Licensing Royalty Rates

1. Licensing Royalty Rates Michael A. Cohen Shareholder Schwabe Williamson & Wyatt

2. The Royalty Rate is only part of the picture Only one component of the total value intrinsic in a product or technology to be licensed Tempting to arrive at a royalty rate by looking at publicly available information concerning other royalty rates for similar technologies BUT, without information concerning other deal components, looking at royalty rates alone will not yield meaningful comparisons or benchmarks

3. Business Factors Impacting the Royalty Rate Importance. Is the technology a breakthrough or core product, or is it merely an ancillary product or minor improvement? Uniqueness. Is the associated intellectual property (patent rights, etc.) strong enough to keep this solution unique? Are there non-infringing alternative products available? Stage of Development. Can the invention be used immediately, or will it require substantial R&D or regulatory clearance to be commercialized? Has the licensor already incurred (and thus will want to recapture through royalties) the majority of the technology development and R&D costs?

4. Business Factors Impacting the Royalty Rate Risk. How certain is it that the solution will work as expected and that the market will be receptive to the solution? Profit margins. Can the invention command high margins, or does the industry or infrastructure (e.g., support needs) keep the margins thin? The licensor needs to know the licensee�s business model and profit margin, because the royalty obviously must be something less than the licensee�s profits. Competitive position of licensor/licensee. If between competitors, a license may introduce price competition into the market and have an effect on the licensor�s own sales in terms of price and volume. Also could impact the licensor�s related but unlicensed IP.

5. Business Factors Impacting the Royalty Rate Combined investment by licensor/licensee. Some economists make this central point: A fair and reasonable royalty is one where the licensor�s share of the licensee�s operating profits (i.e. the royalty rate) equals the licensor�s share of the combined investment by the licensor and the licensee in R&D, production and marketing to bring the product to market. 25% Rule. This rule of thumb states that the licensee should pay a royalty equivalent to 25% of the profit derived from the exploitation of the licensed IP. But a recent study of pharmaceutical and biotechnology industry royalty rates revealed that the 25% rule is not reflected in the myriad of deals that typify the pharma and biotech licensing arena and does not serve as good rule of thumb for arriving at a reasonable royalty rate.

6. Legal Factors Impacting the Royalty Rate Exclusivity. Are the rights granted sole and exclusive, so only the licensee can exercise them, or are they shared with the licensor or others? Recent pharmaceutical industry study revealed that the average royalty rate (based on net sales) for an exclusive license was 10%-15%, for a sole license 7-10% and for a non-exclusive license 4%-7%. Non-royalty based compensation. Does the deal also include upfront payments and/or milestone payments, or are payments entirely dependent on passage of time and/or licensee earnings?

7. Legal Factors Impacting the Royalty Rate Transferability. Can the licensee reassign and/or sublicense the invention? Field of use. In how many fields can the licensee exploit the invention? Territorial scope. Is it a worldwide license, or is it geographically limited, and if so, how narrowly? Duration. How long will the rights last? What is the life expectancy of the licensed IP? Under what circumstances can the licensor terminate the grant?

8. Legal Factors Impacting the Royalty Rate Improvements. Do the licensed rights include the right to improvements to the original licensed IP? Know-how. Often the licensor has information that is essential for the licensee to fully and effectively practice the technology, but which is not covered by the licensed patent(s). Do the deal terms obligate the licensor to share this information with the licensee?

9. Royalty Base is Critical Two Common Royalty Bases Gross receipts (aka gross sales). A gross receipts royalty is a percentage of the gross receipts from the sales of licensed products by the licensee. Gross receipts are the total amount of money collected by the licensee from the sales of the licensed products. Net receipts (aka net sales). A net receipts royalty is a percentage of the licensee�s net receipts from the sales of the licensed products. Net receipts are the total amount of money collected from the sales of licensed products, less deductions for specific items which are usually heavily negotiated. Certain items are often included as deductible items, such as excise taxes, sales taxes, shipping costs, insurance, sales commissions and import/export duties.

10. Royalty Base is Critical Proportion of value attributable to the licensed IP. Many licenses relate only to a component of the final product being sold, or to the manufacturing process itself. In such cases, it is difficult to identify the incremental revenue/value associated with the licensed IP. However, the patented or licensed feature may be the basis for the purchase of the entire product, so profits on sale of the entire product could reasonably be considered as the royalty base.

11. Summary of LES Survey on Pharma & Biotech Royalty Rates and Deal Terms 150 deals included in survey Deals broke down into the following categories: Pharma companies: 28% Biotech companies: 26% Academic institutions: 35% Other: 11%

12. Summary of LES Survey on Pharma & Biotech Royalty Rates and Deal Terms Key findings on deal terms: Small molecule compounds were included in more than 50% of all deals surveyed 88% of deals were exclusive 54% of deals included a fixed royalty; 33% included tiered royalty rates depending on stage of development 80% included an upfront payment 90% included U.S. rights; 70% were worldwide 57% of products covered had estimated peak sales of less than $100M

13. Summary of LES Survey on Pharma & Biotech Royalty Rates and Deal Terms Key findings on royalty rates: Fixed royalty rates used for most deals with preclinical products Average fixed royalty rate for preclinical products was 4.3% Average royalty rates for biological products slightly higher than small molecules Higher valued assets generated both higher upfront payments and higher average royalty rates Range of tiered royalty rates by stage of development: Preclinical: 5-8% Pre-proof of concept: 7-10% Post-proof of concept: 14-18%