OPTEON

1. Structure of Financial Terms in a License OPTEON PTY LTD Philip Mendes Director Level 3, 380 Queen St Brisbane QLD, Australia Ph + 61 7 3211 9033 Fax + 61 7 3211 9025 philip@opteon.com.au

2. Benchmarking financial terms . Benchmarking Financial Terms In licenses Amounts Royalties Milestone Payments Structure What types of financial terms

3. 1. Royalty on sales by a licensee • X% of sales price • Gross sales price; or • Net sales price • Most common type of royalty provision • Royalty is remuneration for quantity of use • Greater the quantity of use, the greater the royalty • The more sales, the greater the royalty • But more to a license than a royalty on sales • Clever ways for licensors to increase their remuneration • Clever ways for licensees to reduce their royalty overhead

4. Licensee grants sub-license Sub-licensee will pay to Licensee Royalties on the sub- licensee’s own sales Milestone payments, etc All that income is sub-license income Licensee pays a royalty of Y% to Licensor on all that income . Royalty upon sub-license income received by licensee Licensor Licensee Sub-Licensee

5. Royalty on sale price for which the last licensee sells product Royalty rate remains fixed, e.g. 2% of sale price of last sale – that is all licensor will receive Licensor might be better off receiving Y% of Sub-license income – might be greater than this 2% - as Licensee will sub-license after value adding and will secure a substantially higher royalty . Royalty upon Last Licensee’s Sales Licensor Licensee Sub-Licensee Buyer

6. 4. Ramped Up Royalties • As a product is more successful, and costs reduce, royalty increases • Licensor forgoes royalties in early stages, in return for higher royalties later • Infrequently seen

7. Royalty on sales in countries where patent granted • Expressed as: • “Valid Patent Claim” • Sales in country where but for license product would infringe a granted patent • That is, you only receive a royalty where sales are made in countries where the sale of a product is protected by a granted patent • Traps: • No royalties on sales made while patent pending (e.g., delays in examination, opposition proceedings etc) • No royalties on sales in countries where patent is not sought, nor granted – ie, if patent in US only, you only get royalties on sales in US

8. Royalty on sales in countries where no patent is granted • This royalty often resisted by licensee – “why should I pay a royalty for sales in countries where there is no patent and I have no power to prevent competitors ? • Royalty might still fairly be payable: • Patent is likely to be taken out in 20 – 25 countries and that may represent 90% - 95% of the world market – so why shouldn’t royalty be paid on sales in remaining countries ? • Licensee will select the countries where patent will be sought • Result • pay full / part royalty, • reducing by 50% if a competing product enters the marketplace, if it would have infringed the patent

9. 7. Royalty stacking • Can arise in two ways 1. Product to be sold needs license in of complementary technology, • e.g., a delivery system • another active ingredient • a complementary product where both sold together e.g., a vaccine cocktail Sale price of product sold reflects complementary technology as well 2. Freedom to operate – license in patent that is infringed • Cannot reduce royalty by whole amount of royalty paid to another person • Alternative: in each case, reduce royalty by X% of royalty paid out, up to max of y% reduction on any royalty payment

10. 8. Royalty Splitting – know how • Split royalties so that they are referable to different parts of the IP that is licensed • Instead of seeking a royalty of 5%: • Royalty of 3% for use of patent • Royalty of 2% for use of know how • Purpose: • If patent is invalidated, license on foot, with a royalty • getting a royalty in countries where there are no patents

11. 9. Reach Through Royalties • Are royalties • Not on a Product derived from your IP • Instead, on a product derived from someone else’s IP, but which your IP validated • Examples: • License of a Mouse Model • Mouse Model validates a drug target • Therapeutic drug developed that acts on that target • Software program – royalties on reagents • Catalyst that reduces manufacturing costs

12. 10. Suspending royalties • Suspend royalties while revocation proceedings are on foot against a patent • Licensee will be concerned that it may be unnecessarily paying royalties if the patent is revoked • Licensor will be concerned to receive royalties if patent stands up • A middle ground is that royalties are • Paid to a trustee • Returned to licensee if revocation proceedings successful • Paid to licensor if revocation proceedings unsuccessful

13. 11. “Most favoured” royalty • Most favoured clause is very common in the case of a non exclusive license • Agree on royalty of 10% • If licensor later grants a license in the same country to a competing licensee for a lower royalty, that lower royalty will apply in lieu of the 10% royalty • Sought by non exclusive licensee to enable it to be better able to compete

14. 12. Royalties on damages • Does Licensor get a royalty of X% on damages ? • Assume: • Cost of Good: $60 • Profit Margin: $40 • Retail price: $100.00 • Royalty: 5% • Damages for lost profits: therefore are: $40.00 • Should licensor get: • 5% of $40.00 ($2); or • 5% of $100.00 ($5) ?

15. 13. Lump Sum License Fees • Once Only License Fee • License fee payable by installments • Signing Fee • To offset past patent expenses, expenses of doing the deal (travel, legals etc) some part of R & D costs,

16. 14. Minimum Annual RoyaltyAlternative to performance obligations • Performance obligations are obligations that a licensee must meet to continue to be licensed • Avoids shelving (non use) of IP • Licensor gets no financial return and wants to be able to license someone else • Avoids inadequate performance (e.g., no commercialisation in a major market, such as US) • Licensor gets inadequate financial return and wants to be able to license someone else

17. 14. Minimum Annual Royalty Examples of performance obligations • Pre market entry milestones to be achieved: (a) If following completion of research, more research is needed to bring products to a market ready state, the completion of that research (b) Completion of animal studies (c) Completion of collection of data for lodging IND in USA (d) filing IND in USA (e) Commencement of Phase 1 Clinical Studies (f) Commencement of Phase 2 Clinical Studies (g) Commencement of Phase 3 Clinical Studies (h) Filing of PLA in USA (i) Approval of PLA. in USA (j) First sale anywhere in the world • Failure leads to termination

18. 14. Minimum Annual Royalty Examples of performance obligations • Sell X quantity of product worldwide by 01.01.05 • Or, sell the following quantities (revenues) in the following Territories in the following Periods: • Failure leads to termination • All motivated by Licensor seeking to maximise commercialisation and therefore revenue

19. 14. Minimum Annual Royalty Alternative to performance obligations • A Pharma / multinational will not accept performance obligations of these type • A large biotech company will not be able to secure those types of performance obligations from a pharma, and so will also not accept them from a licensor • Alternative is Minimum Annual Royalties • A minimum amount of royalties to be paid • Licensee must pay the higher of • Actual royalties, or • Minimum annual stipulated amount • Ramp up the amount year by year • If Licensee elects not to pay, termination

20. 15. Minimum Annual Payments • Similar concept to Minimum Annual Royalties • But refers to all payments payable under the license • For example, credit Milestone payments against the minimum payment amount • May credit other things • Research monies paid • Consultancy fees paid

21. 16. Milestone Payments • Payments made at identifiable points along the development / regulatory pathway

22. Pay royalties on whatDefinition of “Gross Sale Price” • Gross / Net – only labels - definition that is important • Pay on invoice price • Deduct taxes, duties, VAT, GST etc on sale • Deduct returns • Deduct packaging, freight and insurance • Only if separately invoiced • Or lump sum deduction, maximum of 3-5% • Sales to Related companies – transfer pricing • Licenses to Related Companies (with consent)

23. Royalty Rate Methodologies

24. Arriving at the right royalty rate Most reliable method to arrive at a royalty rate Benchmarking combined with DCF Rules of thumb Second least reliable method Statistics and averages Least reliable method

25. 25% RuleRule of thumb • Rule of Thumb • As with all Rules of Thumb – need to use with caution • May be a starting point only – with justifiable departures • Sam Davis, “Patent Licensing”, Patent Law Institute 1958, see Goldscheilder & Marshall, “The Art of Licensing from a Consultant’s Point of View”, Les Nouvelles No 6, 1971 • Licensor should receive 25% of the pre tax profits, and the licensee should receive 75% of the pre tax profits. • Principle is that a royalty should be 25% of an expected profit margin. • Rule used not just to value IP for licensing purposes, but used to assist in determining damages in infringement proceedings. • Rule formulated having regard to a study of numerous worldwide licenses negotiated over many years.

26. 25% RuleOperation • Relies on knowing the margin for an industry • If a margin is generally known or accepted, the 25% can work as a rule of thumb • Margin / Profits subject to interpretation

27. 25% RuleDiscounting for early stage • Assumes that the IP is market ready • Development costs are therefore not taken into account • Should licensee pay same royalty rate if IP is market ready / still requiring $100m of development / regulatory costs ?

28. 25% RuleHow reliable is it ? • A starting point, • A guide • Not an inflexible rule • Royalty Source database table – and new study of applicability of 25% Rule • “Use of the 25% Rule in Valuing IP Les Nouvelles December 2002 p 123

29. Decrease IP not market ready Further R&D Regulatory and compliance matters A highly competitive market High plant production costs High marketing costs Extraordinary capital expenditure that has to be incurred Volatile Margin Increase A robust patent position Access to ongoing know how and trade secrets R&D Program by licensor and prospect of improvements Marketing networks and leads Marketing assistance Proven track record 25% RuleA starting point • Once you have a starting point • What factors may suggest that the royalty should:

30. 25% RuleDon’t make that the royalty rate • Don’t make the royalty rate 25% of pre tax profits • The concept of profit is too easily capable of manipulation • Onerous to keep separate accounting records in relation to different products of a business • 25% is a rule of thumb, an approach • Ascertain the margin • Model the revenues and costs • Arrive at an amount that represents 25% of margin • Apply that as a percentage • Adjust upwards or downwards as the circumstances justify

31. Royalties responsive to development costs / risk • The more development costs a licensor has incurred, the greater return it seeks, the higher the royalty it requires • Put another Way: • The more risk a licensor has taken, the greater the return it seeks • The more development costs a licensee will incur, the lower the royalty it is prepared to pay • Put another Way: • The more risk that a licensee takes, the lower the royalty it is prepared to pay

32. Royalties responsive to development costs / risk • Research organisation licensors typically get a low royalty rate: • compared to the licensee, they take comparatively little risk, and pay comparatively little of the development cost • Research organisations may typically pay $500K to $1-2m in research • Pharma / multinational licensee will typically pay $25 m to $300 in • Further research costs • Development costs • Regulatory costs

33. Average financial terms in University Biotech Deals

34. Pathway to Market - Value

35. Pathway to Market - Risk

36. Royalties on Therapeutic Drugs .

37. Clinical Trials .

38. Variables impacting upon royalty rates • who pays development costs • a research organization perceived to be inexperienced will get a comparatively lower rate • a product with a small market will attract a small royalty rate (e.g. a rare disease) • product with lots of competing products (e.g. headache tablet) likely to attract a small royalty rate • product with a large market, and few competitors will attract a very high royalty rate

39. Structure of Milestone Payments

40. Pre-clinical Milestone Payments Source: Health Advances LLC Analyses of selected Recap reported deals

41. Royalty on Vaccines

42. Royalty on Diagnostic product

43. Royalty rate distribution

45. Royalty Source data

46. Sub-licensee will pay to Licensee Royalties on the sub- licensee’s own sales Milestone payments, etc Licensee pays a royalty to Licensor on all that income Up to 50% non pharma Pharma deals: 30% a good result 25% a poor/ fair result 20% a poor result 15% a very poor result . Royalty upon sub-license income received by licensee Licensor Licensee Sub-Licensee

47. Benchmarking Royalty Rates

48. Benchmarking • Nobody wants to get 3% when the benchmark is 10% • Nobody wants to put a deal at risk by demanding 8% when benchmark is 2% • Need to know what is the right royalty rates • Benchmarking or comparables • Something is worth X because something else that is similar to it achieved X in the market place • Challenge is whether it is truly comparable • No two technologies are identical • How similar / different are they ? • The greater the similarities the greater the reliance on the comparable deal • To benchmark need to source information about deals that concerns comparable IP

49. Sources of informationDatabases • Databases • www.recap.com • www.pharmaventures.com • www.knowledgexpress.com • www.royaltystat.com • www.royaltysource.com • Bioworld Today news archives on www.knowledgexpress.com • Recap: best biotech source – contains most deal making information • Pharmaventures – mostly press releases • Royalty stat and royalty source – broad cross section of industries – compiled from EDGAR • Knowledgexpress: Accesses pharmaventures and royaltysource

50. Sources of informationProfessional Reports • Professional reports • Intellectual Property Research Associates issues reports on royalty rates for all industries, - fragmented information • http://www.ipresearch.com/index.html US $995 US$250 US$1500