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Patent Valuation and the Top 5 List of Patent Damages Issues
Wednesday, October 03, 2007
By Wayne Brown, Partner at Virchow Krause & Company, LLC
Given the increasingly critical role intellectual property plays in today’s global economy, businesses are focusing more resources on identifying and safeguarding these assets. Patents, one form of intellectual property, offer an economic incentive for inventors to publish their findings and obtain infringement protection.
Common circumstances in which a patent valuation or related services may be considered include licensing transactions between a patent holder and third party, acquisitions of companies holding patents, gifting or transfers of patents, litigation settings (for example, patent infringement or lapsed patent cases), capital budgeting, and financial statement presentation.
Patent Valuation Basics
Two fundamental concepts regarding the value of an asset are anticipated economic benefit and substitution. The primary approaches used to value an asset include the income, cost, and market approaches. These concepts and approaches to valuation, which often are applied to value assets such as real estate, are no different when applied to patents and other intellectual property.
The discounted cash flow method (DCF) under the income approach to valuation is by far the most common methodology used to value patents and determine damages related to patents. Variations of the DCF include a profit contribution or "multi-period excess earnings method;" a licensing approach; and a relief-from-royalty-method, which is sometimes referred to as a market approach.
The market approach is used less often for patent valuation and damages cases due to the difficulty in identifying true comparables. Databases do exist that provide information related to transactions involving intellectual property for a fee, including Royalty Source (www.royaltysource.com) and Consor (www.consor.com). When utilizing information from these databases, analyze it carefully for comparability to the subject patent.
An important step in a patent damages case is to determine whether to use a lost profits or a reasonable royalty calculation to develop the damages. This decision can be accomplished by applying a Panduit test based on the four factors outlined in the patent case Panduit Corp. v. Stahlin Bros. Fibre Works, Inc. After determining the form of damages, many patent damages issues need to be taken into consideration.
Below are the top five issues:
#5 – "Book of Wisdom"
The "Book of Wisdom" relates to the information relied upon in developing your conclusions. There is dispute regarding how much weight to give to events occurring subsequent to the date of damages. For example, if you have been provided with actual financial results for a period of time after the date of damages, should your analysis incorporate the actual results or be based solely on projections developed before the date of damages? What if the actual results show a loss while expectations reflected in the projections indicate profitability?
It is important to document and support the reasoning for including or excluding any information. In any event, the information relied upon should assist in developing an analysis that represents a "hypothetical negotiation" between two parties for the rights to the patent in dispute.
#4 – Georgia-Pacific Factors
In the court case Georgia-Pacific Corp. v. United States Plywood Corp., the court outlined 15 factors considered to be important in estimating a reasonable royalty rate for purposes of a patent case. The factors can be grouped into two broad categories relating to licensing activity and the value of the patent.
Over the years, experts have applied the Georgia-Pacific factors in differing approaches. Some experts use the factors as a starting point in their analysis while others consider the factors as an ending point. In addition, while some experts apply specific weights to the factors in calculating a reasonable royalty rate, others simply use them as a general guideline to either increase or decrease the rate.
#3 – The 25 Percent Rule
Using the 25 percent rule, a royalty rate is established between 25 percent and 33 percent of operating profit, adjusted upward or downward based on consideration of various factors among the patent holder and the infringer. This general "rule of thumb" has been accepted in courts and often is utilized as a starting point or general frame of reference for the "hypothetical negotiation."
#2 – Marginal Costs
Whatever costs are included in developing either lost profits or royalty rates, it is important to document the development of and support for them. Three primary methods used as support for the costs included are an analysis of variable costs, a regression analysis, or an accounting analysis.
#1 – Analytical Royalty Approach
Under the analytical approach, a royalty calculation is based on the extra profit that was earned by the infringer as a result of the infringement. This methodology considers the profits earned in excess of the infringer’s normal profits. Depending on whether the "extra profit" is based on dollar values or a percentage of sales, the analytical approach can result in substantially different results; therefore, the development of the infringer’s extra profit should be thoroughly documented and supported.
Wayne R. Brown is a partner at Virchow Krause & Company, LLC in Minneapolis. He leads the Business Valuation and Commercial Litigation practice and currently spends all of his time on business valuation and litigation support issues. He can be reached at 952.351.4625 or email@example.com.
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