Using the market to determine IP's fair market value; new valuation methods can help CTOs carry out their mission of being "business scientists, "extracting maximum cash value from their organization's intellectual property.

The value of a company's intellectual property (IP) helps determine both the quantity and cost of its working capital. This relationship is a relatively new phenomenon and is neither linear nor transparent. Because R&D activity is now under a financial microscope, both the composition of

this relationship and the numerous efforts to make it more linear and transparent are important phenomena for CTOs to understand. Following a brief review of recent legal and accounting events and principles of finance, we set forth an algorithm for determining fair market value of IP capital assets, describe in greater detail a new (capital) market-oriented method especially useful for early-stage R&D, and illustrate the spectrum of financially-oriented asset management opportunities and practices enabled by both the new value and valuation paradigms.

About Fair Market Value

Corporations could not exist without working capital. But capital is not free, and its cost is particularly important to publicly traded companies. Being listed on an exchange means the market--through the power of stock price--will determine at least one important portion of the corporation's cost of capital (1). And when the markets favor a stock, working capital becomes less expensive. Corporations that lower their cost of capital can deploy their capital assets toward commercial objectives more profitably.

To determine how management is extracting profits from its capital assets, professional investors, who help establish stock price, look to several financial performance metrics. These include profitability, or the bottom line, and two metrics that are becoming important for CTOs: "asset profitability" and "asset utilization efficiency." Combined, these asset-focused metrics help investors anticipate future profits. Public capital markets are forward looking. Therefore, current asset utilization efficiency and profitability metrics create profit expectations that corporations are obligated to achieve in subsequent months lest the stock price fall on missed expectations.

The stock-price-based value is known as "fair market value," and it implicitly defines the value of all the company's component capital assets, tangible and intangible. Therefore, in order to set strategy, manage risk, and measure and report on the entire value creation process, leaders must obtain complete information about the fair market value of the assets under their operational control (2). For CTOs, this means IP intangible assets.

For research-intensive companies, creation and deployment of IP is one of the most effective tools for creating value and achieving above-average and sustainable profits (3). Until relatively recently, however, the added value of IP to corporations, excluding the pharmaceutical industry, was debatable. Empirical studies show that the lack of consistent legal interpretations in IP enforcement eroded much of IP's implied value (4). Then, in the fall of 1982, Congress created the Court of Appeals of the Federal Circuit. Coupled with high-profile patent enforcement actions such as Polaroid v. Kodak (Oct. 1986), Kearns v. Ford Motor Co. (Nov. 1989) and Lemelson v. Mattel Inc. (Feb. 1990), the importance of patents and other forms of IP became increasingly apparent (5).

Unfortunately, accounting systems did not have mechanisms for recording the value of a company's IP transparently on its books; book value reported the assessed value of capital assets such as property, plant, equipment, cash, etc., but not intellectual property. The public capital markets noted the omission and between 1978 and 1998, the non-book value of all publicly traded companies rose from 5 to 72 percent of market value (4). Finally, in July 2001, the Financial Accounting Standards Board (FASB) issued SFAS 142, Goodwill and Other Intangible Assets (6). Suddenly intangible assets and other intellectual properties achieved balance sheet visibility, and since then, public markets have anticipated the fair value reporting of IP on corporate ledgers (7).

IP fair market value is important to many (8): managers need to track how IP's financial returns will impact corporate financials (9); investors and analysts seek new avenues for IP-centered portfolio diversification; the IP markets, comprising licensees, licensors and the intermediaries facilitating this transaction space, are equally eager to take positions in IP-based financial instruments and IP litigation (10); the Internal Revenue Service is also keenly interested in the fair market value of IP as it relates to the tax benefit arising from charitable donations (11,12). The obligation to satisfy both internal and external constituents rests not only with business leadership but also with CTOs and CFOs. We discussed the opportunities for CTOs to embrace and lead this value-harvesting process in a previous RTM article (13).

But inherent in these new opportunities for IP financial management are obligations to determine fair market value and develop and exploit IP to its maximum utility, as we discuss now.

Determining Fair Market Value

In theory, a company's fair (market) value generally represents the net sure of the fair value of both its tangible and intangible assets (14). Therefore, a company's market capitalization--the value established by the stock market--generally represents the sum of the fair value of assets, including those such as IP. This key relationship is the basis for calculating fair market value when such value cannot be observed directly.

In order to appreciate the differences between observed and calculated value, the following section sets forth the definition of "Fair Market Value"; presents a hierarchy of valuation methods for observing or calculating that value for IP assets; and presents in greater detail a new market-based method, for valuing a hypothetical technology we shall call Gizmo.

Fair market value (FMV) is the price that an asset would sell for on the open market. It is the price that a willing buyer and seller would agree on, with neither being required to act, and both having reasonable knowledge of the relevant facts (15,16). Within the accounting world, fair market valuation is a relatively novel concept in general (17). It is particularly novel with respect to valuing IP where non-market notions such as "intrinsic value" have long been advocated (18).

A valuation hierarchy

In principle, estimates of fair value should be based on observable market prices and market assumptions. Thus, the more market inputs, the more reliable the estimate (19). Unfortunately, IP markets--excluding music and software licensing--are generally not observable, and the assets are relatively unique. The most rational approach therefore is a fait value hierarchy that defines and prioritizes an agreed set of market inputs to be used for estimates of fair value (see Table 1). The five prioritized inputs are (20):

1. Principal Transactions (observable transactions).

2. Proxy Transactions (observable transactions).

3. Hypothetical Transactions (market-based calculations).

4. Potential Transactions (income-based calculations).

5. Replacement Transactions (cost-based calculations).

The FASB recommends that if observable transactions are not available, then estimates of fair value should be based on the results of multiple other valuation techniques (21). The FASB adds that consistent with the objective of a fair value measurement and with IRS guidelines, all valuation techniques should incorporate the same assumptions that marketplace participants would use in their estimates, assuming such assumptions are based on information that is available without undue cost and effort (22).

Principal and proxy transactions

The best determinant of fair market value is an actual market transaction. Therefore, the best estimate of fair value should be determined by reference to observable (quoted) market prices for identical assets or liabilities at or near the measurement date, whenever those prices are available.

Historical efforts to create IP market price quoting mechanisms, including bid-ask spreads, have not been successful (23). Efforts by the U.S. Patent & Trademark Office to make public the transaction value of each and every IP assignment or license are ongoing, but the form, timeliness and robustness of the proposed dataset are unknown at this time (24). Consequently, estimating fair market value from the value of actual transactions among principals is difficult.

A proxy transaction is the next best determinant of fair market value. A proxy transaction is one in which a willing buyer and seller agree to terms on a derivative financial instrument whose value is linked to the value of the underlying IP asset. Among the proxies that can help determine the fair market value of the underlying IP asset are a variety of IP value insurances, IP portfolio options, IP cash flow securitizations, and IP litigation investment pools. These instruments are relatively new and reflect the growing appreciation that IP is a financial instrument. We discuss many of these new instruments in the next section.

Hypothetical transactions (market-based calculations)

In the absence of principal or proxy transactions, a fair market value can be generally determined using the construct of a hypothetical transaction between a buyer and seller. Among the various alternatives to principal and proxy transaction-based valuations, tax authorities favor this method (25).

Hypothetical transactions can be based on a data set of comparable market transactions or on the index value of a portfolio of like assets of the same class. Furthermore, the hypothetical transaction is to be evaluated in the context of the specific business facts and circumstances the principals faced at the time. Georgia-Pacific Corp. v. United States Plywood Corp. provides a 14-factor framework for performing such an analysis (22).

Leading IP valuation authorities point to some of the challenges with the market approach (25). Among them are the intrinsic challenges that IP is unique, that it is difficult to compare complex deals, and that there are invariably hidden deal premiums. For the reasons noted in the discussion on "Principal Transactions" above, data are relatively difficult to obtain. Notwithstanding the challenges, valuations using comparable data or asset class-based index data are good for an indication of value.

For further refinement, the Georgia Pacific factors can help transform the indication figures into reasonable assessments of fair market value (Table 2). The 14 factors provide grounds for modifying the indicated value of a hypothetical transaction based on the expected value generated by either the comparable or indexed approaches.

Potential transactions (income-based calculations)

Income-based calculations are rigorous. These calculations are designed to capture the economic differences between various assets and liabilities to yield a net present value (6). The components of a present value calculation include:

* An estimate of future cash flows and their timing.

* Expectations about variations in the amount or timing of those cash flows.

* The time value of money.

* The cost of uncertainty and risk.

* Other factors that may further reduce cash flows or increase risk.

Done properly, these calculations expose key variables and deal breakers and introduce the opportunity to employ probability-modeling techniques such as Monte Carlo simulations (18,26).

Option pricing methods are relatively new to the IP industry but are growing in popularity as a valuation technique (27-30). They can be structured to integrate with traditional discounted cash flow models or optimized to more closely function like the market-based methods of comparables and asset class indexing (31,32).

When designed more like market models, option pricing methods have several potential advantages (33,34). First, they circumvent the relatively arbitrary matter of the appropriate discount rate by employing the measurable volatility of an asset's index value as an indicator of risk. In addition, such pricing models can circumvent the uncertainties of future cash flows by employing index values based on the present value of assets in the same class.

Replacement transactions (cost-based calculations)

Last, in the absence of any data supporting transactional, market or income calculations, cost methods can provide a starting point for fair value estimation. The two most common approaches are current replacement or reproduction cost, adjusted to reflect the current condition of an asset. However, current literature suggests that there may be substantial gaps between cost-based value calculations and the values obtained in actual market transactions (35).

Determining Value with TOC-M

The greater the amount of actual market data used in both the market-based and income-based valuation methods, the greater the transparency. Capital markets appreciate transparency and the continuing need to satisfy them creates the pressure to employ the best valuation methods. Among the alternatives described above for calculating market-based and income-based values, the asset class indexing method provides an indication of value with several advantages.

The method we have developed, called TOC-M[TM], stands for Technology Option Capital Model (36). It's based on the Capital Asset Pricing Model (37), with IP-centered enhancements that, similar to the Arbitrage Pricing model, correct for some of the inefficiencies of the intellectual property markets (38). It is standardized with a high degree of uniformity and transparency and with relatively few assumptions. Also, unlike any of the other methods based on either real or proxy transactions or a database of comparable transactions, TOC-M calculates a time series of fair market values. This more robust data set yields volatility and covariance data that are especially useful in constructing investment or capital asset allocation portfolios to maximize return for a fixed level of risk (39).

TOC-M uses data from publicly traded companies whose IP holdings include assets that are members of the same class as the assets being valued. TOC-M performs a log-transform of market capitalization, asset, liability, and IP to normalize data that tend to be log-normally-distributed. TOC-M also incorporates both company-specific and broad market sentiment data to help isolate intellectual property from other contributors to intangible asset value, and to separate brand value from patent value (Figure 1).

[FIGURE 1 OMITTED]

To illustrate the application of TOC-M, we will use a technology acquisition scenario for a target owning key patents in the field of lumbar spine fusion. To begin, we identified four publicly traded companies owning similar class assets: Oratec Interventions, Regeneration Technologies, SDGI Holdings, and Vita Licensing. Then, we extracted from public records their two-year running monthly market capitalizations, quarterly current assets and total liabilities, and monthly patent family counts.

We then log-transformed these data because they empirically are log-normally distributed and the regression models work best on normally distributed data. In the linear regression calculations to determine the regression coefficients, we added the monthly consumer confidence index values and then solved for market capitalization, which represents the most accessible and indisputable measure of fair value.

ln(M[C.sub.t]) = [m.sub.1] ln(C[A.sub.t]) + [m.sub.2] ln(T[L.sub.t]) + [m.sub.3] ln(I[P.sub.t]) + [m.sub.4] ln (Reputation,) + [m.sub.5] ln(CC[I.sub.t]) + b

where:

Ln(X) represents the natural logarithmic transformation of X.

[m.sub.1]-[m.sub.5] represent the coefficients calculated by the linear regression algorithm.

MC is the dependent variable market capitalization, in currency units.

CA is the value of current assets, in currency units (see "What the Factors Mean," next page).

TL is the total liabilities, in currency units.

IP is the number of total patent holdings (unit-less) of a selected entity.

Reputation is 100-FT (Financial Times) ranking (unit-less).

CCI is the consumer confidence index (unit-less).

b is the intercept of the regression line with the axis, and

t is a selected time, the linear regression algorithm usable to generate a series of coefficients over a period of selected times.

The regression equation based on 25 observations showed a multiple R of 0.98, an R Square of 0.97, an Adjusted R Square of 0.96, and a Standard Error of 0.53. The calculated regression coefficients were: Intercept, -8.07; Log of Current Assets, 0.55; Log of Total Liabilities, 0.15; Log of Patent Families, 0.44; and Log of Consumer Confidence Index, 2.08.

Applying the model over a two-year period, we established the value, variance and correlation of the technology's value for the indicated window:

Mean Monthly Return              -3.4%
Standard error of the mean %     14.1%
Monthly MIN %                   -28.7%
Monthly MAX %                    33.8%
Sharpe Ratio                     -0.13
Correlation with S&P 500          0.20

We then applied the equation and the calculated coefficients to the book and patent values of the acquisition target to calculate the acquisition target's value based on the value of its capital assets. The indicated stock price by TOC-M was $19.31. The tendered offer, based on valuation methods other than TOC-M, was $19.87. Thus the TOC-M model was able to predict the total value of the company based on the index-based indicated value of technology in the same asset class.

The TOC-M model is not only effective for biotech or pharmaceutical applications, but has been shown to be effective across a broad range of technologies (Figures 2 and 3). Further, it is also applicable for measuring a company's overall brand value and for measuring the value of other IP assets such as copyrights and trademarks--provided that there are sufficient numbers of public entities owning IP of the same class to give the model acceptable statistical strength.

[FIGURES 2-3 OMITTED]

Notwithstanding the relative ease of use and transparency of index-based valuation methods such as TOC-M, the real benefit of these valuation methods is the way in which they empower their users--the CTOs--to fulfill their missions of being "business scientists" engaged in a much greater range of IP exploitation strategies (40). Because, as the saying goes "if you can measure it, you can manage it"(41), CTOs armed with a clear indication of fair market value can go about the business of developing, buying, selling, and killing IP assets and IP-based projects and leveraging market requirements and scientific acumen.

New Opportunities for CTOs

Beyond the basic business of IP management, the new value and valuation paradigms open entirely new opportunities for IP-based financial strategies and for CTOs to expand the definition of "business science and their role in the technology commercialization process." Fair value calculations make possible the participation of financial markets in IP asset-based investments. This enables investors to take positions in IP-backed assets or to hold IP-backed assets as collate<al. Consequently, managers can use IP resources to diversify financial and technology R&D exposure, leverage operating capital, and support bolder strategies (24). A possible downside is that the increased transparency accompanying fair market valuation impacts the frequency of identifying what may have previously been unobserved managerial errors (42).

Financial and technology R&D exposures

Fair value determinations of a technology's value can help R&D managements better optimize their R&D dollars, their IP portfolios and their risk profiles. For example, a pharmaceutical company developing cancer therapeutics reduced its technology risks and eliminated stacked royalty headaches by acquiring five patents from three universities that were bundled together and licensed as a package. The package is worth up to $300 million to the drug company, with the universities sharing the royalties (43).

Just on the horizon is the next portfolio strategy comprising up to 30 patents from a spectrum of IP suppliers. These deals will include a combination of equity and debt financing based on the residual value of all the IP in the portfolio (based on fair market value) and will be optioned to major industrial companies to optimize their IP rights and freedom to operate, risk diversification and financial benefits. These strategies can also be adjusted to support ongoing in-house R&D, but no matter which scenario is deployed, all require the ability to define the market requirements for maximizing the value of the science, build and manage the partnerships required to obtain the optimum portfolio of valuable technology assets, and value the portfolio (44).

IP-based M&A opportunities

Traditional merger and acquisition strategies seek to exploit emergent operational efficiencies that enable joint cost reductions and yield improved margins; M&A is widely believed to be a net value increasing activity. A number of articles have studied and measured the benefit of M&A and round that while the shareholders of both the target and the bidder firms experience positive returns, the gains of the bidder's shareholders are not significantly different from zero (45). This is generally because markets are forward looking, can calculate the net effect quickly, and bid up the stock price.

IP-based M&A, on the other hand, would not be expected for the short term to be fully anticipated by the markets as the fair value of IP is not yet widely appreciated. In the next few years, corporations that excel at valuing IP at fair market value will find arbitrage opportunities in the IP acquisition markets (46).

Corporate finance opportunities

Asset-backed securitization is a mechanism to reduce both the risk to investors and the cost of capital to issuers. Of the $218 billion in asset-backed securities issued in 2000, $70 billion were backed by mortgages and another $100 billion by auto loans and credit card debt. Only a handful were backed by IPR (Intellectual Property Rights) royalties (47). The reasons were that companies did not appreciate the benefits and investors could not estimate the risks.

The reasons for a company to securitize its royalty cash flows from out-licensed IP, or to engage in a sale/license-back arrangement with its own IP, go beyond obtaining lower-cost capital. Reasons include long-term fixed rate financing, creating a floor value and return for IP (an exemplary proxy transaction, see above), creating non-dilutive capital, non-recourse financing, flexible use of proceeds, few if any restrictive covenants, and certain tax advantages (48).

With increasing transparency into IP's fair market value, more investors are showing a willingness to take a position. The groundwork was established in August 2000 when, for the first time, pharmaceutical patent royalties were turned into marketable securities. The BioPharma Royalty Trust totaled $115 million and included $57.15 million in senior debt, $22.0 million in mezzanine debt, and $22.16 million in equity. Standard and Poor's rated the senior debt single A on the basis of the pledged royalties, the creditworthiness of the licensee, Bristol-Myers Squibb, and the credibility of the assignee on the patent, Yale University (49).

Other corporate finance opportunities made possible by fair value IP assets include novel insurance products. Available today only on a custom basis, these products offer the potential for reducing stock volatility by providing better information to capital markets and better managing litigation by limiting damages.

Fair value implications for IP litigation

There was a time when the sale of an interest in the outcome of a lawsuit was thought to be "champertous," and therefore illegal (50). Things have changed in two ways: first, the definition of champerty has been narrowed, so that the concept prohibits less than it once did; second, a few states, such as Massachusetts and New Jersey, have done away with the practice altogether (51).

Consequently, today there are investment structures that will fund the costs of IP litigation. Most structures acquire the IP at some discount to the expected value of the litigation. Other structures provide financing on a contingency fee basis up to a predetermined amount in support of the law firm servicing the case. Last, in addition to the insurances that can limit corporate damages mentioned above, there are insurances that will protect the value of a jury decision, up to some discounted amount, while a case continues under appeal.

The quantitative metrics of fait market valuation of IP increases the confidence with which investors calculate their returns on such investment opportunities. Recent events suggest even emotional awards are yielding to quantitative metrics (52).

The Bottom Line

IP is one of the greatest sources of value to the research-based corporation. Capital is one of its dearest resources. Extracting the maximum cash value from IP can be accomplished only through knowledge and leverage of its value. Armed with practical financial tools, there is no one better qualified to manage these dear assets than the CTO. Management, especially CTOs, should be prepared to exploit emerging IP-driven opportunities in R&D finance, M&A, corporate finance, bankruptcy, and even IP litigation.

Table 1.--Fair Market Value Algorithm Demonstrated on a Gizmo Patent
Family. (The Gizmo Is a Novel Coating That Increases the Service Life
and Reduces the Maintenance Costs of a Spectrum of Widgets Used in
Heavy Industry.)

Step    Question                         Yes

 1.     Has the Gizmo patent family      The fair market value is based
          been assigned or license         on the value established
          exclusively in the past few      through the principal
          months?                          transaction.
 2.     Has the value of the Gizmo       The fair market value is based
          patent family been insured;      on the value established
          have options on the Gizmo        through the proxy
          patent family been sold; or      transaction.
          has the royalty stream from
          a Gizmo license been
          securitized in the past few
          months?
 3.     Have any Gizmo-like patents      The fair market value is based
          been assigned, insured,          on the value established
          optioned, or securitized         through a hypothetical
          in the past few months, and      transaction, adjusted after a
          are the differences between      consideration of the Georgia
          the Gizmo and Gizmo-like IP      Pacific factors.
          immaterial?
 4.     Is there a sufficient number     The fair market value is based
          of Gizmo alternatives or         on the value established
          Gizmo-like IP for use in         through a hypothetical
          improving widgets held by        transaction, adjusted after a
          publicly traded companies        consideration of the Georgia
          such that an asset-class-        Pacific factors.
          based index would be
          statistically meaningful?
 5.     Is there a reasonable basis      The fair market value is based
          for determining future           on the value established
          cash flows, their risk           through several analyses
          and timing, attributable         simulating an array of
          to the contribution of           potential transactions.
          the Gizmo technology to
          products sold?
 6.     Are there reasonable data        The fair market value may be
          for establishing the             hypothesized on the basis of
          cost or replacement basis        cost modified by the Georgia
          for the Gizmo IP?                Pacific factors.

Step    No

 1.     If not, proceed
          to step 2.
 2.     If not, proceed
          to step 3.
 3.     If not, proceed
          to step 4.
 4.     If not, proceed
          to step 5.
 5.     If not, proceed
          to step 6.
 6.     END

Table 2.--Twelve IP-specific Considerations from the Original 14
Georgia Pacific Factors That Can Help Modify a Valuation Derived from a
Hypothetical Transaction (22).

1.  The nature and scope of the IP
    rights.                             * Is the IP dominant or one of
                                          several alternative
                                          technologies?
                                        * Is the IP restricted to one
                                          territory or to several?
                                        * Is the IP restricted to a
                                          product or industry or field
                                          of use?
2.  The nature and scope of the
    anticipated marketing and
    deployment strategy.
3.  Commercial relationship between
    the parties.                        * Are there competitors in the
                                          field or geography?
                                        * Are they in the same line of
                                          business?
                                        * Are they inventor and
                                          promoter?
                                        * Are they manufacturer and
                                          supplier?
4.  Effect of selling patented
    products in promoting sales of
    other products: so called "razor
    and razor blade."
5.  Duration of IP.                     * Duration of technology--how
                                          long will it last before it
                                          is superseded in the market?
                                        * Is it a passing fad or a
                                          trademark with limited
                                          consumer appeal?
6.  Established profitability of the
      product made under the IP.        * Is there commercial success?
                                        * Is there current popularity?
7.  Utility and advantages of the IP
    over the old modes or devices,
    if any, that had been used for
    achieving similar results.
8.  Extent to which the other party
    has made use of the invention
    and evidence probative of its
    value to the other party.
9.  Nature of the IP.                   * Character of the commercial
                                          embodiment of it as owned and
                                          produced by the owner.
                                        * Benefits to those who have
                                          used the IP.
                                        * State of development of the
                                          IP.
10. Portion of the realizable profit
    that should be credited to the
    IP as distinguished from other
    elements, the manufacturing
    process, business risks or
    significant features or
    improvements added by the
    infringer.
11. Portion of the profit or selling
    price that may be customary in
    the business or comparable
    businesses to allow for the use
    of the IP or analogous IP.
12. Opinion of qualified experts.

References and Notes

(1.) http://www.thecorporatelibrary.com/study/spotlight.asp

(2.) Boulton, R. E. S., Libert, B. D. and Samek, S. M. Cracking the Value Code. New York: Anderson/Harper Collins, 2000.

(3.) McGrath, M. E. Product Strategy for High-Technology Companies. New York: Irwin, 1995.

(4.) Mansfield, E. "Patents and innovation: an empirical study." Management 32 (1986): pp. 173-181.

(5.) Gruenwald, G. New Product Development. Lincolnwood: NTC/ Crain, 1992.

(6.) Financial Accounting Standards Board. Statement of Financial Accounting No. 142. June, 2001.

(7.) FAS 142 requires that goodwill and intangible assets with indefinite useful lives will no longer be amortized, but instead be tested for impairment, at least annually, in accordance with the provisions of FAS 142. FAS 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of." FAS 142 became effective as of Jan. 1, 2002.

(8.) Hunt, I. C. Speech by SEC Commissioner: "Accountants as Gatekeepers--Adding Security and Value to the Financial Reporting System." U.S. Securities & Exchange Commission, at the Federation of Schools of Accountancy, Arlington, Virginia, Oct. 26, 2001.

(9.) Stewart, T. A. Intellectual Capital. New York: Doubleday/ Currency, 1997.

(10.) Kossovsky, N. and Brandegee, B. "Monetization Strategies Other Than Licensing: Emerging Financial Concepts in Intellectual Asset Management." Les Nouvelles 38 (2003): pp. 77-78.

(11.) Martin, D. "Patent Donations--The tale of Intangibles." Special Report on Patent Donations prepared for the Department of Treasury, Internal Revenue Service, Office of Tax Shelter Analysis. Jan. 10, 2003.

(12.) Riordan, T. "Patent Donations Viewed by Some as Chance for Suspicious Write-Offs." New York Times. Match 24, 2003.

(13.) Giordan, J. C. and Kossovsky, N. "It's Time To Think Differently About R&D Assets and the CTO's Role." Research-Technology Management, Jan.-Feb. 2004, pp. 9-12.

(14.) The apparent tautology resolves into a mathematical relationship, first suggested by Merton, in which the market capitalization value represents the value of a call option on the assets of a company whose exercise price is the net present value of the annual service of a company's debt. After, Kealhofer, S. "Quantifying Credit Risk I: Default Prediction." Financial Analysis Journal, 59 (2003): pp. 30-44.

(15.) Determining the Value of Donated Property. Internal Revenue Service Publication 561 (Rev. February 2000).

(16.) The FASB's working definition of fait market value as of Sept. 3, 2003 is "the amount at which an asset or liability could be exchanged in a current (emphasis added) transaction between knowledgeable unrelated willing parties when neither is acting under compulsion."

(17.) Willis, D. W. "Financial assets and liabilities--fair value or historical cost?" Financial Accounting Standards Board Project: Measuring All Financial Assets and Liabilities at Fair Value.

(18.) Razgaitis, R. Early Stage Technologies: Valuation and Pricing. New York: Wiley. 1999.

(19.) "Financial Accounting Standards Board Fair Value Measurement Project Update," Sept. 3, 2003. http://www.fasb.org/project/ fv_measurement.shtml

(20.) The FASB's draft currently recognizes three levels: Observable transactions of same assets, observable transactions of like assets, and calculated indicators of value.

(21.) IRS Rev. Rul. 59-60, 1959-1 CB 237--IRC Sec. 2031.

(22.) Georgia-Pacific Corp. v. U.S. Plywood Corp., 318 F.Supp. 1116, 1120 (S.D.N.Y. 1970); 446 F.2d 295 (2d Cit. 1971); cert. denied, 92 S.Ct. 105 (Oct. 12, 1971).

(23.) Stroud, M. "Invisible Inc." Business 2.0, (2000): pp. 290-294.

(24.) Kossovsky, N. "New financial concepts in patents." Patent Strategy & Management 3 (2003), pp: 1-4.

(25.) Lasinski, M. "Identifying valuable technology within a corporation and standard methods of valuation." Presentation at the Intellectual Property Owners Association, Chicago, IL, Sept. 2003.

(26.) Boer, F. P. The Valuation of Technology. New York: Wiley, 1999.

(27.) Kossovsky, N. and Brandegee, B. S. "Managing the financial uncertainties of technology transfer." Chemtech 27 (1997): pp. 44-45.

(28.) Boer, P. F. "Valuation of Technology Using 'Real Options'." Research-Technology Management July-Aug. 2000, pp. 26-30.

(29.) Kossovsky, N. and Arrow, A. "TRRU[TM] Metrics: Measuring the value and risk of intangible assets." Les Nouvelles. (2000) pp. 139-143.

(30.) Fine, C. R. and Palmer, D. C. "Patents on Wall Street." In, From Ideas to Assets. Berman, B., ed. New York: Wiley, 2002.

(31.) Arrow, A. K. "Managing IP financial assets." In, From Ideas to Assets. Berman, B., ed. New York: Wiley, 2002.

(32.) Amram, M. and Kulatilaka, N. Real Options. Boston: Harvard, 1999.

(33.) Kossovsky, N. "Fair Value of Intellectual Property." Journal of Intellectual Capital 3 (2002), pp. 62-70.

(34.) Boer, P. F. The Real Options Solution: Finding total value in a high risk world. New York: Wiley, 2002.

(35.) Chesbrough, H. W. Open Innovation: The New Imperative for Creating and Profiting from Technology. Boston: Harvard, 2003.

(36.) The method is subject to patents pending, and the patents as well as trademarks are assigned to Technology Option Capital, LLC. All rights reserved.

(37.) The capital asset pricing model (CAPM) is an equilibrium model which describes the pricing of assets, as well as derivatives. The 1990 Nobel Prize in Economics was awarded to William Sharpe "for his contributions to the theory of price formation for financial assets, the so-called Capital Asset Pricing Model (CAPM)."--http:// web.uvic.ca/econ/nobel.html

(38.) A fundamental critique of CAPM, attributed to Richard Roll, is that CAPM holds by construction when performance is measured against a mean-variance efficient index; otherwise, it bolds not at all. To correct for inefficiencies, an alternative asset pricing model to the Capital Asset Pricing Model known as the Arbitrage Pricing Model was introduced in 1976. Unlike the Capital Asset Pricing Model, which specifies returns as a linear function of only systematic risk, Arbitrage Pricing Theory may specify returns as a linear function of more than a single factor. Ross, S. A. "The Arbitrage Pricing Theory of Capital Asset Pricing." J. Economic Theory 13 (1976): pp. 334-360.

(39.) William Sharpe shared his Nobel Prize (37) with Harry Markowitz and Merton Millet for, respectively, "having developed the theory of portfolio choice" and "fundamental contributions to the theory of corporate finance." http://web.uvic.ca/econ/nobel.html

(40.) LeBoeuf, R. "Breakfast Briefing with PPG." Comments made at the Pittsburgh Technology Council, Oct. 1, 2003.

(41.) A cornerstone of Six Sigma. http://www.6sigma.us/ BusinessProcessCharting.html

(42.) Remarks of Brian C. Roseboro, Treasury Assistant Secretary for Financial Markets, SEC Financial Reporting Conference, London, April 25, 2002.

(43.) Elton, J. J., Shah, B. R. and Voyzey, J. N. "Intellectual Property: Partnering for Profit." The McKinsey Quarterly No. 4, 2002, pp. 60-67.

(44.) Giordan, J. C. "Forging Sound Strategic Alliances." Research-Technology Management, March-April 1995, pp. 11-12.

(45.) Gupta, D. and Gerchak, Y. "Quantifying Operational Synergies in a Merger/Acquisition." Management Science 48 (2002): 4 pp. 517 533.

(46.) Malackowski, J. E. and Wakefield, D. I. "Venture investment grounded in intellectual capital." In, From Ideas to Assets. Berman, B., ed. New York: Wiley, 2002.

(47.) Goldman Sachs primer on Asset Backed Securities, Oct. 2001.

(48.) Agiato, J. A. "The basics of financing intellectual property royalties." In, From Ideas to Assets. Berman, B., ed. New York: Wiley, 2002.

(49.) Fischer, B. H. "New patent issue: Biopharma royalty trust." In, >From Ideas to Assets. Berman, B., ed. New York: Wiley, 2002.

(50.) Champerty is a sharing in the proceeds of a lawsuit by an outside party who has promoted the litigation. After, The American Heritage[R] Dictionary of the English Language, Fourth Edition. New York: Houghton Mifflin, 2000.

(51.) Sebok, A. J. "Venture Capitalism For Lawsuits? Why It Doesn't Exist, And What Alternatives For Financing Exist Instead." Findlaw. com Feb. 12, 2001.

(52.) "Rule by numbers." The Economist magazine. April 10, 2003, p. 66.

RELATED ARTICLE: What the factors mean.

Current Assets (CA) is a balance sheet item comprising the sure of all cash and cash equivalents including accounts receivable adjusted for bad debt. The value is the result of empirical observations, transparency and objectivity. This is contrasted with the value of Long Term Assets such as property, plant and equipment (and now intellectual property), a value that today is still determined through rule-based calculations, a significant degree of subjectivity and as the market evidence suggests, fails to account for 70-90 percent of the value of those assets. The value is extracted from corporate financial reports.

Total Liabilities (TL) is a balance sheet item comprising the sum of short term ([less than or equal to] 1 year) and long term (>1 year). Most liabilities are contractual and therefore the reported value is the result of empirical observations, transparency and objectivity. Conceptually, they represent the going forward obligations of investments, typically for capital assets (Long Term Assets), that enable the conversion of intellectual property rights into commercial goods. The value is extracted from corporate financial reports.

Reputation is a correction factor for market inefficiencies, a financial concept recognizing the collective market's periodic ability to overvalue or underprice assets based on emotional factors such as irrational exuberance and unwarranted pessimism. Reputation is a market cap-independent measurement of the "brand strength" of a company--the intangible factor that results in market support for a higher price for a branded good despite the lack of any functional difference from a lower priced but otherwise identical generic. The reputation is established through an annual survey and is published by the Financial Times in a supplement entitled, "World's most respected companies." http://surveys.ft.com/. The rank value is retrieved directly from the survey.

CCI is a second correction factor for market inefficiencies (see "Reputation," above). The Consumer Confidence Index is calculated from the results of the monthly Consumer Confidence Survey, a monthly measure of the public's confidence in the health of the U.S. economy. The Survey is sponsored by the Conference Board and is conducted by NFO WorldGroup. NFO is a member of the TNS group of companies http://www.conferenceboard.org/ The index value is taken directly from the monthly reports.--N.K., B.B. and J.C.G.

Nir Kossovsky, M.D., is a managing director of I/C/M/B Ocean Tomo, a Chicago, Illinois-headquartered intellectual capital merchant bank that structures intellectual property asset-backed transactions for global financial markets. He heads the Technology Option Capital desk. Previously, he was founder and CEO of The Patent & License Exchange, Inc. (today, plx systems, Inc.), a principal consultant with Heisenberg Principals, Inc., and tenured associate professor at the UCLA School of Medicine. He received his M.D. from the University of Chicago, his M.B.A. from the University of Southern California, and completed his post-doctoral studies in pathology as an American Cancer Society Fellow at the Cornell University Medical Center. Author of approximately 200 publications and 33 pending and issued patents, he is also a graduate of the Navy War College and a Captain in the U.S. Navy Reserves. nkossovsky@tocllc.com

Bear Brandegee is a managing director of I/C/M/B Ocean Tomo. Her primary focus is the textile and apparel commercial vertical for which she provides a full range of commercial and retail services. Previously, she was founder and chief operating officer of The Patent & License Exchange, Inc., a principal consultant with Heisenberg Principals, Inc., president of SBI Laboratories, LLC, and held senior marketing and communications positions with Allied Signal (today, Honeywell) and Mitsubushi Electric. Earlier, she was vice president, technology, at Fleishman Hillard, a marketing and communications firm. She received her M.B.A. from the University of Southern California and is the author of more than a dozen publications and a half dozen patent applications. bbrandegee@tocllc.com

Judith Giordan is a director at I/C/M/B Ocean Tomo and co-founder and principal of Aileron Partners, a consulting firm based in Pittsburgh, Pennsylvania and San Francisco, California. Former positions include founder and managing partner of 1EXECStreet, LLC, vice president and global director of R&D--International Flavors and Fragrances, vice president global R&D-PepsiCola, and vice president R&D--Henkel Corporation. She received her Ph.D. in chemistry from the University of Maryland and was an Alexander van Humboldt post-doctoral fellow at the University of Frankfurt, Germany. She has held several adjunct and visiting academic positions and is a former member of the Board of Directors of the Industrial Research Institute. jgiordan@tocllc.com