Category Archives: Investments

Still thinking about the $5 million gift opportunity? Think patents.

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Taxes and estate planning are on the minds of many as the 2012 year winds down and the Bush tax cuts may be coming to an abrupt end. Among the biggest concerns is the likely expiration of the $5 million gift tax exemption. So it’s good news to know that a patent estate can be a real boon to estate planning.

Gifting patents can transfer significant value to the next generation and also address specific concerns:
  • Independent valuation for the IRS
  • Control of the family business
  • Flexibility to sell the business
  • Restricted use of the transferred intellectual property

Patents are usually unvalued and hence a real challenge in family offices for estate planning. But used properly, patents other IP assets can provide value for both intergenerational changes in control and/or minimizing estate taxes. Carthage Intellectual Capital Management (‘Carthage’) has proprietary processes to help family businesses and their tax and estate planning professionals. Here is a case in point:

Suppose a family business with patents or other IP does not intend to transfer the business yet from a parent generation to successor generations. The parent generation wants to make an effective gift of business assets within the $5 million gift tax limitation. But the business does not what to jeopardize ongoing control of the business. Further, the business will ideally want a reversible transaction should future business circumstances need to repatriate the IP assets. Finally, the transaction should be straightforward and not raise valuation questions with the IRS or other taxation authorities. With the caveat that the following is a hypothetical and not a definitive recommendation, here is how IP can be considered in a gifting situation.

First we assume there are intellectual property (IP) assets (patents, trademarks, and copyrights are preferred) that confer substantial economic value to the business. If these have been internally created, the balance sheet will typically not show this value. An IP holding enterprise is then formed to receive the IP and the license-back is created with the principal business. The enterprise may then be gifted to a family trust whose principal purpose is to maintain the IP assets, and receive and distribute back royalties to family members participating in the trust (other entities may be equally suitable but we call them a ‘trust’ as a generic description). In this case, the license back will depend on future occurrences as to when or how much royalty is paid as an annual rate for the license back itself. This in effect defers the need to value the IP assets at anything above the tax free gift basis at the time of gifting as there is not a fully defined income stream upon which to base a higher asset value.

Control of the IP is determined by the license which remains with the operating business and will typically be an exclusive license. The business can separately reserve a ‘put’ to reacquire the IP holding company at its nominal gift value less amortization at a future date, should the business need to repatriate the IP assets themselves (say, for a sale to a third party). This makes the transfer effectively reversible by the parent generation through the operating business. So long as the nominal value of the reversal is the same as the gift it further minimizes the risk of IRS valuation challenges.

If in the future the business is sold to a third party, a more substantial license royalty can be triggered as a consequence of the sale. The necessary use of the IP becomes a warranty obligation of the purchaser as the transferee of the license back. The sale price of the business may then consider the present value of the license back royalties payable to the trust. The selling family business can accept a lower effective sale price from  purchaser because the seller will be required to pick up the license back and make royalty payments triggered by the sale event. For the purchaser, the deductibility of the royalties is generally less that the borrowed capital and associated costs to acquire all assets in a fee simple transaction which can tolerate some purchase premium in a competitive bid situation.

The trust receives and distributes royalty income on a current basis and does not require a change in basis in the IP assets. The certainty of future royalty payments that rests on the degree of risk of warranty default can allow the trust to borrow a principal sum based on the pledge of the continuing royalty income. This principal can be distributed to the trust beneficiaries tax free as an advance on future income. Running interest payments together with amortization of the IP transfer basis will offset future income taxes as a deductible trust expense. Alternately, the trust can sell off the IP assets and realize capital gains at that time for a distribution and liquidation of the trust itself.

Once again, Carthage has extensive experience and the patented processes that can guide family businesses through evaluation of their IP assets and the transactions that can satisfy their estate planning needs. Because these are sophisticated transactions, you will want to consult legal and accounting professionals to determine the suitability of IP for tax and estate planning purposes. But the good news is that Carthage will be there to help you when the time is right to unleash another hidden value of your IP. For questions please contact Carthage at info@carthageic.com.

Writing off a Business may be a Good Time to get Cash for your Patents

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Last month Microsoft (NASDAQ MSFT) reported its first quarterly loss as a public company (7/19/2012).  As losses go it wasn’t much- US $492 Million for the quarter ending June 30, 2012. Of late Microsoft has been earning US $ 6 Billion per quarter. And with more than US $60 Billion in cash, MSFT isn’t going broke any time soon. What’s interesting about this story is that Microsoft wrote off more than US $6 billion in intangible assets. And if you’re any company other than Microsoft, there are some interesting opportunities to use those losses to showcase other intellectual properties you own. You might even be able to recover all of your losses.

In 2007 Microsoft bought a digital ad agency called aQuantive. Back then, companies like aQuantive were perceived as the digital evolution of Internet advertising. Microsoft wasn’t alone- Google, Yahoo and others seeking new revenue models for the Web were also in the hunt for acquisitions. Mergers and acquisitions (M&A) is what big successful companies do when their original business models mature and cease to grow. But there’s a problem with acquisitions- they fail to achieve results more often than they succeed. Don’t take my word for it-McKinsey & Company, a premier global management consulting firm, has been researching M&A activity for years. They empirically observed that 70% of acquisitions fail to meet their revenue targets. And more than a third under estimate the full cost of making the acquisition. (See “New McKinsey research challenges conventional M&A wisdom”, Strategy & Leadership, Vol. 32 Issue 2, pp.4 – 11.) In other words, the odds of success were never in Microsoft’s favor.

Most of the acquisition price of aQuantive was good will, which is one of the intangible asset classes where Carthage Intellectual Capital Management (CICM) provides client services. One of those client services is monetizing intellectual property when they have losses that can offset taxable gains. In the case of aQuantive, Microsoft decided the acquisition really did fail and eliminated $6.2 billion from its balance sheet. Specifically it took a loss of US $6.2 Billion in goodwill. In accounting terms it’s called ‘impairment’. Hypothetically speaking, what could have Microsoft sold at a profit to offset its impairment losses? The answer is- part of its own patent estate. Self invented patents are especially nice because essentially 100% of the selling price is a capital gain. So they constitute the least amount of property you must sell to use up the impairment loss. But what if Microsoft still needs to use those patents? The answer is- license-back the patents it sells. (Not familiar with patent sale license-backs? Check www.carthageic.com to learn more.)

Maybe Microsoft knows this already. I checked the July 19, 2012 8-K statement in which Microsoft officially summarized its business performance in the three months ending on June 30. The word ‘patent’ never appears.

Perhaps Microsoft patents aren’t worth US $6.2 Billion. So we also checked the 8-K and 10-K statements for the last five years (2008 to 2012). Microsoft spent more than US $44.7 Billion in R&D in that period and obtained more than 13.7 thousand US patents according to the USPTO. That averages about US $3.25 Million in R&D per issued US patent. Would Microsoft be dumb enough to spend $45 Billion to obtain zero patent values? Definitely not.

We roughly estimately that a portfolio sale of 2000-3000 patents would be more than enough to satisfy the most conservative of investors. Statistically you wouldn’t even need to very picky because the odds of not buying some highly valuable portfolio assets collectively equal to the portfolio purchase price is pretty close to zero. Especially when Microsoft would be the back-licensee of the portfolio.

But this isn’t about Microsoft- it’s about managing the risk and value of intangibles. And impairments. We are living in times of economic uncertainty- the kind of times that produce impairments from a multitude of calamities. Carthage understands business risk and intangible value. And while Microsoft may not need our help to recover its losses you may know someone who does.

Why Patent Attorneys should talk to Corporate Finance (and why Finance should listen)

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Attention patent attorneys- if you could show your clients an extra $5 or $10 million in ‘found money’, would that be helpful? It’s easy to find and odds are that you helped your client in making it. I’m talking about patents of course. The question is- now that you’ve found it how do you get to the cash that’s in it? There are a few ways to go about it- most of them are hard but one is fairly easy. You are probably familiar with hard paths to patent cash- out-licensing, selling non essential assets or litigation. These ways are hard because finding the parties to complete the deals is hard or in the case of litigation expensive to initiate. Plus these deals are not a sure thing as to whether you can net out the cash after all your hard work and that can make clients very unhappy.

The easier way is monetization. Monetization is recapitalizing patents based on how useful they are in making money for the client. Your clients understand where they use patents for their own businesses, so there is good and reliable information that is easy to obtain and calculates the patent cash value. The counterparties to monetization deals are banks or investors that are eager to invest in your clients’ continuing successful use of those same patents. They are on your client’s side which can’t always be said about prospective licensees and certainly is never the case with infringers.

With monetization, each patent can easily represent US $1-5 million in cash value to the client’s business so even a portfolio of four or five patents can have US$ 4-25 million in ‘found money’ value. Decisions to monetize most often depend on decision makers in your client’s corporate finance department. This is where Carthage Intellectual Capital can help patent lawyers and their firms to close the deal with corporate finance on the ‘found money’ opportunities in patent portfolios. We know the translation values of invention claims and cash. And corporate finance can control the timing and quantity of patent monetization transactions to their maximum benefit. As patent attorneys, you will know where the future transactions will come from. I’m talking about the future patent estate of course. It’s a lot easier to get paid on new patent dockets with the found money of previous patents. Learn more at www.carthageic.com.

Pricing Intellectual Property- The Rule of Eight

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It’s exciting when our clients first learn that their intellectual property (IP) is; a) a capital asset and; b) can be capitalized using our sale license-back (SLB) process. Not surprisingly, the next question is- what’s my IP worth? In the case of patents, here’s a benchmark that Carthage Intellectual Capital uses. Multiply the annual research and development (R&D) expenses times eight. The result is a useful first estimate of the value of your total patent IP portfolio. Hence the name, the Rule of Eight.

The Rule of Eight is not a guarantee of IP value. But it reflects the principle that enterprises create IP today to be useful for an extended period of time. Carthage’s experience is that, on average, the financially useful life of IP is around eight years. The number eight is not merely coincidental; the behavior of patent centric companies anticipates it.

Consider the typical company that relies on patents to make, use or sell its goods and services. A patent’s legal life is 20 years from its priority date. It usually takes 2-3 years for the patent office to examine and issue a patent. That leaves an effective legal life of 17-18 years. Because technology improves over time, patent producing companies continue R&D spending to invent the improvements. Once a patent expires, it is logical that a patent reliant company will likely replace it with a new patented invention.

If a company obtains one patent per year as a result of its R&D, it will possess 17 or 18 legally active patents in the course of a similar number of years. The average legal life of the patent portfolio is the sum of the years of remaining patent lives divided by the number of active patents. In our hypothetical, this turns out to be around nine years. A patent investor will want a ‘risk cushion’ on the investment and 10% is a typical allowance. Therefore eight years is a logically consistent estimate of the time in which a patent portfolio is valuable. And eight times the current year’s R&D expense is an approximation of patent portfolio value if used as an asset for a sale and license-back transaction. The Rule of Eight is a helpful tool for disclosing the financial intentions and value of IP to the financial departments of a business and the financial community at large. To discover the value of your company’s IP contact us at info@carthageic.com. Perhaps the Rule of Eight can turn your IP into ‘pieces of eight’.

PS- If this is your first time hearing about the sale and license-back of intellectual property check out www.carthageic.com to learn more about this revolutionary process that transforms IP into economic gold!

It’s a Demand World- Really??

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Everyone is talking about the need for consumer demand to pull the global economy out of the tank. On this there even appears to be political consensus.  The only issues are taxes and government spending. Some want more taxes and more government spending to fund the demand that the unemployed consumers can’t afford. Others want to cut taxes and government spending to leave money in the hands of the remaining employed and encourage them to purchase more things that they don’t need. Is it me, or are the current strategies just a choice of economic suicide by poison or drowning?

As a capitalist I believe in supply and demand, free markets, and rule of law. So if demand isn’t working maybe it’s time to check out the supply source. Is there a demand for better means to supply our markets? You bet- it’s called innovation. And the asset that fuels innovation is intellectual property. So far, it is untouched by the credit markets. More importantly, it is already an existing group of assets.

Innovation is about doing something better. It can be a bucket, a light bulb, a car, solar collector or a shoe.  Or it can be a better way to furnish an existing good or service. Innovation builds the demand for new means to supply the innovation. Intellectual property like patents is a first means to build the structure needed to furnish the new means of supply. The investment in structure is usually a multiple of the existing market. The key is to access secure asset based credit to build the new means.  Let me again suggest- patents. They are an under recognized and non-capitalized resource representing trillions of dollars in assets. We can access this credit reservoir through the sale and lease mechanics of real property. It’s called the sale license-back of intellectual property. This is not phony demand or stupid consumerism. It’s time to stop being crazy and start being innovative. Really.

Original Thinking and the Origin of Capital

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Jamie Dimon and Mark Zuckerberg have both made a lot of news recently. Dimon is taking heat for presiding over a series of bad hedges that cost JP Morgan US $5 Billion of its capital. Zuckerberg’s fame and infamy is the Facebook IPO which created US $100 Billion in new stock equity and then proceeded to lose US $16 Billion of it in a week’s worth of public trading. There is a difference however. Facebook (FB trading symbol) is still up around US $85 Billion in new and liquid financial equity. JP Morgan is still down around $US 5 billion in capital losses while some hedging counter parties are up $US 5 Billion for a zero sum change in global equity. This is the difference between derivative finance and origination finance. The former is a zero sum game; the latter is the creation of new capital from un-capitalized assets. The latter is what economies need to grow their way to recovery. So where are those un-capitalized assets yearning to be liquid?

Don’t expect it to be another Facebook any time soon. Because of the poor trading performance of FB social media stocks are taking a real hit and those waiting in the IPO queue will likely have to wait longer- perhaps much longer. But there are other assets that are ready to become liquid now and they are called intellectual properties or IP for short. The IP I am referring to are the millions of patents, trademarks and copyrights that have already been made by businesses, inventors and entrepreneurs with cash invested in the past. Many of these assets have added to the cash spent to create them by the fact that they are helping enterprises make new revenues or by saving the costs to make recurring sales. What we are doing at Carthage Intellectual Capital Management is helping IP owners to originate the cash value of their IP through valuation, monetization and management of IP. The core of our system is the sale license-back of IP. In our world, original thinking is the origin of new capital.

Intellectual Property -Investing Opportunity in an Inefficient Market

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The last frontier for inefficient markets might very well be the intellectual property market. Intellectual Property is a huge asset market that is financially very inefficient. It is estimated that in 2012 the replacement value is over $7 Trillion for US patents alone.  Owners of patents, trademarks and copyrights have a difficult time carving out this property for re-sale or to pledge because, for the most part, the business information about intellectual property is buried in the intangibles line of their balance sheets or is simply set at zero.

Believers in the efficient market hypothesis accept the fact that the only thing that moves the price of a security or a property is new information. The principal behind the efficient market hypothesis is that when there is new and actionable information that impacts a company, a government or an industry, the news is immediately transmitted all over the world.  To beat market averages, securities analysts want investors to believe that somehow they can front run this new information.  Otherwise, new information becomes a market commodity and investor returns are driven to average returns by the efficient market hypothesis. But information has to be understood by markets for them to act on it.

When there is inefficiency in financial markets there is an opportunity to make out size returns. Generally this is a result of asymmetrical knowledge about a market. If one obtains actionable knowledge before there marketplace perceives it, the investor can invest while demand is low (and so is pricing). This is the case with intellectual property today. Twenty years ago commercial real estate was another market where there was significant inefficiency of information dissemination.

Commercial real estate had investment inefficiency because the details of pending transactions are not public.  A savvy developer can move zoning codes, have favorable credit lines established and be negotiating with potential anchor tenants all under the radar of the rest of the market.   The potential seller of the property may not have the advantage of knowing this information.  The seller therefore has a lower threshold price in his/her head and is willing to sell at that point.  Twenty years ago large REIT’s (real estate investment trusts) formed to exploit these inefficiencies for their investors’ benefit.  One result is that the commercial real estate market has become more efficient; more and more institutional money has moved into the commercial real estate market. But early investors in REIT’s have made tremendous returns by exploiting the historical information imbalance.

Intellectual property is unique in several ways; the Founding Fathers thought it was important enough to mention it in the US Constitution and give it special rights.  The US Patent and Trademark Office provides a definitive clearing and titling function, and the resulting intellectual properties  either create or defend existing cash flows. And while much of the USPTO information is public, there is profound inefficiency in understanding the asset value of IP. There are as yet few pundits which understand how to guide the investor community to these opportunities. Carthage Intellectual Capital Management is dedicated to making family offices and institutional Investors aware of the opportunities that exist in acquiring existing intellectual properties and entering into license back agreements with their present owners.  Savvy enterprises will realize that, like real estate, it does not require them to own the intellectual property to benefit from its use.

What College Doesn’t Teach You about Sale License-Backs (But Should)

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It’s summer intern season and Carthage Intellectual Capital is in full court press to get its share of the best and brightest.  As bright as they are, the sale license-back is completely unknown to interns. So here’s the primer we are using to get them engaged in the biggest financial revolution yet of the 21st century:

1. Suppose a company has 5 patents all of which are valid for 10 years. The patents originally cost the company $1000 in R&D.

2. Now suppose that Carthage (or a financing company licensed by Carthage) agrees to acquire all 5 patents for $1000. (How we figure this out relies on other patents under license to Carthage).

3, Carthage also agrees to license-back all of the patents to the company to use for 10 years in exchange for a royalty of $150 each year. This works out to $1500 for 10 years. (Again how we figure this out relies on other patents under license to Carthage).

4. Suppose the company has a tax rate of 40% on income only. Assume the $1000 it gets from Carthage is not taxed (more on this in future blogs). Carthage is organized like a partnership and pays no taxes.

5. The $150 the company pays as a royalty is an expense each year and reduces the income by $150. This reduces taxes payable by the company by 40% of $150/yr or $60/yr which is a tax credit and which is like getting cash refunds of $60/yr. ($600 for 10 years).

6. Now we can calculate how the sale license-back affects the company and Carthage over the 10 year agreement as follows:

                                                         Carthage                                         Company

Purchase Patents                             -$1000                                             +$1000

Pay Royalties                                   +$1500                                             - $1500

Tax Credits (40%)                            $   000                                            + $   600

Profits(+)/Losses(-)                        +$   500                                             +$   100

Carthage makes money because the royalties it receives are more than it paid for the patents (+$500). But the Company also makes $100 because its tax credits plus the sale price are more than the royalty payments. This the financial power of licensing versus borrowing.

Now suppose the company had decided to borrow $1000 for 10 years in exchange for paying back the principal of $1000 plus $500 in interest. It still gets $ 1000 but pays back $1500. What then?

The difference is in the tax credit. You only get a tax credit on interest paid on a loan, not the principal. The 40% tax credit on $500 in interest is $200. So instead of paying $1500 pay to the bank, the company pays $1300 net of tax credits which means it costs the company -$300 to borrow $1000 for 10 years. In our examples here licensing-back a $1000 patent pool is $400 cheaper than borrowing $1000. This part is not an invention of Carthage- it is the pre-existing rules of the IRS.

And this is what our interns will be explaining to our clients this summer. Perhaps they will have an opportunity to enlighten your interns as well.

Cash without Benefits

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There is more cash sitting on balance sheets or hiding in mattresses than ever before. What is it waiting for? Not to get screwed out of it again is one answer. Another is what is there worth investing in that can’t get screwed up? As to getting screwed, that’s always part of the risk premium we pay on cash and being careful with who we deal with. But I’d like to suggest one investment that will be hard to screw up and capable of making a very secure return. That investment is intellectual property or IP for short.

We don’t buy or invest in IP today for three reasons. First is, most investors, though they have heard of IP, don’t know what it is, where it comes from or how it is made. The second reason is that we don’t value IP when we make it and we don’t record it on our balance sheets. So even if you do have IP, you treat it as if it were worth nothing. The third reason is that even for those few who know what IP is and what it’s worth, they don’t have any notion of how to turn into an investment without getting screwed.

Capitalism is wonderful for cash in that it can finance the means of supply and the price of demand. Modern capitalism has been particularly good at chasing down price differentials in the cost of supply amongst developing economies to supply the demand of developed countries. But it does involve screwing the wage base of developed economies out of jobs to pay less to workers in the LDC’s. And that’s OK if developed countries keep developing. That is what IP does. It makes IP a unique feature of first world economies.

Unfortunately, the financial sector has been too busy out-placing the current supply side of the current first world economies to learn how to invest in new development. To do that you need to understand investing in IP. As a result not understanding IP as an investment asset, financiers have artificially down sized the pool of credible investments available to investors. When the pool of available investments is limited, then speculation in a perceived finite asset pool is the only way to make money out of assets. This is how financial depressions start. And we are still there.

For those of you yearning to become first world investors here are three things to know. First- IP is patents, trademarks, copyrights and secrets. Concentrate on the first three and you will become rich. Second- you can value IP in use today to know its price. Third- you need to know that Carthage intellectual Capital Management has the people, experience and IP to make your IP a real and ‘screw-proof’ investment that is the future. Learn more at info@carthageic.com.

Litigate, Liquidate or License-Back?

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For patent watchers, the last 12 months have been a truly big year. First was the Nortel bankruptcy auction that fetched nearly US $5 billion for creditors. Second, we witnessed the spectacle of corporate raider Carl Icahn selling off Motorola Mobility (a patent pool actually) for US $12.5 billion. Third, Apple and Samsung are locked in a patent war to see who will control the intelligent telephony platform (i.e. phony computers). Finally, last week Microsoft was the successful bidder at US $1.1 Billion for 800 AOL patents that drive internet business models and processes. So far we see the litigations and liquidations of patents. But where are the sale license-backs? My point exactly.

Now here’s the really weird fact. In financial parlance litigation and liquidation are ‘fear-motivated’ responses to bad circumstances. And ‘fear finance’ usually means selling out of bad situations. But sell-outs tend to depress prices and the exact opposite is happening in our big patent year. The average price of patents in all these event s are going UP in a big way (about 70%/year). And these patents are functionally similar to each other. Go figure.

For those of you hearing about a ‘sale license-back’ for the first time, let me explain. A sale license-back (SLB) is where an investor acquires patents (or other intellectual property for that matter) for a large lump sum and licenses it back to the patent seller in exchange for royalties for the rest of the patents’ legal life. Sound familiar? If any of you have heard of a REIT then you completely get the SLB. A REIT is a pool of real properties that their owners have sold off for a lot of cash and re-leased for their future business use. The REIT uses a sale lease-back to accomplish the same thing financially as a sale license-back. Only the property is different between the REIT and SLB. And also the SLB is patented. Go figure.

Are REIT’s profitable? You bet. Like their financial cousins, the equipment sale lease-backs, a prudently financed lease back arrangement can reliably turn a 25-35% annual IRR on invested capital.

SLB’s are about ‘greed’ finance and I mean that in a most positive way. Greed finance is about acquiring and/or selling into a profitable deal. And SLB’s are financially greedy for both patent owners and investors. So if fear finance has been driving patent prices UP 70% in a year what do you suppose SLB’s will do to patent pricing? Way, way UP! I figure it’s time to get greedy. For more information contact us at info@CarthageIC.com.