How To Tell What Patents Are Worth

TECHfullyBREWED

Publish date: Fri, 14 Aug 2015, 07:44 AM

This article is by Joseph G. Hadzima, Jr., a senior lecturer at the MIT Sloan School of Management and the Martin Trust Center for MIT Entrepreneurship.

This is a lucrative time for intellectual property. Early 2013 Kodak, the bankrupt company that invented the digital camera, sold its portfolio of 1,100 digital photography-related patents to a dozen licensees, including Apple, Microsoft, and Google, for $525 million. Spring 2012, Google bought Motorola Mobility, with its 17,000 patents, for $12.5 billion, to protect its Android mobile operating systems from rivals. Also in 2012, Microsoft acquired 800 patents from AOL for more than $1 billion, only to turn around and sell 70% of them to Facebook for $550 million in cash.

How are companies coming up with these eye-popping valuations? That’s a straightforward question with a complicated answer. Evaluating an individual patent boils down to three steps. First, companies must determine the quality of the underlying invention outlined in the patent. Second, they must evaluate whether the patent is well constructed. Third, they need to figure out how to extract value from the patent.

A little background: Back in the late 1990s, I started to work for Main Street Partners, a venture firm that helped companies spun off out of MIT to commercialize their technologies. One of the biggest challenges we faced was putting a dollar figure on business’ intellectual property. The problem is that IP comes in the form of patents, very dense legal documents filled with technical language and jargon. Most managers don’t have the training to deal with patents—in many cases, their eyes glaze over the minute they hear the word—so they leave it to the lawyers.

But law is too important to leave to lawyers. (Disclosure: I was a practicing lawyer for 17 years.)

The stakes for companies are getting bigger. The recent Google, Apple, Microsoft, and Facebook deals prove that. Research indicates that about 70% to 80% of a company’s market capitalization comes in the form of intangible assets, which include intellectual assets such as patents, trademarks, copyrights, and other business knowledge and know-how. Patents are moving from a legal role to a strategic management one, and company leaders must be prepared.

At Main Street Partners and our portfolio company, IPVision, we developed a formula for evaluating a company’s patents. Originally we devised it as a first-pass screen, but over the years we found that it predicted success very well. Our initial sample included the patent portfolios of more than 9,000 venture-capital-backed companies. Using publicly available data, we assessed the value of those portfolios and then watched over a three-year period to see how well the companies fared. We measured success by a company’s having achieved an IPO or having been acquired; we measured failure by its going out of business.

Our analysis demonstrated that 86% of winners had strong (versus typical) intellectual property portfolios. Granted, this is a correlation and not necessarily causation; a smart patent strategy reflects good management. Leaders who run the patent element of their business well probably also run the rest of their business well, too. But that doesn’t diminish the fact that it is possible to use certain metrics to value IP, and that those metrics will hold up over the long term. If you’re a manager seeking to acquire another company for its IP, or if you’re wondering how to value your own company’s patent portfolio, here’s a primer:

Start at the beginning. Take a look at the company’s patents. You can easily find this information at the U.S. Patent and Trademark Office or at see-the-forest.com, the free IPVision website. How many patents does the company have? How many relative to its competitors? How well positioned are the company’s patents? Has management built a strategic portfolio, or are its patents just a hodgepodge of good ideas?

Next ask how important is the patent’s underlying invention? Is it a transformative invention, like the Cohen Boyer patent, the basic gene-splicing patent devised by two Stanford professors that helped launch the biotech industry? Or is it just an incremental invention, like, say, the addition of a squeaky noise to a child’s toy? One way to help answer that question is by looking at how often the particular patent is cited by other patents. When you’re applying for a patent, you have to describe “prior art,” which means that you need to show how your idea is novel by referencing all the other patents and literature that are similar and the ways in which yours is different. Frequent citations of prior art are an indicator that it is a good patent.

Then ask: Does the patent capture and protect the value of that invention? A patent is like real estate. When you own a piece of real estate you might put a fence around it to keep people from trespassing on your property. The fence is the metaphorical claims in your patent. Well-constructed claims are worth a lot more than flimsy ones.

The final step is to examine how to extract value from the patent. The Cohen-Boyer inventions were fundamental and revolutionary, but it was Stanford’s licensing strategy that was the true genius. Stanford wrote non-exclusive licenses with small upfront licensing fees, in the neighborhood of $10,000, and small-percentage running royalties on any products that were developed using the technology. Since the licensee only had to pay if and when it got a product in the market, getting companies to sign up was relatively easy. As a result, the patent has generated over $250 million in royalty revenue for the University.

Ultimately, individual patents are like bricks and a portfolio is like a collection of bricks. Are the bricks heaped in a pile on the ground, or have they been assembled into a strong and attractive building? Figuring this out is not the lawyer’s job. It’s management that has to decide how to create, protect, and grow value for shareholders.

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