Friday, 19 December 2014

STR-IP takes off

According to a media release recently received by this blogger concerning STR-IP -- that stands for "Startup-IP Program -- a new product from Foresight Valuation Group (an intellectual property strategy and startup advisory business). This is

" ... a new initiative aimed at helping technology startups build an IP portfolio that is aligned with their business goals and that would enhance their valuation. STR-IP is particularly important for startups in IP-rich industries ranging from the Internet of Things (IoT) segments such as wearables, automotive and home automation, to material sciences such as Nanotechnology. Foresight’s capabilities at the nexus of technology, IP and valuation, as well as its location in Silicon Valley, uniquely position it to help startups build an IP portfolio that would assist with their overall market success.

New patent laws in the US under the “First to File” regime, recent Supreme Court decisions, as well as the increased risk of patent litigation, make it absolutely critical for a startup to start building its IP portfolio as early as possible. Foresight’s STR-IPTM program provides startups with a structured approach to aligning their IP strategy with their business model and financial projections.
...
This is a brainchild of Efrat Kasznik (Foresight’s president and founder, Lecturer on IP strategy at the Stanford Graduate School of Business and a one-time guest contributor to IP Finance); we shall be keeping an ear out for news of STR-IP's progress,

Thursday, 4 December 2014

The Secret to Start-up Success: Secure IP from a Local University?

Angel investor and founder of inBounce Entrepreneurship Bijan Khosravi makes several important points in a recent article in Forbes titled, “Why You Want IP for Your Startup.”  First, Mr. Khosravi points out that IP, particularly patents, provide a competitive advantage.  Sure, you have a great idea, but competitors are essentially free to copy that idea without IP protection.  The first mover advantage may not be good enough, especially if you need time to expand to other geographic markets.  This seems to be particularly true in the age of Rocket Internet.  Second, Mr. Khosravi points to local universities as great sources of intellectual property for startups.  He points to the Association of University Technology Manager’s search engine for finding university technology [here, http://gtp.autm.net/].  He provides his own successful example of securing patents from University of California, Davis[Hat tip to Glen Gardner at Vortechs Group.]

IP Issues in Mergers and Acquisitions: Any Recent Examples of Due Diligence Failures Involving IP?

Corporate Counsel has published a pair of informative articles concerning due diligence and intellectual property.  The first article is titled, “Identifying IP Risks in M&A and Tech Joint Ventures: Beyond the Data Room”, by Anne Cappella, Charan Sandhu and Brian Chang of Weil, Gotshal and Magnes.  The second article is titled, “The Financial Impact of IP Issues in M&A,” by Steve Ball and Jon Winter of St. Onge Steward Johnston & Reens.  Both articles provide useful advice designed to help counsel avoid missing intellectual property issues during due diligence.  The overarching message is that corporate counsel should include intellectual property specialists in any due diligence of a potential target.  Both articles raise specific points that should be considered such as: proactively examining a target’s competitors to ascertain whether patent trolls have litigated against the target’s competitors to determine if your target is next; considering potential trade secret misappropriation actions by competitors of the target based on new hires by the target; ensuring that third parties who have worked with the target have not improperly claimed intellectual property possibly owned by the target; having clear title to intellectual property; and properly recording title.  The second article provides a couple of examples where intellectual property counsel were not consulted or there were intellectual property issues missed in the due diligence.  One problem involved Rolls Royce and BMW:

[I]n 1998 the Volkswagen AG Corporation purchased the automobile assets of the bankrupt Rolls-Royce Motor Cars Limited for $790 million, with the value of the physical assets estimated at $250 million. Volkswagen was unaware that Rolls-Royce’s trademark rights were subject to a nontransferrable license from Rolls-Royce Aircraft. Volkswagen purchased the plant, the machinery and the automobile designs from Rolls-Royce, but only learned after the deal that the purchased assets did not include the Rolls-Royce® trademark. So while Volkswagen was able to build the car, it could not brand it with the famous trademark. BMW then acquired the trademark rights for $65 million from the bankrupt Rolls-Royce Aircraft and forced Volkswagen to concede the brand, resulting in a huge windfall for BMW.

The most recent example included Apple’s acquisition of Beats Electronics:

Apple Inc. agreed to acquire Beats Electronics for $3 billion. In doing so, Apple purchased an infringement suit by Bose Corporation, which owns a number of patents directed to noise-cancelling headphones. After the deal was announced, Bose filed infringement suits in district court as well as at the International Trade Commission seeking to ban imports of the Beats headphones into the U.S.
I have to imagine that Apple’s counsel knew they were likely to be sued by Bose Corporation.  Are there any more recent public examples of IP failures in the due diligence before merger or acquisition with a target company? 

Friday, 28 November 2014

The future of the UK Patent Box -- or is it the Nexus: what's the real story?

There's a very helpful client alert from Baker & McKenzie, "IP Tax Regimes (including the UK Patent Box) to be abolished and replaced by new "Nexus"- based regimes", which gives a good account on the fate of the UK's Patent Box. Has it been saved, killed, or modified, people ask. This alert gives the story:

On 11 November 2014, the UK and Germany made a joint announcement about a proposal they had developed to address some of the concerns raised over the OECD's suggested approach to dealing with preferential IP tax regimes.

The likely outcome is that the UK will need to modify its patent box rules, but there is a long grandfathering period, under which benefits from the patent box (and regimes in other countries) can continue to be claimed until June 2021. The regimes will close to new entrants from June 2016, and will be abolished in June 2021.

One of the Actions in the OECD's project to counter Base Erosion and Profit Shifting (BEPS) is on Countering Harmful Tax Practices More Effectively (Action 5). In September 2014, the OECD published a report on Action 5, stating that its Forum on Harmful Tax Practices (FHTP) would be focusing on ‘substantial activity’ in the context of IP tax regimes. The OECD's preferred approach, supported by a majority of OECD member countries, was to require a direct nexus between the income receiving tax benefits and the expenditure contributing to that income. This "Modified Nexus Approach" would require substantial economic activities to be undertaken in the jurisdiction in which the preferential regime exists, by requiring tax benefits to be connected directly to R&D expenditures.

The UK, Spain, Luxembourg and the Netherlands did not favour this approach. The nexus approach was also criticised on the basis that it would create a major compliance burden in tracking the relevant expenditure. Germany has long been a critic of IP tax regimes (including the UK patent box) on the basis that they distort competition. Germany does not have an IP tax regime of its own, although a German Government Minister did say recently that they might consider introducing one.
There's more in the alert, which end with a link to the joint UK-German proposal, which IP Finance reproduces here:
GERMANY-UK JOINT STATEMENT
Proposals for New Rules for Preferential IP Regimes
The Governments of Germany and the United Kingdom are fully committed to ensuring that the G20/OECD Base Erosion and Profit Shifting (BEPS) project is successfully concluded by the end of 2015. This requires all countries involved in the negotiations to work to ensure that progress is made on all of the Actions set out in the BEPS Action Plan agreed by G20 Finance Ministers in July 2013. 
The OECD Forum on Harmful Tax Practices (FHTP) has led work in relation to BEPS Action 5, Countering Harmful Tax Practices More Effectively, Taking into Account
Transparency and Substance. Work within the FHTP has led to the development of proposals for new rules, known as the Modified Nexus approach, based on the location of the R&D expenditure incurred in developing the patent or product. This approach seeks to ensure that preferential regimes for intellectual property require substantial economic activities to be undertaken in the jurisdiction in which a preferential regime exists, by requiring tax benefits to be connected directly to R&D expenditures.
In order to take forward these negotiations, Germany and the UK have co-operated to develop a joint proposal for the consideration of the G20 and OECD member countries in the FHTP. This aims to resolve the concerns countries have expressed about some features of the Modified Nexus Approach, and identify what further work is required in order to enable agreement to be reached on this issue during 2015. Concerns have been expressed about how to calculate qualifying R&D expenditure, transitional arrangements between regimes and time allowed for this through grandfathering provisions, and the tracking and tracing methodology for R&D expenditure that will determine whether it qualifies.
The proposal is based on the following elements, which seek to address the concerns that have been raised, whilst reinforcing the nexus approach and providing safeguards against profit shifting. These also aim to ensure that the approach to implementing new rules is consistent with existing OECD rules on the phasing out of harmful regimes. 
 Uplift of Qualifying Expenditure - where related party outsourcing or acquisition costs are incurred, which do not constitute qualifying expenditure, companies will be able to obtain a maximum 30% uplift of their qualifying expenditure (subject to a cap based on actual expenditure) included within the formula; the 30% uplift refers to the overall expenses for both, outsourcing and acquisition costs;  
 Closure and Abolition of IP Regimes – to allow time for the legislative process, all existing regimes will be closed to new entrants (products and patents) in June 2016. These schemes will be abolished by June 2021. 
 Grandfathering – to allow time for transition to new regimes based on the Modified Nexus approach, IP within existing regimes will be able to retain the benefits of these until June 2021.  
 Tracking and Tracing – the FHTP should work to reach agreement by June 2015 on a practical and proportionate tracking and tracing approach that can be implemented by companies and tax authorities, which includes transitional mechanisms for intellectual property from existing into new regimes, and special rules for previous expenditure. The focus of this should be on developing practical methodologies that companies and tax authorities can adopt. 
Germany and the UK will submit this proposal to the Forum on Harmful Tax Practices, during its meeting on 17-19 November. It is our shared hope that countries will agree that this forms the basis for future negotiations and eventual agreement on this aspect of Action 5. We remain committed to working with all G20 and OECD partner countries to achieve this shared aim. 

Wednesday, 26 November 2014

Licensing mobile technologies becomes even more essential

Dramatic structural changes in mobile communications technology supply, with the demise of vertical integration, is forcing those who are developing standard-essential technologies for 4G and "5G" networks to monetise these efforts through patent licensing, as well as their own product sales. Exiting the handset business, as have most of the original major technology suppliers, including former market leader Nokia earlier this year, eliminates participation in the largest product market, and the need for cross-licensed patent protection there.

Under New Management

The market size for mobile standard-essential patent (SEP) royalties paid remains below 5 per cent ($19 billion [€15.2 billion]) of the $377 billion in annual smartphones sales.

Netting-off
Once upon a time, new mobile communications technologies such as 2G GSM were developed by small clutches of vertically integrated players. Mobile technology pioneers including Alcatel, Ericsson, Nokia, Nortel Networks, Motorola, Qualcomm and Siemens all manufactured handsets, as well as network equipment. Some of these companies also produced communications chips.

Business models were predominantly oriented towards generating income from product sales. Technology development costs and risks of failure (e.g. with demise of the rival U.S. 2G TDMA standard) were compensated for through product sales and in cross-licensing, for little or no cash royalty payments among these major players, to obtain access to all the SEP technologies required to make and sell products.

Vertical disintegration
Over the last decade or so, virtually all the diversified mobile technology manufacturers have exited the handset market. From among the above, brand names Alcatel, Motorola and Nokia live on in handsets, but ownership is now completely removed from the original parent companies. I tracked the demise of some of these in the face of new market entrant challengers in another of my recent postings. Some of them have also ceased sales of other mobile products, including network equipment and chips.

Consequently, all the above parents have lost their ability to obtain a financial return on their mobile technology R&D investments directly through sales of handsets, which is by far the largest product market in the mobile sector. Global market revenues in 2013 were $377 billion for handsets, according to Morgan Stanley; $61 billion for network equipment, including radio, IP & transport and core equipment, according to Ericsson; and around $20 billion in baseband modems (which are mostly embodied in handset products). Nevertheless, the pace of technology development is continuing relentlessly in standard-essential technologies and in mobile technologies in general.

R&D spending continues to increase
Despite so many mobile technology vendors no longer selling handsets, mobile R&D spending, of approximately $42 billion in 2013, has grown 50 per cent since 2008, as indicated in table below. The figures include 12 large technology companies with a predominant or exclusive focus on mobile communications, including several named above. Some of these are quite diversified and do not break out their wireless R&D expenditures in public disclosures, so these figures include some R&D related to other technologies and product markets. However, my total excludes many companies that also invest significantly in cellular R&D; so I believe the table provides a fair, yet approximate, and consistent representation of total R&D investments and their growth by the mobile technology industry as a whole.
 Total Sales and R&D for Leading Cellular Technology Companies

2008
2009
2010
2011
2012
2013
Total Sales
(millions)
$399,917
$353,836
$401,722
$510,840
$559,173
$582,011
Total R&D
(millions)
$27,990
$27,854
$30,829
$37,922
$39,970
$41,927
R&D/Sales
7.0%
7.9%
7.7%
7.4%
7.1%
7.2%
Sources: Includes public disclosures for Alcatel-Lucent, Apple, BlackBerry, Ericsson, Huawei, LG Electronics, MediaTek, Nokia, Qualcomm, Samsung, Electronics and ZTE.

New business model
Value is derived from standard-essential and other patented technologies through the manufacture and sale of one's own products, through cross-licensing to protect one's own product sales from infringement claims and through licensing for receipt of cash royalty payments.

Licensing value, in kind through cross-licensing or in cash, tends to correlate positively or proportionally with product sales revenues. Significantly for Alcatel-Lucent, Ericsson and Nokia, as indicated above, the network equipment business has only around one-sixth the market value of that for handsets. This means the value potential for royalty-generating licenses or royalty-mitigating cross-licenses is also likely to be correspondingly lower there for the mobile SEPs, which tend to apply to both networks and devices.
Therefore, in order to maintain R&D investment levels or increase them, technology developers are increasingly dependent on licensing others' handsets for cash royalties to recoup returns on their costly and risky R&D.

Qualcomm has been able to focus on developing its patent licensing while substantially growing its R&D. It needs to do so because R&D spending (e.g. $5 billion in 2013) exceeds the profit it makes on its chip sales. Qualcomm led the way in licensing with the company being the majority developer of CDMA technologies in the 1990s. Qualcomm's exit from network equipment and handset businesses around the turn of the millennium eliminated its need to patent-protect those operations through cross-licensing. Qualcomm's licensing revenues of $7.9 billion in 2013 are equivalent to a royalty rate yield of 1.77 per cent of total global handset revenues indicated above.

The opportunity to grow licensing income with SEPs and non-SEPs (also referred to as implementation patents) was presented as a significant strategic objective by Ericsson and Nokia at their recent Capital Markets Days in Stockholm and London. Ericsson's 2013 licensing income was around $1.6 billion, which corresponds to a royalty rate of 0.42 per cent on the same basis as for Qualcomm above. Corresponding figures for Nokia were $650 million and 0.17 per cent, respectively.

Nokia, in particular, has a history of handset patent licensing agreements which sought to minimize or eliminate royalty out-payments through cross-licensing, rather than to maximise royalty income. The company needs to unravel previous arrangements and substitute sales volume-dependent agreements for legacy sales volume-independent agreements. The latter were highly beneficial while handset market shares were up to around 40 per cent last decade. These two companies and Qualcomm are also including non-mobile SEPs and non-SEPs in some of their licensing. Ericsson, Nokia and others still need cross-licensing to provide "freedom to operate" in design, manufacture, sale and use of network equipment.

Low barriers with modest royalties paid
The mobile device business--including smartphones, feature phones, tablets and Internet of Things connectivity--has relatively low barriers to market entry through the freely available 3GPP standards. That is why there are so many new handset OEM names in recent years--with the most notable successes including Apple since 2007 and Xiaomi since 2011--seizing substantial market shares.

Ericsson, Nokia and Qualcomm are widely regarded as holding, in total, a substantial proportion, and quite likely the majority, of SEPs reading on 3GPP standards. On this basis, and the fact that Qualcomm has a far more well-developed patent licensing programme than any other company, a total aggregate SEP royalty across all handsets worldwide is most likely to be no more than a mid-single-digit percentage. Five per cent is conservatively more than double the total of 2.36 per cent in royalty rates I have calculated for Ericsson, Nokia and Qualcomm. Other significant SEP holders account for only relatively small licensing revenues. For example, InterDigital Communications, with a business model entirely focused on patent licensing, reported $264 million in patent licensing revenues in 2013. That corresponds to a comparable royalty rate of 0.07 per cent.

Smartphones designers also seek to include features which are subject to non-mobile SEPs and which might be subject to non-SEPs. But the latter are more easily ignored or worked around with alternative technologies, and some features might be omitted if this is not possible. In the case of SEPs, it is at least in theory not possible to implement the standard or part thereof without infringing.

On the basis of financially audited royalty incomes from leading licensors, my estimate that total mobile SEP royalties amount to less than a mid-single-digit percentage of handset revenues is in marked contrast to the erroneous aggregate royalty rate estimates of Intel and others. Elsewhere, I have published a detailed rebuttal of Intel's defective assessment that the smartphone "royalty stack" could amount to $120 on an average $400 smartphone, including SEPs and non-SEPs. That would correspond to a 30 per cent royalty rate, or around $100 billion per year in total royalties. This is more than five times my estimate of less than $19 billion, which includes all mobile SEPs, many non-cellular SEPs and many non-SEPs also thrown in to the licensing bundles. This figure is less than half the mobile industry's R&D spending.

Royalties paid on non-cellular SEPs (e.g. H.264 video and 802.11 Wi-Fi) and non-SEPs amount to no more than additional single-digit billions of dollars. It has been disclosed that Samsung, with 2013 smartphone revenue share of 34 per cent, paid Microsoft an annual $1 billion in licensing fees to implement Android. This is exceptional and accounts for a significant proportion of all non-SEP royalties paid.

I originally published this article in the mobile communications industry trade press with FierceWireless.