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Creating Value From Innovation

presented by

Baldwins Intellectual Propertyand PricewaterhouseCoopers

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Justin LiddellPricewaterhouseCoopersPartner, Corporate FinanceValuation and Strategy

DDI: +64 9 355 8330Email: justin.g.liddell@nz.pwc.com

• Justin has provided valuation advice and opinionsto numerous leading New Zealand andinternational corporates in his 13 years ofexperience in New Zealand and London.

• Justin’s valuation experience spans numerousindustries with particular expertise in the valuationof intangible assets, whether for financialreporting or other purposes.

Your ExpertsWes JonesBaldwins Intellectual PropertyPartner

DDI: +64 9 359 7747Email: wes.jones@baldwins.com

• Wes works primarily in the areas of patents,particularly in the electronics field, but alsoadvises on copyright and design protection. Hespecialises in drafting patent specifications,providing validity and infringement advice,preparing license and other technology transferagreements and advising on intellectual propertyportfolio management.

Rosemary WallisBaldwins Intellectual PropertyPartner

DDI: +64 9 359 7733Email: rosemary.wallis@baldwins.com

• Rosemary works in the area of dispute resolutionacross all areas of intellectual property, and inthe licensing and franchising fields. This includeswork on patent, copyright, trade mark and designdisputes and litigation, providing advice on thecommercialisation of intellectual property andpreparing licensing and technology transferagreements.

Eric LucasPricewaterhouseCoopersPartner, Corporate FinanceValuation and Strategy

DDI: +64 9 355 8647Email: eric.lucas@nz.pwc.com

• Eric is a Corporate Finance Partner withPricewaterhouseCoopers and responsible for theFirm’s Dispute Analysis Practice in NewZealand.

• He has provided complex valuation advice to awide variety of clients, from companies such asFonterra Co-operative Group Limited to smallbusinesses, with particular emphasis onconsumer and industrial product companies.

Mike MorganPricewaterhouseCoopersPartner, TaxMergers & Acquisitions

DDI: +64 9 355 8708Email: mike.j.morgan@nz.pwc.com

• Mike is a Partner in our mergers and acquisitionstax group, specialising in tax due diligence andstructuring for corporate, SME and private equityclients.

• Mike’s experience includes advising on taxeffective structures for intellectual property,particularly for clients in the ICT and biotechindustries.

Tim WhitePricewaterhouseCoopersDirectorPrivate Client Services

DDI: +64 9 355 8216Email: tim.h.white@nz.pwc.com

• Tim provides strategic advice to private companiesincluding strategic and business planning, businessreviews, mergers and acquisitions, capital raising,sustainable cost management, and financialmodelling.

• He is responsible for driving the firm’s EmergingBusiness strategy in Auckland and has a particularinterest in high growth business.

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Contents

• Innovation vs Commercialisation• IP Protection• Tax Optimisation• Commercialisation

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Innovation vs Commercialisation – Tim White

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Innovation vs Commercialisation

Difference Between Innovation and Commercialisation

• Markets rewards commercialisation – not innovation

Innovation– In 1973 the Palo Alto PC (PAPC) became operational and developed:

• mouse• GUI• PAPC also developed Ethernet and laser printer

Commercialisation– Apple successfully commercialised GUI– 3Com successfully commercialised Ethernet– Betamax vs. VHS

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Innovation vs Commercialisation

Commercialising/Monetising IP

• The basic building blocks of commercialisation

Goo

dId

ea

Execution

Externalities

• Market-driven or an innovation lookingfor an application?

• You need to have:– An executable plan– Awareness of, and strategies around

those things you can’t directly influence

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Innovation vs Commercialisation

Challenges: From the Creation of an Idea – toCommercialisation – to Exit

• The Technology Adoption life Cycle

Source: Chasm Group

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Innovation vs Commercialisation

Access to CapitalAt least a year

of cashminimum

Batten downthe hatches

Raise yourfunding as soon

as possible

Pursue M&Aopportunities

Be realistic onvaluations

The VC community will startexercising their leverage

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IP Protection – Wes Jones

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Why is IP Important?

• Provides the legal framework for recognising / protecting your innovation

• Knowledge economy

• Employee Mobility and ease of information transfer

• Greater awareness in capital markets

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How and When to Protect Your IP

• Patents, Registered Designs, Trade Marks, Copyright and ConfidentialInformation

• Patent System – first in, best dressed

• Importance of Branding

• Who owns that IP?

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IP Management

• Maintaining an awareness of the “IP Landscape” in which you operate

• Internal recognition and capture of IP

• Alignment of IP Strategy and processes with corporate strategy andprocesses

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IP Capture

• Build into R&D processes – or at least create awareness of IP

• Use of Invention/Innovation Disclosure

• Importance of confidentiality

• Written employment contracts

• IP database

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• Pre- patent filing and post-filing

• Physical measures

• Agreements with employees and external entities

• Careful consideration of patent filing vs maintaining confidentiality

Confidentiality

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IP Landscape – The Process

• Identify technology competitors

• Identify prospective licensees

• Develop searching strategy

• Select the data

• Process the data (e.g. visual map)

• Use it for strategy, planning and minimising infringement risk

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IP Landscape

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IP Landscape

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• Offer ongoing protection

• Should be part of the IP landscape exercise

• Be aware of territorial issues

Building and Protecting Brands

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Tax Optimisation – Mike Morgan

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Tax Optimisation

Disposal of IP

What is taxable?

– Sale of patents, patent applications (complete spec)

– Licence fees, royalties, payments for right to use

– Sale of any IP developed or acquired for purpose of disposal

What is not taxable?

– Sale of know-how, brands, trademarks, copyright not developed or acquired forpurpose of disposal

– Sale of shares to an IP holding company (conditions apply)

• Proceeds from sale of patents rights can be spread over three years

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Tax Optimisation

Costs of Developing IP

What is deductible?

– Costs of underlying research if expensed for accounting

– Cost of acquiring / applying for patent (depreciable over legal life)

– Payments for right to use other IP

What is not deductible?

– Cost of acquiring brands, trademarks, know-how, copyrights

• Special rules for timing of some tax relief (deferral by election)

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Tax Optimisation

Structuring Considerations

• Ownership Structure

– Individual vs. Company vs. Trust

• R&D Tax Credit

– Must control results of R&D

• GST

– Recovery of GST on costs/GST on sale or licence

Early Consideration is Key!!

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Tax Optimisation

Keeping the Tax Man at Bay

• IRD Attitude

– Sensitive to IP transactions• Especially sale and licence back

– Will review and challenge valuations

– Split between patent rights and underlying invention

– Alienation of know-how possible?

– Keep tax compliance up-to-date

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Commercialisation – Eric Lucas & Rosemary Wallis

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Commercialisation – THE PROBLEM

• Your idea is only the start…..

• How developed is it really?

• Who knows about it?

• Who cares about it?

• Who would like it gone?

• What is its real potential?

• What help do you need to commercialise?

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Commercialisation – THE PROBLEM

• No Distribution

• No Value

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How developed is it?

• Working model?

• Prototype?

• Made in small quantities

• Made in commercial quantities

• Regulatory requirements?

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What is its real potential?

• Market?

• Alternative solutions?

• How copiable?

• Competitor response?

• How long have you got?– e.g. Value

October 2002 $20m(0 – 44)October 2005 $11m(0 – 46)June 2008 $0

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What help do you need to commercialise?

• Product development capability?– Regulatory?

• Production capability– Physical– Organisational

• Sales / Marketing capability

• Distribution capability:

• Typically comes down to:– Money and– Skills

• One size does not fit all

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There are many solutions, but each has its challenges

• Capital injection

• Provision of skills

• Joint venture

• Licensing arrangements

Challenges: - Value of innovation

- Value of contribution / relative contributions

- What royalty rate?

• Sources of Capital

Capital may be expensiveCapital may be expensive

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Value your innovation

• The innovator:– Optimistic

– Believes in the idea (blinkered?)

– May not understand the value of distribution

– May over value

• Costs to replicate often bring us to earth

• Usually DCF BUT!

– Start up cash flows hugely uncertain – wide range of outcomes

– Discount rates horrifying……

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Seed Capital – Proof of concept

Start-up – Initial commercialisation and sale

First stage – Funds to initiate full-scale manufacturing/sale

Second stage – growth financefor operational entity, not yetprofitableThird stage – major expansion

Discount Rate Continuum

% 10 50 90

Second Stage

Third Stage

LBO

First Stage

Start Up

Seed Capital

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Uncertainty lends itself to risk sharing

• Licensing fee spectrum

• Share risks and rewards

– Theoretically value implications should be the same

– Effect of royalty arrangements often not immediately obvious

– Easier to live with over time……

BUTBUT Hard to get the royalty rates ‘right’

• Rule of thumb for licensing

One off fee Fixed and variable fees Royalty per unit/profit share

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Indicative Royalty Rates

Industry Range(%)

Average(%)

Industry Range(%)

Average(%)

Apparel 0-10 4.0 Drugs 0-10 6.8

Automotive/parts 0-10 1.9 Electronics 0-20 6.6

Biotechnology 0-20 7.0 Entertainment 0-25 15.5

Communications 0-25 8.2 Food 0-15 5.5

Computers 0-15 10.8 Hospitality/Leisure 0-10 4.4

Computer software 0-30+ 12.0 Industrial Products 0-30+ 6.4

Consumer Products 0-15 4.3 Medical/Medical Products 0-30+ 8.3

Copyrights & Trademarks 5-15 10.6 Services 0-15 5.8

Distribution 0-10 5.2 Pharmaceutical – Pre clinical 0.3-25 4.3

Toys & Games 5-25 13.1 Pharmaceutical – Launched 5-28 11.6

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Commercialisation – Closing the Deal

• Deal sheet – check before, during and after negotiation

• Know your BATNA

• Work out their objectives

• Don’t get too excited and give it all away for too little

• Time out to talk

• Balance the negotiating team

• Do you like them and do they fit your culture

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• Not a “standard agreement”

• Document your own deal and how it works

• Assume it will go wrong and protect yourself

• Don’t give away too much

• Fair deals tend to last

Commercialisation – Agreements That Work

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Commercialisation – Of What and Where?

• All fields of use or just one

• Designated products with options for more

• Worldwide – can they deliver

• Where’s the best chance of success

• Who pays for more/ongoing IP protection

• Early licensing – excite interest

• Don’t close off options – conceding too much control

• Negotiating leverage – competing candidates

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Commercialisation – Basic Licence Components

• Technology to transfer – protected by IP

• Scope of what’s licensed/transferred

• Type of licence – exclusive/sole/non-exclusive

• Payment – when and how

• Performance – milestones and quality checks

• Manufacturing controls – the China problem

• Enforcement/infringement

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• Research and development

• Background IP – new IP – who owns what and what happens to it at the end

• Warranties – licensor and licensee

• Product liability

• Term and termination

• Audit – 1 in 10 report accurately

• Boilerplate

Commercialisation – Basic Licence Components

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• Need a common vision

• Combination of different strengths

– technology

– product delivery

– branding and marketing

• Joint ownership of IP can be difficult

• Control issues

• What happens to the IP on dissolution

Joint Venture Agreements – The Issues

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Summary & Conclusion

• Honest evaluation of the idea and its potential

• Honest evaluation of the help you need

• One size does not fit all

• Capital providers are sceptical− Capital is expensive

• Distribution is the key

• Licensing / risk sharing is often the way to go BUT:

Be cautious in - Setting royalty rates- Selecting your partners

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Thank You