IPR Tax, Alice Shock, and the Dynamics of the Licensing Market as Reflected by the LES High-Tech Royalty Surveys

By Jack Lu
March 5, 2019

“One of the important trends manifested by the analysis is the retreat of corporate business licensors and the crowding-in of academic and governmental entities in the wake of the AIA introducing inter-partes review at the PTAB.”

“Three is a magic number

Yes, it is …

The past and the present and the future …”

Bob Dorough

Patent license agreementThe Licensing Executives Society (LES) 2017 High Tech Deal Term & Royalty Rate Survey is a milestone event for at least three reasons. First, it was the third survey since the inaugural survey in 2011, and the three surveys fully covered the time period of a decade—from 2008 to 2017. Second, the 2017 Survey marked the fifth anniversary of Inter Partes Review (IPR) procedure and the third anniversary of the Supreme Court’s ruling in Alice v. CLS Bank. Third, at the time of the Survey, a new USPTO Director was nominated by the Trump Administration, bringing a fresh glut of uncertainties, anxieties, and hopes to the already jittery IP market.

What have we experienced in the past decade?

Where are we now?

What will the future look like?

These are the questions we strove to answer when we analyzed the data from the 2017 Survey, as well as the combined samples from the three surveys. The data only tells us what happened in the past, and we do not have a crystal ball to look into the future. However, we endeavored to explore the insights from the data, which, hopefully, would enrich our perspectives, expand our toolkits, and help us navigate the ever-changing IP landscape.

The 2017 Survey was launched on July 28, 2017 and closed on September 30, 2017. The questionnaires were sent to both LES members and other non-member entities, and 155 complete deals were submitted by 70 companies for an overall LES member response rate of 6.3%. Since the inaugural Survey in 2011, the High Tech Royalty Surveys have collected a total of 477 samples.

An important caveat is that the analysis is based on the data from licensing market transactions, and accordingly, our conclusions apply only to the licensing market and its participants. We want to point this out because an event that has positive effects on those profiting in licensing market may have negative impact on those making revenue from the downstream product or service market. Therefore, it is critical to keep the different perspectives in mind while reading this article and the Report.

The following summarizes the key takeaways from the Report.

Changing Demographics

The collected samples of transactions include different organization types of licensees and licensors, cover a wide spectrum of technology types and fields of use (FOUs), and report a variety of other features in exclusivity, type of IP, stage of technology development, and auxiliary payments. The sizes of licensors and licensees have a fairly wide range; so do the peak annual sales of the licensed products, though slightly more than half of them are below $25 million.

Since the 2011 Survey, the share of academic and governmental licensors has increased dramatically, while the share of other licensors, mainly private companies, has declined substantially. Specifically, non-practicing entities (NPEs) have been retreating from the licensing market, and their participation has plummeted since the 2011 Survey.

Accordingly, the percentage of the licensors who participated in the licensing market for purely monetary purposes is much lower in the 2017 Survey, and many more licensing agreements were entered into as a means of building strategic relationships or support new product development.

Descriptive Statistics of Financial Terms

The Report also presents the descriptive statistics and analysis of the financial terms stipulated in the samples from the 2017 Survey and in the combined samples from all three surveys. Several different payment methods have been adopted by the licensing transactions, including flat and tiered percentage rates, flat and tiered unit rate, upfront lump sum payment, and milestone payments, among others. Our analysis focuses mainly on flat running royalty rates as percentages of sales and lump sum payments, which together account for more than two thirds of the combined samples.

The 2017 Survey reports an average royalty rate of 5.69% and a median rate of 5%. Over the 10-year period from 2008 to 2017, the average rate is calculated to be 5.73%, and the median rate, 5%. Average and median rates are tabulated for major features and characteristics of the reported deals, including the organization type and size of licensors/licensees, technology features such as technology field and development stage, field of use, type of IP, and exclusivity, among various others. Similar analysis is conducted and presented for the transactions with lump sum payments.

The analysis further sheds light on certain specific issues arising from the surveys. As an example, to explain the seemingly counterintuitive royalty rate behavior across exclusive and non-exclusive deals, we take a deeper dive into the data and calculate average royalty rates by exclusivity and by licensor organization type, which offers a tentative explanation of the initially puzzling rate pattern.

Economic and Econometric Analysis

To investigate the major issues raised by the three surveys, economic and econometric analysis is conducted based on 213 samples of royalty rates and 96 samples of lump sum payments.  The economic analysis starts with examining the trend of annual average and median royalty rates over the decade of 2008-2017. By analyzing the annual royalty rates under the backdrop of economic cycle, legislation events, and major relevant Supreme Court cases, our analysis reveals insights into how the economic down turn, the America Invents Act (AIA), the Patent Trial and Appeal Board (PTAB), and the Supreme Court landmark rulings such as Alice might have configured the landscape of the licensing market.

One of the important trends manifested by the analysis is the retreat of corporate business licensors and the crowding-in of academic and governmental entities in the wake of the AIA introducing inter-partes review (IPR) at the PTAB. IPR challenges escalate the risk and uncertainty in patent monetization and increase the patent enforcement costs for private patent owners, both of which depress patent valuation. Since IPR essentially does not affect governmental entities and state universities, it has an effect analogous to an extra tax levied on the private patent owners. The IPR tax discourages private patent owners’ participation in licensing markets, while it incentivizes state universities and federal entities to crowd in. Such a shift is further confirmed by the overall licensing market participation data, as well as by the data from the transactions with royalty rates and lump sum payments.

A dummy variable regression model is employed to identify and quantify the effects of various deal-specific and market-specific variables. For example, using the combined royalty rate data from the three Surveys, the analysis reports that certain technology types, such as aerospace and software, command statistically significant premiums; and that exclusive deals are typically associated with higher royalty rates. Also, the technologies in the production or fully developed stage carry higher payments than those in earlier stages, and the combination of know-how, designs, and drawings holds a significant premium in licensing market.

The regression analysis also demonstrates how the market-specific variables interact with and affect the valuation effects of the deal-specific variables such as exclusivity, licensor organization types, and technology fields. For example, it seems that the average royalty rate in software technology licensing has shown a sizeable drop during the post-AIA/IPR period, though that is  based on a limited number of samples.

 

The Author

Jack Lu

Jack Lu PhD, CFA, is a Partner and Chief Economist of Intellectual Property Market Advisory Partners (IPMAP) at Austin, Texas. An economist & financial analyst with an engineering background & research credentials, Jack specializes in economic study, financial analysis, assets valuation, & strategic advisory for IP transactions & litigation, and for IP-intensive corporate transactions & disputes in financing (VC & PE), M&A, equity investment, & distressed assets investment. He currently serves as the Sr. VP for Economic Analysis & Survey, Licensing Executives Society (LES USA Canada). His recent research in IP economics, patent portfolio valuation, and royalty pricing can be found at his SSRN author page, and he can be reached via email.

Warning & Disclaimer: The pages, articles and comments on IPWatchdog.com do not constitute legal advice, nor do they create any attorney-client relationship. The articles published express the personal opinion and views of the author and should not be attributed to the author’s employer, clients or the sponsors of IPWatchdog.com. Read more.

Discuss this

There are currently No Comments comments. Join the discussion.

Post a Comment

Respectfully add to the discussion.

Name *
Email *
Website