Based upon a Federal Circuit Court of Appeals ruling, damage experts can no longer rely on a "25% rule of thumb" to support a reasonable royalty rate. This 25% rule had been accepted by Courts in prior cases as an appropriate means to allocate value to the owner of the IP.
What is this "25% rule of thumb"? It is an arbitrary amount accepted by the courts for many years. This norm concluded that the royalty rate to be paid by the IP licensor should not exceed 25% of the licensor's operating profit. Most licenses of IP are based on some percentage of revenues or operating profits. The "rule" became lore, and an easy way to assess a license royalty rate. Our senior professionals were never bound by the "25% rule". Rather, we always research the market to determine an appropriate rate or range of rates.
The lessons learned from the Uniloc court decision follow:
- Regardless of whether an accounting firm blessed the 25% rule under SAS 73, a detailed analysis of the allocation in a litigation context is required.
- There is no one "rule of thumb" for all IP, no matter the industry, product and market share for the related IP.
- The "25% rule of thumb" is not a substitute for royalty rate searches of comparable IP (database), as well as discussions with licensing professionals. While relief from royalty is an accepted approach, a direct calculation of IP generated cash flows may evolve from an analysis of price premiums or cost savings available from use of the IP.
- Careful consideration of a relative profit split between a hypothetical licensee and licensor may provide insight into a reasonable royalty rate.
The Mentor Group has analyzed numerous licensing agreement and royalty rates for IP, within the context of a business and as standalone assets. Refinements to valuation assumptions are also produced by extensive use of Monte Carlo simulations.