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PAYMENTS AND ROYALTY RATES February 2008 Christi Mitchell, IP Director, Highbury Ltd. Christi Mitchell IP Director. Human Genetics, Molecular Biology, Marketing and Business Degrees Past President Licensing Executive Society (LES) Britain &Ireland; current Board Director
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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 christi@highburyltd.com
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 christi@highburyltd.com
Outline. • Valuing technology • Some valuation methods • Key financial terms • royalties christi@highburyltd.com
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 christi@highburyltd.com
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 christi@highburyltd.com
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 christi@highburyltd.com
Project Process Overview Diagram indicates how Highbury adds value to, and manages the technology/Intellectual Asset commercialisation lifecycle; from idea through to deal implementation. christi@highburyltd.com
Financial assessment • valuation of products / technologies • simple financial models • risk assessment • financial impact of different deal structures • royalties christi@highburyltd.com
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) christi@highburyltd.com
Valuation Insecurity • Value depends on • Ability of licensee to successfully implement it as a process or product • Dependant on a specific market that may be seen differently by the 2 parties • The ability to prevent infringement • Ability to access licensors know how christi@highburyltd.com
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 christi@highburyltd.com
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 christi@highburyltd.com
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) christi@highburyltd.com
Risk assessment/sensitivity analysis Methods 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 christi@highburyltd.com
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 christi@highburyltd.com
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 christi@highburyltd.com
Most important factors affecting Royalty Rates • Strength of IP • Market sector (expected norms) • Degree of exclusivity (field of use restrictions) • Licensor/Licensee characteristics • Economic factors • Phase of development • Duration and scope of license • Commitment to ongoing research • Negotiating skills • Degree of need christi@highburyltd.com
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 Generic IA Biotech Value Drivers christi@highburyltd.com
Royalty rates: Industry Norms • What are they? • What don’t they tell us? • Are they useful? • How can we use them? christi@highburyltd.com
Royalty rates: Industry NormsFranklin Pierce Law Centre christi@highburyltd.com
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. christi@highburyltd.com
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 christi@highburyltd.com
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) christi@highburyltd.com
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 christi@highburyltd.com
Agreement provisions • clear payment terms • timing and delivery • currency exchange provisions • late payment • CIF/FOB • manufacturing / QC • royalty audit provisions christi@highburyltd.com
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 christi@highburyltd.com
Contact • Christi Mitchell: • Intellectual Property Director • Direct Tel: +44(0)1462436894 • christi@highburyltd.com • Elizabeth McNabb: • International Business Development Director • Direct Tel: +44(0)20835556989 • elizabeth@highburyltd.com • Anne Wight: • Business Development Director Highbury Pacific • Direct Tel: +64(0) 21432424 • anne@highburyltd.com christi@highburyltd.com