UNDERSTANDING FINANCIALS: LICENSING

A Component of the Dawnbreaker Administered DOE

Commercialization Assistance Program

Presented by: Jon Sienkowski

Agenda

• DOE guidelines

• Income Statement

• Examples

• DOE Return on Investment Calculation

• Valuation, forms of payment, and royalty rates

• Appendix: Clauses to consider

Motivation / Approach

• Evolving from R&D company to commercial enterprise – will need to address investor and business requirements

• Developing financials helps to expose holes in the plan, identifies key milestones, and shows key levers for the business

• Best to start early in the process and iterate

• Keep it simple

What is a License?

• Permission granted by an owner or inventor to use

the owner’s proprietary information, invention or

material

• Items that can be licensed include:

– Patents (also including know-how, software models,

designs, drawings, formulations, process flow,

setpoints, etc.)

– Trademarks - words, names or symbols identifying

goods made or sold, distinguishing them from others

– Copyrights - original works of authorship fixed in any

tangible expression form

Licensing Deals – Types of IP

Source: Licensing Executives Society 2011 Survey

6

Terminology

• Licensing-in: a firm obtains a license to expand its IP assets

• Licensing-out: a firm spins out its IP for use by others

Assumptions

• Basis of calculating the served available market size

• Growth assumptions by year

• How did you calculate/estimate the sales of the potential licensee (license revenue base?)

Market(Sect 1.4)

• Identify sources of revenue – products, parts, services, or royalties from licensing

• How did you estimate the royalty rate (look at comparables for similar goods/services)?

• Assumptions about the terms of your planned licensing arrangement?

Revenue(Sect 4.3, 4.4)

• State any assumptions you used along with your methodology for calculating/estimating the expenses in this section.

• Headcount, legal, marketing, facilities, other operating expenses

Expenses(Sect 4.4)

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Templates on eLearning websitehttp://www.dawnbreaker.com/elearning/

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Pro Forma Income Statement - License

XYZ Corporation

For years 2015 to 2019

Market Phase II (2015) Phase II (2016) 2017 2018 2019

Served available Market size 864,000,000 1,036,800,000 1,244,160,000 1,492,992,000 1,791,590,400

Rate Market growth 20% 20% 20% 20% 20%

Sales (Revenue) base for licensing

$0 $0 $5,000,000 $20,000,000 $30,000,000

$ market share - total market 0.0% 0.0% 0.4% 1.3% 1.7%

Royalty % 5.0% 5.0% 5.0% 5.0% 5.0%

Revenues

Royalties 0 0 250,000 1,000,000 1,500,000

Upfront or milestone payments 0 200,000 750,000

Consulting or after sale services

0 0 50,000 25,000 25,000

SBIR/STTR Contract R&D 500,000 500,000 0 0 0

Total Revenue $500,000 $700,000 $1,050,000 $1,025,000 $1,525,000

Operating Expenses

Licensing-in & Royalties 0 0 0 0 0

Sales 0 25,000 25,000 0 0

Marketing 0 75,000 50,000 20,000 20,000

Cost of services 0 0 25,000 12,500 12,500

Administrative (G&A) 0 0 20,000 20,000 20,000

SBIR R&D 465,000 465,000

Internal R&D 0 0 100,000 100,000 100,000

Legal 25,000 15,000 5,000 5,000 5,000

Facilities 0 0 5,000 5,000 5,000

Total Expenses $490,000 $580,000 $230,000 $162,500 $162,500

Operating Earnings (EBIT)

Operating Earnings (EBIT) 10,000 120,000 820,000 862,500 1,362,500

Operating Margin % 2.0% 17.1% 78.1% 84.1% 89.3%

Income

Income Before Tax 10,000 120,000 820,000 862,500 1,362,500

Tax rate 35% 35% 35% 35% 35%

Taxes 3,500 42,000 287,000 301,875 476,875

Net Income $6,500 $78,000 $533,000 $560,625 $885,625

Net income as %/sales 1.3% 11.1% 50.8% 54.7% 58.1%

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• View the technology as a stand alone Strategic Business Unit (SBU).

• Develop the financials as an incremental approach over base line business, assigning support costs as appropriate.

Financial Perspective

Revenue:

• Definition of licensed property

• Scope of license

• Estimate market size and develop sales forecast for licensee

• Royalties/lump sump payments

• Define basis of royalty and terms

• When will royalties be earned and paid

11

Pro Forma Income Statement

12

Market Phase II (2015) Phase II (2016) 2017 2018 2019

Served available Market size 864,000,000 1,036,800,000 1,244,160,000 1,492,992,000 1,791,590,400

Rate Market growth 20% 20% 20% 20% 20%

Sales (Revenue) base for licensing

$0 $0 $5,000,000 $20,000,000 $30,000,000

$ market share - total market 0.0% 0.0% 0.4% 1.3% 1.7%

Royalty % 5.0% 5.0% 5.0% 5.0% 5.0%

Revenues

Royalties 0 0 250,000 1,000,000 1,500,000

Upfront or milestone payments

0 200,000 750,000

Consulting or after sale services

0 0 50,000 25,000 25,000

SBIR/STTR Contract R&D 500,000 500,000 0 0 0

Total Revenue $500,000 $700,000 $1,050,000 $1,025,000 $1,525,000

Revenue:

Definition of licensed property

Scope of license

Estimate market size and develop sales forecast for licensee

Royalties/Licensing fee

Define basis of royalty and terms

When will royalties be earned and paid

Pro Forma Income Statement

Pro Forma Income Statement

Operating Expenses:

Forecast expenses you will incur in supporting

the Licensee:

• Selling expenses

• Marketing

• Cost of the supporting services

• Internal R&D for meeting milestones or

ongoing improvements

• Legal

• Facilities 13

14

Operating Expenses

Licensing-in & Royalties 0 0 0 0 0

Sales 0 25,000 25,000 0 0

Marketing 0 75,000 50,000 20,000 20,000

Cost of services 0 0 25,000 12,500 12,500

Administrative (G&A) 0 0 20,000 20,000 20,000

SBIR R&D 465,000 465,000

Internal R&D 0 0 100,000 100,000 100,000

Legal 25,000 15,000 5,000 5,000 5,000

Facilities 0 0 5,000 5,000 5,000

Total Expenses $490,000 $580,000 $230,000 $162,500 $162,500

Operating Earnings (EBIT)

Operating Earnings (EBIT) 10,000 120,000 820,000 862,500 1,362,500

Operating Margin % 2.0% 17.1% 78.1% 84.1% 89.3%

Income

Income Before Tax 10,000 120,000 820,000 862,500 1,362,500

Tax rate 35% 35% 35% 35% 35%

Taxes 3,500 42,000 287,000 301,875 476,875

Net Income $6,500 $78,000 $533,000 $560,625 $885,625

Net income as %/sales 1.3% 11.1% 50.8% 54.7% 58.1%

Expenses: Forecast expenses you will incur in supporting the Licensee

Pro Forma Income Statement

15

Other Licensor Considerations

• Indemnification, third-party infringement

• Exclusivity and assignability

• Territory

• Partition of risk

• Improvements/grant-back

• Tracking

• Termination

See appendix of this presentation for more on these with example clauses

Questions to address:• What is the agreement length and how many

years left in the life of the patent?

• How passive is your relationship with the licensee?

• On what basis is the royalty rate established?

– Gross sales

– Final sales value to the customer (net sales)

– Operating profit

– On a unit basis

– Cost savings

16

Basis for Royalty Calculations

https://s3.amazonaws.com/ktmine_cdn/ktMINE+Royalty+Rate+%26+Deal+Structure+Study.pdf

18

80-90% of licensees report royalties incorrectly

A record inspection and audit clause is important in

agreement

How will the licensing agreement be

structured to reduce your risk?

• Upfront payments - ability of the licensee to make upfront payments

• Milestone payments

• Tiered royalty rates based on volume

• Minimum royalty amount paid

• Indemnification issues

• Performance expectations

• Marketing activities to promote technology

• Length of license and termination

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INDUSTRY EXAMPLES

Publicly Traded Companies

• Semiconductors, networking equipment:

– AmberWave, InterDigital, MOSAID, Qualcomm,

Rambus, Tessera, Walker Digital and Wi-LAN.

• Qualcomm Technology Licensing Division:

2013 2012 2011

Revenues $7,554M $6,327M $5,422M

EBT $6,590M $5,585M $4,753M

EBT Margin 87% 88% 88%

Info from Qualcomm annual report 2013: http://investor.qualcomm.com/common/download/sec.cfm?CompanyID=QCOM&FID=1234452-13-483&CIK=804328

NSF Funded Study – Industry Patent

Licensing Revenue

http://www.nsf.gov/statistics/infbrief/nsf13307/nsf13307.pdf

Patent licensing revenue is <1% of overall revenue (except medical equipment)

• Small, mature company with a mix of licensing,

product, and R&D revenue.

• Listed as one of “Hot 50” companies for bioenergy

• Company develops enzymes for biofuels, animal

feed, detergents, etc.

• Excerpt from annual report:– “…agreement called for BASF to pay an aggregate $6.0 million upfront

license fee as compared to the $5.5 million that Abengoa paid for an

expansion of their non-exclusive C1 license in 2012.”

Dyadic – Enzyme Technology for Biorefineries

Dyadic Annual Report – 2013 - https://www.otciq.com/otciq/ajax/showFinancialReportById.pdf?id=118188

Dyadic – Enzyme Technology for Biorefineries

https://www.otciq.com/otciq/ajax/showFinancialReportById.pdf?id=118188

Dyadic Annual Report 2013

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General Term “Clusters”

1. Subject of the license

2. What kinds of rights does the license give

3. Financial terms

4. Technology’s growth and development over

time

Source: WIPO - http://www.wipo.int/export/sites/www/freepublications/en/licensing/903/wipo_pub_903.pdf

Dyadic Licensing Agreements

Excerpts from Dyadic 2013 Annual Report highlighting licensing terms:

Abengoa AgreementOn February 18, 2009, the Company and Abengoa Bioenergy New Technologies, Inc. (“Abengoa”)

entered into a non-exclusive license agreement (the “Abengoa License Agreement”) which became effective on May 12, 2009.Under the Abengoa License Agreement, the Company

granted Abengoa the right to use certain patent rights and know-how owned by

the Company relating to the C1 Platform Technology for the large-scale production of enzymes for use in manufacturing biofuels (including cellulosic ethanol and butanol), power and/or chemicals. The Abengoa License Agreement provides

for facility fees and royalties to be paid to Dyadic upon the commercialization of biofuels and other products which utilize the Company’s materials and technologies.On April 23, 2012, the Abengoa License Agreement was amended and restated (the “Amended Abengoa License Agreement”) to provide Abengoa with additional rights which include, among other things,

worldwide rights to use the Company’s C1 Platform Technology in the licensed fields. The Amended Abengoa License Agreement also 56OHSUSA:757375561.9 further clarifies Abengoa’s

rights to sell enzymes produced using the Company’s C1 Platform Technology to third parties for use in both first and second generation biorefining processes for the production of fuels, chemicals and/or power. In exchange for entering into the Amended Abengoa License Agreement, Abengoa paid the Company an additional non-refundable upfront license fee for the expanded rights.

Excerpts from Dyadic Annual Report – 2013 - https://www.otciq.com/otciq/ajax/showFinancialReportById.pdf?id=118188

Dyadic Licensing Agreements

Excerpts from Dyadic 2013 Annual Report highlighting licensing terms :

BASF

On May 6, 2013, the Company entered into a non-exclusive worldwide research, development and license agreement with BASF SE (“BASF”). Under

the terms of the agreement, BASF is entitled to use Dyadic’s patented and

proprietary C1 platform technology to develop, produce, distribute and

sell industrial enzymes in certain fields for a variety of

applications. BASF agreed to fund research and development at

Dyadic’s research lab in The Netherlands. In addition to this funding, BASF

paid Dyadic a non-refundable upfront license fee of $6,000,000, and

has agreed to pay certain additional research and commercial milestone

fees and royalties upon commercialization

Excerpts from Dyadic Annual Report – 2013 - https://www.otciq.com/otciq/ajax/showFinancialReportById.pdf?id=118188

Dyadic Licensing Agreements

Excerpts from Dyadic 2013 Annual Report highlighting licensing terms:

CodexisOn November 14, 2008, the Company entered into a non-exclusive license agreement (the “Codexis License

Agreement”) with Codexis, Inc. (“Codexis”) which granted to Codexis the non-exclusive right to use

Dyadic’s C1 Platform Technology for the development, production and sale of enzymes in

the fields of biofuels, certain pharmaceuticals, chemicals, air treatment, water treatment and

the conversion of biomass into fermentable sugars for use in certain non-fuel products. Codexis

also obtained access to specified materials of Dyadic relating to the C1 Platform Technology. In the field of biofuels, the

license is sublicenseable to Equilon Enterprises LLC dba Shell Oil Products US (“Shell”) or any

affiliate of Shell in which it holds a 50% or greater ownership interest, and sublicensable to third parties in certain

pharmaceuticals, chemicals, air treatment, water treatment and the conversion of biomass into fermentable sugars for

non-fuel products. Dyadic and Codexis each agreed that neither it nor its affiliates or sublicensees will assert any

claim of infringement of any patent covering improvements to the Dyadic materials that were made by that

party or its affiliates or sublicensees against the other party, or its affiliates, sublicensees, successors, distributors, or

customers.

The Codexis License Agreement provides for Codexis to pay Dyadic certain license issuance

fees, milestone payments, and fees based on the volume of products sold or

manufactured using the C1 Platform Technology. In accordance with the Codexis License Agreement, Codexis paid

Dyadic an upfront payment of $10 million (the “Codexis Upfront Payment”) during the year ended

December 31, 2009 after Dyadic satisfied certain performance criteria. The Company did not recognize

any license revenue from the Codexis License Agreement during the years ended December 31, 2013 or 2012,

respectively.

Excerpts from Dyadic Annual Report – 2013 - https://www.otciq.com/otciq/ajax/showFinancialReportById.pdf?id=118188

DOE RETURN ON

INVESTMENT CALCULATION

DOE Return on Investment

• DOE requires separate calculation of the Return on Investment (ROI) or the Net Present Value (NPV) of the SBIR grant.

• Compares present value of product/license profits to grant “investment”– 10 year window of product sales

– Requires you to extend out detailed 5 year pro forma

• Spreadsheet template is provided on eLearning website – Also available on DOE

website:http://science.energy.gov/sbir/applicant-and-awardee-resources/grant-application/

Worksheet

Worksheet – DOE Funding

The initial investment for the DOE calculation is associated only with the SBIR funds provided by DOE.

Worksheet – Company Revenue

Worksheet – Company Revenue

Market size and growth rates are based on your analysis of the licensee’s Served Available Market (SAM)

Market share – estimate licensee’s market penetration in latter years, back up with reasonable logic and assumptions

Numbers should agree w/ pro forma in years where they overlap

Worksheet – Company Revenue

Royalty rate is entered based on your analysis. May stay the same or be reduced.

Modify spreadsheet to include any other revenue streams including up front and milestone payments, product sales, etc.

Worksheet – Company Revenue

Operating Margin and Operating Profits (EBIT or EBITDA) are based on your analysis. Longer term projections should trend to industry averages.

Worksheet – Company Revenue

Discount Rate is the cost of raising debt and equity investments (aka the weighted average cost of capital) and risk of the investment – 15% is a reasonable first pass.

Resources:http://ardent.mit.edu/real_options/RO_current_lectures/weighted_average_cost_of_capital.pdfhttp://ardent.mit.edu/real_options/RO_current_lectures/

Worksheet – Company Revenue

• There is no right answer - higher is better. • If you’re above 30 for pure licensing model, you might be

doing something wrong! Check to make sure you’re entering numbers in 1,000s.

VALUATION, FORMS OF

PAYMENT, AND ROYALTY RATES

Perspectives for Valuation

• Return on R&D Costs

• Market approach

• Value based

• Rule of thumb

40

Return on R&D Costs

Present Value of money techniques

Involves forecasting each year’s royalty stream over the term of the license agreement and discounting each year’s after-tax amount by your cost of capital to get a net present value (NPV).

41

Market approach• Involves researching royalties

negotiated between independent

parties for the exchange in a license

agreement of similar property.

42

Value based• Involves understanding the value of the

technology to be licensed to the

licensee (i.e., cost savings, enables

new market, greater market share,

higher price, better quality, better

performance, etc.).

43

Licensing Executives Society Data

45

Technology Assessment/Value drivers

• Market Potential– Market size

– Stage of market development

– Economic health

– Competitive advantage

• Strength of IP– Pioneer patent

– Degree of development

• Synergy with licensee’s strategy– Synergy with marketing, sales, distribution

– Synergy with technology

• Industry standards

Licensing Executives Society Data

47

What is the Licensor’s goal in structuring

royalty fees?

• Motivate the licensee to perform

– Up-front payment - licensor must recoup costs

– Minimum royalties - ensures continued

performance

• Licensor should ensure fairness

48

Types of Royalties

• Any form of consideration including:– Lump sum

– Periodic payments

– Milestone payments

– Up-front followed by periodic payments

– Minimum royalties

– Pre-paid royalties

– Sub-license royalties

Licensing Executives Society Data

Licensing Executives Society Data

51

Traditional Methods of Calculating Royalties

• Industry standard royalties

• 25% rule

• Based on savings realized by the

licensee

• Inherent value (licensor costs)

• Based on apportionment of risk

52

Sources of Typical Royalty Rates

• Free: ktMINE Royalty Rate Resource Guide and Royalty Rate and Deal Structure Study – both are recommended downloads!

– http://www.ktmine.com/free-resources/royalty-rate-resource-guide/

– http://www.ktmine.com/free-resources/royalty-rate-deal-structure-study/

• Overview of valuation resources - a free guide to sources for royalty rates, licensing fees, intangible asset transaction values, and related financial data http://valuationresources.com/EconomicData/Royalty.htm

• Pay: RoyaltyStat® is a subscription database http://www.royaltystat.com/

• A Guide to Royalty Rates in Pharmaceutical Licensing Deals http://www.pharmaventures.com

• Dawnbreaker Business Planning Guide – Chapter 6

• Pay: Licensing Executives Society: http://www.lesusacanada.org/

• Pay: Association of University Technology Managers: http://www.autm.net/Home.htm

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54

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RoyaltySource®

Transaction Analysis

Industry Licenses (nos.) Min. Royalty,% Max. Royalty,% Average,% Median,%

Automotive 35 1 15 4.7 4

Computers 68 0.2 15 5.2 4

Consumer Gds 90 0 17 5.5 5

Electronics 132 0.5 15 4.3 4

Healthcare 280 0.1 77 5.8 4.8

Internet 47 0.3 40 11.7 7.5

Mach.Tools. 84 0.5 26 5.2 4.6

Pharma/Bio 328 0.1 40 7 5.1

Software 119 0 70 10.5 6.8

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The “25% Rule”

• A licensor can reasonably demand 25% of

pre-tax profit if:

– The licensor adds significant value to the venture

– The licensor comes to the table well-prepared

– The technology is commercially sound

– Provides a starting point only

– The negotiation process is complex and affected

by many factors

57

25% Rule Illustrated

Total Anticipated Licensee Revenue $100

- Licensee Cost of Goods Sold $50

- Licensee Operating Costs $30

Licensee net pre-tax profit (EBIT) $20

Royalty based on 25% of pre-tax profits = $5

Royalty as % of licensee’s revenue 5%

58

Take Aways

• Financials are a necessary part of

planning

• Assumptions are key and must be

validated

• Don’t be overwhelmed – work with your

Dawnbreaker Business Acceleration

Manager

Questions?

Please complete the survey at the end of

the webinar

Jon Sienkowski

Business Acceleration Manager

jsienkowski@dawnbreaker.com

APPENDIX

61

Exclusive licenses

• Will the terms restrict your rights to continue

to conduct R&D in this field?

– Assure that licensor rights are expressly clarified in

the license

• Consider granting an exclusive license with a

clause to revert to non-exclusive if

performance criteria are not met

– Also consider, losing license for non-performance

62

Territory

• Can vary in scope

– Highly restrictive - use at one site

– Very lenient - global

• Best to provide rights only to a territory

where licensee has appropriate sales,

marketing, and distribution channels

63

Issues

• Indemnification

– One party to a contract holds the other party

harmless in the event that a lawsuit is brought by

a third party

• If you accept the indemnity, you are saying that you are

legally responsible and will act as a shield

– Things to consider

• Is the indemnity limited to certain types of claims, certain

geographic regions, a specific dollar amount

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Licensee/Licensor indemnification

• “Licensor shall indemnify Licensee and hold Licensee harmless from any damages and liabilities (including reasonable attorneys’fees and costs)….”

• “Licensee shall indemnify Licensor and hold Licensor harmless from any damages and liabilities (including reasonable attorneys’fees and costs)….”

Sample, partial clauses taken from License Your Invention by Attorney Richard Stim

Such clauses should be negotiated and full implication understood

65

Issues

• Assignability– A clarification of the party to whom the rights

are assigned

• Affiliates, acquirers, subsidiaries

• Do you know who owns whom?

– What happens to those rights in the case of a

merger/acquisition

– What happens to those rights in the case of a

bankruptcy?

66

Assignability clauses

• Restrictive clause

– “Licensee will not

assign, transfer, or

encumber its interest

in this agreement, or

the rights granted to

Licensee without the

prior written consent of

Licensor…”

• Less restrictive clause– “Licensee can assign its

interest in this Agreement to a third party whereby the third party buys or otherwise acquires all the assets of the licensee to which the agreement relates…”

Excerpts from Companion to Licensing Negotiations - Robert Goldscheider

67

Sublicensing clauses

• No rights without

approval

– “The exclusive license

granted does not include the

right to sublicense without

the prior written approval of

Licensee….”

• Approved with

conditions

– “Licensor grants

licensee the right to

grant sub-licenses in

the licensed territory

provided that

Each sub-license has a

grant which is

consistent with…”

Excerpts from Companion to Licensing Negotiations - Robert Goldscheider

68

Termination

• Based on time– Upon expiration of the

term of this Agreement…

Licensee shall surrender

or deliver to Licensor…”

• Based on time– Upon expiration of

earlier termination

of this Agreement,

Licensee and any

sublicensee will

immediately and

without notice deliver

to Licensor…”

Excerpts from Companion to Licensing Negotiations - Robert Goldscheider

69

• Improvements– Improvements are enhancements to the licensed

technology that could be made by either party

– Define the domain of relevant improvements at the outset

• Restrictive - relates to licensed technology and are patentable

• Less restrictive - Any advances that relate to licensed technology whether or not they are patentable

• Grantback– is "an arrangement under which a licensee

agrees to extend to the licensor of intellectual property the right to use the licensee's improvements to the licensed technology."

Issue - Improvements and Grantbacks

70

• Grantbacks by

Licensee

– To the extent that

Licensee develops

technology outside the

scope of licensor’s

intellectual property

rights…licensee will

not be obligated to pay

royalties to licensor

• Definitions– “Licensee’s

Improvement Patents”will mean all patents and patent applications of all countries owned, acquired, or controlled by licensee during the term…provided that the claims thereof cover inventions falling within the scope of one or more of licensed patent claims…..”

Improvements and Grantbacks