Patent monetisation through a sale or licence strategy can be significantly rewarding for a company and its shareholders, but a successful outcome requires planning, resources, an informed risk assessment and a certain amount of grit. Monetisation has historically never been easy and changes in the IP monetisation landscape over the past few years have made the process even more challenging – potential buyers are better informed, licensee targets have become more sophisticated and the legal landscape has evolved often to raise the hurdles for realising a maximising outcome.
In the consideration of monetising all or part of a patent or other IP portfolio, a key initial decision will be the choice between the sale of the patent assets to a third-party buyer or the pursuit of an in-house licensing strategy. An in-house licensing strategy can often involve working with one or more partners to provide experienced resources, investment funding or legal services. This sell or license decision will have important implications for the likely amount that a patent holder should expect to receive and the timing of realised proceeds. Of course, there are likely to be additional strategic components to the decision, such as the importance of the patents to core business plans, the willingness to enable others to use the patented technology, potential reputational risk, the appetite for financial risk and the need for and timing of cash infusions. Even when thinking about the implications of this decision, the issues can be many, depending on the complexity of the situation that a patent holder faces. Although there are multiple decisions to consider before starting a monetisation programme, this chapter focuses on certain implications of the ‘sell or license’ option analysis.
An analysis of whether to sell or license typically involves at least the following interrelated considerations:
- marketability of patent assets;
- funds and resources available;
- timing requirements; and
- risk tolerance.
Each of these and their inherent interrelatedness are discussed below.
Marketability of patent assets
As an initial matter – given the investment of time and resources typically required for a successful patent monetisation programme, whether through sale or licensing – it is critically important to conduct sufficient due diligence early in the process to assess the marketability of the subject patent assets. This step will result in a threshold determination regarding the likely success and inherent risks of the monetisation effort. Further, the depth of such analyses – in particular, analyses of validity and infringement/use matters – will often depend on the type of monetisation effort that is ultimately undertaken. But in any situation, an informed assessment of the marketability of the patent assets and the inherent risks of achieving a successful outcome is a critical step prior to beginning the monetisation effort.
This due diligence effort requires an evaluation of (at least):
- claim scope;
- the associated portfolio breadth and depth;
- portfolio age;
- past, present and potential future market relevance;
- evidence of use in the market;
- the likelihood of any validity issues;
- any existing encumbrances;
- the need (or not) for retaining a grant-back right to the patents in the event of the sale; and
- the decision to impose any field or other restrictions on a licensee.
The investment in this due diligence is not insignificant and can require external resources.
An additional benefit of performing early due diligence is that potential licensees or buyers will want to understand the above issues before entering into a transaction. Upfront due diligence should provide the information that licensees or buyers seek and will likely lead to a higher-value outcome for the patent owner. It allows a patent holder to manage the licensing/sale process, as opposed to the process managing them. To this end, typical outputs of due diligence activities are claim charts that effectively map the patent claims to products or services. Potential licensees, financing providers or buyers often have limited resources at their disposal and typically do not have the bandwidth to perform these investigative steps on every offered portfolio. Having already performed the research and being able to provide the underlying materials to prospective acquirers, investors or licensees can result in a higher price or more favourable terms.
Funds and resources available
Assuming that the due diligence phase leads to a conclusion that a sufficient market opportunity exists, an assessment of the level of funds and resources available mapped against the estimated cost of the programme is an important next step in the sell versus license decision. In the case of pursuing a licensing strategy rather than a sale, it is likely that significant funding will be required. A hybrid licensing strategy could be pursued where these funds would be provided by one or more partners, and there are many versions of this strategy in today’s market.
To successfully license in today’s environment, it is often necessary to file a patent infringement suit to convince a potential licensee to seriously engage in licensing negotiations and close a deal. It can be risky to accuse a party of infringement, even when offering a licence, without being prepared to sue or defend a declaratory judgment action (eg, see MedImmune Inc v Genentech Inc 127 S Ct 764 (2007); SanDisk Corp v STMicroelectronics 480 F3d at 1372 (Fed Cir 2007); Teva Pharm USA v Novartis Pharm 482 F3d 1330 (Fed Cir 2007)). The patent holder may find itself in court whether that was the plan or not. As has been well publicised, engaging in patent litigation is expensive. Even for a smaller case, the American Intellectual Property Law Association (AIPLA) estimates that patent litigation could cost over $2 million through trial (AIPLA 2013 Report of the Economic Survey). In practice, costs are far greater than $2 million in most cases. One tactic that a defendant may adopt is to use legal manoeuvring to increase the plaintiff’s costs, potentially by filing a post-grant review, demanding voluminous discovery, contesting all motions, filing numerous motions of its own or refusing to comply with discovery in any meaningful way. To handle these situations, access to $5 million or more in available funding may be necessary.
Another possible method to reduce the required funding amounts would be to follow a hybrid licensing strategy and engage contingency fee litigation counsel and/or an outside investor in the litigation in exchange for a share of the proceeds. One challenge with relying on this approach is that contingency fee litigation counsel have become highly selective of the cases that they will accept on a contingency basis. Only the highest-quality patents with strong infringement evidence are likely to be accepted on a contingency fee basis. Performing significant due diligence upfront pays dividends in these types of discussion, as the demonstration of quality assets and marketability is also what contingency fee counsel and outside investors focus on.
The timing requirements for receiving revenue are another consideration in the sell versus license decision. The timing of any expected payments is likely to differ substantially, depending on the choice of a sale or licensing strategy. In many instances, a sale can result in a lump-sum payment to the patent holder, less any brokerage fees. A recent report demonstrates that the patent sale market has remained fairly active over the past five years (RPX 2014 Transaction Marketplace Report). The number of portfolios offered for sale on the market has trended upwards in recent years, ranging from about 600 to 800 per year, and approximately 20% to 40% of these offered portfolios were eventually sold. Other reports on the patent transaction market suggest that although portfolios have continued to sell, recently prices have been trending lower and the required portfolio quality has increased (eg, see ipfinance.blogspot.com/2015/06/ipbc-global-2015-conference-report-i.html). This is particularly the case with software-dominated portfolios and portfolios of standard-essential patents.
Alternatively, a licensing approach can result in many years passing before the expected licence fees are realised in actual cash flow. Although the timing of payments under a licence approach can vary substantially given specific facts and circumstances, there are a number of factors to consider, including:
- the duration of litigation;
- the chances of settlement; and
- the willingness to discount cash-flow expectations for settlement purposes.
Figure 1. Hypothetical comparison of cash-flow timing
Click here to view the image.
The first thing to consider is that, as discussed above, a licence strategy will likely involve asserting one or more patents against the licensing target(s). In general, the ensuing patent litigation can take more than two years before a judgment is obtained at district court level (PwC 2015 Patent Litigation Study). The filing of a post-grant review by the defendant can even delay the effective start of litigation. This has become an effective delay method employed by licence targets and has also proven successful at invalidating many patents. If a patent holder wins a judgment at trial, this award is likely to be appealed. The appeal process can add another 18 months before an award is paid and can potentially overturn a successful trial result. A licensor should be prepared for the possibility of it taking as much as five years, if not longer, before significant revenues may be realised. Figure 1 compares hypothetical cash-flow timing under three different scenarios:
- outright sale;
- licensing with discounted settlements; and
- litigation to final judgment.
Of course, this figure illustrates the process of taking a patent through litigation and appeal, and most patent licence/litigation matters do not go this far. As shown above, the path to quicker revenues under a licensing approach is to settle with licensing targets/defendants. Settlements are generally entered into at a discount to what the expected damages would be through litigation. In practice, in cases where the settlement ‘ask’ is less than lower single-digit millions of dollars, a case can settle within the first year or two – especially when the asserted patents appear to have a reasonably strong infringement and validity position. In cases where the settlement ‘ask’ is closer to double-digit millions or more, a defendant will often choose to fight in court for a longer period rather than settling, especially if there is a perceived weakness in the infringement, validity or damages aspect of the case.
In conclusion, the primary timing considerations depend on the capacity to wait out the years required to pursue patent litigation to fruition and the likelihood of earlier payments from settlements that are bound by the considerations of cash-flow needs and risk.
Risk tolerance is an additional consideration. The benefit of selling a patent portfolio is often the certainty of at least some cash flow. As discussed, unlike a sale, a licensing strategy involves taking on significant risk that the expected royalty/settlement revenues may never occur, due to the risks inherent in patent litigation. As discussed above, a hybrid licensing approach is a potential middle ground between these options.
Patent litigation is a risky and uncertain undertaking. The patent holder can lose in many ways, because it must succeed in every aspect of the case in order to secure a judgment if no settlement occurs. Key risks in patent litigation include:
- the identification of prior art that would invalidate the patent either through an inter partes review or at trial;
- failure to prove infringement, potentially because of an adverse claim construction ruling; and
- failure to prove to a jury or judge that a meaningful amount of damages is due.
Recent data suggests that the overall success rate for plaintiffs is about 33%; however, if the case reaches trial, the plaintiff success rate increases to about 67% (PwC 2015 Patent Litigation Study). Also, changes in patent law may occur during the course of the patent litigation that could result in a material increase in the risk and a subsequent lower probability of success for the plaintiff. The due diligence conducted upfront should increase the patent holder’s confidence that it will prevail on the merits at trial and therefore have better odds of success.
In summary, the litigation risk has a direct impact on the discount applied to a direct patent sale compared to the expected licensing revenues that may be achievable over time. Given this, the risk tolerance of the patent owner is an important consideration in the sell versus license decision and its expectations regarding the amount of proceeds.
What is a ‘fair’ sale price?
The above discussion naturally leads to the question of what is a ‘fair’ sale price for a given patent portfolio. Clearly, there is a price at which each potential seller would elect to sell its patent portfolio rather than pursuing a licensing strategy, although that price likely differs for each patent owner and situation. Industry participants have suggested a rule of thumb that a patent portfolio might sell for about one-tenth of its expected licensing/enforcement value (eg, see articles.latimes.com/2012/apr/09/business/la-fi-tn-aol-patents-sold-to-microsoft-20120409).
Figure 2. Model of expected selling price compared to expected damages
Click here to view the image.
Figure 2 presents a basic model of a hypothetical, risk-adjusted purchase price discount for a standalone patent portfolio that was expected to be asserted against a single licensee target. This simplified model assumes that:
- there is a single defendant;
- the overall likelihood of success through litigation would follow the historical average of about 33%; and
- an acquirer would require a venture capital level of return of 40%.
Based on this model, which is for illustration purposes only, the likely expected selling price would be just over $1 million if the damages expectation at trial were $20 million.
As shown in Figure 2 above, under these basic assumptions it would be highly unlikely that a deal could be consummated until a threshold damages figure at trial of about $9 million was reached. The upfront due diligence activities could potentially support a significantly higher purchase price, assuming that the perceived risk of invalidity and non-infringement is less than the historical average.
In reality, every patent transaction or assertion situation involves a unique fact-specific scenario and consequent determination of value. There is no ‘one size fits all’ answer and the simplified model presented in Figure 2 would not likely fit the specific facts and circumstances of a given situation. A patent portfolio may have value in the tens of millions, or even higher, based on the strength of its claims and widespread infringement. A serious seller and buyer will spend time examining these questions in detail (based on the results of the upfront due diligence). Serious buyers will often also independently research the existence of prior art to get a better understanding of validity issues.
The likely sale price that may be achieved also typically depends on the expected use of the patent portfolio. For example, the most likely patent portfolios to transact involve patents where there is clear evidence of industry use and the potential damages are significant. In situations where the patent portfolio relates to a new technology or approach to solving a specific problem in the high-technology space, it is often more challenging to complete a transaction and the amount that a buyer would be willing to pay may be lower, but sharing upside revenues can also be involved. Patents in the pharmaceutical space can behave differently.
The sell versus license decision is complex and involves a consideration of a number of factors to arrive at the best answer given the facts and circumstances of the seller, as well as connection with the right buyer or licensee. These considerations include conducting upfront due diligence to assess the marketability of the patent assets, and then analysing the funds and resources available, the timing requirements and the risk tolerance. Even though successfully monetising a patent portfolio is challenging, it is far from impossible. Resources are available to help during all phases. The right portfolio, the right resources and the right strategy can generate significant value for the patent holder and any other stakeholders.
The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the opinions, position or policy of Berkeley Research Group, LLC or its other employees and affiliates
Michael J Dansky, Brian Frizzell and Bradford J Kullberg
This article first appeared in IAM magazine. For further information please visit www.iam-magazine.com.