Transcript Structure of Financial Terms in a License OPTEON PTY LTD Philip Mendes Level 3, 380 Queen St Director Brisbane QLD, Australia Ph + 61 7 3211 9033 Fax.

Structure of Financial Terms in a License
OPTEON
PTY LTD
Philip Mendes
Level 3, 380 Queen St
Director
Brisbane QLD, Australia
Ph + 61 7 3211 9033
Fax + 61 7 3211 9025
[email protected]
Benchmarking financial terms
.
Benchmarking
Financial Terms
In licenses
Structure
Amounts
What types of
financial terms
Royalties
Milestone Payments
1.


Royalty on sales by a licensee
X% of sales price
 Gross sales price; or
 Net sales price
Most common type of royalty provision

Royalty is remuneration for quantity of use
 Greater the quantity of use, the greater the royalty
 The more sales, the greater the royalty

But more to a license than a royalty on sales
 Clever ways for licensors to increase their remuneration
 Clever ways for licensees to reduce their royalty overhead
2.




Royalty upon sub-license
income received by licensee
.
Licensee grants sub-license
Sub-licensee will pay to Licensee
 Royalties on the sublicensee’s own sales
 Milestone payments, etc
All that income is sub-license
income
Licensee pays a royalty of Y% to
Licensor on all that income
Licensor
Licensee
Sub-Licensee
3.



Royalty upon Last Licensee’s
Sales
Royalty on sale price for which .
the last licensee sells product
Royalty rate remains fixed, e.g.
2% of sale price of last sale – that
is all licensor will receive
Licensor might be better off
receiving Y% of Sub-license
income – might be greater than
this 2% - as Licensee will sublicense after value adding and
will secure a substantially higher
royalty
Licensor
Licensee
Sub-Licensee
Buyer
4.



Ramped Up Royalties
As a product is more successful, and costs reduce, royalty
increases
Licensor forgoes royalties in early stages, in return for higher
royalties later
Infrequently seen
Cumulative Gross Sales in
up to 100m
100m to 250m
250m to 500
over 500m
US$m
4.0%
5.0%
6.0%
7.0%
5. Royalty on sales in countries
where patent granted



Expressed as:
 “Valid Patent Claim”
 Sales in country where but for license product would infringe a
granted patent
That is, you only receive a royalty where sales are made in countries
where the sale of a product is protected by a granted patent
Traps:
 No royalties on sales made while patent pending (e.g., delays in
examination, opposition proceedings etc)
 No royalties on sales in countries where patent is not sought, nor
granted – ie, if patent in US only, you only get royalties on sales in
US
6. Royalty on sales in countries
where no patent is granted



This royalty often resisted by licensee – “why should I pay a royalty for
sales in countries where there is no patent and I have no power to prevent
competitors ?
Royalty might still fairly be payable:
 Patent is likely to be taken out in 20 – 25 countries and that may
represent 90% - 95% of the world market – so why shouldn’t
royalty be paid on sales in remaining countries ?
 Licensee will select the countries where patent will be sought
Result
 pay full / part royalty,
 reducing by 50% if a competing product enters the marketplace, if
it would have infringed the patent
7.



Royalty stacking
Can arise in two ways
1. Product to be sold needs license in of complementary
technology,
 e.g., a delivery system
 another active ingredient
 a complementary product where both sold together
e.g., a vaccine cocktail
Sale price of product sold reflects complementary
technology as well
2. Freedom to operate – license in patent that is
infringed
Cannot reduce royalty by whole amount of royalty paid to
another person
Alternative: in each case, reduce royalty by X% of royalty
paid out, up to max of y% reduction on any royalty payment
Stack for
freedom to
operate z%
Stack for
delivery
system y%
Royalty x%
8.
Royalty Splitting – know how
 Split royalties so that they are referable to different parts of the IP that
is licensed
 Instead of seeking a royalty of 5%:
 Royalty of 3% for use of patent
 Royalty of 2% for use of know how
 Purpose:
 If patent is invalidated, license on foot, with a royalty
 getting a royalty in countries where there are no patents
9.
Reach Through Royalties
 Are royalties
 Not on a Product derived from your IP
 Instead, on a product derived from someone else’s IP, but which
your IP validated
 Examples:
 License of a Mouse Model
 Mouse Model validates a drug target
 Therapeutic drug developed that acts on that target
 Software program – royalties on reagents
 Catalyst that reduces manufacturing costs
10. Suspending royalties
 Suspend royalties while revocation proceedings are on foot against a
patent
 Licensee will be concerned that it may be unnecessarily paying
royalties if the patent is revoked
 Licensor will be concerned to receive royalties if patent stands up
 A middle ground is that royalties are
 Paid to a trustee
 Returned to licensee if revocation proceedings successful
 Paid to licensor if revocation proceedings unsuccessful
11. “Most favoured” royalty
 Most favoured clause is very common in the case of a non exclusive
license
 Agree on royalty of 10%
 If licensor later grants a license in the same country to a competing
licensee for a lower royalty, that lower royalty will apply in lieu of the
10% royalty
 Sought by non exclusive licensee to enable it to be better able to
compete
12. Royalties on damages
 Does Licensor get a royalty of X% on damages ?
 Assume:
 Cost of Good: $60
 Profit Margin: $40
 Retail price: $100.00
 Royalty: 5%
 Damages for lost profits: therefore are: $40.00
 Should licensor get:
 5% of $40.00 ($2); or
 5% of $100.00 ($5) ?
13. Lump Sum License Fees
 Once Only License Fee
 License fee payable by installments
 Signing Fee
 To offset past patent expenses, expenses of doing the deal (travel, legals
etc) some part of R & D costs,
14. Minimum Annual Royalty
Alternative to performance obligations
 Performance obligations are obligations that a licensee must meet to
continue to be licensed
 Avoids shelving (non use) of IP
 Licensor gets no financial return and wants to be able to license
someone else
 Avoids inadequate performance (e.g., no commercialisation in a major
market, such as US)
 Licensor gets inadequate financial return and wants to be able to
license someone else
14. Minimum Annual Royalty
Examples of performance obligations
 Pre market entry milestones to be achieved:
(a) If following completion of research, more research is needed to bring
products to a market ready state, the completion of that research
(b) Completion of animal studies
(c) Completion of collection of data for lodging IND in USA
(d) filing IND in USA
(e) Commencement of Phase 1 Clinical Studies
(f) Commencement of Phase 2 Clinical Studies
(g) Commencement of Phase 3 Clinical Studies
(h) Filing of PLA in USA
(i) Approval of PLA. in USA
(j) First sale anywhere in the world
 Failure leads to termination
14. Minimum Annual Royalty
Examples of performance obligations
 Sell X quantity of product worldwide by 01.01.05
 Or, sell the following quantities (revenues) in the following Territories in the
following Periods:
Territory
USA
Europe
Period
2003
2004
each year thereafter
2003
2004
each year thereafter
Units of Product
1m
1.5m
2m
1.5m
2m
2.5m
 Failure leads to termination
 All motivated by Licensor seeking to maximise commercialisation and
therefore revenue
14. Minimum Annual Royalty
Alternative to performance obligations
 A Pharma / multinational will not accept performance obligations of
these type
 A large biotech company will not be able to secure those types of
performance obligations from a pharma, and so will also not accept
them from a licensor
 Alternative is Minimum Annual Royalties
 A minimum amount of royalties to be paid
 Licensee must pay the higher of
 Actual royalties, or
 Minimum annual stipulated amount
 Ramp up the amount year by year
 If Licensee elects not to pay, termination
15.
Minimum Annual Payments
 Similar concept to Minimum Annual Royalties
 But refers to all payments payable under the license
 For example, credit Milestone payments against the minimum payment
amount
 May credit other things
 Research monies paid
 Consultancy fees paid
16. Milestone Payments
 Payments made at identifiable points along the development /
regulatory pathway
No
1
2
3
Milestone
Phase I trials commence
Phase II trials commence
Phase III trials commence
Amount US$
2000000
5000000
10000000
Pay royalties on what
Definition of “Gross Sale Price”





Gross / Net – only labels - definition that is important
Pay on invoice price
Deduct taxes, duties, VAT, GST etc on sale
Deduct returns
Deduct packaging, freight and insurance
 Only if separately invoiced
 Or lump sum deduction, maximum of 3-5%
 Sales to Related companies – transfer pricing
 Licenses to Related Companies (with consent)
Royalty Rate Methodologies
Arriving at the right royalty rate
Most reliable method to arrive
at a royalty rate
Benchmarking combined with DCF
Second least reliable method
Rules of thumb
Least reliable method
Statistics and averages
25% Rule
Rule of thumb








Rule of Thumb
As with all Rules of Thumb – need to use with caution
May be a starting point only – with justifiable departures
Sam Davis, “Patent Licensing”, Patent Law Institute 1958, see
Goldscheilder & Marshall, “The Art of Licensing from a Consultant’s Point
of View”, Les Nouvelles No 6, 1971
Licensor should receive 25% of the pre tax profits, and the licensee should
receive 75% of the pre tax profits.
Principle is that a royalty should be 25% of an expected profit margin.
Rule used not just to value IP for licensing purposes, but used to assist in
determining damages in infringement proceedings.
Rule formulated having regard to a study of numerous worldwide licenses
negotiated over many years.
25% Rule
Operation
 Relies on knowing the margin for an industry
 If a margin is generally known or accepted, the 25% can work as a rule
of thumb
Anticipated Sale Price
400
Anticipated Sale Price
400
Margin 10%
40
Margin 15%
60
25% Rule
10
25% Rule
15
Royalty %
400
10
Royalty %
2.5
 Margin / Profits subject to interpretation
400
15
3.75
25% Rule
Discounting for early stage
 Assumes that the IP is market ready
 Development costs are therefore not taken into account
 Should licensee pay same royalty rate if IP is market ready / still requiring
$100m of development / regulatory costs ?
Anticipated Sale Price
800
Margin 20%
25% Rule
Royalty
160
40
Discount for early stage
50%
60%
70%
80%
800
40
5
2.5
2
1.5
1
25% Rule
How reliable is it ?
 A starting point,
 A guide
 Not an inflexible rule
 Royalty Source
database table – and
new study of
applicability of 25%
Rule
 “Use of the 25% Rule
in Valuing IP Les
Nouvelles December
2002 p 123
25% Rule
A starting point
 Once you have a starting point
 What factors may suggest that the royalty should:

Decrease
 IP not market ready
 Further R&D
 Regulatory and compliance matters
 A highly competitive market
 High plant production costs
 High marketing costs
 Extraordinary capital expenditure
that has to be incurred
 Volatile Margin
 Increase
 A robust patent position
 Access to ongoing know how and
trade secrets
 R&D Program by licensor and
prospect of improvements
 Marketing networks and leads
 Marketing assistance
 Proven track record
25% Rule
Don’t make that the royalty rate
 Don’t make the royalty rate 25% of pre tax profits
 The concept of profit is too easily capable of manipulation
 Onerous to keep separate accounting records in relation to different
products of a business






25% is a rule of thumb, an approach
Ascertain the margin
Model the revenues and costs
Arrive at an amount that represents 25% of margin
Apply that as a percentage
Adjust upwards or downwards as the circumstances justify
Royalties responsive to development costs / risk
 The more development costs a
 The more development costs a
licensor has incurred, the greater
licensee will incur, the lower the
return it seeks, the higher the
royalty it is prepared to pay
royalty it requires
 Put another Way:
 The more risk a licensor has taken,
the greater the return it seeks
 Put another Way:
 The more risk that a licensee
takes, the lower the royalty it is
prepared to pay
Royalties responsive to development costs / risk
 Research organisation licensors typically get a low royalty rate:
 compared to the licensee, they take comparatively little risk, and pay
comparatively little of the development cost
 Research organisations may typically pay $500K to $1-2m in research
 Pharma / multinational licensee will typically pay $25 m to $300 in
 Further research costs
 Development costs
 Regulatory costs
Average financial terms in University
Biotech Deals
Average financial term s in University Biotech Deals in US$ 1980 to 2003
Type of financial term :
1980-1986
Up front fee
$20,085 (n=21)
Royalties on sales
4% (n=25)
Royalties on sub license income 37.4% (n=9)
Source: Nature Biotechnology June 2003 p 620
1987 - 1990
$40,655 (n=35)
5.1% (n=43)
34.3% (n=17)
1991 - 1994
$48,649 (n=53)
4.2% (n=62)
28.4% (n=27)
1995- 2003
$87942 (n=24)
3.9% (n=24)
28.4% (n=14)
Pathway to Market - Value
Discovery
Lead
Pre-Clinical
Phase I
V
A
L
U
E
PATHWAY TO MARKET
Phase II
Phase III
Registration
Pathway to Market - Risk
Discovery
Lead
Pre-Clinical
Phase I
V
R
A
I
L
S
U
K
E
PATHWAY TO MARKET
Phase II
Phase III
Registration
Royalties on Therapeutic Drugs
.
THERAPEUTIC DRUG
Technology is at the following stage:
Royalty % Milestone payments
in US $
1.Identification of new chemical entity (new
compound etc)
3-5
100K – 1m
2.Therapeutic indication based on structure
3-6
200K – 2m
3.In vitro data upon the chemical entity showing a
positive therapeutic indication
4-7
300K – 4m
4.Animal studies upon a suitable animal model
showing a positive therapeutic indication
5-10
500K – 5m
5.Toxicology studies indicating no adverse
toxicological effects
6-12
500K – 8m
6.Commencement of Phase I trials
7.Commencement of Phase II trials
8.Commencement of Phase III trials
9.Product licensed by FDA
6-12
8-15
9-18
12-30
500K – 10m
1m – 25 m
2m – 100m
2 x previous
milestones +/- < 20%
Clinical Trials
.
Phase I:
Phase II:
Phase III:
Clinical Trials
Testing a new drug or treatment in a small
group of people (20-80) for the first time to
evaluate its safety, determine a safe dosage
range, and identify side effects
Drug or treatment is given to a larger group of
people (100-300) to see if it is effective and to
further evaluate its safety
Drug or treatment is given to a larger group of
people (1,000-3,000) to confirm its
effectiveness, monitor side effects, compare it
to commonly used treatments, and collect data
Variables impacting upon royalty rates
 who pays development costs
 a research organization perceived to be inexperienced will get a comparatively
lower rate
 a product with a small market will attract a small royalty rate (e.g. a rare
disease)
 product with lots of competing products (e.g. headache tablet) likely to attract a
small royalty rate
 product with a large market, and few competitors will attract a very high
royalty rate
Structure of Milestone Payments
No
Milestone
Amount US$
1.
Phase 1 clinical trials commence anywhere in the world
1,500,000
2.
Phase 2 clinical trials commence anywhere in the world
3,000,000
3.
PLA approved, but only in respect to the first such approval
anywhere in the world
8,000,000
Pre-clinical Milestone Payments
Source: Health Advances LLC Analyses of selected Recap reported deals
Royalty on Vaccines
VACCINE
Technology is at the following stage:
Royalty %
Milestone payments in US$
1.Identification of antigen
2.Animal studies showing immune response
3.Animal studies showing immune response and
protection
4.Toxicology studies indicating no adverse
toxicological effects
5.Commencement of Phase I trials
6.Commencement of Phase II trials
7.Commencement of Phase III trials
8.Product licensed by FDA
3-5
4-7
5-8
100K – 2m
250K – 2.5m
500 – 3m
5-10
500 – 3.5m
7-10
7-12
8-15
10-20
750K – 5m
2m – 10m
5m – 15m
2 x all previous milestones +/up to 20%
Royalty on Diagnostic product
DIAGNOSTIC
Technology is at the following stage:
Royalty % range
Milestone payments in US$
1.Identification of punitive marker
(protein, gene sequence etc)
4-8 for 3-5 years then
declining to 15-35% of
estimated profit in 5th year
after product launch
10-25% of aggregate of total
milestone payments
2.Correlation between disease state and
marker in small study of 10-20 patients
6-12 for 3-5 years then
declining to 25-60% of
estimated profit in 5th year
after product launch
20-30% of aggregate of total
milestone payments on filing
PLA with FDA
Range of Total: 0-5m
3.Correlation between disease state and
marker in large study of 100 patients
8-15 for 3-5 years then
declining to 50-75% of
estimated profit in 5th year
after product launch
50-70% of aggregate of total
milestone payments on PLA
approval
Range of Total: 0-5m
Range of Total: 0-5m
Royalty rate distribution
Licenses by Industry: Probability of Ranges
License In
0-2%
2-5%
5-10%
Aerospace
50%
50%
Automotive
52.50%
45%
2.50%
Chemical
16.50%
58.10%
24.30%
Computer
62.50%
31.30%
6.30%
Electronics
50%
25%
Energy
66%
Food/Consumer
100%
10-15%
15-20%
0.80%
0.40%
>25%
25%
33%
General M FG.
45%
28.60%
12.10%
Gov't/University
25%
25%
50%
Telecommunication/Other
40%
37.30%
23.60%
License Out
0-2%
2-5%
5-10%
10-15%
40%
55%
5%
Aerospace
20-25%
14.30%
Automotive
35%
45%
20%
Chemical
18%
57.40%
23.90%
0.50%
Computer
42.50%
57.50%
15-20%
20-25%
Electronics
50%
15%
10%
25%
Energy
50%
15%
10%
25%
Food/Consumer
12.50%
62.50%
25%
General M FG.
21.30%
51.50%
20.30%
2.60%
0.80%
0.80%
Gov't/University
7.90%
38.90%
36.40%
16.20%
0.40%
0.60%
Telecommunication/Other
11.20%
41.20%
28.70%
16.20%
0.90%
0.90%
>25%
2.60%
0.90%
Royalty Source data
Royalty upon sub-license income
received by licensee

Sub-licensee will pay to Licensee




Royalties on the sublicensee’s own sales
 Milestone payments, etc
Licensee pays a royalty to Licensor
on all that income
Up to 50% non pharma
Pharma deals:
 30% a good result
 25% a poor/ fair result
 20% a poor result
 15% a very poor result
.
Licensor
Licensee
Sub-Licensee
Benchmarking Royalty Rates
Benchmarking
 Nobody wants to get 3% when the benchmark is 10%
 Nobody wants to put a deal at risk by demanding 8% when benchmark is 2%
 Need to know what is the right royalty rates
 Benchmarking or comparables
 Something is worth X because something else that is similar to it achieved
X in the market place
 Challenge is whether it is truly comparable
 No two technologies are identical
 How similar / different are they ?
 The greater the similarities the greater the reliance on the comparable deal
 To benchmark need to source information about deals that concerns
comparable IP
Sources of information
Databases
 Databases
 www.recap.com
 www.pharmaventures.com
 www.knowledgexpress.com
 www.royaltystat.com
 www.royaltysource.com
 Bioworld Today news archives on www.knowledgexpress.com
 Recap: best biotech source – contains most deal making information
 Pharmaventures – mostly press releases
 Royalty stat and royalty source – broad cross section of industries – compiled
from EDGAR
 Knowledgexpress: Accesses pharmaventures and royaltysource
Sources of information
Professional Reports
 Professional reports
 Intellectual Property Research Associates issues reports on royalty rates for
all industries, - fragmented information
 http://www.ipresearch.com/index.html
US $995
US$250
US$1500
Sources of information
Professional Associations





Licensing Executives Society
“Les Nouvelles” Journal
www.lesi.org
Members can search journal on line
Wealth of opinions and observations about royalty rates for different
types of industries
 Techno-L Discussion group
 Accessible at http://www.autm.net/index_ie.html
 Searchable archive of queries posted and replies with opinions and
views onroyalty rates for different types of industries
Sources of Information
Press releases and web searches
 Press releases about deals in a particular industry or dealing with certain
categories of products
 Sources of press releases
 Archived press releases on the web:
 http://www.prnewswire.com
 http://money.cnn.com/
 http://www.businesswire.com
 http://www.prweb.com/
 And Google
Benchmarking
 Find comparable deals
 Ascertain their financial terms
 Ascertain the things about the deals that are
 Similar
 Different
 Assess the extent to which a deal can be a Comparable
 Assembles all the comparable deals and form conclusions
 The closer other deals are, the more reliable they are as benchmarks
 The further away they are, the less reliable they are