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

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.

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