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Copyright © 2012 by William J. Murphy, John L. Orcutt, Paul C. Remus. All rights reserved.

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Library of Congress Cataloging-in-Publication Data:

Murphy, William J. (William Joseph), 1949-

Patent valuation : improving decision making through analysis / William J. Murphy, John L.

Orcutt, Paul C. Remus.—1

p. cm.—(Wiley finance series)

Includes bibliographical references and index.

ISBN 978-1-118-02734-9 (hardback); ISBN 978-1-118-22213-3 (ebk);

ISBN 978-1-118-26082-1 (ebk); ISBN 978-1-118-23590-4 (ebk)

1. Patents—Valuation. 2. Decision making. 3. Patents—Accounting. I. Orcutt, John L.

II. Remus, Paul C., 1945- III. Title.

HF5681.P3M87 2012

657'1;.4—dc23

2012005831

Preface

We have a very simple goal with this book: to help inventors, entrepreneurs, executives, technology acquirers, technology managers, lawyers, judges, and anyone else who is part of the patenting process to make better patent decisions. Most readers of a book titled Patent Valuation are likely to appreciate that patented inventions are important. So, we are going to skip over the typical introduction to an intellectual property book that tells readers about the importance of intellectual property—in particular, patents—in a knowledge-based world. We assume that readers already know that patented inventions provide the foundation for modern economies and for many of the world's most successful companies.

What many readers may not fully appreciate, however, is a more subtle but equally important reality that stems from two related concepts. First, making informed decisions about the creation, management, and defense of patented inventions can distinguish competitive success (and significant wealth creation) from competitive failure (and economic waste). For patents to achieve their value-generating potential, numerous actors performing a variety of functions need to make multiple decisions. For example, inventors need to decide which research projects to pursue and how much to invest in the research project. If a patentable invention results from the research project, the inventor needs to decide whether to patent the invention and, if the answer is to patent, how much to invest in prosecuting the patent. Decisions then need to be made about patent management. Should the patent holder use the invention, transfer it to a third party, or do both? If the patent holder seeks to transfer some, or all, of its patent rights, how should the transfer be structured and at what price? Overlaying all these decisions are equally important litigation decisions. Should the patent holder sue a potential infringer (and how much should it spend on the litigation)? At what price should the patent holder settle? When should an alleged infringer settle a potential lawsuit, and when should it defend? As the societal importance of patents continues to increase, so, too, does the importance of wisely making each of these various patent decisions (and thousands more related decisions).

The second concept is that patent decisions can be significantly improved by recognizing that they can be quantified, compared, and evaluated. In short, patents and their related decisions can be valued and are implicitly valued even if that valuation frequently goes unnoticed. Through an attentive and disciplined thought process, valuation allows a decision maker to determine the course of action that provides the most advantageous outcome. Despite its acceptance in other business settings, valuation has been slow to develop as a wide-ranging decision-making tool for patents. One reason (and probably the most powerful reason) for this failure to systematically employ valuation analysis to guide patent decisions is the common misperception that patent valuation is too difficult. Because most patent decision makers believe that valuing patents is an inherently difficult exercise, they often believe that it is foolhardy to invest much energy into valuation unless it is absolutely required, such as when licensing a set of patent rights. Such thinking could not be more misguided. On the one hand, it fails to appreciate the extent to which valuing patents can improve patent decisions. Moreover, the idea that patents are overly difficult to value is simply wrong. One of the most fundamental premises of this book is that intelligent valuation skills are accessible to, and should be used by, each of the various decision makers in the patent process. This book provides narrative descriptions of the various topics, illustrative cases, step-by-step valuation techniques, user-friendly procedures and checklists, and an abundance of examples that help to make patent valuation an understandable decision-making tool that can be deployed throughout an organization.

Outline of the Book

This book is organized into three parts. Part One examines the foundations for patent valuation and decision making. Chapter 1, “Valuation Basics,” presents an overview of valuation and its role in decision-making processes. Chapter 2, “Patent Basics,” provides a review of patent law basics. Because patent rights—separate from the underlying use of a patented invention—are central to an invention's ability to generate value, it is critical to understand those rights when valuing a patent. Chapter 3, “Valuation Analysis to Improve Patent Decision Making,” provides an overview of the wide range of patent decisions that can benefit from valuation analysis and examines decision-making strategies that help to guide how much valuation analysis to conduct in a particular situation. With real-world applications in mind, this chapter also explains how valuation techniques can help to inform decision making without becoming tedious, overly burdensome endeavors. Chapter 4, “Disassembly,” explains how the basic task of disassembling a valuation problem into its component parts can often be the most crucial step for generating a useful valuation. Disassembly helps the valuator to identify the individual factors that collectively generate the overall value of the item being valued, generate a better understanding of those individual factors and how they interact to generate value, organize the information so that it can be dealt with in a manageable way, and identify and eliminate extraneous information that is not important to the valuation process. This chapter also demonstrates how to incorporate disassembly techniques into patent valuation analyses.

Part Two provides the fundamental tools needed to value patents. Chapter 5, “Preparing for the Valuation,” details the preparatory work that should be done before launching into a thorough valuation exercise. Chapter 6, “Income Methods: Discounted Future Economic Benefits Analysis,” describes the basic discounted future economic benefits (DFEB) model for valuing patents. Chapter 7, “Advanced Income Methods: Incorporating the Value of Future Decision Opportunities,” seeks to expand on the basic DFEB model to incorporate the value of future decision opportunities. The basic DFEB model does not fully capture future flexibility and choices that are embedded in patents, but more advanced techniques (such as real options theory and decision trees) do. Chapter 7 explores the theoretical and practical applicability of these advanced techniques. Chapter 8, “Market Methods,” analyzes a number of the market methods that are used to value patents. This chapter also explains the strengths and weaknesses of these methods and how they can be effectively employed. Chapter 9, “Cost Methods,” explains the core cost methods for valuing patents and demonstrates how to make practical use of them.

Part Three presents specific, practical scenarios that benefit from patent valuation. Chapter 10, “Pricing Patent Licenses,” examines how to structure and price patent licenses. One of the most critical times for valuing a set of patent rights is when patent rights are being transferred voluntarily, and licenses are the most common method for such transfers. Chapter 11, “Patent Infringement Damages,” provides an overview of U.S. law for calculating damages in patent infringement cases. The consequences of infringement litigation can be very material to a party, which makes understanding how patent damage awards are computed important to intelligent decision making in numerous litigation and nonlitigation patent settings. The potential net returns from bringing a lawsuit as well as the potential net costs from being sued for infringement should factor into a multitude of patent decisions. Chapter 12, “Unlocking the Potential Value within Patents,” considers the latent, capital-generation potential that exists within patents. Unlocking the potential value of patent assets to access investment capital is critical to the creation and growth of entrepreneurial firms. This chapter describes a number of emerging methods for extracting this potential value from patents and explains the intersection between traditional valuation analysis and these emerging practices. Chapter 13, “Valuation in Patent-Based Tax-Planning Strategies,” explores patent-based tax-reduction strategies and explains the role of valuation in these strategies.

Acknowledgments

We could not have completed this project without our colleagues at the Intellectual Property Valuation Institute (IPVI), which is part of the Franklin Pierce Center for Intellectual Property at the University of New Hampshire School of Law. Our IPVI colleagues, in particular Gordon Smith and Professor Susan Richey, have provided us invaluable assistance and insights throughout the book-writing process. We have also received substantial support from UNH Law Assistant Professors Jon Cavicchi and Tom Hemstock, who are two of the best law librarians in the world.

During our work on this book, we have had a number of talented research assistants who have provided us with thoughtful and generous assistance in researching and editing the book. They include Jeremy Barton, Jacki Lin, Ian Mullet, Sarah Rogers, and Joseph Young.

The various decision trees that we provide in this book were developed using TreeAge Pro. We would like to thank TreeAge Software, Inc. of Williamstown, Massachusetts (www.treeage.com) for providing us with a complimentary license to construct the decision trees for this book.

The authors would also like to thank Professor Ray Friel of the law faculty at the University of Limerick, Ireland, for his welcome advice and encouragement. The authors would also like to thank the law faculty at University College Cork, Ireland, who sacrificed the 2011 eLaw Summer Institute, an unexpected occurrence that fortuitously provided some much needed time for Bill to work on this book.

Finally, and most important, we want to thank our families and friends for their support. Bill would like to thank his family, in particular Tyler and Kristen Murphy, who have had to listen to more about patent valuation than any two college students should. John would like to thank his wife, Corinne, and his children, Xavier, Alexandre, and Morgane, for all the sacrifices they made to allow him to work on this book. John particularly wants to thank Morgane, who became a regular at his office while he worked on various drafts of the book and provided him with constant support and motivation. Everybody at UNH Law misses not having her around as much. Paul would like to thank his wife, Ann, and his children, Amy, Dana, and Jeb, for their encouragement and support. Paul would like to extend an additional thank-you to Amy and Dana, two lawyers, who put up with his seemingly unending hypothetical questions.

Part One

Foundations for Patent Valuation and Decision Making