The price of them apples: Ready to license but unsure how much the technology is worth?

With new and early stage technologies, or perhaps new uses for existing technologies, the value of the technology for licensing purposes is often not able to be readily determined.

In the absence of a commercialisation track record, the risk is that the value for the licensed technology (licence fees, milestone payments, royalties) may be set too high or too low.

Set too high and the technology may fail to attract a willing licensee, or exploitation of the technology may prove to be commercially unviable, and the technology’s potential brought to an abrupt end.

Set too low, and the licensor risks missing out on its fair share of the fruits of commercialisation, as well as setting a possibly problematic precedent for future licensing deals, particularly those including a most favoured nation (or customer) clause where the licensor is required to offer a licensee terms at least as favourable as those agreed with other licensees.

With tangible property, the value at any given time is commonly said to be the price that a willing buyer will pay, perhaps informed by price indications or offers over.

This approach may similarly apply to the acquisition of intellectual property outright but is much harder to apply to early stage technology in a licensing context. Licensed rights will likely continue for many years with the value of the technology subject to many variables over that time (such as the success of further development effort and its cost, market interest and take up, and new competing technologies).

There are a number of companies that can be engaged to provide an IP valuation to inform licensing decisions but such a valuation is not always possible or appropriate (due to cost, time constraints, or other factors).

There is also merit in saying who better to determine value than a licensor who has developed a technology and intimately knows its benefits and challenges on the one hand, and a willing licensee who has assessed the technology, its commercial potential and rewards on the other.

However, this article began by noting that the value often could not be determined by those parties so that observation takes us no further forward.

It is generally not advisable to kick commercial issues down the track for later agreement but the issue of the valuation of early stage technology may be an exception to that general rule, as long as there is a framework and safeguard in place.

Framework

Whilst acknowledging that the parties are currently unable to determine a value for the licensed technology, a framework should be agreed setting out the context and principles for the valuation to be determined at a later date.

The framework will likely include some or all of the following items, perhaps including a weighting or value where appropriate:

• the licensor’s investment in the technology at the date of the licence;
• each party’s cash and in-kind contributions to any future R&D involving the technology;
• each party’s inventive contribution to the technology and any modifications or improvements;
• the background or enabling IP to be made available by each party, whether for further R&D or for the purposes of commercialisation of the technology;
• costs in taking the technology to market (including regulatory compliance costs, trial expenses);
• the definitions of gross and net revenues or similar to which a royalty will be applied; and
• any differentials based on market sector and territory.

The parties may also be able to agree on a minimum and maximum value for the technology, providing a range within which the value will be agreed using the framework.

The more the parties are able to agree and in as much detail, the more streamlined the final determination of the technology’s value will be.

In short, the parties should agree as much as they can at the time of entering the licence agreement.

Safeguard

The reason why it is usually not advisable to delay agreement on commercial terms is the old ‘agreement to agree’ chestnut which begs the question, what happens if the parties can’t agree?

Assuming the framework has been clearly set out in the licence agreement, hopefully this problem will not arise.

However, hope is not a strategy on which empires are built, nor will it alleviate the concerns of licensees who have invested in taking a technology to market and don’t yet know how much they will be required to pay the licensor for the commercialisation rights.

That risk warrants a safeguard to protect each party in case agreement cannot be reached on the value of the technology.

Typically, that safeguard would be the ability for one or both of the parties to refer the matter to an independent expert for final determination.

The mere fact that such a mechanism exists may be sufficient to encourage the parties to agree the final value themselves, instead of having a third party do it for them.

If not, then at least each party knows that a value will be determined and within a prescribed timeframe (as set out in the agreement, usually between 30 to 60 days from the date of referral).

The agreement should ensure that the expert does not make the determination in isolation but is required to do so based on the framework already agreed by the parties, with the expert’s role confined to making a determination on issues that the parties to that point have been unable to agree upon.

So whilst either or both of the parties may not entirely like the price of them apples, the value will still be a determination within the scope of the framework initially agreed by the parties.

This is part of a series of occasional articles providing some practical tips and guidance on contracting and licensing issues. Other articles include Licence to Rights / Rights to License (An IP licensing regime not dependent on crossed fingers) and Entering into a Head Contract? Tips for Alleviating the Head-Ache of Subcontracting. If you have suggestions for issues that it would be helpful to be covered, please email Richard Browes at rb@fal-lawyers.com.au.