Business Valuation Case Study - Intellectual Property

The Background:

Lakelet Advisory Group (“LAG”) was requested to perform a business valuation on a patented medical device that addressed the challenges of a personalized air filtration system. Our client was interested in determining the value associated with this patented product “AS IS” and the value of the patent with “additional developments”. The additional developments included medical testing, functioning set of prototypes, transportation compliance and the appropriate governmental certifications.

The inventor was an educator. The inventor was most passionate about solving this severe medical problem affiliated upon patients requiring oxygen or “clean air.” The patented product had the following characteristics:

  • A portable oxygen delivery system that provides an ergonomic means for storing oxygen in a wearable configuration without substantially inhibiting the user's movement - a significant lifestyle improvement over the conventional systems presently available;
  • Provides high storage capacity to accommodate both an oxygen delivery rate and duration of use that will enable the user to participate in their desired physical and recreational activities; 
  • U-shaped tank design provides 1-1.5 liquid liters / 750 gaseous liters of oxygen under pressure allowing for up to twice the capacity; 
  • The oxygen contained may be in a liquid or gaseous state or a mixture of liquid and gas depending upon the temperature and operating conditions; and 
  • Offers a constant flow demand of at least 2 gaseous liters per minute for a duration of at least 6 hours.

The patent was a US patent. It was only upon our initial meeting with the inventor that the inventor realized the overall global applications. Air quality is truly an international problem - especially, in China and India. Fortunately, Lakelet was able to present this product to these markets through our international business relationships.

LAG has had extensive knowledge in this air purification market and medical device sectors, especially in the international arena. Lag’s experience included air purification solutions for medical facilities, home and large international trauma centers.

The Problem:

The challenges were:

  • The patent covered only the US market; 
  • Inventor had a solid patent, but did not explore the additional development, as defined above; 
  • Although numerous parties, both nationally and internationally, were interested in the product - terms and financial structures associated with the value for the medical device covered the entire spectrum; 
  • Variances in the international standards associate with such a medical device; 
  • The inventor wanted to sell the product's rights outright; and 
  • Concurrent with the normal risks related with the start-up product launch, this product included a host of medical, transportation and international challenges. 

As stated above, Lakelet needed to provide two valuations - (1) with the product "AS IS" and (2) cost / benefit of implementing the additional developments before seeking a sale of the patent. 

After meeting with all the stakeholders, Lakelet Advisory Group was selected for the engagement based knowledge of this market space, references and credentials as an Accredited Business Valuator (“ABV”) as recognized by the American Institute of Certified Public Accountants.

The Solution:

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LAG interviewed numerous scientists, manufacturers, investors and patent attorneys to fully understand the options and processes available. In addition to the interviews, LAG brought into the engagement international specialist who could add “color” to the manufacturing, registration and certifications in the numerous countries being explored.

Valuing early stage, technology-based intellectual property assets is challenging, in large part due to the difficulty in incorporating the effects of risk and uncertainty inherent in these assets into their valuation. Monte Carlo methods were originally designed to model physical and mathematical problems. However, variations of this method also provide valuation analysts with a powerful tool to effectively address risk and uncertainty, particularly in the context of determining intellectual property values related to transactions or strategic decision-making. 

Technology-based intellectual property (“IP”) assets, usually protected as patents and/or trade secrets, are typically valued using the same three common approaches as are used to value businesses or other assets. These approaches include: 

  1. Income approach; 
  2. Market approach; and 
  3. Cost approach. 

However, technology-based IP assets (and many other IP assets including patents and trade secrets unrelated to technology, along with trademarks and copyrights) pose many unique challenges to a valuation analyst. A few illustrative examples of such challenges include: 

  • Income approaches are often difficult to implement for a variety of reasons, including the difficulty in quantifying the portion of a product or service's cash flows that are attributable to the subject IP asset; 
  • Market approaches are often difficult to implement for many reasons, including the fact that IP assets are, by definition, unique. As such, comparable market transactions are often difficult or impossible to find. In addition, because IP assets are not traded on public markets and the transactions themselves are typically confidential, there are few public sources that reveal deal details that would be sufficiently comparable to be used to implement a market approach, and the data available from sources that do exist is often incomplete; and 
  • Cost approaches are often difficult to implement because the cost to create the subject assets is almost always unrelated to the value of the asset (e.g., income generation, cost savings, etc.) that can be gained from use of the asset. 

However, in addition to these challenges, perhaps the most difficult issue associated with valuing technology-based IP assets is accounting for the significant risks associated with many of these assets. Accounting for risk is particularly difficult in the very common situation when technology-based IP assets are valued prior to any (or significant) commercialization success; i.e., when the assets are “early stage.” 

In addition to these and other methods, the use of Monte Carlo simulations in conjunction with the Income Approach provides the valuation analyst with a flexible, powerful tool for performing valuations of early stage, technology-based IP assets. Given the nature of Monte Carlo simulations, they are particularly useful when the valuation is being performed to support transactions or strategic decision-making. 

 The Monte Carlo method is most often used in conjunction with the application of an Income Approach to valuing early stage, technology-based IP assets. Compared to a traditional Discounted Cash Flow model that generates a single Net Present Value (“NPV”) result, the Monte Carlo model, gives the user the flexibility to assign various probability distributions to key assumptions and run a large number of trials to determine a distribution of NPVs based on the variability assigned to key assumptions. In doing so, the users of the model are able to better account for the inherent uncertainty in predicting the future value of key assumptions and, therefore, provide a more holistic look at the potential value of relevant IP assets. 

As with any valuation process, a prerequisite to determining the Discounted Cash Flow is to generate a “risk rate” or a rate to discount the future revenue streams.  For this specific valuation the Capitalization Rate (“risks”) was extremely high. This was due to:

  • A start-up; 
  • Un-tested patents;
  • No prototypes; 
  • No certifications; 
  • US based patents vs. international; 
  • Claims included in the patent applications may not survive to the issued patents and the scope of surviving claims may be uncertain; 
  • Issued patents may prove to be invalid when challenged; 
  • Successful completion of an in-process technology is not guaranteed; 
  • Implementation of the subject technology into products and services may be difficult or impossible; 
  • Manufacturing scale-up may not be technically viable; 
  • Costs of R&D, product integration, and manufacturing scale-up may be much higher than anticipated, perhaps even prohibitively high;
  • Market success has not been convincingly proven and often cannot even be tested until late in the product development process; 
  • Anticipated regulatory approvals may be delayed or denied; 
  • Unanticipated safety and efficacy issues may arise related to the in-process or finished product; and 
  • Innovation may be moving at a rapid pace, causing the economic life of a particular technology to be unknown and, perhaps, short-lived. 

Based upon our research, marketing and financial analysis, LAG believes that it was more cost effective (and risks adverse) to sell the patented product "AS IS".

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