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Workshop for Intellectual Property Insurance Valuation: 

Marsh Technology Conference 2005 Zurich May 26th and 27th Workshop for Intellectual Property Insurance Valuation Matthew Hogg, Kiln Phil Antoon, Kroll


Agenda Kiln 4Thought Enquiry Process Types of Intellectual Property Intellectual Property Valuation Methodologies Valuation Case Study #1 – M&A Scenario Valuation Case Study #2 – Existing IP

Kiln 4Thought: 

Kiln 4Thought The 4Thought policy is the first to recognise and protect the value of a company’s ability to exploit its IP rights and the value of any brand which is intrinsically linked to such IP. Legal Challenges That any registered Intellectual Property right of the Assured is found invalid It is found that the Assured has by the manufacture, sale or use of its product infringed upon IP rights of another That the Assured’s IP rights vest in part or in whole in an employee That an employee not be restrained from applying his/her knowledge of the Assured’s IP after ceasing employment Government Action – Implementation of any law, order, regulation that: Renders null and void any registered IP Grants an identical registered IP right to a competitor in contravention to the law Prevents the Assured from exploiting his IP rights Restricts or prevents import or export of IP rights

Kiln 4Thought, cont’d: 

Kiln 4Thought, cont’d What can be insured? IP-Rich Products’ future revenue streams Licensing Revenue Royalty Receipts IP “Value” – accounting principles R&D Expenditure Financial Investment Loan Arrangement Transaction involving IP rights

Kiln 4Thought, cont’d: 

Kiln 4Thought, cont’d Worldwide protection available Blanket or IP family covered Limits increasing all the time Yearly policy but up to 48 months indemnity period Premiums difficult to determine – 1%-5% rate of limit

Enquiry Process: 

Enquiry Process Valuation Due Diligence Potential Insured to complete Application to be sent to Kiln Kiln informs potential Insured that it suggests Kroll perform the valuation Kiln sends contact information of Insured to Phil Antoon / Kim Cauthorn Kroll performs the valuation on behalf of Kiln but paid by Insured Valuation issued to Kiln Legal Audit Comprehensive list of IP to be insured attached to completed Application Lawyers hired on behalf of Kiln but paid for by potential Insured Legal Audit should be low cost, high turnaround, using only publicly available information to avoid conflict issues Audit issued to Kiln

Types of Intellectual Property: 

Types of Intellectual Property There are a number of Intellectual Property assets for which first party insurance can be provided: Patents Trademarks/Trade Names Copyrights Trade secrets and know-how Registered Designs Topography Rights and Database Rights Other intangible property rights

Intellectual Property Valuation Methodologies: 

Intellectual Property Valuation Methodologies There are three generally accepted methodologies that are utilized to estimate the insurable value of Intellectual Property: Income Approach The Income Approach is typically the most applicable approach to utilize when valuing income-producing Intellectual Property, as value is measured by calculating the present value of future economic benefits to be derived by the asset. The two most frequently used variations of the Income Approach are the royalty savings (or relief from royalty approach) and the excess cash flow method. Market Approach The Market Approach measures the value of Intellectual Property through an analysis of recent sales or offerings of comparable assets. Due to a lack of publicly available sale or transaction data regarding most Intellectual Property assets, a Market Approach is often not applicable in valuing Intellectual Property. Cost Approach The Cost Approach measures the value of Intellectual Property by the cost to replace it with another of like utility. The Cost Approach recognises that a prudent investor would not ordinarily pay more for an asset than the cost to replace it new.

Intellectual Property Valuation Methodologies (cont’d.): 

Intellectual Property Valuation Methodologies (cont’d.) For Intellectual Property insurance coverage we often rely extensively on the Royalty Savings method, a variation of the Income Approach. Under the Royalty Savings method, the value of Intellectual Property is reflected in the present value of after-tax royalties the owner of the asset avoids paying by owning the asset and not having to license it from a third party. We apply the Cost Approach in circumstances where the Insured was covered for reimbursement of R&D expenses. The Cost Approach is also applicable when valuing Intellectual Property assets that are not income-generating, e.g. internally developed software that is used for internal purposes and databases. In some cases, we may also apply the Excess Cash Flow method, which is another form of the Income Approach.

Valuation Case Study #1 – M&A Scenario: 

Valuation Case Study #1 – M&A Scenario As part of an acquisition, companies are required pursuant to IFRS and US GAAP accounting to estimate the fair value of all of the identifiable intangible and tangible assets of the acquired company, and amortize the finite lived assets over their expected remaining useful lives. Indefinite lived assets are not amortized, but are instead tested for impairment on an annual basis. This is a strict requirement for financial reporting purposes, and is closely reviewed by the auditors. In this example, a company has just acquired an equipment manufacturer. The intangible assets that have been identified for financial reporting purposes are patents, trade name, and customer relationships. For the purpose of this workshop, we will focus on the valuation of the patents. As the patent is a licensable asset, the most common method to measure value is the royalty savings approach. The values ascribed to the Intellectual Property assets for financial reporting purposes may be utilized to estimate the insurable value of the IP.

Valuation Case Study #1 – M&A Scenario, cont’d: 

Valuation Case Study #1 – M&A Scenario, cont’d Execution of the Royalty Savings method Select an appropriate royalty rate (as a percent of revenue) Search for agreements regarding the licensing of comparable technologies Review of the royalties paid as for the use of the comparable technologies, and a comparison relative to the insured patent Analyze the company’s excess earnings, and hence its ability to pay a royalty and still generate a fair return Project the expected future annual revenue attributable to the Intellectual Property; Calculate the royalties that the owner is relieved from paying by multiplying the projected annual revenue by the royalty rate; Reduce the royalties by the taxes that would be due on the incremental profit created by the relief from paying royalties; Discount the after-tax annual royalty savings to present value at the appropriate discount rate; Sum the discounted after-tax royalty savings to estimate the value of the Intellectual Property.

Valuation Case Study #2 – Existing IP: 

Valuation Case Study #2 – Existing IP The second case study focuses on a technology company that has patents on projects that are still in development, and have not yet reached technological feasibility or market commercialization. Three approaches may be utilized to estimate the insurable value of the IP: The cost approach to measure the reimbursement of R&D expenditures associated with the IP; The royalty savings approach to measure the licensable value of the underlying IP; and The excess cash flow approach to measure the full value of the patents and related intangible assets

Valuation Case Study #2 – Existing IP, cont’d: 

Valuation Case Study #2 – Existing IP, cont’d Cost Approach Implementation of the cost approach would encompass measuring the R&D costs that have been incurred to date on the project. Royalty savings approach This approach would be applied in the same manner as detailed in the first Case Study, with the exception of probability weighting the expected future royalty income to reflect the uncertainty associated with the project achieving technological feasibility. Application of this approach assumes that the owner would license the rights to the IP in exchange for future royalty payments to a third party during or at the end of the R&D phase, rather than commercializing and marketing the completed product using its own resources. Excess cash flow approach This approach could be utilized to measure all of the IP and associated intangible asset value of the R&D project. This is the accepted method for valuing in-process research and development projects as well as other intangible assets such as customer relationships for financial reporting purposes, and provides the maximum value of the project as it captures the value of all related intangible assets, not just the patented IP.

Valuation Case Study #2 – Existing IP, cont’d: 

Excess Cash Flow Approach Methodology The principle behind the excess cash flow method is that the value of an income-generating intangible asset is measured by the present value of the projected future cash flows attributable to the intangible asset over its remaining useful life. To estimate excess cash flows, revenues attributable to the intangible asset are projected over the remaining useful life of the asset. Expected costs - including in this case remaining R&D costs - cost of sales, operating expenses, and income taxes - are deducted from projected revenues to arrive at after-tax cash flows. From after-tax cash flows, depreciation is added back and after-tax contributory charges (for the use of tangible and other intangible assets) are deducted to arrive at the excess cash flows specifically attributable to the project’s intangible assets. Since the asset in this case is an in process research and development project, the cash flows would be probability weighted to reflect the risk associated with achieving technological feasibility. These probability weighted excess cash flows are then discounted to the present and summed to arrive at the value of the intangible asset. Valuation Case Study #2 – Existing IP, cont’d


Contacts Kiln Matthew Hogg – London 207 886 9000 www.4continuity.com Kroll Phil Antoon (212) 833-3411 pantoon@krollworldwide.com Kim Cauthorn (713) 276-8627 kcauthorn@krollworldwide.com

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