Maximum Affordable Royalty Rate – A Useful and Underutilized IP Valuation Method

Challenge: You have software and hardware patents that are licensable to as many as a dozen different prospective licensees already established in the industry. You have reason to believe that your patent portfolio could become a standard in the industry. How do you determine a royalty rate to maximize your royalty income ?

Approach:

  1. Think of the adoption of your patented technology as a new commercialization project within each of the prospective licensee companies.
  2. Evaluate each prospective licensee’s projected discounted cash flow resulting from commercial use of the technology.
  3. Include in the financial model a line item for royalty payment.
  4. The maximum affordable royalty rate (MARR) is the value of the royalty payment, expressed as a percent of net sales, that yields a net present value (NPV) of zero for the project.

Lessons Learned from Case Studies:

  • The maximum affordable royalty rate can vary widely across different companies in the same industry. In one case involving storage area network technologies, the roualty rates ranged from 3% to 20% of the annual revenues of the prospective licensees.
  • Inputs to the financial model can be based on public information as well as industry expert judgement regarding revenue growth rate, internal discount rates, and the percentage of total company revenues attributed to products embodying the technology
  • For prospective companies with negative free cash flow, affordable royalty rates can be assumed equal to those of peer companies with positive cash flow

A Strategy to Maximize Income

This usefulness of this technique of financial modeling to arrive at maximum affordable royalty rates company by company is that you now have a starting point for developing and quantitatively assessing various licensing (and sub-licensing) strategies for impact on licensing income. Some discrete scenarios to consider:

  • Establish your technology as an industry standard via licensing to as many prospective licensees as possible
  • “Outsource” licensing by allowing sub-licensing to one primary licensee, perhaps the one company that can afford to pay the highest royalty, based on its financial model
  • Limit the licensees to those companies with the fastest time to market

Use of MARR has been particularly helpful to companies with valuable technology-based IP but little to no experience in licensing. Interested in finding out how MARR can help you, too?  Contact us at https://www.prakteka.com/contact-us/

See also: DCF Analyses in Determining Royalty, Daniel Burns, les Nouvelles, Journal of the Licensing Executives Society, September, 1995, accessed November 7, 2018, http://www.danielburnsassociates.com/wp-content/uploads/2011/08/DCFAnalysisInDeterminingRoyalty.pdf

And for more on what matters when you’re working at the technology/business interface, see our content on technology assessment, technology commercialization, technology valuation, and “seeing the future” on our website: https://www.prakteka.com/

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Coyright 2018

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