Constructing a holistic corporate patent monetisation strategy

Over the past several years, the term ‘patent monetisation’ has come to be synonymous with patent assertion, and particularly with the assertion of questionable or even frivolous patent infringement claims by certain types of non-practising entity (NPE) seeking to extract licence fees from technology product or platform companies by initiating or threatening meritless infringement litigation and then offering to settle the claim for an amount well below the target’s expected cost of defence. More recently, small retail businesses which resell those products or use those platforms have also been targeted.

There are a number of reasons for this perceived conflation of monetisation and assertion. Because litigation is public, it is the most visible form of patent monetisation. Beyond that, the patent abuse rhetoric that permeates the public policy debate on the pros and cons of the US patent system tends to focus directly on this form of patent exploitation, and the term ‘patent troll’ is now firmly established in the lexicon of legal and business pejoratives.

Even where an infringement claim may be legitimate, from the target’s perspective assertion-based patent licensing may look like a zero-sum game where the only consideration received in exchange for payment of a licence fee is the ability to avoid or settle costly litigation – the practical effect of which is a form of after-the-fact patent infringement insurance.

However, what does not get nearly as much press are the variety of other, less adversarial mechanisms that technology-based operating companies can use to extract value from their patent portfolios in a business-friendly, win-win context. In fact, the total amount of economic value represented by business transactions in which patents act as a significant deal driver is likely several orders of magnitude greater than the combined litigation costs, damages awards and settlements resulting from patent assertion during a comparable time period.

Holistic IP value extraction strategy

Webster’s defines ‘holistic’ as: “relating to or concerned with wholes or with complete systems rather than with the analysis of, treatment of, or dissection into parts” (emphasis added). This is precisely the way that technology companies should approach the challenge of extracting value from or monetising their IP assets and, particularly, their patent holdings.

The underlying premise of the approach described here is that a corporate IP monetisation programme should be designed top-down as if it were a systems engineering project, where the relevant objectives, resources and constraints are clearly identified and balanced to produce a result that is optimised for each company. The discipline of systems engineering emerged in the late 1950s and early 1960s in the US aerospace industry and is based on the central premise that the optimal design of any complex system (whether technological, economic or social) requires that the various cost-performance trade-offs associated with competing design alternatives be identified and, as far as possible, resolved.

The first and most important step in the design of a holistic corporate patent monetisation programme is to identify the primary objective. If there are multiple objectives, these need to be prioritised or ranked with regard to their relative importance and desirability. One way to classify the various objectives is in terms of the applicable ‘value extraction level,’ as described below.

Once the corporate monetisation objectives have been clearly defined, the next step is to consider and prioritise the various available resources. This should be done in terms of both the legal options and transaction structures for achieving those objectives, as well as the content and architecture of the company’s patent portfolio and the quality and reach of the individual patents therein.

With regard to monetisation mechanisms, these must include the option of initiating patent infringement litigation against competitors in order to:

• obtain and then either enforce or ‘sell’ an injunction that forces the competitor to remove or change the infringing product features or process steps (which is still available to operating companies after the Supreme Court decision in eBay upon a sufficient showing of irreparable injury);
• recover damages for past infringement and, in cases where an injunction is not available, impose a court-ordered ongoing royalty obligation or compulsory licence for continued use of the patented subject matter (which has been common practice outside the United States for many years and has been adopted by an increasing number of district court judges following eBay);
• dismiss the suit in exchange for the competitor taking a licence or entering into a cross-licence on reasonable financial or other terms; or
• use the prospect of an injunction or a large damages award to incentivise the competitor to voluntarily design around the asserted patents, thereby increasing the cost of the goods it sells and potentially resulting in a loss of market share in favour of the rights holder due to the absence of features or functions that consumers want.

Notwithstanding the importance of the enforcement option, if one adopts a holistic view of patent monetisation, the relative desirability of enforcement in terms of its risk-return profile must be evaluated in relation to the applicable business-based alternatives. These include cross-licensing, non-exclusive licensing with technology transfer, exclusive field-of-use licensing with or without tech transfer, outright sale, collateralisation, as well as more inclusive corporate transactions such as technology spin-outs, joint ventures and full-on M&A deal structures. In the United States, this risk-return analysis with respect to patent enforcement is now essential in light of post-America Invents Act patent validity challenges before the Patent Trial and Appeal Board; recent Supreme Court decisions limiting patent-eligible subject matter and requiring more certainty in claims’ scope; district court and Federal Circuit decisions constraining reasonable royalty damages for infringement; and looming patent reform legislation. Perhaps the most significant and pervasive change in the US legal landscape affecting the patent enforcement risk-return calculus involves the adoption of the so-called ‘English Rule’ with respect to fee shifting (also known as ‘loser pays’).

IP value extraction levels

For operating companies – particularly those that are publicly traded – the compensation and survival of senior executives depend directly on various corporate financial performance metrics, such as:

• profit and loss (eg, earnings before interest, taxes, depreciation and amortisation, price/earnings multiples, free cash flow or internal rate of return);
• balance sheet (eg, retained earnings, debt-to-equity ratio);
• share price; and
• market cap (as a surrogate for enterprise value).

Accordingly, one of the most important functions of a corporate chief IP officer should be to make the CEO look like an executive rock star by translating the company’s IP value extraction strategy into terms that investors and financial markets will understand and reward. In this context, the available patent-related monetisation options may be classified according to the following IP value extraction levels, as detailed in the chart below:

• Level 1 – profit and loss top-line revenue enhancement;
• Level 2 – reduction of patent-related cash outflows;
• Level 3 – increased market share or new business creation; and
• Level 4 – enterprise value.

As one proceeds from Level 1 to 4, the magnitude of the patent value that can be extracted generally increases, but it becomes more difficult to quantify the relative contribution of patents and related intellectual property, compared with other value drivers.

System design process

The process for systematically developing a holistic IP value extraction programme can be subdivided into the following activities.

Step 1 – identify and prioritise the company’s principal value extraction objectives in light of resources and constraints

The first process step of identifying and prioritising corporate objectives is used to illustrate the application of a systems engineering approach in the top-down design of a corporate patent value extraction programme. However, the same approach is equally applicable to the other steps of the process, as described below.

One of the primary visualisation tools used in analysing and optimising any system are flowcharts of the types shown in Figures 2, 3 and 4. This form of diagrammatic system depiction helps to identify the individual complementary or competing system design elements and to highlight the interrelationships (eg, trade-offs) between and among them that might otherwise go unrecognised.

At the highest level, objectives may be classified as financial, defensive, strategic and mixed.

Figure 1. ‘Stranded’ and ‘underutilised’ intellectual property represent valuable sources of monetisable corporate assets

The most obvious financial objective is the enhancement of top-line profit and loss revenue growth via licence fees (ie, Level 1 value extraction). Referring to Figure 1 and the taxonomy chart below, this may involve non-exclusive licensing of ‘stranded’ non-core patents, either with or without the transfer of related technology in the form of design data, manufacturing know-how, prototypes or source code. Conceptually, this form of monetisation includes both value-added carrot licensing and assertion-based stick licensing. However, stick licensing usually requires litigation (at least at the beginning of the programme) and thus may introduce sensitive corporate culture or PR constraints. Stranded patents – whether internally generated or acquired as a result of M&A activity – can also be monetised via various divestive structures, including an outright sale. Patent sales may be accounted for on the profit and loss sheet as operating revenue (if they are a regularly occurring business practice) or on the corporate balance sheet as cash reserves resulting from the sale of a capital asset.

Another Level 1 value extraction option is exclusive field-of-use licensing of ‘underutilised’ patents in non-core (non-competitive) applications or markets, again either with or without tech transfer.

The profit and loss bottom line may also be improved at Level 2 by reducing costs in the form of balancing payments, net royalties or other cash outflows in a more or less friendly cross-licensing context via targeted internal patent development or the acquisition of third-party patents. In the best case, improving the strength of one’s patent position may reverse the net cash flow in cross-licensing from expense to revenue. Additional Level 2 cost savings can be achieved by reducing patent maintenance, filing and prosecution costs via abandonment of low-value non-core patents.

Defensive objectives include:

• deterring patent infringement claims from current and prospective competitors by creating a fear of retaliation via infringement countersuits;
• settling patent infringement litigation via cross-licensing; and
• purchasing potentially troublesome patents to prevent them from falling into the hands of patent assertion entities (PAEs), also known as ‘taking them off the street’ (although this is usually achieved more cost effectively via membership of a defence collective – such as RPX, AST or OIN – where the acquisition price is shared among the members).

One example of a strategic objective would be the assignment of stranded patents, typically along with some tech transfer, to corporate spin-outs or joint venture entities in lieu of cash for an equity interest, either with or without a continuing royalty stream. Another would be the transfer of exclusive field-of-use licence rights in underutilised patents in one or more non-competitive markets or applications, with or without tech transfer or product support via a consulting arrangement. As an alternative to an exclusive field-of-use licence, underutilised patents may be assigned to the spin-out or joint venture with either a reservation of exclusive field-of-use rights or a grant-back licence for the current and anticipated business of the assignor, or in all fields other than the business of the assignee (although retaining ownership is usually the preferred option).

Step 2 – analyse the strengths and weaknesses of the company’s existing portfolio

With regard to the above discussion on monetisation objectives, the first and most important thing to do when analysing an operating company’s patent portfolio is to classify individual patents as core or non-core. Once this is done, the non-core patents are further analysed to identify stranded non-core patents that may have significant value in non-competitive applications or markets, while the core patents are further analysed to locate underutilised core patents whose claims scope may be broad enough also to cover non-competitive markets or applications.

It is also essential to identify critical holes in the company’s existing patent coverage in terms of its current or anticipated business that can be filled by targeted internal patent development or the acquisition of third-party patents. A valuable byproduct of the portfolio analysis process is determining which of the company’s products are covered by which of its patents – something that large companies may not know. An even more useful byproduct may be to learn which of the company’s patents cover its competitors’ products.

As is well known, for larger corporate patent portfolios the audit process can be greatly expedited and improved by the use of commercially available or internally developed software-based analytic and visualisation tools. These are used most effectively in conjunction with domain experts in the relevant technologies and product markets, both in formulating the inputs (eg, keywords and search strings) and in interpreting the results.

Step 3 – identify promising counterparties for stranded or underutilised patents

This step focuses on the current players and anticipated new entrants in the relevant markets, as well as the prospective convergence of technologies that currently represent discrete markets. In this context, a variety of commercially available software-based mapping, landscaping and visualisation tools use patent data to identify companies that are planning to enter the markets covered by the subject patents. As in the portfolio analysis phase, these tools are best used in conjunction with technology and industry experts, either internal to the rights holder or as retained third-party consultants. In addition, both upstream and downstream players in the relevant supply and distribution channels should be considered as potential counterparties.

In evaluating and ranking prospective counterparties, it is useful to consider the synergies and complementarities between their patent portfolios and the patents being monetised. Obviously, the value of a patent to a prospective buyer or exclusive field-of-use licensee depends on whether it merely adds to its existing coverage or fills critical holes in its portfolio with respect to its current business or future expansion plans (which may or may not be public).

Counterparty selection should also involve analysing the strengths and weaknesses of each candidate’s existing patent position with regard to its competitors’ patents. A useful visualisation tool in this context is a three-way mapping of patent coverage (eg, by the US Patent and Trademark Office (USPTO)) or international sub-classes, as between the current rights holder, each of the prospective counterparties and their primary competitors.

In some cases, the selection of a counterparty may have more to do with the products or services of one or more of its competitors than with its own. For example, if a company needs defensive protection against a larger competitor whose main profit centres are in areas where the two companies do not compete, then it may be a better candidate for the purchase of stranded non-core patents or the acquisition of an exclusive field-of-use licence to underutilised core patents covering the competitor’s main profit centres than a company that is actually in the markets covered by the patents.

Figure 2. Financial monetisation objectives

Step 4 – identify and prioritise the preferred value extraction mechanism(s)

After the prospective counterparties for both stranded non-core patents and underutilised core patents have been identified and ranked, the preferred monetisation mechanism for the top two or three (or more) counterparties in each category can be selected.

For stranded patents, these mechanisms include both stick (assertion-based) and carrot (technology-based) non-exclusive licensing, exclusive field-of-use licensing, sale and corporate transactions, such as spin-outs and joint ventures.

In the case of stick licensing, the primary consideration to the prospective licensee is immunity from litigation. The rights holder typically demonstrates the need for this immunity with claim charts (which may provoke a declaratory judgment in district court or an inter partes review, post-grant review or covered business method proceeding before the USPTO), or by filing an infringement action either against the prospective licensee or against another company with similar products.

However, as mentioned above, assertion-based licensing may conflict with the rights holder’s corporate culture or may create negative PR issues by allowing it to be characterised as an evil patent troll (even an operating company is an NPE when it does not itself practise the patents being asserted). Some companies have tried to avoid this by outsourcing patent assertion to a ‘privateer’ with special expertise in patent enforcement. Because of standing requirements, the enforcement entity must own the patents (or at least be an exclusive licensee, in which case the owner is a necessary party to the enforcement action), but the litigation proceeds are typically shared even where there has been a transfer of ownership to the enforcement entity.

In the case of carrot licensing, specific trade secrets and know-how in the form of product design or manufacturing know-how and test data, along with physical assets such as prototypes and source code, should be inventoried and scheduled. Consulting services by the licensor (eg, in connection with the adaptation of licensed technology to the licensee’s products or manufacturing processes) may also add significant value.

Beyond licensing, there are various monetisation alternatives involving the assignment of patents, such as outright sale, sale with revenue sharing, corporate spin-out and formation of a joint venture. Finally, the increasing interest and availability of patent collateralisation (ie, the use of patents as the primary or sole security for a loan) should also be considered.

A sale may be structured in a variety of ways, including:

• an outright sale where the purchase price is paid fully;
• a sale with fixed instalment payments;
• a sale with an up-front payment plus a back-end performance-based revenue-sharing arrangement; or
• a sale with performance milestones or periodic minimum payments and a reversion of ownership if any of the milestones is not met or payments are not made.

Figure 3. Defensive monetisation objectives

The sale may include either a non-exclusive or exclusive field-of-use reservation or grant-back licence to cover the seller’s future markets or products, as well as field-of-use limited rights (exclusive or non-exclusive) to use improvements made by the buyer in non-competitive applications or markets.

In addition to other operating companies, potential buyers may include NPEs, such as defensive aggregators, or PAEs and privateers, depending on the seller’s tolerance with respect to negative PR blowback for indirect assertion, as discussed above.

On occasion, the assignment of patents may be a primary driver of a larger corporate transaction, such as a comprehensive asset sale or even a merger. Recent examples are the acquisition of Palm by HP and the acquisition of Motorola Mobility by Google.

Another form of sale for stranded non-core intellectual property involves assigning patents to a corporate spin-out or newco joint venture entity. The transfer may be in lieu of cash in exchange for an equity interest in the new venture, or a future royalty stream or earn-out. In the case of a joint venture, other partners may contribute complementary intellectual property, operating capital, domain-specific management or technical expertise. There may be a transfer or secondment of assignor personnel with expertise sufficient to further develop or adapt the associated technology or the transferred intellectual property (eg, key inventors). The assignment may contain reversion rights which require reassignment in the event that specified performance milestones are not achieved or may be coupled with a convertible note that triggers reassignment if certain deferred payments are not made.

Underutilised core intellectual property is often best monetised via field-of-use licences for non-core applications or markets. These could be non-exclusive, exclusive or sole (where the licensee has exclusivity as to all except the licensor), and may involve tech-transfer or consulting services to help adapt the licensed technology to the non-core field. The licence may include grant-back rights for the licensor’s use of the licensee’s patented improvements outside the licensed field of use.

The best candidates for an exclusive field-of-use licensing programme are underutilised patents that cover multiple non-core (from the perspective of the rights holder) and non-overlapping (from the perspective of the licensees) markets or applications, which are effectively sold (in terms of exclusivity) in each field. The challenge is in defining the fields in such a way that they not only are non-overlapping when the licences are granted, but will remain so over the life of the licences. In order to avoid problems with future convergence of product technologies – as happened with pagers, mobile phones and hand-held computers (which were known as personal digital assistants) – the fields should be defined in terms of markets or customers, rather than the underlying technology (eg, mobile devices, telecom infrastructure, medical, aerospace and automotive).

An effective structure for implementing a multiple exclusive field-of-use licensing programme is a hub-and-spoke model, with the rights holder at the hub and each individual exclusive field-of-use licensee at the end of a different spoke. Using this structure, improvements on the licensed subject matter made (and owned) by any exclusive field-of-use licensee can be exclusively licensed back to the rights holder-licensor for all fields outside the one granted to that licensee. The rights holder-licensor can then grant some or all of the other exclusive field-of-use licensees exclusive or non-exclusive rights in their respective fields via sub-licences. In addition, the licensor might provide consulting services to the licensees in connection with adapting the improvements to their particular products or applications.

However, in implementing such an arrangement, there are legal and business risks that should be considered and mitigated as far as possible. First, there is the risk that one or more individual licences may be judicially determined to be non-exclusive, despite the fact that the licence is clearly designated as exclusive. This can result from the licensor retaining too many strings on how the licensee can exploit the licensed rights within the licensed field (eg, a veto right over who the licensee can sue for infringement within the field). The result of such a determination will be that the licensee lacks standing to sue and the suit must be brought in the name of the rights holder-licensor. Also, under the prevailing case law, even if the exclusive licensee has standing to sue, the rights holder-licensor is an indispensable party and must be joined either as a co-plaintiff or as an involuntary defendant, which can create business conflicts for the licensor where the accused infringer is a supplier, customer or business partner in another area outside the licensed field. While these risks can be minimised by careful drafting, they must be considered. The inclusion of an effective dispute resolution mechanism is critical.

Underutilised core intellectual property may also be monetised in the context of a corporate spin-out or joint venture entity, as discussed above in connection with stranded non-core intellectual property. However, in this case, assignment of the relevant intellectual property is replaced by an exclusive field-of-use licence limited to the contemplated business activities of the spin-out or joint venture.

A joint venture structure can be particularly effective in monetising the unused applications of underutilised core intellectual property. In this case, the rights holder could enter into a joint venture, either contractually or by forming a newco joint venture entity, with one or more companies with domain expertise and market presence with respect to applications of the patented technology outside the rights holder’s area(s) of primary interest. To use a not too hypothetical example, suppose that the rights holder’s core business is military and commercial avionics, but some of its patent claims use the word ‘vehicle’ rather than ‘aircraft’ (assume further, for Section 112 validity purposes, that the patent’s written description supports applications of the claimed invention(s) other than aircraft, either generally or specifically). The avionics company could form a joint venture with a major automobile manufacturer and grant the joint venture partner or the joint venture newco (as the case may be) an exclusive field-of-use licence to the relevant ‘background’ patents and related technology, as well as to future improvement patents and technology that the licensor develops in the area, limited to the automotive field.

In consideration, the partner could provide management and marketing expertise in the automotive arena, technical support in adapting and extending the licensed technology, and some or all of the operating capital. Patented ‘foreground’ improvements to the licensed technology made by the licensee could flow back to the licensor, on either an exclusive or non-exclusive basis, for non-automotive (or specifically for avionics) applications, on either a royalty-free or royalty-bearing basis.

In theory, depending on the breadth of the relevant patent claims, the joint venture model can be extended to multiplayer arrangements, where each partner receives an exclusive field-of-use licence in a field that does not compete with either the rights holder-licensor or the joint venture activity and does not overlap with the designated field of any other joint venture partners (which obviously becomes more challenging as the number of partners increases). In this case, the joint venture structure closely resembles the hub-and-spoke pure exclusive field-of-use licensing model discussed earlier. The primary difference between the two is that the joint venture approach can more easily accommodate various forms of collaboration between the partners in terms of product development in new application areas or co-marketing, particularly with a newco joint venture entity as opposed to a multiparty contractual arrangement, whose management tends to be more complex.

As part of the design of a corporate IP value extraction strategy, each individual company should consider the relationship between patent monetisation via sale, licensing, sale, spin-out or joint venture and monetisation via cross-licensing. This relationship is more or less reciprocal, in that the more encumbered a patent is by virtue of previously granted non-exclusive licences, the less valuable it is for prospective purchasers or exclusive field-of-use licensees that may wish to further monetise the patents by subsequent licensing, cross-licensing or enforcement.

In this context, various strategies can be employed to insulate newly acquired patents – whether internally generated or purchased – from being encumbered by existing cross-licences. Generally, this is done by vesting corporate ownership of the patents in the first instance not in the operating company, but rather in a separate patent holding company that is not a wholly owned subsidiary of, or is otherwise controlled by, the operating company. While the corporate structuring mechanisms for achieving this result – and the tax implications – are beyond the scope of the present discussion, suffice to say that the primary consideration from a patent monetisation perspective relates to the absence of control over how the holding company chooses to monetise. This effect can be mitigated by appropriate contractual restrictions, although these may present the risk that the real (ie, equitable) owner of the patents may be judicially determined to be the operating company and not the holding company, thus defeating the purpose of the original transfer.

Finally, low-value (non-core) patents and applications may be abandoned or donated to improve the corporate bottom line by reducing or eliminating US and foreign maintenance fees and costs. In addition, the prosecution of selected pending applications may be terminated to eliminate follow-on filings and prosecution costs.

Figure 4. Strategic monetisation objectives

IP finance – the use of patents as loan collateral

No discussion of a holistic patent monetisation programme would be complete without considering the use of patents by operating companies to secure non-dilutive debt financing from commercial banks or specialty lenders. To be clear, we are not talking here about blindly including corporate IP assets as ‘boot collateral’ in a pool consisting of all of a company’s assets simply by including a reference to ‘general intangibles’ in the security agreement. Rather, IP finance requires a separate valuation of the IP assets in order to partially or wholly secure the loan amount.

IP collateralisation – as well as its close cousin IP securitisation (eg, Bowie bonds) – made its debut in the late 1990s and early 2000s and was focused on trademarks (widely recognised consumer brands) and copyright (rock star music catalogues and first-run movies). With a few notable exceptions, patents were seldom used as the primary or sole loan collateral. This is because they are much harder to value than other forms of intellectual property. IP finance requires a future income stream in the form of licence fees, royalties or other periodic payments that is both predictable and steady. This works well for well-known brands and content where past earnings are a good predictor of future revenue in a discounted cash-flow analysis. However, because patented technology is always at risk of becoming obsolete – either through non-infringing incremental improvement or as a result of disruptive innovation – the predictability factor is problematic. The exceptions have usually involved collateralising or securitising large patent portfolios from acknowledged industry leaders and technology pioneers, such as Motorola and Alcatel-Lucent.

However, notwithstanding this history, there has been a resurgence of interest in patent collateralisation – particularly by specialty lenders such as Fortress and IP Financial, which have acquired, or have access to, deep patent valuation and sales expertise. One of the reasons for this renewed interest is the emergence of a secondary market for patent sales, which tends to increase the liquidation potential of the patent collateral and thereby lessen the risk of the lender being unable to recoup the loan balance in the event of a default by the borrower. The lender may also partially or wholly pass off the risk of loan default to a large insurer via a ‘wrap’ or consolidate individual loans into a package that is then acquired by a reinsurer.

Putting it all together

In the not-so-distant past, when patents were viewed solely in terms of the legal franchise that they conferred upon their owner (ie, the right to exclude others from commercialising the invention covered by the claims), non-exclusive licensing and infringement litigation were the obvious monetisation vehicles. However, as patents have come to be accepted as an asset class (regardless of whether they really are), other value extraction mechanisms modelled after more traditional assets have been adopted, or adapted, for patents.

Unquestionably, the ability to exclude competitors from the market defined by the patented features or functions, the right to tax them for use of the claimed subject matter via licence fees and the right to force them to incur the expense of designing around the claims still provide powerful incentives for creating, or investing in the creation of, new and non-obvious technologies and products. However, a variety of other, less adversarial transaction-based mechanisms and deal structures are available to technology companies. And in the process of creating corporate value, they also tend to promote the progress of the useful arts.

While not all of the mechanisms described here may apply to any particular company or patent portfolio, they should at least be considered as candidates in a top-down, structured design approach to patent monetisation, bearing in mind the old admonition: “When the only tool one has is a hammer, all problems look like a nail.”