Issue #26-2 | July 18, 2013

Royalty rate research now requires examination of the full text of comparable license agreements

In the wake of the Uniloc decision that threw out the “25% rule,” valuators turn to searching for comparable data in a sea of licenses. To be sure, as pointed out by Steve Economou of ParenteBeard, writing in January’s Business Valuation Update, strict third-party review of valuation reports points out the challenges of using comparable royalty rate data, many of which are eased by careful examination of the full text of relevant IP license agreements.

  • Data points are typically wide ranging (e.g., 1% to 9%): There are often reasons for the disparity, explainable upon review of the full text of the license agreements;
  • Underlying terms of any single royalty agreement may negate its comparability: Valuators should examine the full text of agreements used in royalty research to find like terms and circumstances;
  • Data are from extended periods of time;
  • Data are from large and small companies;
  • Assessing the quality of a technology from a licensing agreement is difficult;
  • Evaluating underlying economics and motivations in each transaction is difficult; and
  • Many agreements are between related parties: Again, a review of the full text of the license agreements can reveal related parties or lead to further related research.

What factors influence royalty rates in technology license agreements?

According to a white paper by Howard Johnson, the guiding principles of royalty rate negotiations are “economic fairness” to both licensor (the IP owner) and licensee and a revenue stream that reflects the value the licensee received from the licensor over the term of the license agreement.

Product factors that affect royalty rates:

  • The competitive advantage of the products to be licensed products;
  • The scope and remaining life of any licensed patents relating thereto;
  • The licensee’s right to ongoing technology and product improvements;
  • The market size and potential in which the licensee will sell the licensed products;
  • The degree of complexity in the sale of licensed products and the extent customization is required; and
  • The ability of the licensee to sublicense.

Licensor factors that affect royalty rates:

  • The licensor’s presence in its own market (brand acceptance, reputation, financial stability, etc.);
  • The level of commitment to the licensed products, including future spending plans; and
  • The technical, sales, and marketing support offered.

Licensee factors that affect royalty rates:

  • The licensee sales estimates relative to market potential;
  • An offering of guaranteed minimums;
  • An established sales presence and reputation in the territory; and
  • The ability to offer product enhancements.

Florida enacts Daubert standard for expert witness testimony

A little late to the party, the Florida legislature passed a bill to adopt the Daubert standard for expert testimony. It went into effect on July 1. Florida is now aligned with the federal courts and the majority of state courts that already have adopted Daubert, wholesale or in part. The new test replaces the state’s controversial Frye standard.

Under Daubert, the court functions as a gatekeeper, admitting only testimony from a witness who qualifies as an expert in the field, whose testimony is helpful to the jury, is relevant, and is “the product of reliable principles and methods.” Opponents of the new legislation contended that the introduction of a Daubert-like standard will lead to prolonged litigation because of the resulting Daubert challenges and hearings.

When valuing a noncompete, research the applicable state laws where the agreements would be enforced

In Chapter 7 of BVR’s Benchmarking Identifiable Intangibles and Their Useful Lives in Business CombinationsGary Trugman lays out an eight-step, “with-or-without” analysis on how to value noncompete agreements. The appraiser estimates value based on the difference between two discounted future benefits calculations, one with the noncompete in force and one without.

Step 1 is to identify the legitimacy and “economic reality” of the noncompete.

Stephanie Singer, who practices at WilmerHale, defines the first step in testing the economic reality of the noncompete as checking the state laws where the agreement would be enforced. State laws can influence the enforceability of many noncompete provisions. Smith holds out California as an example. “California does not uphold noncompete agreements under most circumstances.” No enforceability, no value.

That we cannot agree on the definition of a ‘patent troll’ should give pause to efforts to regulate them

Joff Wild in International Asset Management magazine again cautions legislators in the U.S. and elsewhere to tread lightly when it comes to regulating what are often derogatorily referred to as “patent trolls.” This time the suggestion is that, if we can’t even agree on terminology, there is danger in applying regulation or even special scrutiny.

Wild frames the question as follows: What is a troll, or an NPE, or a PAE, or, perhaps more importantly, who gets to decide?

Santa Clara University Law School professor Colleen Chien distinguishes between nonpracticing entities and patent assertion entities (a term Chien claims for herself) by suggesting PAEs eliminate startups, which, presumably by definition, are not yet “practicing.”

PatentFreedom, a database used by a source for many studies on the effects of patent trolls, makes no such distinction. It uses NPE, and it lists companies it labels as NPEs. As Wild points out, Tessera is listed in all of its glory, but Chien would not refer to Tessera as a PAE, nor an NPE, nor a troll. So, which is it? If you were to ask Business Insider, it is one of technology’s most “fearsome” trolls.

Key point: As we have discussed often in IP Value Wire, the relentless attacks on “patent trolls,” from the lay press to legislative actions, executive orders, and, more recently, an FTC 6(b), study negatively affects the component of value that exists in patents because they can be held and enforced by third parties. This component exists in all technology patents, not just those owned by the third parties, the NPEs. That we cannot even agree on definitions should be an alert that all should just step back and take a deep breath.

Three new developments illustrate the growing globalization of patent protection and research

CPA Global reported that China’s State Intellectual Property Office (SIPO) will use the same patent classification system as the European Patent Office (EPO), beginning January 2014.
The USPTO announced the launch of the Global Patent Search Network, a database that will allow users to search non-U.S. patents in both English and the patent’s native language. It is a database of Chinese patents, with machine translations provided by the SIPO of China, and is limited to Chinese patents granted between 2008 and 2011. It’s a start.

Intellectual Property Watch reported Poland’s minister of culture and national heritage, Bogdan Zdrojewski, has asked the country’s ministry of justice to create new intellectual property courts. The new entities would become departments of regular courts, uniquely responsible for handling IP disputes.

IP strategy will drive interactive game builder Zynga

Don Mattrick, formerly the president of the Interactive Entertainment Business at Microsoft, has been appointed the new CEO at Zynga, of “Farmville” and “Words With Friends” fame. His Microsoft division was responsible for the Xbox and the revolutionary Kinect, a device that enables users to control games, movies, and music with physical motion and voice commands, replacing the traditional controller, such as a keyboard or joystick.

Watch for an aggressive, multipronged approach to exploiting Zynga’s IP. Though Mattrick isn’t an IP operations techie, he will develop and follow a comprehensive IP strategy.

Patents: IAM Magazine reports that between February 2012 and January 2013 “Zynga’s patent portfolio went from containing a single U.S. grant to 89 patents.” There is a decided emphasis on casino gaming and online gambling patents, and Zynga already claims its “Zynga Poker” is the world’s largest poker game. Mattrick believes in innovation, and, to be sure, early on there will be an assessment of what Zynga owns, what it controls, and what is missing.

Licensing: Toys have been licensed to Hasbro. From Amazon to eBay to Best Buy, consumers can find Farmville plush, collectibles, card games, and puzzles. In early 2012, Zynga licensed its first game to Slingo (prior to this, Zynga was the developer of all of its games). “Zynga Slingo” is a bingo-type game played on Facebook. Readers can expect increased licensing activity, especially as Mattrick reviews what Rovio has done.

Collaboration: Online gambling is big business now, and Bloomberg reports that the U.S. market for online gambling may reach $7.4 billion a year by 2017, according to Manchester, U.K.-based researcher H2 Gaming Capital. Zynga is already applying for licenses to operate in states where gambling is permitted. It appears the cards are stacked against Zynga, as existing stakeholders pretty much get their way—but those stakeholders are experiencing P&L issues as well, so expect a sustained effort to partner with entrenched casinos and other players in the gambling marketplace.

Apple loses e-book price collusion case

A Federal District Court ruling against Apple in the e-book price-fixing case last week is likely to reverberate throughout the digital media business even as Justice Denise Cote’s ruling is appealed by Apple, and even as the judge sought in her 160-page decision to limit the scope of the ruling.

According to Paul SweetingContent Licensing’s chief contributing editor, Apple used the same strategy to enter the music and book markets and is seeking to do the same now with its Internet radio and streaming music services. Music licensing agencies ASCAP and BMI are already at loggerheads with online radio service Pandora and, notes Sweeting, the ruling against Apple in the e-books case could provide Pandora the opening to argue that Apple and the music publishers engaged in a conspiracy to raise the price of music publishing performance rights to the detriment of Pandora.

The new ruling could also delay any effort by Apple to enter the subscription video streaming business—a move many analysts have regarded as inevitable—by making it harder for Apple to engage in simultaneous negotiations with TV rights owners. More generally, the ruling, if it stands, could leave rights owners leery of any appearance of negotiating en masse with potential licensees.

Content Licensing offered a complete case analysis in its July 15 issue. To receive a free copy of the issue, drop us a note.


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