Moving markets

The ever-changing IP monetisation marketplace for PAEs

of available intellectual property, this article Entities whose business strategy discusses a significant in-flow of private is centred on IP monetisation are and public capital to support monetisation operating in an industry that is efforts as well as a maturing pool of serial performers, currently on their second or undergoing rapid transformation third generational cycle of managing PAEs and controlled growth and thus armed with a track record to approach capital markets and raise larger By Peter D Holden, George Park and amounts of funding. Anupama Jain Notwithstanding this upswing in activities, the PAE community faces Despite the naysayers, the momentum several significant challenges to sustain the created from seminal IP deals such as current level of growth, and – especially Round Rock Research and Nortel has considering the constant state of change – remained strong, resulting in continued it is hard to predict what the PAE landscape growth in licensing revenues and patent will look like 12 months from now. There sales. We have also seen continued is, however, an increased recognition from inflows of private (non-corporate) capital leaders in the PAE community that the into the IP ecosystem, put to work in a costs, complexity and legal uncertainty of plethora of ways, from the financing of litigation are increasing at the same time public shells via reverse merger through as margins are decreasing. This pattern is to the formation of dedicated IP funds and forcing behavioural and structural changes even to the creation and strengthening on the part of the PAEs, from seeking more of sovereign wealth funds from Asia. nuanced strategies for enforcement to Whatever euphemism is used to describe demonstrating a greater willingness to seek the resultant IP monetisation entities early returns through a more collaborative – patent trolls, non-practising entities than combative style. There is a clear flight (NPEs) or patent assertion entities (PAEs to quality by the more established PAEs, – this term is used henceforth) – there is acquiring larger, deeper, broader portfolios, no doubt that they are an important and putting more and higher-quality patents in growing part of the IP ecosystem, not only suits (and having even more in reserve) with in the United States but increasingly in much better financing. The better-managed Asia and Europe. In 2012 they represented PAEs operating at this level will prevail over 50% of patent suits in the United and prosper. On the other hand, there is States, and they now deploy significant no doubt in our minds that at the bottom amounts of capital and employ ever- of the market, the pursuit of punitive/ increasing numbers of highly qualified extortion-type suits will decline, and there personnel. will be a good deal of consolidation between We are seeing an increased volume and PAE operators at this level, as they seek to quality of patent offerings from major global create scale and pool capital. corporations and research centres, which As this correction continues – are now more willing to collaborate with which is a normal and healthy part of PAEs, whether openly or surreptitiously. an industry growing up – there will be Corresponding to the increase in the supply a healthy ‘secondaries’ market in which www.iam-magazine.com Intellectual Asset Management July/August 2013 37 Moving markets

the better-staffed and funded PAEs will Figure 1. Illustrative ecosystem of patent monetisation entities buy or take control over the worthwhile litigation ‘books’ of ailing, under-funding or under-exploited PAEs. The holy grail Interdigital VirnetX DSS/Lex Acacia CopyTele of PAEs, whether public or private, is that no quarterly earnings report or Rambus WiLAN Pendrell RPX Marathon financial year is ever dependent upon a single settlement, sales event or outcome. Tessera MGT Unwired Spherix For this, there must be mutual funds of Planet holdings across different technologies and ParkerVision Vringo markets, different counterparties, different Recent entrants (many Publicly less than 1 year old) strategies for monetisation and even listed Internet Defensive groups Patents Corp different monetisation teams in order to companies Pools diversify income streams and manage risk accordingly. Mobile Unified Altitude Media Patent The legitimisation of IP monetisation via the public markets Phoenix IV HDMI Arendi Licensing GPC/IPH Pluritas Licensing Figure 1 provides an illustrative breakdown Fergason Mosaid Inflexion of selected entities in the patent Patent PMC Point Pragmatus MPEG-LA monetisation ecosystem, categorising such entities by whether they are publicly listed Papst IP Navigation Round Rock Sipro or private and whether, broadly speaking, Private companies the foundational intellectual property was IPVALUE AST Sisvel internally generated or acquired externally. Until recently, when speaking of public Inventergy OIN Via Licensing IP companies, we were often referring to a first generation of technology development Internally generated Externally generated corporations that generated their own patents patents intellectual property as an offshoot of product Not comprehensive, subject to change development activities; these companies included Interdigital, Tessera, WiLAN and Mosaid. They blazed a trail in terms of wait for uplift on the stock or formal listing delivering sizeable returns to shareholders back onto NASDAQ once revenues become and succeeded in raising additional capital forthcoming. Figure 2 highlights some of the through secondary offerings. more prominent transactions of this type in As licensing programmes based on the last 12 to 18 months. their core intellectual property have been Patent holders invited to participate winding down, the continued success of in these ventures need to look carefully these companies will be determined by at the distribution waterfalls for such their ability to expand beyond their core arrangements, since while the public technical areas of competence (eg, wireless market story is compelling, the high cost and semiconductor) into new markets such of this capital is often less understood in as med-tech or light-emitting diodes, terms of actual distributions received by as well as to develop the required skills the founding management teams net of to effectively acquire new intellectual investors’ return of capital, hurdle rates of property, without unacceptable decreases 5% to 10% and sizeable warrant packages. in revenues. For every success story (eg, VirnetX), The last year saw the rise of repurposed there are many others that are still public shell companies specifically fashioned waiting to generate revenues and achieve to monetise portfolios of patents acquired aspired results. or brought into the public company in This repurposed public vehicle model, some structured finance arrangement or however, does provide the management reverse merger. Many of these transactions team with much more liquidity than if were driven by hedge funds and private it were to seek private venture or debt equity funds in New York, fast becoming a funding, and it provides public investors centre for IP financing. In some situations with an entry point into IP monetisation, the public shell companies are dormant or serving as a demonstration that Wall underperforming operating companies; in Street is taking intellectual property more others, they are clean, capitalised over-the- seriously as an uncorrelated alternative counter bulletin board shells which, with asset in its own right. However, in several the newly acquired intellectual property, cases, these public vehicles simply do

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Figure 2. The reverse merger phenomenon and the rise of public IP companies

Openwave (OPWV): founded Apr 2012: sold mediation and May 2012: changed name to Sep 2012: charged Apple and 1996, with a focus on mobile messaging product businesses Unwired Planet (UPIP) and Google with infringement internet as a software supplier focus to IP licensing Jan 2013: acquired 2,400 in the mobile telecom sector and enforcement Ericsson patents

ICO Global Communications Jun 2011: changed name to Oct 2011: acquired Feb 2012: litigation against ZTE (ICOG): founded 1995 to provide Pendrell (PCO) and focus to ContentGuard Apr 2012: acquired 1,300 patents in 5 transactions mobile communications IP monetisation; acquired IP patent holding company Mar 2013: acquired 125 services using satellites consultancy Ovidian Nokia patents

Document Security Systems Oct 2012: announced merger Mar 2013: Lexington makes equity investment in (DSS): specialises in fraud and with Lexington Technology VirtualAgility, providing access to patent portfolio and counterfeit protection for Group, a private IP litigation against Salesforce documents & digital information monetisation company

Innovate/protect

Vringo (VRNG): founded in 2006 Mar 2012: announced merger with Aug 2012: raised US$31M to Mar 2013: announced with a focus on mobile products IP firm Innovate/Protect, acquiring buy 500 patents from Nokia partnership with Virginia Tech and platforms, including patents purchased from Lycos and Oct 2012: filed lawsuit Intellectual Properties video ringtones asserted against AOL, Google, etc against ZTE

Sampo IP

American Strategic Minerals Nov 2012: merger with Sampo IP Mar 2013: establishment of Mar 2013: filed lawsuit Corporation (ASMC): engaged in LLC, acquiring set of notification “IP Research and Services against Sony, Siemens, Dell uranium and vanadium patents, and name change to Center” to generate revenues and others mining in Colorado Marathon Patent Group (MARA) from monetisation

not have enough intellectual property The increased flows of risk capital into (‘one-trick pony’ syndrome), capital or the IP ecosystem management resources to ensure long- Over and above the increased buying of term growth or sustainability, and may be intellectual property between operating dependent on the fact that future revenues companies, as well as by public IP need to be recycled back into the company companies such as Acacia, Interdigital, to make such acquisitions – Vringo’s Vringo and Tessera that have capital acquisition of Nokia patents, for example resources on the balance sheet or the – to provide this growth. If such revenue is ability to raise capital on the secondary not forthcoming, the company risks sinking public markets, 2012 was a banner in a perfect storm of falling stock price, no year for the consolidation of a whole visibility on near-term revenues and no community of capital providers to support cash reserves to sustain licensing efforts or IP monetisation. Figure 3 provides an acquire new intellectual property to provide illustrative breakdown of the various a ‘growth story’ to shareholders. This is categories of IP capital provider. By covered more generally in the next section. number of entities, the most populous are www.iam-magazine.com Intellectual Asset Management July/August 2013 39 Moving markets

those entities that provide project-based Figure 3. Increased availability of IP funding via financial entities financing, where the capital is not invested ‘blind’, but rather focused on a very specific Patent focused investment proposal made by a prospective financial groups team or buyer. These entities include multi-strategy hedge funds, angel networks, law firms and existing PAEs looking to expand on their current holdings. A Patent litigation Private investment IP M&A services and Regional second category of financial provider is the financing funds IP capital placement development dedicated IP funds or captive private equity • Arca Capital • Alpha Funds agents funds funds that have a fixed allocation from • Burford • Altitude Capital • Barclays (RPX, • France Brevets their total capital raise to make towards IP • Calunius • Coller Capital ACTG, IDCC) • Hamburg IP Fund investments. These range from established • Committed Capital • Fortress • Evercore (AOL, • IP Gest investors such as Intellectual Ventures to • Fulbrook • Intellectual IDCC) • ITRI/ Taiwan • Harbour Discovery • Houlihan Lokey • China SOEs (2013) newcomers such as Hudson Bay, Iroquois • Hudson Bay Capital • Inv Capital Partners (PWAV) • Japan (2014) and Juridica. • IMF/Bentham • Northwater Capital • KPMG (Qimonda) We have also seen the rapid rise of IP • Iroquois • NW Patent Funding • Lazards (Nortel, M&A and capital advisory services and • Juridica • Panoptis Motorola, Kodak) placement agents to help find buyers/ • Pragmatus • Paradox Capital • Pluritas investors in large IP divestitures, as well as • Vannin • Rembrandt • 3LP Advisors to advise management teams attempting • 1624 Capital • Techquity to raise their first or follow-on funds or to Not comprehensive, subject to change obtain reverse merger financing of public shells; again, New York has become a leading locale for this activity. as critical to their growth. A final source of capital – which is It is worth noting a concern from often difficult to quantify and may take several PAEs that with this influx of new the form of low or zero-cost loans as well capital from these many different sources, as dedicated pools of managed capital – is there can be increased competition for government funding, almost exclusively by premier IP offerings, over and above entities in Asia and Europe. The motives the normal competition that PAEs can for providing such funding are varied, expect from sophisticated sellers. A way but generally address one or more of the to mitigate this, which has been limited following drivers: to date because PAEs are usually very • Provide risk capital and expertise private and secretive with each other, is to support regional IP monetisation to collaborate and syndicate acquisitions, initiatives from local companies, especially on the larger transactions of universities and research centres. US$100 million and greater. We are seeing • Provide a collective purchasing encouraging signs of this in 2013, and capability, again with a seasoned IP hopefully this trend will continue. team selected for the purpose, to acquire world-class IP which is then seeded IP monetisation failures analysis to local companies to reduce the ‘tax’ Over the last few years, we have been imposed on them by foreign patent asked to help ongoing IP licensing teams, holders, especially with international programmes or special purpose vehicles, expansion in mind. often by providing new capital to sustain • Stimula te a marketplace for IP trading the licensing programmes through in the local country or as a claim on litigation or to help manage litigation becoming an IP hub for Asia, Europe, etc. activities and expenses, complete reverse engineering (which is always more costly Previous efforts have failed badly than expected), or get through some other because of political interference in the execution challenge. Through this process, IP funds’ investment goals, choice of an we have seen the same set of fundamental inexperienced management team, lack challenges arise – these are summarised in of quality deal flow and the absence Table 1. In most situations, the problems of mechanisms (post-acquisition) to arise from inexperienced management disseminate the intellectual property underestimating the cost, complexity and to worthwhile licensees. It is very clear, uncertainty involved in managing a privately however, that Chinese/Hong Kong, funded licensing programme. Very often, Singaporean, Taiwanese, Korean and the fortunes of the licensing programme Japanese sovereign and regional funds rest too much on one or two critical continue to see an IP investment capability settlements, rather than having enough

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Table 1. Commonly recurring reasons why monetisation programmes fail

Failure mode/risks Mitigation solutions

First-time GP team • Programmes need IP teams with 10+ years of IP monetisation experience as a for-profit business, including /lack of investment expertise in IP management, IP licensing or sales and, increasingly, IP finance. experience • Teams should have ability to handle complex transactions as they scale: portfolio management. Lack of follow-on • Several project funds have underestimated the costs of monetisation and have had to terminate or capital/dry powder liquidate holdings. • Programmes need to have sufficient funds to manage the entire lifecycle costs of investments, including sufficient reserves for follow-on. Management needs to exercise extreme caution in pricing assets, plus much more care and attention in partnering with outside law firms. One-trick pony • The fall-out rate of patents in suit is very high. An alarming number of licensing discussions do not have enough licensing programmes depth and breadth to go the distance beyond early quick wins. • There may be a limited number of patents in suit, but supporting patents and follow-on patents in the suit is becoming more important in licensing discussions, as is the pedigree of the patents. All or nothing mentality • Sustainable licensing programmes are ones where pragmatism and early settlements go hand in hand with tenacity tenacity to see a particular suit through to the end. Sometimes, you also have to walk away. High operating costs • IP due diligence is complex, requiring multiple technical, legal, financial, investment and market/business inputs. and diligence delays Many funds do not have the experience, processes or tools in place to efficiently evaluate opportunities, leading to cost overruns and delays. • Management needs to build risk management and an execution bias towards diligence, along with the ability to say no quickly.

redundancy and spread of outcomes, across nascent, but this is quite unusual. multiple counterparties and with different • Uncritical reliance on the contingent ways of monetising the assets to offset this law firm – selecting a top plaintiff law risk. Other key factors that warrant further firm to represent the team in litigation detail include the following: provides strong validation for the case. • Immature/non-important intellectual While necessary, it is not sufficient. property – though it may seem obvious, Notwithstanding careful cash-flow we have seen too many licensing management, time management, programmes fully financed and staffed policing of senior partners to get the with intellectual property which simply necessary time and attention, and is not commercially important enough ensuring that incentives are aligned, it is to realise significant return, never mind also critical that the patent holder or in- return founder’s capital. This may house team oversee project management be because the intellectual property and pursue broader business goals, relates to technologies which are not yet including considering quick settlements established in the marketplace, requiring to support early returns on capital many years for the technology to be and closing down programmes quickly successfully deployed and to thus offer when prospects of success become meaningful royalty potential, assuming questionable. that this happens at all. A second • P erceived or real lack of dry powder problem is that the technical solution for contingencies – defendants in PAE provided by the intellectual property suits will carefully review the finances may not be an important part of the of the PAE to better understand their value chain of a product, component cash reserves and capability to last out or service. It is very hard to justify protracted licensing discussions. PAEs authorising a licensing programme should carefully plan for contingencies where the risk-adjusted addressable and weighted outcomes from multiple market is less than US$250 million suits (some will settle early, some will (net of encumbrances, liens and other lose, some will be delayed through re- risks), and indeed, we do not normally exam and other tactics, and some may engage with a patent portfolio unless go all the way through trial and appeals), the addressable market is US$1 billion and develop realistic budgets. A healthy or more. In some situations – such as balance sheet, strong licensing team organic light-emitting diode or mobile and tier-1 litigation counsel are also payments – the demand for intellectual clearly important in establishing the property may be extremely high, even conviction, capability and capital to be though the actual marketplace is still seen as a serious counterparty. www.iam-magazine.com Intellectual Asset Management July/August 2013 41 Moving markets

Table 2a. Some challenges to PAEs engaged in litigation

Increased (tacit) negative sentiment towards certain PAEs Greater challenge to prove essentiality (and justify corresponding royalty rates) of allegedly standards-essential patents Increased scrutiny on damages models Greater difficulty to claim past damages on expired patents Higher bar for PAEs to claim ‘domestic industry’ in International Trade Commission when acquiring assets of operating companies Increased difficulty in upholding sub-licence rights to assert granted to PAEs (standing issues) Increased challenge to get an injunction ➡

Table 2b. Some operational and business consequences of the above challenges

Law firms backing away from fully contingent/partially contingent arrangements Average time to settlement increasing Reduced settlement amounts Increased costs of litigation and need for greater reserve/contingency allocations Increased failure rate of single-patent suits Increased uncertainty on licensing outcomes Reduced margins on licensing programmes

A ‘higher bar’ for PAEs engaged in performing licensing programmes to create litigation a critical mass of intellectual property, Whether it is changing sentiments in the spread risks and pool management district courts or simply the pure number resources. of PAE-driven suits that is creating a strain As well as greater creativity on the on the system and heightened exposure, types of partnership and structures of IP a repeated concern from PAEs, whether monetisation (see further below), we also private or public, is that the ‘bar’ on see top PAEs recalibrating their businesses lawsuits is getting higher while the gross to diversify portfolios, reduce uncertainty, margins from litigation are decreasing. share costs and behaviourally change Table 2a summarises some emerging legal the way in which they manage licensing and structural challenges that PAEs face programmes. Some of the key trends we in growing their licensing businesses, and have seen include the following as the PAE Table 2b highlights some of the operational industry continues to evolve: and business consequences of these • Flight to quality – PAEs are buying changes. Some of these challenges apply to larger, deeper portfolios and putting all patent litigations and others appear to more patents in suit, as well as holding specifically address PAEs. a deeper pool of back-up patents for licensing and sale. Mitigating factors for PAEs and • Gr eater focus on pedigree – PAEs retooling for growth are increasing attention to the R&D Despite the above challenges, perceived leadership and history of the patents to or real, what is clear is that the PAE show good standing, importance of the community is not static. Rather, it intellectual property and the time and is adapting dynamically to these money that went into generating the developments, though we believe there will patents. be some correction to the breakneck roll- • Bet ter financed – through public out of reverse merger/public IP companies vehicles as well as private investments, and a decline at the low end of the market PAEs are becoming better financed, with focused on single-play and extortion- deeper reserves of capital to sustain based litigations (and the departure of larger acquisitions and manage more the discretionary sources of capital that licensing programmes in parallel. financed these). We also believe that we • Revenue diversification – PAEs are are starting to see the roll-up of under- achieving a steady state of more

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Figure 4. More creative, diverse strategies by patent holders ongoing licensing programmes on a secondary distressed basis from teams that either have run out of money or are Syndicated deals Inter-corporate sale Privateer/NPE sale deals underperforming and require additional transactions support. This is a powerful way of achieving non-organic growth and it 1,500 patents & assets 125 patents (Mar 2013) is our view that a sizeable number of US$525M (Dec 2012) – US$100M (Apr 2013) such secondary opportunities will be available in the next 12 months as the

1,700 patents sold PAE community consolidates. Undisclosed (Dec 2012) – US$375M (Jun 2012) 2,400 patents (Jan 2013) • Increased financial and investment sophistication – setting up special- purpose vehicles which are tax 498 patents sold efficient (including offshore options) – US$350M (Nov 2012) 500 patents – US$22M (Aug 2012) 650 patents sold – US$550M (Apr 2012) and negotiating preferred returns and hurdle rates to better reflect the true cost of capital committed are critical Agreement for syndicated licensing 230 patents – US$160M (Jan 2012) components of managing IP investments (Feb 2012) 925 patents sold – US$1.1B (Apr 2012) and make a huge impact on the More creative approaches and structures in order to realise IP value investment performance of PAEs.

PAEs fortunate enough to have capital, predictable aggregate returns by scale and diversified investments and leveraging different revenue streams revenue streams will be well positioned for (eg, paid-up licences, running royalties, growth and – equally important – more able lump-sum payments from patent sales), to adapt to the changing litigation landscape each with their own risk characteristics and fortunes of the IP marketplace. and timelines/returns profiles and with greater attention to the downside More creative modes and partnerships protection of investments. for IP monetisation • Portfolio diversification – PAEs are Patent holders are considering more and investing across different technologies more creative ways of commercialising their and markets in order to provide sector intellectual property that simply would not diversification. have been contemplated even three years • Sc aling through partnership – as well ago, certainly not to the scale we are seeing. as a core in-house team and favoured Figure 4 highlights some of these deals. litigation counsel, PAEs will begin to With regard to inter-corporate patent back different IP monetisation teams to sales, there have been transactions where provide additional operational scale and the motives for the deal were clearly to take advantage of new perspectives focused on liquidity for corporations that and access points in the IP ecosystem. are distressed, undergoing restructuring • S yndication – in order to spread or looking to divest assets which are capital risk as well as access larger non-core or non-competitive. Examples opportunities which may not have include Interdigital’s sale of 1,700 patents been possible otherwise, PAEs are to Intel in June 2012 for US$375 million in beginning to explore co-investment order to meet shareholders’ expectations and syndicated transactions, as well as on revenue growth and to implement a pooling portfolios in critical new areas share buy-back programme, as well as such as mobile payments. Lexmark’s sale to Funai of 1,500 patents • Glob al outreach – most PAE activity is plus technology assets, reflecting the currently centred in the United States, changing dynamic of the consumer printing but other geographies will become industry away from highly commoditised an increasingly important part of a ink-jet printing towards higher-margin PAE’s portfolio mix – whether it be laser printing and document image services litigation via German or UK courts, or businesses. For Funai, experienced in large- sale of patents to new buyers in China, volume, low-margin manufacturing and Korea and Taiwan. Given the extensive with sophisticated marketing channels in restructuring and bankruptcies in Europe Asia, where the ink-jet printing market and Japan of late, these locales have is stable, the deal represents a significant become increasingly important sources opportunity to acquire seminal IP and of deal flow for IP capital providers. technology assets at a very attractive price. • IP secondaries – PAEs are also acquiring Microsoft’s landmark US$550 million sale www.iam-magazine.com Intellectual Asset Management July/August 2013 43 Moving markets

of 650 patents to Facebook in April 2012, Figure 5. A higher bar on valuation by financial players by contrast, was not necessarily solely based on liquidity considerations, but could Traditional valuation processes have resulted from the strategic alignment between the two companies. This could Technical analysis Legal analysis Economic analysis have been only part of a broad-reaching • Map to products/ • Prior art/validity • Addressable markets partnership, details of which will be standards • Claim strength/scope • Royalty rate & probably never fully revealed. • Claim strength/scope • Enforceability benchmarking The last 18 months have also seen • Detectability • Encumbrance analysis • NPV analysis corporations more and more willing to • Invention timeline • Courts’ analyses sell to PAEs – suffice to say that the on damages privateer model is alive and kicking. Vringo’ s acquisition of 500 Nokia patents in August 2012, Unwired Planet’s + acquisition of 2,400 patents from Ericsson Additional IP investment criteria in early 2013 and Pendrell’s acquisition of 125 Nokia memory patents in March 2013 are prominent examples of these. Execution risks Financial risk assessment For these publicly listed PAEs, such Management team/capabilities Downside protection analysis Concentration issues Weighted returns analysis acquisitions provide highly sought-after Budget/cost management: Pricing sensitivity analysis scale and growth, building off their initial • purchase price Market risk factors licensing successes with their founding • monetisation costs Legal risk factors IP portfolios. For the corporations, it Monetisation blueprint: Technical risk factors is a way of providing not just liquidity, • strategy Cash flow analysis and contingencies but also off-balance sheet capital, • time to market Rate of return of revenues management resources and additional • status of technology Absolute multiple on costs • supporting materials to patent leverage to their portfolios which may not have been available if they attempted to commercialise the patents in-house. We have also seen several prominent a trusted third party and manager, in the syndicated IP acquisition deals in the last form of Transpacific IP. year, in which a single entity provides Notwithstanding the increased a collective purchasing capability for scrutiny from the antitrust authorities multiple ‘members’, which then receive concerning the nature of these pooled defensive rights to the acquired patents. capital alliances, there is no doubt Allied Security Trust, in a much that such syndications will continue expanded role to what it has undertaken to be serious and viable buyers in the traditionally, acted on behalf of multiple marketplace for the foreseeable future. corporate members – most notably ARM As prominent companies such as Alcatel- Holdings, which essentially underwrote Lucent, Qimonda, ST Ericsson and Renesas the transaction – facilitating a complex publicly announce restructuring, debt transaction to acquire close to 500 patents financing and bankruptcy, it is safe to for US$350 million from MIPs, with the assume that there is a valuable role for operating business and a smaller subset these entities in the marketplace, providing of assets being sold to Imagination liquidity options to these distressed Technologies of the United Kingdom. companies and amounts of capital that Likewise, in what will probably go down were perhaps unattainable from single as one of the most surprising and unlikely corporate buyers. partnerships in 2012, Intellectual Ventures Finally, mention should be made of pooled capital resources and members’ the large multi-strategy funds showing capital with those of RPX to acquire a interest in leveraging intellectual property significant number of assets from Kodak in the form of asset-backed loans. This has for US$525 million. Finally, Transpacific been well covered in earlier IAM articles IP’s facilitation of the acquisition of (“IP debt: the new monetisation option”, Phoenix Technologies’ BIOS portfolio to a by Joseph Jennings, May/June 2013, issue syndicate of Taiwanese corporations which 59). Such deals could be considered as make most of the world’s laptops and PCs an investment strategy in themselves (as not only made strategic sense, but also recently announced by Fortress, delivering broke new ground as the first known case debt-like returns in the 10% to 15% range, where Asian companies (alone) took the with first capital back from monetising initiative to collaborate to take potentially the secured intellectual property in a incendiary assets off the marketplace via default situation) or as more creative

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ways of financing the M&A transaction committed capital from other investors. in the first place, especially as the cost • Lack of financial skills in the of capital is expected to significantly management team. increase over the next two to three years. • Unrealistic returns expectations. Large buy-out funds have been much • Poor communication/characterisations more aware and sensitive to the fact of risks. that an acquiree company’s intellectual • Poor cash-flow management and property may be exhausted by the master oversight of external consultants and licence agreements held by the acquiring law firms. company, and some acquirees may be • Choice of wrong management team looking at creative ways to divest their to run the PAE (eg, too risk adverse, assets and leverage these financially in too risk seeking, corporate licensing some way prior to the formalisation of any experience but not entrepreneurial acquisition. enough). As the IP marketplace becomes more • No portfolio management experience competitive, IP investors will need to be where multiple projects are being run able to handle not only straightforward IP in parallel. asset purchases (‘directs’), but increasingly in order to attract the best-quality assets The latter point is interesting because and people, more complex and creative investors expect PAE managers to be much ‘structured’ transactions, whether co- more proactive in managing licensing ownership, joint ventures, IP M&A projects than perhaps they are used to – carve-outs, patent pools, syndicated this includes a triage approach of closing deals, catch-and-release corporate down licensing discussions more quickly, partnerships or synthetic royalty and selling off less critical patents, cutting income partnerships. costs as much as possible and settling earlier to get returns back more quickly. A final word on realised value and Investors will also pay special attention returns – an investor’s perspective to whether interests are aligned with Financial investors are often more sensitive the PAE management teams in terms of to the rate of return of capital (IRR) compensation, incentives and commitment than to the absolute multiple on capital to the full programme to guard against invested (ROI). In practice, this means that the turnover of personnel, and especially investors require reassurance on when they leadership. will receive their principal capital back A huge part of investor diligence will be and then the profile of returns thereafter. focused on two factors: Typically, funds are looking to achieve a • Proper pricing of the assets, including gross IRR of 20% or more; from a returns understanding total programme costs point of view, this is the equivalent of and returns. getting a 2.5x multiple on total costs (on • Execution strategy, capability and risk. a running or cash-on-cash basis) over a five-year period. Interestingly enough, a As Figure 5 shows, this requires 20% IRR may also be achieved by returning PAEs to repurpose traditional valuation just a 1.75x return on capital in three models and include additional emphasis years, lending to the argument that quick on discount factors to take into account settlements – even if value is left on the operational challenges such as management table – and patent sales are important credentials, IP monetisation strategy strategies for down-side protecting (ensuring no dependency on a single investments and still achieving acceptable strategy or outcome for success), time returns for investors. to revenues and quality of claims charts What is as important to investors, as and supporting materials. It also requires alluded to earlier, is much more visibility much more sophisticated approaches on properly characterising the risks in an incorporating legal, technical and market investment and more metered analysis risks into the financial returns models. on the returns scenarios, as well as ways With increased financing and support of mitigating these uncertainties should from the private equity and hedge fund things go wrong. communities, and the increased demands It is worthwhile pointing out from placed on PAEs as public entities, PAEs an investor perspective the following have been forced to become much more criticisms directed at PAE management investment savvy and disciplined in teams, in no particular order: evaluating risks and uncertainties, pricing • Difficulties in drawing down pledged or assets and calculating weighted (risk- www.iam-magazine.com Intellectual Asset Management July/August 2013 45 Moving markets

adjusted) returns. This has also precipitated the emergence of a new support community Action plan A of investment bankers, financial advisers and consultants that specialise in IP New trends are emerging around the revenues remains to be seen. financing. All of these, we feel, are very operation of patent assertion entities (PAEs) • We now see a new generation of IP positive developments in the evolution of that will have a significant effect on the monetisation management teams with intellectual property as an investment-grade sector over the coming years: demonstrable track records showing asset class. • Intellectual property has become a repeatable returns. Like venture capital, viable, investment-grade asset that is such ‘serial performers’ will be much attracting significant inflows of new sought out by capital providers. capital by a new population of capital • There are, and will continue to be, providers via both public and private legislative and structural challenges vehicles. to PAEs, with inevitable corrections • The extent to which the reverse merger and consolidations in the marketplace. phenomenon of repurposing intellectual However, the better funded and property into public vehicles can managed PAEs are already retooling and Peter D Holden is senior vice president, survive beyond quick wins and scale adjusting to these developments in order investments and acquisitions, at IPVALUE. up to create annuities and sustainable to ensure sustained growth. George Park is director of business development and Anupama Jain is a licensing associate with the firm

The contents of this paper represent the views of the authors and do not reflect the opinions or positions of IPVALUE or its clients

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