Under Appendix D-1 is the "Financial Valuation of Intellectual Assets"
under Appendix D-2 is the University Licenses: How Big a Piece of the Pie? and 
under Appendix D-3 is the "Valuation of a Technology."
under Appendix D-4 is the Summary List of Technology Licenses: Royalty Rates & Industry Risk.
 

Appendix D – 1

“Financial Valuation of Intellectual Assets”

Excerpted from “Marketing of Advanced Materials Intellectual Property”, Twelfth International Conference on Composite Materials, July 8, 1999, Paris France by Michael  Martin  

Financial Value. Following is a discussion of all valuation methods considered to determine the range of acceptable economic values as a starting point for negotiations and to determine the appropriate royalty rate.  Ultimately, value is established between two parties across the table.

1)     Cost Approach.  The Cost Approach values Intellectual Property assets based on the cost to create and develop or to replace the assets under consideration.  This valuation method is based on the premise that no party involved in an arm's-length transaction would be willing to pay more to use the property than the cost to replace the property.  The estimated cost to develop the technology may be based upon historical development costs or the projected cost to develop an asset of similar value as of the date of valuation.

The Cost Approach allows for consideration of other cost elements involved in bringing the "replacement" asset to the same level of economic performance as the original asset had at the time of valuation.  For instance, full replacement of a proprietary product may involve lost sales and profits during the period of development, as well as incremental marketing and promotional expenses to secure a comparable market position for the replacement product.  The typical result of using the Cost Approach is a lump-sum value of the subject technology as opposed to a running royalty rate.

The main limitation of this approach is its lack of consideration for all elements of future income and/or profit streams, market conditions, useful life, and the risk associated with receiving future economic benefits.  Another limitation of this approach is the inherent assumption that the asset is “replaceable” with one of equivalent value, an assumption that often does not apply to intellectual property, which is unique by definition.

Nonetheless, the Cost Approach may be a very appropriate method for valuing assets with certain characteristics.  For example, this approach may be appropriate for valuing embryonic, basic technology for which market applications cannot yet be defined.  Also, if the technology is narrow in scope and thus easy to replicate or "design around," the cost approach may be appropriate.

2)      Market Approach. The Market Approach values assets based on comparable transactions between unrelated parties.  Factors to consider include the nature of the assets transferred, the industry and products involved, agreement terms, and other factors, which may affect the agreed-upon compensation.  There are two articles in Appendix D-2 and D-3 which can provide a basis for the initial valuation.

3)      Income Approach. For property dedicated to a business enterprise, including intellectual property, future benefits are preferably measured in terms of income generated by the Intellectual Property. The Income Approach does just this, as it values assets based on the present value of the future income streams expected from the asset under consideration.  The expected future cash flow stream from the asset, usually a series of periodic amounts, may be quantified using a variety of approaches depending on the specific circumstances of each case.

The duration and timing of the cash flow stream is determined by forecasting the useful life of the property, which can be determined in any one of several ways:

a)      the physical or service life of the asset

b)      the statutory or legal life of the asset

c)      the economic life of the asset - the period of time during which the property is producing an adequate return

d)      the functional or technological life - the period after which the technology becomes commercialized but before which the asset becomes technologically obsolete. 

The business risk associated with the realization of the stream of expected cash flows may be captured through the use of an appropriate discount rate.  The discount rate should reflect a rate of return on investment that is commensurate with the risk associated with the commercial exploitation of the assets under consideration.  This discount rate is used to discount future expected cash flows back to the present in the net present value calculation.

4)      Relief From Royalty Approach. The Relief From Royalty Approach is based on the following premise: a property's value can be measured by what the owner of the property would pay in royalties if it did not own the property and had to license it from a third party (i.e., the licensing costs avoided by virtue of owning the property).  Conversely, this approach may also quantify the amount of income that the owner would generate by licensing the intellectual property to others.

This method requires that the Intellectual Property have been developed to the point where it can be expected that products encompassing the Technologies could be produced within a reasonable period of time.  Second, there was sufficient data to develop reasonable estimates of the royalty base (i.e., projected revenues).  Third, there was adequate data to support the determination of a reasonable royalty rate.  Finally, the Relief From Royalty Approach accounts for market conditions, the economic life of the Technologies and the risk associated with receiving future economic benefits.

5)      Methods for Determination of an Appropriate Royalty Rate

a)      Market Approach. Market Approach entails searching for negotiated royalty rates from comparable licensing transactions. Some examples are found in Appendix D-2 and D-3.

b)      Profit Apportionment Approach - The need to split or share the anticipated profit "pool" between licensors and licensees of intellectual property has been recognized and endorsed by licensing practitioners, Tax Court case law, and Internal Revenue Service regulations. In the case of licensing intellectual property assets, there are several “rules of thumb” that are commonly employed when determining a reasonable profit split.  A common rule of thumb is referred to as the “25% rule.”  Marcus B. Finnegan and Herbert H. Mintz provide a good overview of this rule in an article from The Business of Licensing: “While the percentage may be variable depending upon the facts, there is fairly common acceptance of a figure of 25 % of the profits earned by the licensee as a reasonable royalty to the licensor.” 

c)      Excess Earnings Approaches - The Excess Earnings Approach values a property by the incremental earnings which may be achieved by the subject assets with intellectual property protection (e.g., a patent) relative to the profitability of similar "benchmarks."  Examples of "benchmarks," as used here, may include profit margins on products without intellectual property protection or more general measures of normal industry profit levels.  The "excess earnings" may result from the proprietary product commanding a price premium, delivering certain manufacturing cost savings, or achieving larger sales quantities. 

d)      Cost Savings Approach - Occasionally, the only income-enhancing contribution of an intellectual property is in the form of manufacturing (or other) cost savings that accrue to the owner (or licensee) of the property.  In such cases, the quantum of the cost savings may constitute an appropriate basis for determination of a reasonable royalty rate. 

Appendix D-2

University Licenses: How Big a Piece of the Pie?

By The ReCapping Corporate Alliances  

  The ReCapping Corporate Alliances database lists more than 1,100 university research collaborations and/or license agreements involving more than 300 universities. Of these, approximately 400 university agreements were commenced between 1993 and the present. Of this most recent group, more  than half (213 agreements) have been publicly filed under the SEC's  disclosure requirements for publicly traded biotechnology companies. 

We took a 10% sample of the most recent publicly filed agreements, selecting  university alliances which included license terms and had been subjected to little or no redaction of confidential terms. Of the 21 agreements selected, 15 entailed simple product or technology licenses, while six also entailed sponsorship of license-related research. As shown on the chart below, average  university license payments totaled $324,000 per agreement, consisting of $42,000 in upfront fees and $282,000 in milestone payments (both event-based milestones and up to five years of license maintenance fees). In addition, those agreements entailing sponsored research averaged an additional $681,000 of committed research payments by the commercial licensee to the university licensor. 

It is noteworthy that such license and research payments have doubled, on average, as compared to a similar analysis we performed of 100  university/biotech agreements covering agreements commenced between 1980 and 1992. In the earlier analysis, license payments averaged $165,000, consisting of $30,000 in upfront fees and $135,000 in either milestones or advance royalty payments. Sponsored research commitments to the university licensor averaged $351,000 per agreement. 

  This chart shows the distribution of royalty rates for the sample of 1993-97 agreements. Specifically, the chart shows the maximum royalty rates payable to the university licensor on the basis of product sales by the commercial licensee. 

The sample size was increased to 23 agreements to reflect inclusion of two additional university licenses wherein a royalty was negotiated in lieu of any  upfront or milestone payments. As noted in the chart, all but three of the deals were licensed on an exclusive basis for the agreement term (usually the life of patents). The average royalty rate for the sample was 4.4% of net sales, ranging from 2% to 9% of net sales. 

This average maximum royalty rate has been remarkably consist over multiple time periods. When the sample of 100 university/biotech agreements described earlier was subdivided into deals commenced from 1980 through 1986 and from 1987 through 1992, in each case approximately the same average royalty rate was obtained. There has, however, been a steady trend toward exclusive licenses over time. 

 Finally, while such analyses may be informative as to the university "slice," additional information is required to evaluate the size of the "total pie." In an earlier analysis (How the Elephants Dance Part 2), we described in detail the economics of pharma/biotech alliances. In particular, recent discovery stage alliances have averaged $47.6 million in total pre-commercial payments--consisting of $1.7 million in upfront fees, $20.3 million in milestone payments, $13.9 million in R&D reimbursement, and $8.5 million in equity payments (upfront and contingent). By such a standard, at least, the university portion of the "total pie" is meager indeed. 

When average royalty rates paid by pharma to biotech are considered, however, interpretation of the results becomes more complicated. First, as the accompanying chart demonstrates, pharma/biotech royalty rates tend to increase as a function of the stage of product development at the time an agreement is signed. As the basis of comparison, discovery stage alliances are probably most applicable to university licensing agreements, although in the case where a discovery stage pharma/biotech alliance subsumes one or more pre-existing university agreement, the university agreement(s) must somehow be evaluated as "pre-discovery." 

Secondly, a simple comparison of average royalty rates (4.4% for university agreements versus 7.3% for discovery stage pharma/biotech agreements) does a disservice to the careful drafting of most such agreements. For example, on the university side, approximately half of university licenses provide for an alternative royalty mechanism to be used in the event the technology is sublicensed (as is the case in a pharma/biotech deal). Usual sublicense participations range from 20-50% of licensee's financial benefits from the sublicense, both in terms of royalties and of pre-commercial payments. On the pharma/biotech side, the majority of such agreements provide for explicit sharing of third party royalties (including university licenses), normally including a "floor" royalty to the biotech which is 50% of the maximum rate otherwise payable. 

To overcome such complications, we analyzed in detail several specific instances where a university license was subsequently sublicensed in connection with a pharma/biotech agreement. In this manner, we intended to identify the actual payment terms, from biotech to university and from pharma to biotech, as the basis for interpretation of the size of the university's "slice", as well as of the "total pie." 

1. The UCLA/Xoma license agreement concerning monoclonals for treating and diagnosing septic shock provided for approximately $100,000 in total pre-commercial payments to UCLA, plus up to 3% royalty on net sales. By comparison, the Xoma/Pfizer development and license agreement, executed nine months later, provided $2 million in upfront payments, reimbursement of development costs (which exceeded $28 million over five years), plus 33+% royalty on net sales. In this instance, UCLA's "slice" was approximately 5-10% of the "total pie" fashioned by Xoma and its pharma partner, Pfizer.

2. This instance involves two universities, Brigham & Women's Hospital and Beth Israel Hospital, which jointly licensed to AutoImmune the use of Type II collagen in the treatment of rheumatoid arthritis. Collectively, the university agreements entailed research payments of $3.7 million, plus 5% of sublicense milestone payments and 10% of sublicense royalties (not to exceed 1.5% of net sales). By comparison, the AutoImmune/ Schering-Plough development and license agreement, executed 3.5 years later, provided $0.5 million in upfront payments, plus over $54 million in aggregate milestone payments and 15% royalty on net sales by Schering. Apparently, the university license agreement was "front-loaded" in this instance--trading substantial early research payments for a relatively small (5-10%) "slice" in downstream, contingent payments.

3. The State University of New York (SUNY) licensed to Cortech certain human elastase inhibitors. SUNY received a $10,000 upfront fee, plus 50% of all sublicense royalties. Cortech sublicensed its rights to Marion Merrill Dow (now owned by Hoechst) almost immediately, in return for approximately $8 million in equity and milestones, reimbursement of development costs (which exceeded $11 million over seven years), plus 10% royalty on net sales. The university license agreement was "back-loaded" in this instance--taking little in initial fees in favor of a 50% "slice" of downstream royalty payments.

4. Finally, the University of Illinois/Alliance Pharmaceuticals license agreement concerning perflourocarbons for in vivo imaging provided for approximately $400,000 in total pre-commercial payments to the University of Illinois, plus a 6% royalty on net sales. By comparison, the Alliance/Boehringer Ingelheim development and license agreement, executed roughly four years later, provided $14 million in upfront and equity payments, $12 million in milestones, partial reimbursement of development costs (which exceeded $6 million over four years), plus 15% royalty on net sales. In this instance, the University of Illinois' "slice" consisted of 3% of initial payments and 40% of royalties, equating to approximately 25% of the "total pie" fashioned by Alliance and its pharma partner, Boehringer.

Appendix D-3

Appendix D-4

Summary List of Technology Licenses
Royalty Rates & Industry Risk

Licensing Executives Society
Chemical, Polymers and Associated Industries Committee
Winter Meeting, Crystal City, Virginia
December 12, 1996