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PAYMENTS AND ROYALTY RATES
February 2008
Christi Mitchell, IP Director, Highbury Ltd
Christi MitchellIP Director
• Human Genetics, Molecular Biology, Marketing and Business Degrees
• Past President Licensing Executive Society (LES) Britain &Ireland; current Board Director
• International Chairman, Life Sciences LESI• International licensing experience over 25 years• International Biotechnology and Healthcare start
up and university spin-out company experience • Venture Capital experience
VALUATION
• KNOWLEDGE BASED INDUSTRY – CENTRAL TO THE UK ECONOMY
– Innovative ideas leading to IP rights and wealth creation:
• Improved products
• New brands
• Creative expressions
This process is being increased by the erosion of Global trade barriers
Outline.
Valuing technology
Some valuation methods
Key financial terms
–royalties
Market due diligence
• Establishing the market potential– potential for viable revenue streams,
– cost of independent development
– costs of commercialization
– impact of previous attempts to commercialize
• Market sector review including macro factors and market trends – consumer awareness
– government constraints
Build Financial Model
• Forecast market size and growth• Forecast sales – value & volume• Forecast market share (competitor due diligence)• Review price structures across all territories• Review take to market costs, including:
– sales & marketing– IP implementation– Further R&D– Regulatory requirements & hurdles
• Review distribution chain – risks & costs
Other Due Diligence
• Due Diligence leads to Financial Data– IP due diligence
– Product due diligence• Forecasts, markets, timeframes, need, take to market route
– Partnering costs (legal, other support, time factors, deal implementation)
– Corporate due diligence• Stability, margins, ethics, reputation
Organisation/inventor with
Idea
Protecting theinvention
Planningcommercialisation
Implementation
Manage andenhance the
inventionprotection
Developbusinessstrategy
Developcommercialisation
strategy
Undertake duediligence and
market research
Identify suitablepartners
Manage dealconstruction andimplementation
Project Process OverviewDiagram indicates how Highbury adds value to, and manages the
technology/Intellectual Asset commercialisation lifecycle; from idea through to deal implementation.
Financial assessment
• valuation of products / technologies
• simple financial models
• risk assessment
• financial impact of different deal structures
• royalties
Some valuation methods
• REMEMBER: Agreement on IP valuation is the most difficult hurdle in the negotiation.– Seller focuses on reward
– Buyer focuses on the risk
• Generally made up of lump sum plus royalty ( lump sum/milestone payment scheduling varies across the world)
Valuation Insecurity
• Value depends on
1. Ability of licensee to successfully implement it as a process or product
2. Dependant on a specific market that may be seen differently by the 2 parties
3. The ability to prevent infringement
4. Ability to access licensors know how
Simple financial models
Valuation methods are based on:
Cost
–for early technology
Potential income
–when application is evident
Market data
– when the technology is developed
Cash Flow Analysis
• what will the investment cost?
• how much cash will it generate each year?
• To calculate Cash Flow:– Define the value of the investment
– Calculate the size of the benefits
– Determine the timing of the benefits
– Quantify the uncertainty of the benefits
– Do the benefits justify the investment ??• Remember – cash flow is not profit
Risk Adjusted Discount Rate
• This is an adjustment for the time value of money and the inherent risk
• Calculated risk : – Cost Of Capital + a fudge factor = The Hurdle rate – used to discount future cash flows back to today.
• The result of summing the Discounted current and future cash flows = The Net Present Value (NPV)
• +ve NPV = likely good investment (it adds value to the company)
Risk assessment/sensitivity
analysisMethods to assess risk:• Add risk factor to discount rate or create ‘hurdle’
rate e.g.20%• Determine sensitivity of model to various
unknowns by calculating different scenarios, e.g. - lower price or market share - development costs are higher - development takes longer - cost of goods are higher than forecast
Other valuation methods
• DCF (Discounted Cash Flow)– Problem,“The future cash flows of raw technology are
uncertain”
• Monte Carlo– A mean estimate of cash flows, and statistically modelled
range of expected cash flows.– Produces an unbiased distribution of present values where the
mean can be taken. (objective method)
• Capital Asset Pricing Model (CAPM)– Adjust the “Hurdle Rate” based on the amount of “systemic
risk” = Risk Adjusted Discount Rate (RADR)– This allows degrees of risk to be incorporated
Key financial terms
• Equity investment– control
• Upfront payments– commitment
• Milestone payments– risk sharing
• Other payments– e.g. manufacturing facility, research, patent or clinical costs
• Royalties– profit sharing
Most important factors affecting Royalty Rates
o Strength of IP
o Market sector (expected norms)
o Degree of exclusivity (field of use restrictions)
o Licensor/Licensee characteristics
o Economic factors
o Phase of development
o Duration and scope of license
o Commitment to ongoing research
o Negotiating skills
o Degree of need
Generic IA Biotech Value Drivers
• Value Drivers– Market
• Reached peak?• Growth rate• Market share
– Cost• Operating• development
– Time• Patent life• Proof of concept
– Option• Strategic• operating
• Risk Drivers– Internal risk
• Strategic fit or dilution
– Substance risk• Safety
• Efficacy
• availability
– Competitor risk• In class
• Out of class
– Commercial risk• Image
• Economics
Royalty rates: Industry Norms
• What are they?
• What don’t they tell us?
• Are they useful?
• How can we use them?
Royalty rates: Industry Norms Franklin Pierce Law Centre
Industry Royalty Norm
Chemical 1-5%
Computers 3-5%
Consumer Products 2%
Electronics <1-5%
Pharmaceuticals 4-15%
Industry NormsWhat don’t they tell us?
• the range of royalty values• the stage of development• to what the royalty rate relates• what other financial components exist
– Down payments– Milestone payments– Equity etc.
• any other aspects of the deal– Exclusivity – Timing of payments etc.
Financial negotiation
• market estimates – establish a baseline
– share market data
– agree top line figures
• openly discuss key assumptions
• identify corporate drivers– fixed hurdles - NPV / IRR
– turnover of £ X m
Risk verses Reward
• Licensee prefers royalty– Allows them to limit the consequence of uncertainty
• Licensor prefers (dp) downpayment– Quicker rate of return
– Will not share licensees implementation risk
– Avoids royalty mismanagement by licensee
– Requires less enforcement/monitoring than royalty
– Dp raises negotiation cost (requires greater due diligence to get the price right)
Timing
• early payments– carry high risk to the licensee
– have high impact on NPV
• late stage payments– are paid on specific target achievements
– carry lower impact on NPV
Agreement provisions
• clear payment terms – timing and delivery
– currency exchange provisions
– late payment
– CIF/FOB
• manufacturing / QC
• royalty audit provisions
Conclusions
• Relating risk to reward is difficult
• There are many valuation methods
• IP values are not static
• Industry norms only tell part of the story
• Patents lapse, value may not hold into perpetuity
• Use a mix of valuation methods
Contact
• Christi Mitchell: – Intellectual Property Director
• Direct Tel: +44(0)1462436894• [email protected]
• Elizabeth McNabb:– International Business Development Director
• Direct Tel: +44(0)20835556989• [email protected]
• Anne Wight:– Business Development Director Highbury Pacific
• Direct Tel: +64(0) 21432424 • [email protected]
