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Goldscheider 25 Percent Rule
Goldscheider 25 Percent Rule
Goldscheider 25 Percent Rule
Rule In Valuing IP
BY ROBERT GOLDSCHEIDER, JOHN JAROSZ AND CARLA MULHERN*
Introduction in copyright, trademark, trade se- ents, the Swiss subsidiary of a large
cret and know-how contexts as well. American company, with 18 licens-
A
s the importance of intellec-
tual property (“IP”) protec- Since the Rule came into fairly com- ees around the world, each having
tion has grown, so has the mon usage decades ago, times, of an exclusive territory. The term of
sophistication of tools used to value course, have changed. Questions each of these licenses was for three
it. Discounted cash flow,1 capitali- have been raised on whether the years, with the expectation of re-
zation of earnings,2 return on in- factual underpinnings for the Rule newals if things continued to go
vestment,3 Monte Carlo simulation4 still exist (i.e., whether the Rule has well. Thus, if any licensee “turned
and modified Black-Scholes op- much positive strength) such that sour,” it could promptly be re-
tion valuation methods 5 have it can and should continue to be placed. In fact, however, even
been of great value. Nonetheless, used as a valid pricing tool (i.e., though all of them faced strong
the fairly simple “25 Per Cent whether the Rule has much nor- competition, they were either first
Rule” (“Rule”) is over 40 years old mative strength). or second in sales volume, and
and its use continues. Richard In this paper, we describe the probably profitability, in their re-
Razgaitis has called it the “most fa- Rule, address some of the miscon- spective markets. These licenses
mous heuristic, or rule of thumb, ceptions about it and test its factual therefore constituted the proverbial
for licensing valuation.”6 underpinnings. To undertake the “win-win” situation. In those li-
The Rule suggests that the lic- latter, we have examined the rela- censes, the intellectual property
ensee pay a royalty rate equivalent tionship between real-world royalty rights transferred included: a port-
to 25 per cent of its expected prof- rates and real-world industry and folio of valuable patents; a continual
its for the product that incorporates company profit data. In general, we flow of know-how; trademarks de-
the IP at issue. The Rule has been have found that the Rule is a valu- veloped by the licensor; and copy-
primarily used in valuing patents, able tool (rough as it is), particularly righted marketing and product
but has been useful (and applied) when more complete data on incre- description materials. For those li-
mental IP benefits are unavailable. censes, the licensees tended to gen-
The Rule continues to have a fair erate profits of approximately 20
degree of both “positive” and “nor- per cent of sales on which they paid
mative” strength. royalties of 5 per cent of sales. Thus,
1. D.J. Neil, Realistic Valuation of Your IP, the royalty rates were found to be
32 les Nouvelles 182 (December 1997); History of the Rule
25 per cent of the licensee’s profits
Stephen A. Degnan, Using Financial Models One of the authors — Robert
to Get Royalty Rates, 33 les Nouvelles 59 on products embodying the pat-
(June 1998); Daniel Burns, DCF Analyses in Goldscheider7 — did, in fact, under- ented technology.9
Determining Royalty, 30 les Nouvelles 165 take an empirical study of a series
(September 1995); Russell L. Parr & Patrick of commercial licenses in the late
H. Sullivan, Technology Licensing: Corporate 1950s.8 This involved one of his cli-
Strategies For Maximizing Value 233-46
(1996); Richard Razgaitis, Early-Stage
Technologies: Valuation and Pricing 121- *Robert Goldscheider, Chairman, Interna-
58 (1999). tional Licensing Network.
2. Robert Reilly & Robert Schweihs, Valuing John Jarosz and Carla Mulhern, Princi-
Intangible Assets 159-66 (1999).
7. See, e.g., Richard S. Toikka, In Patent pals, Analysis Group/Economics.
3. Parr and Sullivan, pp. 223-33.
Infringement Cases, the 25 Per Cent Rule We would like to thank the following in-
4. V. Walt Bratic et al., Monte Carlo Analyses Offers a Simpler Way to Calculate Reason-
Aid Negotiation, 33 les Nouvelles 47 (June able Royalties. After Kumho Tire, Chances dividuals for their hard work and useful
1998); Razgaitis, pp. 160-77. are the Rule Faces Challenges to its comments on earlier drafts of this paper:
5. Dr. Nir Kossovsky & Dr. Alex Arrow, Daubert Reliability, Legal Times 34 (August Jaime Baim, Laura Boothman, Jeff Kinrich,
TRRU™ Metrics: Measuring The Value and 16, 1999). Jennifer Price, Chris Vellturo and Robert
Risk of Intangible Assets, 35 les Nouvelles 139 8. Robert Goldscheider, Litigation Back-
(September 2000); F. Peter Boer, The Valuation Vigil. The views expressed here are ours
grounder for Licensing 29 les Nouvelles 20, 25
of Technology: Business and Financial Issues In (March 1994); Robert Goldscheider, Royalties and do not necessarily represent those of
R&D, 302-06 (1999). as Measure of Damages 31 les Nouvelles 115, others at the International Licensing Net-
6. Razgaitis, p. 96. 119 (September 1996). work or Analysis Group/Economics.
Number of Industries
ented elements, the manufacturing 8
process, business risks, or significant 7
features or improvement added by 6
the infringer.” 5
4
Justification for the Rule
3
The Rule, based on historical ob- 2
servations, provides useful guid- 1
ance for how a licensor and licensee 0
should consider apportioning the <0% 0%-20% 21%-40% 41%-60% 61%-80% >80%
benefits flowing from use of the IP.
Somewhat untenable (and unreal-
istic) is guidance that either the li- Figure 8
censor or licensee is entitled to all Royalty Rates and Successful Licensee Profits
of the returns. No bargain would Median Average Royalty
be reached. Though a 50:50 start- Industry Royalty Operating as % of
ing split has a ring of a “win-win” Rate Profits Profit Rate
situation, in fact, the evidence sug- Automotive 5.0% 11.3%* 44.1%
gests otherwise.
Chemicals 3.0% 12.0% 25.0%
Richard Razgaitis has identified 6
Computers 2.8% 8.3% 33.3%
reasons for why a 25/75 (starting)
split makes sense.42 First, “that’s the Consumer Goods 5.0% 18.4% 27.1%
way it is.” Numerous licensors and Electronics 4.5% 13.1% 34.3%
licensees have agreed to a 25/75 Energy & Environment 3.5% 9.2% 38.1%
split. It is, according to him, the in-
Food 2.3% 14.2% 15.8%
dustry norm. Second, typically 75
per cent of the work needed to de- Healthcare Products 4.0% 18.5% 21.6%
velop and commercialize a product Internet 5.0% 10.4% 48.0%
must be done by the licensee. Third, Machine/Tools 3.4% 9.6% 35.0%
“he who has the gold makes the
rules.” Licensees have considerable Media & Entertainment 9.0% -13.5%* -66.7%
leverage because of the numerous Pharma & Biotech 4.5% 25.8% 17.4%
investment alternatives open to Semiconductors 2.5% 31.9% 7.8%
them. Fourth, a 3-times payback ra-
Software 7.5% 25.1% 21.4%
tio is common. Such is obtained by
a licensee retaining 75 per cent of Telecom 5.0% 14.5% 34.5%
the return by investing 25 per cent. Total 4.3% 18.8% 26.6%
Fifth, technology is the first of the 4
required steps of commercializa- * Fewer than 5 observations in data set.
tion. The others are making the
product manufacturable, actually Figure 9
manufacturing it and selling it. Fi- Distribution of Profit Split - Successful Licensee Profits
nally, the ratio of R&D to profits is
10
often in the range of 25 to 33 per cent.
9
Number of Industries