its worth must be documented with actual evidence. As former President Ronald Reagan famously said, "Trust, but verify." The more information a company has specific to its purchased or internally developed IP, the better.

DOCUMENTING IP VALUE IN A NON-LITIGATION SETTING

The stakeholders in an entity's IP are varied and numerous. These stakeholders expect returns from IP, just as they would from any other asset. Management must show how the IP fits into the company's overall strategy and its use in generating current and future returns. This understanding of IP's use and value allows the company to effectively articulate to shareholders the benefits of their investment.

How do you prove your IP's worth? Start with the following questions:

• What's included in the valuation?
• What's the premise of value?
• What products do you sell now or will sell in the future that feature this IP?
  • How much revenue and profits have you earned, or will you earn, on these products?
• What benefits do you receive from incorporating this IP into your products?
  • What form do these benefits take and can they be quantified? How?
• What benefits do you forgo by not putting this IP to use?
• Why do customers like this IP?
  • How does it make customers feel?
• How does this IP contribute to your overall brand?

Documenting these answers puts your IP in the context of value. By moving your IP from the vague and amorphous to the world of quantified results, you move the understanding of your IP's value from "unknown" to "worth something."

REVENUE STREAMS

Of equal importance is understanding how others are using your IP. Many organizations that license out their IP fail to adequately manage this revenue stream to guarantee they are actually receiving the full value they are owed.

In accounting terminology, royalty revenue is considered a "passive activity," yet a licensor should be anything but passive if it wants to ensure it is being paid the appropriate royalties. Studies have shown that reporting and payment deficiencies were found in 89 percent of audits.

To ensure financial compliance of each license agreement, capture at least the following data:

• licensee contact information;
• IP description and understanding;
• coverage by territory and expiration dates;
• definition and understanding of the royalty base;
• royalty rate (especially if it changes by product or over time);
• reporting requirements and payment terms; and
• minimum and milestone payments and requirements.

Ultimately, a royalty audit will provide the most detail on a licensee's compliance with the terms of the agreement. The licensee has its own interests in mind when it is calculating and reporting royalties. Therefore, it is important for the licensor to ensure that its interests are being served. Most license agreements include provisions for the licensor to audit the books and records of the licensee. A regular audit program will ensure that you are receiving the correct amount and that your IP is being used in accordance with the terms of the license.

LICENSE NEGOTIATIONS

The documentation required by shareholders, auditors, and licensees is similar to that required in an arms-length license negotiation. Regardless of whether you are the licensor or licensee, it is important to understand the IP's use and how the marketplace values the technology. The licensor's negotiating position is established by several concepts:

• Potential value of the enlarged market for products incorporating the technology if licensing to a party that does not compete directly with licensor for product sales.
• In the alternative, the potential loss of value to the licensor due to decreased product sales if licensing to a direct competitor. Put another way, how much are the licensor's sales going to be cannibalized by the sales of the competitor?
• Compensating for any potential loss of value through structure of the license (territory limitations, field of use limitations, exclusivity provisions).
• Compensating for any potential loss of value through a negotiated cross-license with a competitor that would give both parties rights to desirable technology.

In the actual license negotiation, the licensor must come to the table with quantifiable evidence of these points demonstrated through analyses and must be ready to discuss these estimates with the potential licensee. If done correctly, the licensor can establish the framework for the negotiation in a way that is beneficial for both parties.

EVIDENCE OF IP VALUE IN LITIGATION

If litigation ensues, the documentation becomes factual evidence in establishing the IP's value. For example, consider purchase-price allocations. Although performed for financial statement reporting, these allocations are an important documentation resource in litigation matters. Reports can contain information on a variety of intangible asset classes, including patents, copyrights, trademarks, trade secrets, and license agreements. The reports may also include market, income, and cost approach valuations; revenue projections and expectations; royalty rate estimations; market comparables analysis; and relief from royalty valuations. The amount paid by a plaintiff in acquiring a company with desired patents is unquestionably relevant in the calculation of damages should those patents later be asserted in litigation.

Another critical piece of evidence may be customer testimonials and product reviews. A customer survey might be the only way to prove that the patented feature was the reason for a customer's purchase. A recent court opinion highlighted this point, stating, "[w]hile one can assume that those who wanted the feature found it desirable and were willing to pay for it ... , there is no way of knowing (short of interviewing the customers, which was never done) whether this feature alone drove the decision to purchase ... or put otherwise, whether the presence or absence of the allegedly infringing feature 'was of such paramount importance that it substantially created the value of the component parts.'"

Documentation lays the groundwork that enables an organization to truly understand how it derives value from its IP. There are many sources of useful documentation that can provide an understanding of economic value, whether in the setting of license negotiation, royalty compliance, litigation, or valuation. All IP stakeholders should be aware of these types of documentation and understand their uses.

Michele M. Riley is a managing director with the accounting, financial, and economic consulting firm Invotex Inc. in Washington D.C. Email: mriley@invotex.com. Lynton Markham is a consulting affiliate with Invotex in San Francisco. Email: lmarkham@invotex.com.