Pricing Intellectual Proper Litigation Risk In IP Transactions
How to Price Intellectual Property (IP) Litigation Risk in Transactions
Published on: Mar 4, 2016
Transcripts - Pricing Intellectual Proper Litigation Risk In IP Transactions
34 Coquito Court, Menlo Park • California 94028 • Phone 650.854.1914 • www.litigationriskmanagement.com • firstname.lastname@example.org
Bruce Beron, Ph.D., President
IP Litigation Risk in Transactions
A Case Study
© Bruce Beron 2014 Pricing IP Risk 2
Parties on both sides of an IP transaction, be it licensing,
a patent sale, or M&A, often struggle with how to deal
with IP litigation risk.
The seller or licensor minimizes the risks.
The buyer or licensee wants indemniﬁcation for any risks.
The basis for compromise is often based on negotiation
trade-offs, not a rational basis.
One of the parties may have to yield on some other issue to get
the deal done.
Often, however the risks are small enough that they should not be
a signiﬁcant factor in the negotiations.
© Bruce Beron 2014 Pricing IP Risk 3
We propose a business-like approach to Valuing IP
The underpinnings are a Decision Analytic framework
It is a quantitative approach
Decision and Risk Analysis
Uses explicit quantitative probability judgments
Risk is taken into account by the use of probability
First, let’s look at a few basic concepts that we will be using.
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Our valuation criterion will be the Expected Net Present
Value of the resulting monetary cash ﬂows.
Think of it as a probability weighted average.
Expected Value represents the average value—if you could play
We deﬁne Expected Value as the sum over all the outcomes of each
outcome times its respective probability.
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The art of business-like decision-making is the art of
balancing risk and reward.
Many lawyers and business people do not have a
clear, unambiguous deﬁnition Risk.
Requires a statement of likelihood like:
Or, most effectively, a probability (quantitative)
And requires a statement of consequence
Hit by a car
Lose our shirts
Or, most effectively, lose ten million dollars
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Many attorneys and business people do not think as
clearly as they might about the rewards either.
The upside too requires a statement of likelihood and a statement of
We almost always focus on the risks, the downside
It is usually quantiﬁable and attributable after the fact
There is someone’s name on the check
The accounting system knows exactly how much was misspent
The potential upsides are never precise or well deﬁned
Very few people get ﬁred for increasing sales by 30% when they should
have increased them by 40%
Very few attorneys are criticized for settling a case for $20M when the
expected loss was $10M
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Risk is Uncertainty: There are even risks when there is
no possible downside.
You own the opportunity to call the toss of a coin.
If you call it correctly, you will win $5M.
The expected, or average value is .5 x $5M = $2.5M.
I am sure that most of us would sell that opportunity for signiﬁcantly
less than $2.5M.
The difference between the Expected value and your Minimum Selling
Price (your Reservation Price) is your Risk Premium, the amount you are
willing to give up on average to remove uncertainty.
That you might lose and not have $5M
The Reservation Price will be proportionally signiﬁcantly smaller for a
coin toss for $5M than it would be for a coin toss for $50.
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In a purchase of IP for business purposes (not strictly
for royalties), one must consider whether the purchase
is for offensive or defensive purposes.
Both relate to protecting either an ongoing business area or a
Offensive use of the IP would be to impede competitors in your
market, either by excluding them or putting them at a competitive
disadvantage by extracting royalties.
Defensive use falls into two categories:
IP is relevant to the particular business to be protected
Can be used to counter sue and for cross licensing for settlement purposes
IP relates to other business markets of competitors who might sue.Threat of
your suing in those areas should competitor sue you.
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Evaluating these business impacts is straightforward.
Start with a very simple business cash ﬂow model.
Future probabilistic projections of:
Fixed and Variable
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For the purchase of IP relating to the entry into an
existing competitive market, there are two risks:
Offensive: The IP will not protect your position in the market when
asserted against competitors.
Defensive: The IP will not protect you through countersuit or
settlement ammunition for cross licensing.
Both offensive and defensive value (risk) must be
looked at probabilistically.
The value of the IP is the difference between having
and not having it.
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Let’s look at a simple case study.
A contract electronics manufacturer is being forced, by the
marketplace to move upstream in the development process.
The current business model assumes no risks, other than manufacturing
quality and on-time delivery
Competition and customers are compelling them to become, essentially,
an OEM manufacturer
Include design as well as manufacturing
They would have to take on more risk in a market with razor-thin
margins, as they would have to indemnify their customers for:
IP Litigation liability
The question they needed answered was:
How much should they charge their customers for these risks on a unit
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For the purposes of this case study, which relates to a
business line extension, the trolls do not have a direct
impact on these decisions.
Generally, for business driven decisions, the existence of, and
possible suits by, trolls do not have a signiﬁcant effect.
The one exception is the purchase of IP assets to keep them out of the
hands of trolls.
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The source (Types of Plaintiffs) of potential IP litigation
is an important factor to consider in evaluating IP
Major v Minor
Participant or Non-participant in relevant market
For example, Trolls would be included in Major or Minor
The distinction between Major or Minor may be less important
today as capital can ﬂow to fund many potentially high stakes
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There are other important factors to consider in
evaluating IP litigation risk.
For each category we need to assess a base case (median) value:
Likelihood of litigation
Cost of Trial
Out of Pocket
Distraction of management and key technical personnel
Depend on intensity and duration of plaintiff’s pursuit
Likelihood of losing
Damages if we lose
Royalty Rate Basis
Our part of a ﬁnished product
Value of the ﬁnished product
Likelihood and Value of Settlement
Value as a percentage of the expected trial outcome
An Indemnity Cap is not uncertain, but we include it to measure its
impact on the cost of IP risk.
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Let’s ﬁrst examine the context or frame of this
Category Specific Prod. Area
Mechanical Related Design
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Now let’s look at the initial base case (median) inputs.
Inputs - Base Case
as Pct. of
EV of Lit
Lit. Cost if
0.01 0.90 35% $2.M 35% 0.65 1.25 1.5% 0.20 2.00 $10.M
0.02 0.85 50% $1.5M 30% 0.55 1.10 2.0% 0.20 2.00 $10.M
0.07 0.65 60% $2.M 65% 0.40 1.40 3.0% 0.25 2.00 $10.M
0.03 0.75 55% $1.5M 50% 0.35 1.20 2.5% 0.20 2.00 $10.M
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Relevant data is usually available, even if only as a
simple calculation based on experience and general
For example, this is how one might estimate the likelihood of a claim
by a Major Market Player
Number of similar products produced over the last 5 years and the
number of suits that have resulted from each of the categories.
There are 10 manufacturers of the same end product.
Each has had 5 new models/year over that time period.
There haven’t been any claims on this particular component.
If there had been one, the probability would be 1/(10 manufacturers x5
products / year x5 years) = .4%.
Our customer is a Major Market player so they would very likely be a
codefendant, and, since we have had a long relationship, we expect
that their patent portfolio would likely be available for a countersuit.
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For each category or source of possible litigation, we can develop
a sensitivity chart which shows which inputs’ ranges have the
greatest impact on the expected value of that source of risk.
The ﬁrst four or
capture >95% of
For each input variable, we
assess a consistent range -
the 10th percentile and the
Net Present Value
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Now we can focus on doing research and/or thinking
further about the critical inputs for each category.
For the Major Non-Market player
Probability of a claim
Royalty Rate determined by jury
Settlement Value as a percent of the Expected Trial Outcome
Probability of Liability
The initial estimates and ranges are a “gut feel” assessment based
on experience and “back of the envelope” estimates.
Sometimes that is all we have to go on, but it is still better than ﬂying by
the seat of your pants for the overall risk assessment.
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The summaries show that the largest risk, not
unexpectedly, comes from the Major Non-Market
Major Market Player Minor Market Player
$ 0 . 0 0 3 $ 0 . 0 0 7
Probability of Claim
Expected Cost if Claim
Expected Cost as % of Unit Cost
Major Player Non Market
Minor Player Non Market
Probability of Claim
Expected Cost if Claim
Expected Cost as % of Unit Cost
The results can also be displayed in the
form of a probability distribution
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Our approach has several beneﬁts:
It develops a logical foundation, transparent to both sides.
It quickly and efficiently determines which issues are critical.
Which have the greatest ﬁnancial impact and risk for both parties
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It focuses negotiations on these critical issues quickly
Reveals explicitly any signiﬁcant disagreements
Shows the effects of these disagreements on the deal
Saves time and money in coming to an agreement
This approach can be used to evaluate the IP Litigation
Risk in any transaction.
© Bruce Beron 2014 Pricing IP Risk
For further information, please:
Visit our website at:
bruceberon at lrmi dot com