"Ten tips for start-up valuation"

Intellectual Property Marketing Advisor has just circulated this feature entitled "Ten tips for start-up valuation", penned by Martin Zwilling (CEO & founder of Startup Professionals, Inc., and Managing Partner of Southwest Software Ventures & and Consulting). The theme is that, when selling a start-up to potential investors, it's important to get them excited about your team, your product, and your company. Once they're hooked, they cut to the chase and ask the key question: “What is your company’s valuation?” That's when the tips come into play. As a sucker for lists, I found myself drawn almost magnetically towards them. According to Martin:

"* Place a fair market value on all physical assets (asset approach). ... New businesses normally have fewer assets, but it pays to look hard and count everything you have. Be sure to include computer equipment, office equipment, furniture, tools, and the value of inventory or prototype products [So far, so good ...], including development costs [... but I'm not convinced that 'development costs' lie comfortably within 'fair market value', particularly for prototypes that do not fit within the R&D template of a well-established technology].

* Assign real value to intellectual property. The value of patents and trademarks is not certifiable, especially if you are only at the provisional stage. A “rule of thumb” often used by investors is that each patent filed can justify a $1M increase in valuation [I hope that a 'Ten tips for investors in a start-up valuation' will caution against such an arbitrary and extravagant rule of thumb. The patent may be useful or useless, valid or invalid; the existence of a market, and the projection of a product or process (whether patented or not) into that market, may prove more useful guidance].

* All principals and employees add value. [How true, particularly if they're (i) nailed down by decent contract terms, (ii) happy to stay put and (iii) not claiming the IP rights for themselves] Assign value to all paid professionals, as their skills, training, and knowledge of your business technology is very valuable. Back in the “heyday of the dot.com startups,” it was not uncommon to see a valuation upped by $1M for every paid full-time professional programmer, engineer, or designer [But look what happened to most people who invested in doc.com start-ups and gave up their day jobs ...].

* Early customers and contracts in progress add value. [Another good point] Every customer contract and relationship needs to be monetized, even ones still in negotiation. Assign probabilities to active customer sales efforts, just as sales managers do in quantifying a salesman’s forecast. Particularly valuable are recurring revenues, like subscription amounts, that don’t have to be resold every period. [The formal accounts and public trading statements of customers can enhance the start-up's value: if your early customers are the Procter & Gambles or the GEs of this world, it might by worth leveraging this]

* Discounted Cash Flow (DCF) on projections (income approach). In finance, the income approach describes a method of valuing a company using the concepts of the time value of money. The discount rate typically applied to start-ups may vary anywhere from 30% to 60%, depending on maturity and the level of credibility you can garner for the financial estimates. [This is the point at which the tips allude to factors that make a business look less valuable -- but it's important to be realistic and to appreciate that investors are buying a risk as well as an opportunity]

* Discretionary earnings multiple (earnings multiple approach). If you are still losing money, skip ahead to the cost approach. Otherwise, multiply earnings before interest, taxes, depreciation and amortization (EBITDA) by some multiple. A target multiple can be taken from industry average tables, or derived from scoring key factors of the business. If you have no better info, use 5x as the multiple. [the investor will probably have his own guidelines for selecting a multiple and, particularly if familiar with the sector, may be hard to shift]

* Calculate replacement cost for key assets (cost approach). The cost approach attempts to measure the net value of the business today by calculating how much it could cost for a new effort to replace key assets. [This is a tricky one: a key patent may be irreplaceable if the start-up is built around it. But that doesn't mean that the start-up is worthless]

* Find “comparables” who have received financing (market approach). Another popular method to establish valuation for any company is to search for similar companies that have recently received funding. This is often called the market approach, and is similar to the common real estate appraisal concept that values your house for sale by comparing it to similar homes recently sold in your area. [I'm not enthusiastic about this. Unlike real estate, where comparators are relatively easy to find and the criteria for their evaluation are stable and predictable, IP-based start-ups rarely have such good comparators, except for low-risk brand- or design-based start-ups like a new burger franchise or teen-driven fashion house]

* Look at the size of the market, and the growth projections for your sector. [As indicated above, I think this is really important] The bigger the market and the higher the growth projections are from analysts, the more your start-up is worth. For this to be a premium factor for you, your target market should be at least $500 million in potential sales if the company is asset-light, and $1 billion if it requires plenty of property, plants and equipment [No comment, but many readers will not find it hard to read my mind ...].

* Assess the number of direct competitors and barriers to entry. Competitive market forces also can have a large impact on what valuation your company will garner from investors. If you can show a big lead on competitors, you should claim the “first mover” advantage. In the investment community, this premium factor is called “goodwill” (also applied for a premium management team, few competitors, high barriers to entry, etc.). Goodwill can easily account for a couple of million dollars in valuation". [Being second on to the market is also useful in a sales pitch. The innovator has had to educate the market as to the desirability, functionality etc of a new product or process at its own expense, but second-timers have no such inconvenience].

I'm sure that readers of this weblog will have some comments of their own, so I hereby throw this feature open for debate. Please feel free to post your responses below.

So What Will Branding Look Like in a Small Car World?

One of the most interesting aspects of trade mark practice is to deal with the relationship between trade marks and brands. When I had the pleasure to speak last July in India on branding, I dutifully attempted to set out the differences between trade marks and branding. Characterizations of this distinction abound and we did our best to distill them down for the audience. It was all most entertaining, until--during the Q&A afterward-- a person from the trade mark department of a major multinational was asked to what extent she was involved in brand activities at the company. The answer was simple and direct: "Not at all".

Her comment reminded me how both close, yet how removed, trade mark practice is from branding. Trade mark lawyers deal with issues such as likelihood of confusion, source identification, and inherent distinctiveness of trade marks. At the end of the day, however, the trade mark profession is apparently there to serve the further interests of the brand. What the brand manager wants is the assurance that all is quiet on the trade mark front, so that the she can get on with the task of developing and sustaining value in the brand.

I was reminded of this when reading an article that appeared in September 19th issue of The Economist, entitled "Small Isn't Beautiful: The Car Industry." The article described the continuing challenges confronting the automobile industry. From my IP perspective, one particular portion of the discussion caught my attention. There, the article, citing analyst Max Warburton, explained one major set of reasons why small vehicles are less profitable for car companies than are large vehicles, by comparing the small-car Fiat 500 with the sports utility Audi Q7 as follows:

"...[T]he fixed costs are nearly identical, whereas the variable costs of making the Q7 (labour, raw materials, and so on) are only about 10,000 Euros higher for the Audi. Yet the Fiat sells for as little as little as 10,000 Euros, compared with a sticker price of at least 40,000 Euros for the Audi."

The article went on to list three factors that augur in favour of a permanent trend in favour of small vehicles:

(1) The sale of more pricey cars has been encouraged in part by the availability of cheap leasing credit. In addition, there was an anticipation of a high post-lease sales price, which is depressed if too many such high-price vehicles are leased and later put into the secondary resale market.

(2) Baby boomers will more more likely to purchase smaller cars in their later years, because they will require less seating capacity.

(3) Stronger emissions standards will favour small vehicles.

Find the Killer Brand

I have several thoughts on all of this.

1. The article emphasized in bas-relief the relationship between branding and profitability, and the branding potential to leverage variable costs several times over the ratio of variable costs to fixed costs. It is no wonder that branding at the high end of a product line is so coveted. That said, the article also revealed the difficulty of leveraging brands in an environment with a clear (at least to The Economist) trend away from a consumer preference for high-end car products.

2. If it is true that smaller cars will be increasingly preferred, and that the margin on the sale of each such car will be materially less than that earned on the sale of a branded high-end vehicle, then the challenge is how to restructure a successful branding stratgegy in such an environment. In such a situation, there will be in increasing emphasis on unit sales to make up for the loss of profits from decreased high-end brand sales.

3. From the branding point of view, the trick would seem to be to find the right branding for a lower-priced product offered by a company that had previously emphasized a higher-end product in its high end/low end product mix, and had calibrated its brand accordingly. This rebranding effort will need to compete with current brands that are perceived as identifying smaller cars of high value. How this competition of rebranding cars to emphasize smaller vehicles at the lower price range, both at the house mark and model name level, will play out may go a long way to determining the long-term viability of at least some of the companies in the auto industry.

IC Knowledge Center

IP Finance doesn't do reciprocal links with other websites, but it's always happy to draw the attention of readers to interesting sites with which they may not be familiar. Last week, following a podcast discussion with Mary Adams, I came across IC Knowledge Center: Information and Ideas on Intellectual Capital, which you can access here. There's a weblog here, but it's part of a more complex site which is maintained on behalf of the international IC Rating Community and is an example of a rather interesting international cooperation between experts in the US and Sweden in the evaluation of the dynamics of an IP portfolio in terms of a business's human capital, relationship capital and structural capital (click here for an explanation of terms) rather than as, eg, a set of dry legal monopolies.

Can One Contract Around a Trade Secret?: Further Comments

I do not usually follow up a blog post. I will make exception, however, in connection with the blog post of Monday, "Can One Contract Around a Trade Secret"? The Comments received (8 at last count) have been thoughtful, indeed instructive, about the uncertainties surrounding trade secrets and their treatment under various laws. In particular, there appears to be significant divide between the US position (or at least one view of the position), on the one hand, and the English legal tradition on the other.

I urge readers who have not followed these Comments to have a look at them. I would also encourage additional readers to add their Comments to the discussion. I am especially interested in comments from readers who practice under the civil law tradition. Is the position under the civil law more like the US, or English position, or does it stake out a "third way" to understand the nature of trade secret rights?

One thing has become clear: there are many aspects of trade secrets law that do not yield a single answer. We hope to consider further several of these aspects in future blog posts.

Irish make IP-friendly amendments to Finance Act

In "Tangible Tax Relief for Intangible Assets", written for International Law Office by Aoife Murphy and Robin Hayes (WhitneyMoore), the authors welcome changes in the Irish tax set-up that will benefit intellectual property rights owners.
They explain:

Right: Ireland is taking steps to improve the position of IP rights exploitation

* the Finance Act 2009 introduced wide-ranging tax relief on capital expenditure incurred by companies on the acquisition of intangible assets in order to enhance Ireland's appeal as a location for the development and exploitation of intellectual property; a wide range of IP now falls within the scope of Ireland's tax incentive regime for the acquisition of intangible assets, enabling companies previously not entitled to tax relief on intangible assets to avail themselves of a tax write-off.

* the definition of an 'intangible asset' which qualifies for the relief has been extended and now includes (i) patents and registered designs, design rights and inventions; (ii) trade marks, trade names, trade dress, brands, brand names, domain names, service marks and published titles; (iii) copyright and related rights within the meaning of the Copyright and Related Rights Act 2000; (iv) certain plant breeders' rights; (v) know-how generally related to manufacturing or processing; (vi) sale authorizations in relation to medicines or products of any design, formula, process or invention; (vii) rights derived from research prior to authorization, on the effects of items covered directly above; (viii) licences in respect of such intangible assets referred to above; (ix) any 'non-Irish' right similar to those outlined above; and (x) goodwill which is directly attributable to the items set out above.

The authors then detail how the relief works, explaining that where a specified intangible asset is held for more than 15 years and then sold, there is no clawback of capital allowances unless the asset is sold to a connected company which subsequently claims allowances in respect of the capital expenditure on the asset. They also mention new provisions relating to Stamp duty and the restrictions and (sadly necessary) anti-avoidance measures that seek to prevent abuse of the relief.

The authors' final word on the reforms is this:

"The absence of a wide-ranging tax relief for the acquisition of intellectual property (except for certain cases such as patents and software) was considered to be a problem for some years. It is anticipated that the changes to the tax regime will encourage more companies to develop and exploit intangible assets from an Irish base and should help to increase Ireland's portfolio of overseas investors".

Can One Contract Around a Trade Secret?

I begin a new teaching term next week and that means two sessions with my MBA students, setting out the basics of IP law, before we delve into the challenges of the IP-managerial interface. I have been teaching IP for a long time and that should mean that there is very little angst connected with this part of the course. Sadly--au contraire! There is one segment of the presentation--trade secrets--that I always approach with the "fear and trembling" usually associated with more existential issues.

Put briefly, at some time during the treatment of trade secrets there is always at least one thoughtful, attentive student who asks the ultimate question--"So why do we need trade secret protection as a separate and distinct right? Surely it can be subsumed into other rights--such as contract and tort--that handle the subject matter." Over the years, I have worked up an answer that seeks to point the advantages of having a separately protectable right for valuable secrets. I was recently pleased to find that my notions about trade secrets were supported as part of a much wider-ranging article by the distinguished IP scholar Mark Lemley, in his most interesting article, "The Surprising Virtues of Treating Trade Secrets as IP Rights", Stanford Law Review, vol. 61, Nov. 2008.

From time to time on this blog I will consider various aspects of Lemley's analysis, because I am firm believer that trade secrets should be viewed more centrally as part of anyone's bundle of IP rights. In this blog post, I want to consider one aspect that has practical as well as doctrinal significance, namely, whether one can contract around trade secrets law (similar, e.g., to the question that arises under copyright law whether one cannot contract away the right to reverse engineer).

Thus Lemley writes:

"In trade secret law, [the question] comes up in three significant contexts: efforts to contract around the requirement of secrecy itself, whether in business disputes or in restrictive employment covenants, efforts to ban reverse engineering by contract, and the question of whether a confidential relationship can be implied absent a contract" (footnotes omitted.)

The rationale for not allowing one to contract away a trade secret right is stated in a footnote to Lemley's article, where James Pooley argues as follows:

"The law relating to trade secrets reflects a balance of public and private interests in the encouragement of innovation, the preservation of ethics and the maintenance of a free marketplace of ideas and movements of labor. The balance should not be upset in any given transaction by private understandings between the parties."

Lemley is a bit more circumspect, stating that "... my inclination is to prevent parties from opting out of particular rules of trade secret law, at least to the extent they rely on trade secret rather than contract remedies."

Sadly, there does not seem to a dispositive answer to this question. In my view, the issue of whether one can contract around trade secrets is a "big thing". I encounter one or another of the three scenarios described by Lemley on a frequent basis and I am uncertain about what to advise if the client asks about the ultimate enforceability of the "contract around" provision. The underlying difficulty is always the same--if there is a broad right to "contract around" the trade secret right, why exactly should trade secrtes be placed in same pantheon as patents, copyright and trade marks"? And while I am still stammering to give a cogent answer on that question, there then follows the ultimate query--"If so why should we be mentioning trade secrets in the same breath?"

I have less than a week to prepare myself for this year's inevitable bout with uncertainty about the answers to these questions. Sharon Sandeen has characterized trade secrets as "the Cinderella of intellectual property law". I am not sure, however, that discussing trade secrets with challenging MBA students is exactly "the ball" that Sandeen has in mind. Any advice will be welcome.

Char Girl or IP Right?

Those IP security interests again: calling all stakeholders!

Following what was an extremely interesting and constructive seminar earlier this week on the UNCITRAL proposals for dealing with securitised interests in IP rights, the Intellectual Property Office (that's the operating name of the Patent Office in the UK) would like to hear further views from stakeholders on the principal outstanding issues, which we will feed into the next round of negotiations beginning on 2 November.

Right: stakeholder or steak holder? It's difficult to decide after so many 'meatings' ...

To this end the IPO has set up a dedicated e-mail address (uncitral@ipo.gov.uk) and would like to receive opinions and comments on the current draft text by 30 October -- that's pretty close, but time is of the essence. The text of the UNCITRAL proposals can be found at http://www.uncitral.org/uncitral/en/commission/working_groups/6Security_Interests.html

A very short note on the seminar appears here and a fuller report will be produced next week when time permits. Anyone wanting to read the fascinating history of the UNCITRAL proposals, as viewed through the eyes of this blog -- which was founded in response to them -- can read the whole story in reverse chronological order by clicking here.

Oops!

Some of you may have already received a portion of an intended blog post. The publication of the post was in error and it has been deleted on the blog site. I hope to have the full blog post completed by tomorrow, at which time I expect to show more dexterity in the use of Blogger. Sorry to any of you who wondered whether I had stayed up too late reveling last night.

Denmark's new transfer pricing IP valuation guideline

Skat's (Denmark's tax authorities) have issued new guidelines on IP valuation entitled "Transfer Pricing, controlled transactions, valuation". Google's handy translation tool will translate the lengthy download in the link for interested readers. Deloitte's summary provides the once over:

"The new guidelines significantly change the generally accepted approaches to valuing individual intangible assets, as well as entire businesses, for Danish transfer pricing purposes. The guidelines focus on forward-looking valuation approaches, which are generally in line with the methodologies followed by most taxpayers. However, the documentation requirements included in the guidelines are broad and extensive and not well-defined. Accordingly, the guidelines should be considered in detail when contemplating IP or business reorganizations involving Danish groups or entities." Deloitte

Madonna, The Mail on Sunday and "undisclosed sums"

Last week publicity-conscious music icon Madonna (Ciccone) was reported to have accepted substantial (if sadly undisclosed) damages for privacy and infringement of copyright over the publication by The Mail on Sunday newspaper of "purloined" photos of her December 2000 wedding to Guy Ritchie. Through her solicitor she informed the judge, Mr Justice Peter Smith, that she would be donating the damages to her Raising Malawi charity.

Unlike many other events in Madonna's life, her wedding was private. However, in 2003, an enteprising interior designer, while working on her home in Beverly Hills, surreptitiously copied at least 27 photos from her wedding album. These photos were passed on to Bonnie Robinson, who offered to sell them to the Mail on Sunday. The paper did not purchase them at that time, but waited till the predicted announcement of the couple's divorce, at which point there was huge media interest about her marriage, and bought the photos then. Ten of these photos were published just three days after the divorce announcement and without prior warning. Madonna then instituted legal proceedings against both Robinson and the paper, alleging breach of privacy and copyright infringement.

A solicitor for Associated Newspapers, which publishes The Mail on Sunday, said that it accepted that it had acted wrongly and offered its sincere apologies to Madonna and her family for invading her privacy and infringing her copyright.

While the public was probably preoccupied, as was the media, with the details of Madonna's private life and career activities, IP lawyers are more interested in things like the sort of money that infringers agree to pay over to charities in order to settle infringement claims. Is there a "going rate"? Is the scale of undisclosed payments based on the severity of the infringement or the degree of celebrity of the claimant? And is it possible for the party paying the sum to derive the benefit of Gift Aid or other tax benefit?

While statements in court only talk of undisclosed sums being so donated, it must be possible to get some useful information -- if only on an historical basis -- from the records that the charities themselves must keep. The Charity Commission in the UK is responsible for overseeing the financial activities of British charities and their reporting requirements, but those charities not registered in the UK are presumably registered and supervised elsewhere, where different record-keeping and confidentiality requirements may apply.

Do any readers have any insights into this issue? If so, can they please share them with the rest of us.

That seminar ... and some expressions of thanks

A fuller report on today's seminar, "IP rights and the UNCITRAL secured transaction project: the draft recommendations and their potential consequences for British lenders and IP owners", will follow on this weblog in due course -- and before I post it I should add that I'd welcome comments from those present, since my organisational responsibilities caused me to miss some of the contributions.

At this point all I'll say is this:

* The main speaker, Spiros V. Bazinas (Senior Legal Officer at UNCITRAL secretariat), set out the project's aim and purpose, with a particular focus on IP financing and the UNCITRAL IP Supplement. This meant that he was on his feet and speaking/responding for the best part of three hours. The fact that he did so, dealing with some very tough questions from IP and banking interests alike, was hugely appreciated. Thanks, Spiros.

* The chairman (Professor Graham Penn) and the panellists -- Ben Goodger (Rouse Legal), Mark Bezant (LCI) and Nigel Page (Finance Editor, Intellectual Asset Management) -- took the time and trouble to turn up an hour before the event and discuss the main issues in some detail, to facilitate the smooth running of the seminar. Thanks, all of you.

* Further thanks are due to the volunteers who have served on an informal basis to promote interest in IP securitisation and to inject some urgency into its consideration by rights owners, licensees and their professional advisors. These include but are not limited to Eva Lehnert, Dawn Franklin and Lorin Brennan. The London office of Olswang gave us a room with a panoramic view, large enough to hold nearly 100 people, with coffee and biscuits too, for which we were all very grateful. Amazingly, the list of those attending incurred only four no-shows -- something of a record.

* The proceedings have been recorded and, assuming that the recording is audible, will be made available via this weblog to all who are interested.

So Who Are Apple and Google Really Competing Against ?

Let's be honest: there is nothing better than an epic hi-tech battle. If Gog and Magog were the warriors of choice in Biblical days past and future, then their equivalents today are Google, Microsoft and Apple. In particular, with the recent departure of Google CEO Eric Schmidt from the Apple board of directors in early August, all eyes are focused on the alleged structural conflict between these two hi-tech titans. Even if Apple and Google are notionally allied in common struggle against Microsoft, they will find themselves in direct conflict over supremacy in the high tech world. Or so it is claimed.

One view of this struggle was discussed in an August 17, 2009 article written by Peter Burrows for Business Week and entitled "Apple and Google: Another Step Apart". The focus of the article were the recurrent two-way hi tech struggles, first between Microsoft and IBM (control of the PC), then between Microsoft, on the one side, and Netscape and Sun, on the other (control of access to the internet) and, more recently, between Apple and Google (control of the multiplicity of connectivity devices and platforms).

There is something a bit artificial about the typology--where are Intel and HP, for example? Nevertheless, there is merit in considering what the article describes as the "cultural opposites" -- Apple ("closed, customer-oriented, quality-focused") versus Google ("open, cloud-oriented, quality-focused"). As stated in the article:

"Google is the chief advocate for a wide-open world of Web standards, in which programmers should be able to run just about any software on virtually any computing device ... [including] dozens of Android-based handsets [are you listening, Apple iPhone?]."

On the contrary, we have Apple, with an emphasis on

"applications ... designed to work only on Apple devices. The company's ultimate goal is create an alternative, more exclusive universe, where consumers gladly play by Apple's rules as they use its stylish, easy-to-use products."

From the point of view of innovation, which view is better placed to prevail? Per Professor Henry Chesbrough of University of California-Berkeley, if history is any guide, Google has the upper hand. According to the article, Apple lost out to Microsoft (perhaps more exactly, Wintel, being Microsoft Windows plus Intel chips) in the 1980s because Apple sought to maintain a closed hardware-software ecosystem while Microsoft relied on a legion of independent software developers and PC manufacturers.

Find the Closed System

Based on this community development model and using history as a guide, Apple would seem to be poised to suffer another long-term defeat. After all, the Android system is all about encouraging a community of developers and device manufacturers to base their developments around the open connectivity operating system, while cloud farms, be they of Google or others, will allow users to store and retrieve gobs of data off-site in a far-away cloud.

I am not totally convinced about this conclusion (although, to be fair, the article does conclude that "for now, at least, there's plenty of growing room for both"). Underpinning the analysis is the larger phenomenon whereby hi tech companies are seeking to integrate and consolidate, where software and hardware are increasingly being brought under one corporate roof (such as Oracle seeking to buy Sun). With respect to Apple and Google, however, this one-stop shop view does not quite ring true.

Apple may find its iPhone threatened by Android-based devices but, at the end of the day, if Apple is to succeed a decade hence, it will have to develop another world-beating device. It is just as likely that the Android threat will not be relevant to the success or failure by Apple of this new device, whatever it is. Google is still about leveraging "search", while Apple is still about the next great device and the software to support it. The ultimate struggle for both is not the existential threat posed by each of them for the other, but the ability of each to build on its strengths and to innovate successfully for another generation.

Something tells me that, no matter how attractive it might be journalistically speaking, to view the enfolding competitive challenges of Apple and Google as an updated two-way struggle redolent of the IBM-Microsoft (or Microsoft-Apple) struggles 25 years ago, the reality is fundamentally different. Success for Google and/or Apple will not be about vanquishing the other, but continuing to innovate in a way that makes sense for each particular company. History is not prescriptive but, at best, instructive. This observation applies equally to the hi tech world.

Hi Tech Consolidation?

Memo on some UNCITRAL issues now available

Ahead of tomorrow's seminar on the UNCITRAL proposals on secured interests in intellectual property rights (details here), a memorandum has been prepared which addresses some of the issues that are thought to cause concern or reflect practical problems and which are likely to raised in the course of the afternoon. While this document is being sent to all registrants for the seminar, it can also be downloaded by IP Finance readers here.

If everyone turns up, there will be over 90 people present -- an amazing number for what until recently was seen as an obscure, uninteresting and almost irrelevant issue for many businesses. There's still room for a few more participants: email Sandra Holloway here if you'd like to come. There is no charge for registration.

Can Luxury Goods Survive in the Online Environment?

Finding business models that work for the on-line sale of goods continues to be work-in-progress. Perhaps the best-known attempt to propose an appropriate model is Chris Anderson's (editor of Wired magazine) notion of "the long tail." As set out in his book of the same name, the idea is that bricks-and-mortar distribution is characterized by severe limitations on space and the like -- such as a limited shelf space -- that have the effect of limiting the number of goods that can be reasonably offered. Liberated from the physical restriction of space, niche products -- the long tail -- can enjoy commercial success via online sale and distribution.

Different views have been expressed on just how generalizable is the notion of the long tail. I thought about this question in reading an article entitled "When Cheap is exclusive: Selling designer goods online, "that appeared in the September 5th issue of The Economist. The gist of the article is that a number of online sites have sprung up (in the current jargon--"e-tailers") devoted to the sale of so-called luxury goods online at discount prices. While the bricks-and-mortar luxury good stores, such as Bloomingdale's and Sax Fifth Avenue, are finding themselves stuck with increasingly large stock of unsold merchandise, the e-tail business for luxury is thriving, in large part as a discount price distribution alternative to dispose of this unsold inventory.

What is interesting is that the attraction of these sites (such Gilt Groupe, HauteLook, Rue La La and Vente-privee.com) is in fact a combination of discounted prices together with a customer structure that seeks to preserve the sense of exclusivity that is so important for the sale of luxury goods. Thus these sites may be used only by members, who themselves have been asked to join only another member. As well, the sites frequently run 24-hour sales on a frequent basis, thereby attempting to maintain a high level of interest by customer members.

According to the article, the same designers and purveyors of luxury goods who would resist widescale discounting of their luxury products in the traditional stores are prepared to do so in an online environment. The key to success of an e-tailer site selling luxury goods is how well the site creates a "theatrical environment", despite the discounting of the luxury brand.

So what is one to make of this development? Several thoughts come to mind.

1. A major ingredient of the sale of luxury items in a bricks and mortar world is the ability to manage selective distribution of the product, which thereby serves to support a premium price level. Customer exclusivity is a function of the drawing power of the luxury goods being sold, and of the ability of the brand owner to get the customer to pay the premium price.

2. However, selective distribution seems light years from this approach to selling luxury goods online. In the e-tailing experience described in the article, exclusivity becomes a direct function of limited access to membership at the site. This sense of customer exclusivity is reinforced by the fact that the goods at sale bear luxury labels, even if these goods are being discounted. This is no minor accomplishment. Try to count the number of discount retailers that you know where exclusivity is accompanied by material price discounting of luxury goods.

3. Given this seemingly unnatural combination of exclusivity, luxury goods, and price discounting, how will the discounting affect the long-term aura of the luxury brand? It is difficult to believe that a luxury good can maintain its upscale reputation in the face of a continuing public perception that the luxury product is being sold at a discount.

4. It is true that customer exclusivity could have the effect of softening any such blow, because the relevant public is thereby limited in scope. Nevertheless, assuming that the on-line customer base is roughly similar to the typical customer for the luxury product in the bricks and mortar environment, the word will get out to the relevant consumer population. This cannot be a very positive result for the brand owner.

5. Assuming that e-tailing of luxury goods online threatens the long-term value of the brand, perhaps the answer to the question raised in (3) is that the luxury goods industry is prepared to tolerate the discounting of its products online only for a limited period of time. Under this view, these e-tailer sellers of luxury goods serve to provide another channel of sales only as long as the economy remains sluggish and the exuberance of customers to pay a premium price for luxury goods is diminished. Once the economy recovers, the luxury goods industry will take dead aim at these online distributors.

The upshot is that the long-term relationship between luxury goods and the online environment remains unclear, whether long tail, no tail, or fairy tail. It is a saga worth following.

Pray for the Luxury Good

Securitisation: two items

1. Dr Aaradhana Sadasivam (KhattarWong Singapore) has in recent months been working on an article, "Securitizing Rights Over A Patent and Balancing the Securing Interests of Each Party to the Transaction". While her practice base is Singapore, the article is not geographically limited in its perspective and draws on US case law and some international developments as well as local provisions. If you'd like to take a look at this draft and let Aradhana have your comments, the article (currently just over 5,600 words long) is here and you can email Aaradhana here.

Right: For some, security is a blanket to stroke -- but it takes more to comfort lending institutions who lend on the strength of IP rights

2. The seminar scheduled for next Wednesday afternoon, 14 October, on the UNCITRAL proposals on the securitisation of IP rights (full details of the seminar are here) has now got well over 70 registrants. There's still room for a few more. To secure your place, email Sandra Holloway here and tell her you're coming. The event's free.

What Happens to a Sublicence When the Main License Comes to an End?

We once again delve into that most murky of IP licensing topics--sublicensing. When one considers the number of trees, if not entire groves, that have been felled to provide the paper needed for books and articles on licensing, then a mere tree or two is all that has been required to publish the entire corpus on sublicensing (full disclosure--at least one or two branches have been devoted to my own publications on the topic).

Perhaps the most interesting legal issue that arises out of sublicensing is the question of what happens to the validity of a sublicence if the main licence comes to an end. After all, while the IP rights being sublicensed derive from the licensor and not from the licensee/sublicensor, the sublicence agreement itself is between the sublicensor and sublicensee; as a contractual matter, the licensor is absent.

I remember that when I first began to examine the question, I asked a local colleague--who stated, with complete confidence, that the sublicence must come to an end with the termination of the main license. I then contacted a distinguished IP colleague abroad, who opined with absolute assurance that the termination of the main licence had no affect on the validity of the sublicence. Neither pointed me to any case law that has dealt with the issue on a principled basis. More to the point, surely both cannot be right. So what are the points for and against each of these contrary positions?

Sublicense Terminates with the Termination of the Main Licence

1. If the sublicensee is assumed to take rights of use in the IP through its agreement with the licensee, and the scope of the sublicence is bounded by the scope of the main licence, then when the main licence comes to an end, the basis for the grant of sublicence no longer exists. If that is the case, then the sublicensee is in breach of its use of the IP rights that were with the subject of the sublicence. The licensor can chose not to exercise its negative right against the "unauthorized" use of its IP rights; but, if it does choose to exercise its rights against the sublicensee, the sublicensee has no defence based on the erstwhile sublicence.

Comments

The parties can attempt to avoid this result by agreement. Thus the sublicence agreement can include a provision that the sublicence survives the termination of the main license. Query: does the licensor also need to be a signatory or otherwise to express its consent to such a clause?
Sublicence Does Not Terminate

1. It has been argued that when a sublicensee has lived up to the terms of its sublicence, then it would be inequitable that the sublicence be deemed to have been revoked, especially when the sublicensee has invested materially in the performance of the sublicence (see Ellis, Patent Licenses (3d ed. 1958).

2. The sublicence is in essence an agreement between the licensor and sublicensee, the validity of which is unaffected by the status of the main licence (see Brunsvold and O'Reilly, Drafting Patent License Agreements, 4th ed.)

Comments

i. The difficulty with the first point is that its appeal to equitable principles may be limited to common law jurisdictions. Also, it requires a case-by-case determination,which makes it unsatisfactory as a basis to support the general proposition.

ii. As for the second point, there is no compelling basis to support the conclusion that the default position is that the fundamental relationship is between the sublicensee and licensor.

iii. With respect to a trade mark licence governed by the law of a jurisdiction where quality control is required, the licensor may have relied upon the licensee to carry out the quality control function. If so, the licensor may not be in a position to ensure continuing quality control if the licensee is no longer tied contractually to the licensee.

The upshot of the foregoing is that there does not appear to be any single position on the question that can be viewed as being the better one. In such a circumstance, the sublicensee that wishes to protect itself is advised to cover the issue in its sublicence agreement, it being recognized that, unless the licensor also explicitly agrees to this result, the ultimate enforceability of such a provision cannot be assured.

What Are Valuable Patents: Does The Question Matter?

David Wanetick (Incremental Advantage) has shared with IP Finance his latest paper, entitled "How Patent Vulnerability Impacts Valuation". A copy of the full text can be found here. Wanetick considers four principal topics: (i) What makes a patent vulnerable? (ii) The impact of uncertainty on patent valuation; (iii) What makes a patent valuable? and (iv) Strategic considerations. I found of particular interest the factors listed by Wanetick that inter alia make a patent valuable. The list can be summarized as follows:

1. Anticipated licensing revenues:
2. Ability to trigger sales of end products:
3. Ability to generate add-on sales;
4. Ability to generate sales in new markets;
5. Stage of development of commercialization (the earlier the stage, the more risky the enterprise and the less valuable the patent);
6. Quality of law firm (e.g., measured by the degree of success of the law firm in sustaining an invalidity challenge;
7. Quality of patent examiner (an examiner with a longer tenure and a record of granting patents that withstand an invalidity challenge);
8. Size of portfolio being sold (a patent family is most valuable when the portfolio includes between 25 and 76 patent families).

Some of these factors are "real economy" considerations, namely, patents that facilitate commercial exploitation are more valuable. Other factors are more in the vein of indicia. After all, e.g., there is nothing inherently valuable in a patent that has been examined and granted by a more senior examiner, unless such a patent is connected with activities that have "real economy" value. The relationship between these two types of factors is not explicitly spelled out in the paper.

In comparison, there is the view of Allison, Lemley, Moore and Trunkey in their oft-cited article, “Valuable Patents” (The Georgetown Law Journal, vol. 92, n. 3, March 2004). Here, the authors distinguish between why a patent is filed and what is the indicium of a valuable patent. In a word, some patents are worth more than others because the patent has greater commercial value. And what is the proxy for determining this class of more valuable patents? According to the authors, the best indicium of a valuable patent, as so characterized, is that it is litigated. The article then goes on to discuss various characteristics of litigated patents.

While some patents are commercially more valuable than others, and the best proxy for determining a valuable patent is whether or not it is litigated, the authors do recognize that there are a variety of factors that may give rise to a patent filing. Thus

1. Patentees are simply irrational in their filing and registration practice;
2. Valuable patents are overlooked by their owners (the "Rembrandts in the Attic" syndrome);
3. Patents are licensed without the need to resort to litigation;
4. Patents are used as signals to consumers, competitors, and the like;
5. Patents are used defensively to protect against third parties with their own patents;
6. Patents are a form of lottery where a small number of patents account for the lion's share of the payoff for registration.

I am not quite certain about what the ultimate payoff is in this kind of analysis. Both studies agree that the most valuable patents are those with superior commercial value. They depart in their consideration of the indicia of such patents. What one ultimately does with this information is not totally clear, especially when indicia do not imply causality. That said, the question becomes whether it is worthwhile engaging in an analysis to determine what is a valuable patent. Perhaps the readers can shed further light on the answer to this question.

The Search for the Valuable Patent

Diamonds are…

For those interested in IP rights behind jewellery, PRWeb reports that tomorrow is the bid deadline for the auction of the Friedman's Jewelers and Crescent Jewelers' intellectual property. The auction will take place on 9 October.

According to PRWeb, intellectual asset management consulting firm CONSOR has identified “a myriad intangible assets in the Friedman's estate, including the valuable trademark ‘Say it with Diamonds’”. When Friedman's Inc. purchased Crescent Jewelers in 2006 they together became the leading US operator of jewelry stores with over 475 stores, generating over US$435 million in annual revenue.

For more information on the IP asset portfolio for sale see here. For more information on the recent acquisition of Whitehall Jewelers’ IP by Bidz.com see here.

Calculating lost profits: a monster of our own making?

Technology Transfer Tactics is currently advertising Calculating Lost Profit in IP and Patent Infringement Cases by Nancy J. Fannon ASA, CPA-ABV, MCBA. Published by Business Valuation Resources, this book is reportedly a 690 page hardback that will set you back US$329 + S&H if you buy it in the next ten days, whereupon the price rises to US$379. According to the promotional literature,

"Calculating Lost Profits in IP and Patent Infringement Cases brings together the comprehensive body of knowledge on lost profits damages and delivers a definitive resource for IP professionals, tech transfer execs, financial experts, and attorneys. Written by Nancy Fannon, owner of Fannon Valuation Group, and other industry leading experts, Calculating Lost Profits delivers a thorough analysis of current case law and valuation methodology that form the basis of damage awards in IP and patent infringement cases. It comes with 24/7 access to the online edition, which includes the full text of relevant court opinions, a searchable PDF version of the book, plus bonus content and updates as they are released".

I'm not familiar with this book (which, I'm sure, is very worthy) but can't help feeling that, if we've created a web of issues that take nearly 700 pages to expound, we have unleashed a monster of our own making. And how much of the lost profits are related to the cost of calculating how much profit has been lost? More seriously, we live in an era in which patents are commercially exploited -- and infringed -- on an international or global basis. Differentials in calculation as between major markets might lead to interesting forum-shopping questions. But if this book captures the necessary principles and approaches for calculation of lost profit in the US, where are its equivalents in other markets?