Too Big to Think

When I was a kid, I loved dinosaurs because, among other things, dinosaurs were SO Big. Big is very cool to the young and relatively small. But the other amazing thing about the really big dinosaurs was that their brains were so small- way smaller than my kid’s brain. Big dinosaurs’ brains were so small that they needed a ‘helper brain’ near their hind quarters so their back end could keep up with the front end. When I was older I sometimes wondered what happened when the two brains disagreed with each other. Was it the equivalent of a Jurassic brain freeze? Well, no matter- dinosaurs went extinct. Maybe they just got too big to think.

Watching the US Congress debate and momentarily jump off the 2012 ‘Fiscal Cliff’ on New Year’s Eve brought back those dinosaur memories. Tomorrow (March 1), it appears they are going to take the leap. I couldn’t help thinking that the Federal Government was just too big for the two brains- Republican and Democrat- that were trying to control the beast. The choices- cut spending or increase taxes to save the government and the economy- now constitute the entirety of a binary decision conflict for an organization comprising around a fifth of the US economy. Apparently there are no other solutions that can solve this pending extinction.

Innovation is about problem solving with new solutions. When these emergent solutions are sufficiently unique, without precedent and useful, they can be turned into intellectual property. And intellectual property can be a valuable asset when it solves recurring problems that have economic dimensions. Increasing revenues or decreasing expenses are just the sort of economic dimensions I am thinking of.

The way to get these unique solutions also involves using binary logic. To see if a proposed solution is true, we use a scientific method that starts with the problem that is also a testable hypothesis. Computer geeks will recognize this method in the familiar IF THEN algorithm (IF such and such is true, THEN this or that will result). In business or academia or government this is the function of R&D. The proposal either does what we propose or it doesn’t- that’s the ‘binary’ part of the process. The key is to make the problem small enough to test in a laboratory or an environment that’s much smaller than place we intend to use the solution in the event it’s true. The Federal government knows how to do this- it has dozens of laboratories doing it every day. So do big businesses and big universities.

The thing about a big problem is that usually it is a collection of smaller problems which themselves are sometimes collections of even smaller problems. The smaller the problem, the easier it is to solve. But solving small problems is boring and tedious and not very glamorous. No one holds a press conference to announce the solutions of a portfolio of very small problems. There is no Nobel Prize for the guy who solves the biggest number of small scale experiments. The CEO doesn’t get the corner office with a hundred small deals as often as with the One Big Score- even if there are a thousand losses on the way. This is often true of intellectual property as well. But, as it turns outs, these small innovations are the sure thing solutions that actually work and have actual value.

This year I resolve is to think smaller and smarter. Dinosaurs may be big and cool but they are also extinct. I think maybe it’s a good time to be something else. Like a smaller mammal. With patents.

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

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 want 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.

For Estate Planning, Don’t Forget the Patent Estate (Part 2)

In my last blog we discussed the good news as to how a patent estate can be a real boon to estate planning.

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

Case 2- A family business with IP does not intend to transfer the business from a parent generation to successor generations. We will assume there are intellectual property (IP) assets (patents, trademarks, and copyrights are preferred) that confer substantial economic value to the business. An IP holding enterprise is formed to receive the IP and the license-back is created with the principal business. The IP holding 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 an asset value.

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 rests on the degree of risk of warranty default. If this is a low risk, it 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 purpose. 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 another example, check my previous blog at www.carthageic.com.

For Estate Planning, Don’t Forget the Patent Estate (Part 1)

Lately, when I read about patents in the news, the focus is usually on mega companies and mega patent estates.  It’s true that about 80% of all US patents issue to large institutions and big businesses. But the 20% that’s left over still matters to the small businesses and inventors that own and use them. Taxes and estate planning are on the minds of many in this 20% category as the 2012 year winds down and the Bush tax cuts may be coming to an abrupt end. So it’s good news to know that a patent estate can be a real boon to estate planning.

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

Case 1- Consider the family business where the next generation has taken management control of a business while the parent generation still owns a substantial portion of the business. If there are intellectual property (IP) assets (patents, trademarks, and copyrights are preferred), odds are good that they are unvalued even though they may confer substantial economic value to the business. If the IP assets are placed in a holding company, they can enter into a license back with the principal business for defined, time-based royalties to be paid back over the remaining economic life of the IP. This license-back allows for easy computation of a present value of the holding company. The stock of the IP holding company can then be exchanged with the business stock held by the parent generation in a tax free, ‘like kind’ exchange of property of equal value.

The royalties paid to the holding company can be distributed to provide an annuity income to the parent generation that now owns the IP holding company (and no longer owns the business). In turn the parent generation can, at its discretion, gift portions of the royalties to the next generation that may or may not be participants in the business. The royalty payments themselves are typically completely deductible to the back licensed business which lowers the total tax burden of the business. The back license itself is now an IP asset of a known transaction value that can be subsequently monetized by borrowings or subsequent sale and back-licensing. This latter option now increases the financial liquidity of the business by raising cash that reflects the IP asset value. Finally, the IP itself in the holding company is an amortizing asset, so over time, it dissipates to a zero or de minimis value for estate succession purposes. The amortization also acts to lower the net tax basis of the gross royalties.

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. To be sure these are sophisticated transactions and you will want to consult your professional service providers to determine the suitability of IP for tax and estate planning purpose. 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 another example, check my next blog at www.carthageic.com.

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

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)

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

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!

With the Facebook disaster will the wait for IPO be longer?

FACEBOOK FALLOUT: Y Combinator’s Paul Graham Just Emailed Portfolio Companies Warning Of ‘Bad Times’ In Silicon Valley

In the article, Graham warns that the Facebook disaster means extended waits for all companies thinking of going public until  the market is attractive to IPOs again.

So what about the mezzanine-stage tech company with products, revenues, and a need for capital to grow? Consider the new concept developed by Carthage Intellectual Capital Management: a sale/license-back of its patent portfolio. Monetize your patents by selling them for needed capital and, in return for an annual fee, get a license back to use them just as before.

The concept is similar to a sale/leaseback of real estate, equipment, or software. The cost of capital is less than equity and the capital more available with less onerous terms than with a bank loan. There are tax advantages for the company–use the NOL that’s probably on your balance sheet and pay fully tax expensed license fees. And, should the company be willing, there is potential upside to company and investor through out-licensing in non-competitive fields of use of geographical area.

Send Lawyers, Guns and Money- and IP

In yesterday’s Wall Street Journal, I read the following in an article by Jennifer Smith and Ashby Jones:

The embattled New York law firm Dewey & LeBoeuf LLP has filed for bankruptcy protection, a move that effectively ends what had been at its height a 1,300-lawyer global enterprise and marks one of the largest law-firm failures in U.S. history.

Should we be surprised? America produces more lawyers than the rest of the world combined. In fact our recurring bumper crop of barristers is leading some institutions to offer subsidies for law students to not complete their legal education. And sadly, it’s led other US law firms besides Dewey & LeBoeuf to liquidate their partnerships. In the current soft economy the over-supply of billable hours is depressing the price per billable hour. The free market is at work in the business of law.

So what’s a lawyer to do? Perhaps emigration could work for some of the surplus. After all, the rule of law is essential for the orderly creation, preservation and transfer of wealth and property in free markets. Places like Brazil, Russia, Indonesia and China really could use more law and order to protect their burgeoning capitalist class from the predations of criminals, swindlers and politicians (but bring a gun just in case). It would certainly pave the way to more amicable dealings with the USA via the common language of law. Much of the greatness of America today was built by past generations of immigrants. Perhaps American lawyers are the vanguard of the next emigration cycle. But I doubt that many American lawyers will find solace in this option.

That leaves two other choices- quit lawyering or find something that is under-lawyered. There are many that would applaud the former option but I am not one of them. Instead what this army of disenfranchised lawyers can do is help to turn the universe of intellectual property assets (IP) into new investments.  This is the mission of Carthage Intellectual Capital Management. We can show lawyers through the principles of contracts and licensing how to turn IP- patents trademarks and copyrights- into cash for IP owners and royalty revenues for investors, bankers and financial institutions. There’s a real shortage of knowledgeable lawyers for IP based transactions. The money will be quite good and much safer than guns.

It’s a Demand World- Really??

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.