PAYMENTS AND ROYALTY RATES

1

• PAYMENTS AND ROYALTY RATES
• February 2008
• Christi Mitchell, IP Director, Highbury Ltd

2
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

3
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

4
Outline.

• Valuing technology
• Some valuation methods
• Key financial terms
• royalties

5
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

6
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 RD
• Regulatory requirements hurdles
• Review distribution chain risks costs

7
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

8
Project Process Overview
Diagram indicates how Highbury adds value to, and
manages the technology/Intellectual Asset
commercialisation lifecycle from idea through to
deal implementation.
9
Financial assessment

• valuation of products / technologies
• simple financial models
• risk assessment
• financial impact of different deal structures
• royalties

10
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)

11
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

12
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

13
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

14
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)

15
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

16
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

17
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

18
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

19
Generic IA Biotech Value Drivers

• 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

20
Royalty rates Industry Norms

• What are they?
• What dont they tell us?
• Are they useful?
• How can we use them?

21
Royalty rates Industry Norms Franklin Pierce
Law Centre
22
Industry NormsWhat dont 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.

23
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

24
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)

25
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

26
Agreement provisions

• clear payment terms
• timing and delivery
• currency exchange provisions
• late payment
• CIF/FOB
• manufacturing / QC
• royalty audit provisions

27
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

28
Contact

• Christi Mitchell
• Intellectual Property Director
• Direct Tel [phone]
• christi_at_highburyltd.com
• Elizabeth McNabb
• International Business Development Director
• Direct Tel [phone]
• elizabeth_at_highburyltd.com
• Anne Wight
• Business Development Director
• Highbury Pacific
• Direct Tel [phone]
• anne_at_highburyltd.com