This is the third in a three-part series providing insight into patent valuation and the importance of intellectual property when valuing and selling privately held companies. Part 1 provides a primer on how patents impact business valuation and part 2 outlines 10 specific factors that impact a patent’s value. Here we’ll review how a patent is valued from the perspective of the licensee.
A given patent usually has dramatically different value for various potential licensees or acquirers. Savvy licensing professionals will conduct intensive due diligence to understand the dynamics of their potential licensing partners in order to seize the incremental advantages associated with deconstructing their business models. Some of the factors that determine how much value a licensee or acquirer would place on a particular patent include:
- Ability to commercialize. The value of licensing a patent is reduced if the licensee would have to make significant capital investments to produce a product that incorporates the patented invention compared to a licensee who already has the requisite production infrastructure in place.
- Stature of the inventor. In many closely-knit industries (such as colorectal surgery), the players with buying power are well-aware of the most renowned inventors. These decision makers are often inclined to buy products that incorporate the inventions introduced by renowned inventors. In these scenarios, patents granted to the most respected inventors inherently have more value than patents granted to unknown inventors. This incarnation of “the Matthew Effect” is analogous to the value that art dealers place on provenance (the history of an artwork’s ownership).
- Value of depriving competitors of key technologies. Sometimes (particularly large) companies license in or acquire technology solely to keep it out of the hands of competitors. Depriving a competitor of a crucial ingredient in producing a product could result in their delay in introducing competing products to lucrative markets and force them to make significant expenditures in terms of having to design around hard-to-reproduce technologies. Professionals engaged in negotiating patent licensees should shop their technologies to several competing potential licensees so as to raise the competitive spirits among the potential licensees.
- Acquirer’s or Licensee’s portfolio concentration. The breadth and depth of the destination portfolio is a function of the value that an acquirer will place on a patent under consideration for purchase. For instance, companies contemplating acquiring a patent for strategic (rather than commercialization) reasons that have no patents in a particular discipline will typically value a patent with broad claims covering that discipline more favorably than a company that has a rich patent thicket in the given discipline. The explanation for the variance is that companies that already have a robust portfolio derive less incremental freedom to operate by acquiring such a patent than companies for which such acquisition could be used as a Trojan Horse for placing a stake in a new discipline.
- Capital raising implications. Licensees can win economic advantage by realizing that winning a license agreement can be enormously helpful to a patentee seeking to raise capital. In other words, a large company can often pay a lower royalty rate when it knows that its agreement will validate the licensor’s technology and such validation and license agreement will increase the ability of the licensor to attract funding. The leverage that the licensee may exert in such a scenario is a function of the number of licensee agreements that the licensor has executed. The licensee will have quite a bit of leverage if it stands to become the first licensee but perhaps no leverage if it is the twentieth such licensee.
- Economic impact of licensing agreement. A licensor can negotiate a reduced royalty rate by demonstrating that its licensing agreement will enable the licensee to achieve reduced production costs for its entire product line. For instance, if a licensee is currently producing 150,000 sensors at a cost of $1.25 each, it may be able to reduce its costs per sensor to $1.00 if it enters into a license agreement to produce another 50,000 sensors.
- The profitability of the industry and the importance of acquiring such patents. The wealthier the purchasers or licensees are, the more they can afford to pay. Thus, companies involved in direct battles with competitors will pay more than companies with no particularly pronounced competitive concerns. The rivalry between Qualcomm and Broadcom is resulting in generous licensing and reassignment opportunities for patent-holders. However, when this rivalry diminishes, so too will their compensation to inventors and patentees. Finally, patents that are expected to be adopted by standard setting bodies are valued higher than business method patents.
Patent valuation requires knowledge of the relevant inventions, market conditions, and patent law. It also entails the ability to bring a myriad of facts and considerations together to build an argument about the value that you believe your patent merits. In the final analysis, the value of patents is not only a function of the revenues and other economic and strategic benefits that it will yield. It is also a function of the timing of the transaction and the negotiating abilities of the principals involved.
This featured guest post is written by David Wanetick, Managing Director at IncreMental Advantage, a strategic advisory firm. He leads all of the firm’s Devil’s Advocacy Audits. He teaches courses on Negotiations, Behavioral Economics and Decision Making at The Business Development Academy. David can be reached at [email protected].
This article is provided by Axial Inc. and its affiliates for educational and informational purposes only and is not intended to constitute, and should not be construed as, legal or business advice. This article is a summary that we believe may be of interest to you for general information. It is not a full analysis of the matters presented and should not be relied upon. Prior to acting upon any information set forth in this article or related to this article, you should consult independent legal counsel.