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BVD-November 2008.indd 1
1. Introduction
The introduction of SFAS 141/142 and subsequent IFRS business combination accounting rules has shaped the business valuation
profession in many ways in recent years.
These rules have a constant impact on the
way the market approach can be applied.
The comparability of accounting policies has
already been a challenge when performing
a valuation within an international context
or with guideline companies listed in other
countries than the subject company. The latest evolutions of accounting rules have again
changed the landscape. While the objective
of fair value accounting is to make financial statements more in line with investors
expectations, these new rules also have an
effect on the way the business valuation professionals look at these financial statements
1.
as new challenges have arisen in the application process of the market approach.
The implementation of new accounting rules
for business combinations under US GAAP
(SFAS 141) as well as under the International Financial Reporting Standards (IFRS
3) have changed the way we now look at
goodwill and intangible assets in the balance sheets. Goodwill is no longer subject to
amortization but to impairment tests. Even
more importantly, the purchase accounting
process in business combinations results in
the recognition of intangible assets being
recognized in the balance sheets and amortized over their remaining useful life. In
a certain way, the amortization of goodwill
has been traded-off against the amortization
of intangible assets.
These accounting rules have significantly
changed the asset structure of balance
sheets, earnings profi le and volatility of
corporations subject to an intense M&A
activity. For example, in France as of end
2005, approximately 40% of the consolidated
shareholders equity of the French groups
in the CAC 40 index is composed of intangibles assets and goodwill, even after the
significant impairment campaign that led
to record asset write-downs during the years
2001 and 2002.1 In Germany, intangible assets (including goodwill) account for about
30% of the total balance sheet of the DAX 30
index corporations and a similar figure of
32% is reported for the United Kingdom for
Vivendi Universal has written down assets for 16 billion and France Tlcom for 10 billion at almost the same
time when AOLTimeWarner recorded an impairment loss of $54 billion.
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ratio analysis
New accounting rules related to business combinations
are interesting to valuation people as they have an impact
on the comparability of different companies, especially
when we make a comparison between companies that are
Company Y
Balance sheet
Intangible assets and goodwill
Tangible assets
Working Capital
Capital Employed
Net financial debt
Net equity
0
1000
500
1500
500
1000
Balance sheet
Intangible assets and goodwill
Tangible assets
Working Capital
Capital Employed
Net financial debt
Net equity
200
800
500
1500
500
1000
P&L
Sales
EBITA
Amortization expenses
EBIT
Financial expenses
Tax @ 40%
Net income
Net income before amortization
1000
200
0
200
-25
-70
105
105
P&L
Sales
EBITA
Amortization expenses
EBIT
Financial expenses
Tax @ 40%
Net income
Net income before amortization
1000
200
-10
190
-25
-66
99
105
Ratio analysis
ROCE (pre-tax)
Sales / Capital Employed
Working Capital / Sales
EBITA margin
EBIT margin
Net margin
Net margin before amortization
13,3%
0,67x
0,5x
20,0%
20,0%
10,5%
10,5%
Ratio analysis
ROCE (pre-tax)
Sales / Capital Employed
Working Capital / Sales
EBITA margin
EBIT margin
Net margin
Net margin before amortization
13,3%
0,67x
0,5x
20,0%
19,0%
9,9%
10,5%
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Comparable 2
Balance sheet
Intangible assets and goodwill
Tangible assets
Working Capital
Capital Employed
Net financial debt
Net equity
0
1000
500
1500
500
1000
Balance sheet
Intangible assets and goodwill
Tangible assets
Working Capital
Capital Employed
Net financial debt
Net equity
200
1800
1000
3000
1000
2000
Balance sheet
Intangible assets and goodwill
Tangible assets
Working Capital
Capital Employed
Net financial debt
Net equity
200
800
500
1500
500
1000
P&L
Sales
EBITA
Amortization expenses
EBIT
Financial expenses
Tax @ 40%
Net income
1000
200
0
200
-25
-70
105
P&L
Sales
EBITA
Amortization expenses
EBIT
Financial expenses
Tax @ 40%
Net income
2000
400
-50
350
-50
-120
180
P&L
Sales
EBITA
Amortization expenses
EBIT
Financial expenses
Tax @ 40%
Net income
1000
200
-20
180
-25
-62
93
Ratio analysis
ROCE (pre-tax)
Sales / Capital Employed
Working Capital / Sales
Market value of equity
Market value of invested capital
Valuation multiples
2.
3.
Comparable 1
13,3%
0,67x
0,5x
??
??
Ratio analysis
ROCE (pre-tax)
Sales / Capital Employed
Working Capital / Sales
13,3%
0,67x
0,5x
Ratio analysis
ROCE (pre-tax)
Sales / Capital Employed
Working Capital / Sales
13,3%
0,67x
0,5x
3000
4000
2000
2500
MVIC / EBIT
P/E
11,4x
16,7x
MVIC / EBIT
P/E
13,9x
21,5x
This approach is correct for the market approach and not the tax shield related to the amortization of the intangible asset.
For simplification purposes, we assume that the various discounts and premiums both offset each other in this case.
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Applying the multiples derived from the sample to the Subject Company, we obtain the following valuation results:
Drivers
Market value of
Invested Capital
EBIT
200
MVIC / EBIT
12,7x
2532
2032
Net income
105
P/E
19,1x
2504
2004
2004 - 2032
Let us now analyze the case where we adjust the financial drivers of both Comparable 1 and Comparable 2 for
amortization expenses to see whether we can eliminate this
suspected distortion. In this second approach, we adjust P
/ E and MVIC / EBIT multiples4 for amortization expenses
in the denominator and still assume that the various discounts and premiums both offset each other.
Comparable 1
Comparable 2
Balance sheet
Intangible assets and goodwill
Tangible assets
Working Capital
Capital Employed
Net financial debt
Net equity
0
1000
500
1500
500
1000
Balance sheet
Intangible assets and goodwill
Tangible assets
Working Capital
Capital Employed
Net financial debt
Net equity
200
1800
1000
3000
1000
2000
Balance sheet
Intangible assets and goodwill
Tangible assets
Working Capital
Capital Employed
Net financial debt
Net equity
200
800
500
1500
500
1000
P&L
Sales
EBITA
Amortization expenses
EBIT
Financial expenses
Tax @ 40%
Net income
1000
200
0
200
-25
-70
105
P&L
Sales
EBITA
Amortization expenses
EBIT
Financial expenses
Tax @ 40%
Net income
2000
400
-50
350
-50
-120
180
P&L
Sales
EBITA
Amortization expenses
EBIT
Financial expenses
Tax @ 40%
Net income
1000
200
-20
180
-25
-62
93
Ratio analysis
ROCE (pre-tax)
Sales / Capital Employed
Working Capital / Sales
13,3%
0,67x
0,5x
??
??
Ratio analysis
ROCE (pre-tax)
Sales / Capital Employed
Working Capital / Sales
13,3%
0,67x
0,5x
Ratio analysis
ROCE (pre-tax)
Sales / Capital Employed
Working Capital / Sales
13,3%
0,67x
0,5x
3000
4000
2000
2500
MVIC / EBITA
Adj. P/E
10,0x
14,3x
MVIC / EBITA
Adj. P/E
12,5x
19,0x
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Applying the valuation multiples computed prior to amortization expenses, we obtain the following results:
Drivers
Market value of
Invested Capital
Market value of
Equity
EBITA
200
MVIC / EBITA
11,3x
2250
1750
105
adj. P/E
16,7x
2250
1750
Drivers
1750
Market value of
Invested Capital
Market value of
Equity
EBITA
200
MVIC / EBITA
12,5x
2500
2000
105
adj. P/E
19,0x
2500
2000
1750
5.
6.
The adjusted net income is computed by adjusted the reported net income by the amortization expense, net of the tax shield effect. It should be noted that
not all.
The distortion with the results yielded with the average sample multiples stems from the fact that Company 1 (for unexplained reasons) has lower multiples
than Company 2. There are a number of reasons that could explain such as a situation, but this is outside the scope of this article.
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Table 6: Diverging R&D policy between the subject company and the peer group: unadjusted multiples
Subject Company
Company 1
Comparable 2
Balance sheet
Intangible assets and goodwill
Capitalized R&D
Tangible assets
Working Capital
Capital Employed
Net financial debt
Net equity
100
0
900
500
1500
500
1000
Balance sheet
Intangible assets and goodwill
Capitalized R&D
Tangible assets
Working Capital
Capital Employed
Net financial debt
Net equity
0
100
1900
1000
3000
1000
2000
Balance sheet
Intangible assets and goodwill
Capitalized R&D
Tangible assets
Working Capital
Capital Employed
Net financial debt
Net equity
125
75
800
500
1500
500
1000
P&L
Sales
R&D expensed
EBITA
Amortization expenses
R&D amortization
EBIT
Financial expenses
Tax @ 40%
Net income
1000
50
200
0
0
200
-25
-70
105
P&L
Sales
R&D expensed
EBITA
Amortization expenses
R&D amortization
EBIT
Financial expenses
Tax @ 40%
Net income
2000
0
400
0
-100
300
-50
-100
150
P&L
Sales
R&D expensed
EBITA
Amortization expenses
R&D amortization
EBIT
Financial expenses
Tax @ 40%
Net income
1000
0
200
0
-50
150
-25
-50
75
Ratio analysis
ROCE (pre-tax)
Sales / Capital Employed
Working Capital / Sales
R&D investment (% of sales)
Market value of equity
Market value of invested capital
13,3%
0,67x
0,5x
5%
??
??
Valuation multiples
Ratio analysis
ROCE (pre-tax)
Sales / Capital Employed
Working Capital / Sales
R&D investment (% of sales)
13,3%
0,67x
0,5x
5%
Ratio analysis
ROCE (pre-tax)
Sales / Capital Employed
Working Capital / Sales
R&D investment (% of sales)
13,3%
0,67x
0,5x
5%
3000
4000
2000
2500
MVIC / EBIT
P/E
13,3x
20,0x
MVIC / EBIT
P/E
16,7x
26,7x
Applying the multiples derived from the sample to the Subject Company, we obtain the following valuation results:
Table 7: Diverging R&D policy between the subject company and the peer group: Valuation results with unadjusted
multiples
Valuation analysis
Drivers
Market value of
Invested Capital
EBIT
200
MVIC / EBIT
15,0x
3000
2500
105
P/E
23,3x
2950
2450
Drivers
2450 - 2500
Comparable 1
Market value of
Invested Capital
EBIT
200
MVIC / EBIT
13,3x
2667
2167
105
P/E
20,0x
2600
2100
Drivers
2100 - 2167
Comparable 2
Market value of
Invested Capital
EBIT
200
MVIC / EBIT
16,7x
3333
2833
105
P/E
26,7x
3300
2800
2800 - 2833
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Table 8: Diverging R&D policy between the subject company and the peer group: adjusted multiples
Subject Company
Company 1
Balance sheet
Intangible assets and goodwill
Capitalized R&D
Tangible assets
Working Capital
Capital Employed
Net financial debt
Net equity
100
0
900
500
1500
500
1000
Balance sheet
Intangible assets and goodwill
Capitalized R&D
Tangible assets
Working Capital
Capital Employed
Net financial debt
Net equity
0
100
1900
1000
3000
1000
2000
Balance sheet
Intangible assets and goodwill
Capitalized R&D
Tangible assets
Working Capital
Capital Employed
Net financial debt
Net equity
125
75
800
500
1500
500
1000
P&L
Sales
R&D expensed
EBITA
Amortization expenses
R&D amortization
EBIT
Financial expenses
Tax @ 40%
Net income
1000
50
200
0
0
200
-25
-70
105
P&L
Sales
R&D expensed
EBITA
Amortization expenses
R&D amortization
EBIT
Financial expenses
Tax @ 40%
Net income
2000
0
400
0
-100
300
-50
-100
150
P&L
Sales
R&D expensed
EBITA
Amortization expenses
R&D amortization
EBIT
Financial expenses
Tax @ 40%
Net income
1000
0
200
0
-50
150
-25
-50
75
Ratio analysis
ROCE (pre-tax)
Sales / Capital Employed
Working Capital / Sales
R&D investment (% of sales)
13,3%
0,67x
0,5x
5%
7.
Comparable 2
??
??
Ratio analysis
ROCE (pre-tax)
Sales / Capital Employed
Working Capital / Sales
R&D investment (% of sales)
13,3%
0,67x
0,5x
5%
Ratio analysis
ROCE (pre-tax)
Sales / Capital Employed
Working Capital / Sales
R&D investment (% of sales)
13,3%
0,67x
0,5x
5%
3000
4000
2000
2500
MVIC / EBITA
P/E excl. Amortization
10,0x
14,3x
MVIC / EBITA
P/E excl. Amortization
12,5x
19,0x
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Table 9: Diverging R&D policy between the subject company and the peer group: Valuation results with adjusted
multiples
Valuation analysis
Drivers
Market value of
Invested Capital
EBITA
200
MVIC / EBITA
11,3x
2250
1750
105
adj. P/E
16,7x
2250
1750
Drivers
1750
Comparable 2
Market value of
Invested Capital
EBITA
200
MVIC / EBITA
12,5x
2500
2000
105
adj. P/E
19,0x
2500
2000
2000
The adjusted net income is computed by adjusted the reported net income by the amortization expense, net of the tax shield effect. It should be noted that
not all.
BVD-November 2008.indd 8
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Offsetting different accounting policies and making companies more comparable, or bringing accounting based
figures closer to economic realities have always been a
part of the valuation process. However, looking at recent
changes in the US and international accounting rules, one
might wonder whether they are making the job any easier
to us? While this all becomes more complicated, what a
tremendous business opportunity this represents for the
valuation profession!
This article was originally published in the Business
Valuation Review. 26.1 (2007).
Introduction
All methods of evaluation of the equity value of a company
on a going concern basis require the estimation of a representative net cash flow or net benefit and an appropriate
capitalization rate. A capitalization rate is the rate of return
used to convert estimated maintainable discretionary cash
flow to present value. The equity value is usually written in
the following way:
Vt =
CFt+1
tcap
CFt+1
kg
(1)
(2)
BVD-November 2008.indd 9
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company specific circumstances, the growth factor normally is comprised of the expected long term inflation, and
may incorporate an incremental real growth rate. Where
expected real growth has been reflected in the estimate of
maintainable discretionary cash flows, that same growth
should not be accounted for again in the capitalization
rate.
BVD-November 2008.indd 10
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Figure 1: Discretionary cash flow growth model and effective growth rate.
Effective growth rate G(k, g, N, ge) to perpetuity
1
k-G
1-
(1+g)
(1+k)
N
+
N-1
(1+g) (1+ge )
k-g
(1+k)
-N
(3)
(k ge )
g
Economy e
Cash Flow
m
Co
ny
pa
Company expected
growth
growth ra
Effective
Years
Figure 1 shows the model. In the first N years over
which
the business plan of the company is defined, the discretionary cash flow is growing at a rate g expected from
the companys business plan. After this period of time, we
assume that the growth rate of the discretionary cash flow
will follow the growth of the economy ge. Based on the
values of g, N, ge and the cost of equity k determined
from eq. 2, it is possible to calculate using equation 3, an
effective growth rate G (k, g, N, ge) valid to infinity. The
right end side of equation 3 shows the present value of the
series of cash flows shown in Fig.1 discounted at a rate k.
The left end side is written as 1/(k-G) in order to be able
to use the effective growth rate G directly into an equity
value formula.
te G
Economy expected
growth
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Conclusion
The valuation of the equity value of a company requires the
determination of a number of variables such as a representative net cash flow (CF), a discount rate (k) and an expected growth rate (g) of the cash flow. The representative net
cash flow assumed to be generated to perpetuity, can easily
be determined based on companys performances if no
growth is taken into consideration. Moreover, if the built
up method is used to evaluate the discount rate, all rates of
return associated with equation 2 can be determined quite
easily based on tables available in the literature except for
the company specific risk (the non-systematic risk). In this
case, a detailed study of the company position within the
industry should be conducted and a rate premium typically
between 0 and 5% should be added or subtracted to the
overall rate of return depending on whether the company
performs better or worst than the average company in the
industry. Finally, an effective growth factor of the cash
flow valid to infinity should be determined. Which growth
factor should be used (the long term growth of the company estimated by the management team, the long term
estimated growth of the industry or the growth rate of the
economy)? In the past, there was no practical approach to
address such problem. In this paper, we propose to use a
two stage model where in the first stage we consider the expected growth of the cash flow found in the business plan
of the company (g) over the forecasted period (N) (typically
five to seven years) and in the second stage, we consider
the long term expected growth rate of the economy (ge).
This allows us to calculate an effective growth rate which
depends on g, N, ge and the discount rate k. This effective
rate can then be used in the equity value formula (equation
1) to estimate the en bloc fair market value of the outstanding shares of the company.
Note: Tables such as the one shown in Table 1 for various
values of g, k, N and ge are available from the author.
Contact e-mails: Robert Schulz: schulz.robert@ireq.ca ; Fernand Gurin: Fernand.Guerin@USherbrooke.ca .
Acknowledgments
The author would like to thank Professor F. Guerin from
University of Sherbrooke for helpful discussions regarding
this novel practical approach.
References
[1] Shannon Pratt, The Cost of Capital, second edition,
2002, editor Wiley & Sons Inc.
BVD-November 2008.indd 13
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Traditionally documentary discovery was a fairly straightforward task. Counsel would meet with his or her clients
and generally identify the key people that were involved in
the facts relating to the claim. Each of these individuals is
asked to gather all relevant documents and counsel would
compile and review them in formulating the Affidavit of
Documents. It is in this context that the rules of discovery
were formulated; however, recent technological advances
have had a significant impact on the way that organizations deal with information and documents. The modern
world generates far more documentation than ever
before, and this has necessarily impacted the way that litigators undertake the documentary disclosure exercise. In
todays world, litigators must consider electronic discovery
or e-discovery as it has some to be known when dealing
with electronic sources of information and documentation for litigation.
1.
Electronic information is different than paper information: it is far more voluminous, easily deleted, sometimes
recoverable and potentially more costly to review and may
contain private or privileged information. Identifying the
varied sources of electronic information can be a challenge
in itself. In addition to a users computer, relevant information can be found on other less obvious places such as
servers, removable media (e.g. CDs, DVDs, floppies), portable devices (e.g. USB thumbdrives, iPods, external hard
drives), communication devices (e.g. Blackberry, PDA,
smart phones), and backup tapes. All of these sources can
be found in the custody of the litigants or with external
third parties such as internet service providers or off-site
storage/hosting facilities.
Even after the potential sources of the relevant information
have been identified, there are further issues and challenges based on the type and format of the information. These
challenges are illustrated with the following questions:
This article refers mainly to legislation and practice in Ontario although reference is also made to the Sedona Canada Working Group which covers
all of Canada.
BVD-November 2008.indd 14
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t "SFPOMZUIFBDUJWFMFTSFMFWBOUPSJTBGVMMGPSFOTJD
analysis required (i.e. deleted information)?
t *TUIFSFMFWBOUJOGPSNBUJPOJOBOBDDFTTJCMFGPSNBU
PS
are additional steps required to access the information?
(e.g. outdated backup software, encrypted information,
legacy accounting system)
BVD-November 2008.indd 15
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The rapid growth of the technology services industry related to e-discovery has produced some very powerful tools
for assisting counsel and their clients in sifting through the
enormous quantities of electronic information common to
litigation today. Some technologies focus on the culling of
documents by eliminating de-duplication2, so that when
identical electronic documents are identified, counsel only
has to review the document once. Other technologies assist
counsel in the review stage using techniques like clustering (grouping documents with similar content) or concept
searching (identifying documents that might have a relationship to key documents even if it does not exactly match
search parameters).
&YQFSU8JUOFTTFT3PMFJO%JTDPWFSZ
With the proliferation of digital information, the documents requested during discovery can come in many
forms and large volumes. As a result, experts (such as
Chartered Business Valuators) are being called upon more
often to assist counsel in processing, reviewing, and organizing this information to identify and highlight salient
facts, particularly when the subject at the heart of the
litigation involves valuation or other specialized expertise.
The increased significance placed on electronic documents
has expanded the role of the expert in their ability to assist
counsel. Now the expert must be familiar enough with
e-discovery concepts and be in a position to understand the
clients obligations and ability to produce relevant information during discovery. An expert should also be able to recognize when a computer forensics expert or an e-discovery
vendor is required to assist in accessing the information
that they need for their own work, and they should have a
working understanding of the operative legal framework.
Chartered Business Valuators may be called on to act as
experts in either a consultative or testifying role. Best
practices dictate that counsel be in contact with potential
experts early on. Doing so earlier rather than later enables
the expert to communicate what data and information he
or she needs to best address the questions posed to provide
an opinion. In turn, this may shape the evidence that is
provided as part of discovery and the scope of relevance in
documentary disclosure. For example, an expert may be
able to inform counsel early on what data is relevant for the
analysis that will ultimately be performed, despite the appearance on its face otherwise. Counsel should work with
experts to make sure that the ultimate testifying expert gets
the right data early on to support the experts report.
Early consultation with counsel can also be helpful in
structuring and detailing the oral discovery of the other
side. Knowing what information the expert wishes to
review enables counsel to conduct a more efficient and
effective oral examination of the opposing party and get
undertakings to provide information needed. Experts can
2.
&YQFSU8JUOFTTFT8PSLJOH1BQFST
Experts should bear in mind the capacity in which they
have been retained. If an expert is not going to present a
report and testify (a consulting expert) his or her notes and
working papers may be protected by litigation privilege
and will not be subject to disclosure to the other side. The
situation is quite different for an expert retained for the
purpose of providing testimony. As soon as the experts
report is delivered (as is generally required before trial), any
documentation that the expert created or received during
the course of his or her retainer will likely be required to
be disclosed to the opposing counsel on its request. This
means that testimonial experts should be very careful
about what documents, including electronic documents,
they produce. Computer forensic techniques can be used to
resurrect old drafts and opinionated emails. Some counsel
often requests a preliminary review and oral opinion before
anything is committed to paper. In other instances, counsel
may also seek to work with the expert while he or she drafts
the report to ensure that clear language that would assist
the court is used and to minimize or avoid the exchanging
of drafts.
De-duplication is the automated process of eliminating identical documents using specialized software to improve the efficiency of review by reducing
redundancy.
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8IBUUIF'VUVSF.BZ)PME
The attention that electronic evidence has received from the
Canadian legal community demonstrates the importance
it will play in the future of litigation in Canada. Likewise,
the valuator needs to seriously consider e-discovery and
the guidelines developed by the legal community to deal
with it; the guidelines have implications relating to what
foundational material is ultimately available to the valuator, both as a consulting expert and a testifying expert. As
these guidelines, are put into practice, case law will further
clarify how e-discovery is carried out and how this will
further affect the role of the expert.
Introduction
As the U.S. economy continues to evolve, the total business
assets of the typical corporation are increasingly comprised
of intangible assets. The most important intangible assets
of a company are usually intellectual property. Intellectual
property assets include patents, copyrights, trademarks,
and trade secrets.
By nature, corporate intellectual property is more difficult to identify, value, and manage compared to corporate
tangible assets. While many elements of valuation and
damages calculation are relevant to intellectual property in
general, this discussion will focus on estimating damages
related to patent infringement.
The importance of properly managing patents has been
highlighted in several highly publicized patent disputes.
The most notable dispute was between (1) Research In Motion (RIM), the company that makes the popular BlackBerry wireless device, and (2) a company named NTP Inc.,
which claimed that RIM improperly used a patent owned
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Damages in patent infringement cases are provided by
statute 35 U.S.C. Section 284. This statute reads in pertinent part:
Upon finding for the claimant the court shall award
damages adequate to compensate for the infringement, but in no event less than a reasonable royalty
for the use made of the invention by the infringer,
together with interests and costs as fixed by the
court.
When the damages are not found by a jury, the court
shall assess them. In either event the court may
increase the damages up to three times the amount
found or assessed.
The court may receive expert testimony as an aid
to the determination of damages or of what royalty
would be reasonable under the circumstances.
The holder of a patent that has been infringed is entitled to
one or both of:
1. lost profits from sales that the patent holder would have
made but for the infringement and/or
2. the payment of a reasonable royalty on sales of the infringer that depended on the infringed patent.
These infringement damages are known as compensatory
damages.
In addition, if the infringer is found to have willfully infringed the subject patent, the patent holder may be entitled
to triple damages, known as punitive damages.
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As discussed above, there are two measures of patent damages: lost profits and reasonable royalty. Each of these two
measures is discussed below.
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A lost profits analysis measures the additional profits the
patent holder would have received but for the alleged
patent infringement. At the outset, it must be determined
whether the patent holder did in fact lose profits due to patent infringement. There are a number of tests that determine the appropriateness of lost profits damages in patent
litigation. The most common is known as the Panduit
four-part test.1
Under the Panduit test, the patent holder must prove:
1. demand for the patented product,
2. the absence of acceptable noninfringing alternatives,
3. the patent holders capacity to produce the product and
fulfill any demand, and
4. the profits the patent holder would have made.
It is important to note that the first three factors address
the issue of causation, involving proof that the patent
infringement directly caused actual lost sales and/or profits
by the patent holder. The Panduit four-part test addresses
the presumption that there would have been greater profits
but for the alleged infringement.
The factors that aid in the determination of whether the patent holder lost profits depend on the facts and circumstances
of the parties and products involved. For example, in a twosupplier market, the first two factors can often be inferred:
1. there is already evidence of demand for the patented
product and
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services that either were made or could have been made
by the patent holder as a result of the patent infringement. Volume erosion estimates can be based on calculations of either absolute sales volume or market share.
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or services of the patent holder that were caused by the
patent infringement. Factors that should be considered
in estimating price erosion include:
1. the relative prices of products sold by the parties,
2. changes in overall prices for the product caused by
the entry of an additional participant in the market
for the product, and
3. lower sales growth caused by the distractions and
expense of litigation related to the subject patent.
The extent of volume erosion and price erosion in turn
depends on a number of factors, including (1) demand
for the affected product(s) and (2) the number of market
participants. For example, in a market with only two
participants, it is likely that the patent holder would
have received most of the sales actually made by the patent infringer.
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market can have a detrimental effect on the reputation
of the product in general.
When this new product infringes the subject patent, this
factor can negatively impact the reputation of products
in general in the relevant market segment and, therefore, can cause lower sales and profits of products made
by the patent holder.
Reasonable Royalty
A reasonable royalty rate can be estimated using an analytic approach. The goal of an analytic approach is also to
estimate the royalty rate that would have been agreed upon
in an arms-length transaction.
A royalty rate analyses represents one of two scenarios:
1. royalty income that is actually earned or hypothetically
could be earned by the patent holder, and
2. the savings to the patent infringer from not paying a
reasonable royalty to the patent holder.
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