Disruptive Tendencies

Skype - Joltid Licensing Dispute: Epic M&A Screw-up?

eBay must be ruing the day that it signed the M&A deal to buy Skype for $2.6b, in addition to an additional $530m as part of the earn-out provisions. Its original vision of incorporating Skype functionality into its auctions never happened. Despite that, Skype has proven itself to be quite interesting as a standalone entity, with some value potentially to be recouped via a spin-out IPO. However based on an eBay 10-Q form filed with the SEC on 7/30/2009, this is now at risk over a dispute over a license.

It seems that some of the core functionality within Skype is based on peer-to-peer software licensed from Joltid, a company also controlled by the founders of Skype, Niklas Zennstrom and Janus Friis. So if I get this right, Joltid entered into a non-arm’s length license with Skype (pre-acquisition), a company that Zennstrom and Friis also controlled. When eBay acquired Skype, it would have known that while it was “buying” Skype, it wasn’t buying Skype source code, it was licensing it from Joltid. Given the amount of money involved in the deal, and the fact that the principals were the same, insisting on a perpetual, fully paid up license, in some Field of Use (voice, IM and video applications) with rights to derivatives would seem to have been very do-able.

Instead, it appears that Zennstrom and Friis pocketed a boatload of eBay cash, and retained control of Skype’s destiny via a licensing agreement. Now with the M&A (and liquidity) at risk, eBay is now over a barrel. Negotiate and pay for that fully paid up license, re-write everything, or write it all off as the worst deal of the century. OK, maybe that’s overstating it, the Time Warner-AOL deal sucked pretty badly too.

I’ve been involved with transactions that have nearly fallen apart at the eleventh hour because of legacy tech transfer licenses. “What do you mean we’ll have to pay 4% royalties ad infinitum? We’re buying the company!” When it gets to this stage and a deal’s at risk, the original licensor has all of the leverage, and will often be “bought off”, at the expense of the shareholders, to make the issue go away so the deal can get done.

Having negotiated multiple technology transfer and M&A deals, I have learned that it is imperative to construct the tech transfer deal with M&A in mind. Exclusivity in a well-defined Field, rights to Derivative Works, Non-Assertion of IP rights, a built-in cap or royalty buy-out to convert to a license in perpetuity, are all essential. Of course, in a non-arm’s length licensing agreement, like that between Joltid and Skype, the license terms would have been very different, but in this case it is incumbent on the acquirer to recognise this and force the issue while they have the leverage.

In hindsight, many would agree, this acquisition missed the mark strategically, resulting in a $1.43b writedown. But it’s hard to fault big, bold plays with the potential to break new ground. I have a deep admiration for those involved in transactions like that. But a key takeaway is the tactical execution by eBay’s M&A team appears to have missed the inherent conflicts of interest and let slide the licensing agreement with Joltid. Now, with no leverage, it’s biting them hard. Caveat emptor!

That’s my .02!

Martin Suter

(martin.suter at iplicensing.net)

Nortel’s Devolution to Non-Practicing Entity?

As someone who once wore a Nortel employee badge, and who counts many ex-Nortel employees among friends and family, watching Nortel’s descent from the peak has been hard to watch. Those, with better visibility into the decision-making than I, will ultimately dissect all of the wrong turns. 

Financial mismanagement, ill-conceived M&A deals, and strategic missteps have, unfortunately, landed Nortel where it is today – in bankruptcy protection and actively divesting entire businesses; its enterprise business possibly to Avaya, its wireless business to Ericsson. But like the Black Knight in Monty Python’s “The Holy Grail”, they’re “not dead yet”, despite hacking off multiple limbs.

When Nokia Siemens Networks’ bid was announced for Nortel’s remaining wireless business (CDMA and LTE roadmap), the decision to exclude wireless-related patents was a very strong indicator of intent. Under the terms of the announced transaction, NSN received a license to Nortel wireless IP, while Nortel retained ownership of said IP. According to reports, the Ericsson deal construct is very similar, with ownership of Nortel patents remaining with Nortel.

Once NSN’s stalking horse bid was announced, others emerged as suitors for the wireless business, including most notably RIM and the eventual winner of the auction, Ericsson.

Why would RIM pursue Nortel’s wireless business at the 11^th hour? Is it because it aspires to get into the CDMA/LTE base station business? I’m guessing not. Could it be that RIM saw Nortel’s moves signaling a fundamental shift in its future business model? Rather than remaining in the messy business of actually producing and selling product, why not sell off the operating businesses for a bunch of cash, throw in non-exclusive licenses to Nortel’s IP, and re-emerge as Nortel, the Non-Practicing Entity (aka Patent Troll)?

Few companies have been as badly burned recently, by NPEs, as has RIM. With its $612.5m settlement with NTP, for what ultimately amounted to the assertion of just a couple of claims (the validity of which was being seriously challenged), and more recently, its settlement with Visto for $267.5m, I’m sure RIM can see a day when Nortel, the NPE, asserts claims against RIM’s LTE products, at a cost to RIM that makes its $1b pseudo-offer seem reasonable. No doubt this is why RIM is rumoured, already, to be pursuing licensing discussions with Nortel for LTE patents.

A key here is that Nortel, as an NPE, would no longer be constrained by the usual rules of engagement that make the assertion of claims, by practicing entities (PEs), so rare. As a going concern, and even with an impressive patent portfolio (reportedly 5,500 patents), it would be highly unlikely for Nortel to assert its patent position against its main competitors. A kind of détente exists with patent holders, who understand that an assertion here will bring a counter-assertion there. The worst fear of PEs, however, is the NPE (or Troll), for which this détente is irrelevant, and where the business model is uniquely about asserting and monetising IP rights.

So Ericsson gets a pass on LTE patent assertion by Nortel, a key US customer committed to LTE, and a team capable of enhancing the CDMA to LTE migration story. Not a bad deal for $1.13b. And while one is tempted to feel sorry for NSN, its original bid of $650m turned out to be woefully miscalculated. One can only guess at what losing the deal with Nortel will end up costing NSN; in legal costs, eventual royalties and market share. Conversely, Ericsson will have gained in all of these areas. Kudos to its management team for realising this.

So what of Nortel? Can it make the transition from multi-billion dollar equipment vendor to NPE/licensing company? There certainly are precedents, even in Nortel’s backyard. Wi-LAN and Mosaid are two companies that have gone done this path, each of which has developed IP licensing as a core competency. Keep an eye on key Wi-LAN or Mosaid employees. If they start to leave, perhaps it’ll be to take on the challenge of monetizing Nortel’s patent portfolio. And if I’m Jim Balsillie, I’d be super pissed.

That’s my .02!

Martin Suter

(martin.suter at iplicensing.net)

A Nine Inch Nail in the Recording Industry ’ s Coffin

I find it fascinating that many market disruptions are not technological, but rather business models enabled by technology. What happens when there are no barriers to entry? What happens in a world with no friction? What happens when customers can interact directly with sellers?

Dell shook up the PC industry by first selling direct to end-users. Google has gone from a Search engine to the dominant force in advertising, and along the way has figured out how to do "free" very well. eBay brought the garage sale to the world. And finally, recording artists are realising that there's money to be made selling direct to your fan base, without compromising your artistic integrity.

Nine Inch Nails just released a collection of 36 songs, called "Ghosts I-IV". MSNBC.com suggests that "2008 may go down in history as the beginning of the end for the recording industry." I beg to differ. It's been like watching death by 1000 cuts in slow motion. 2008 is hopefully the year where the final nail is hammered into the coffin, a nine inch nail.

Where did it all go wrong for the music industry?

Record companies are licensing companies. What is a "record deal", if not a license granting rights to an artist's intellectual property to a record company along with the rights to make or have made physical product, the rights to distribute and sell this IP in return for a royalty rate paid to the creator of the IP. For decades, they held the keys to the kingdom. Barriers to entry were high...Studio time, production and mixing equipment, analog master tapes were expensive, manufacturing, promotion to radio stations, and distribution channels...The studios had a wonderfully integrated system, but it was a closed system. The only way that an artist could get a record on somebody's turntable was to play within the system, by their rules.

Video may have killed the radio star, but digital is what killed record companies.

The shift from analog/vinyl to digital was the first nail in their coffin. Cheap, ubiquitous broadband was another nail. Napster got people used to downloading content and not having a physical instantiation of the music (i.e. a CD) and was another nail. MySpace and other social networking sites facilitated the viral promotion of artists; another nail. YouTube further helped them distribute music videos and concert footage; another nail (This one in MTV). Apple bundled GarageBand with the MAC, enabling anyone to produce decent quality music quickly and cheaply; yet another nail. iTunes and the iPod gave us a means of storing and cataloguing our music, eliminating the need for a home stereo system or physical form factors; another nail. iTunes gave us a means of purchasing music that no longer required a trip to the mall; the eighth nail in the coffin.

And in the past year, major artists like Radiohead and now Nine Inch Nails selling direct to their fans. Hopefully, the ninth and final nail.

In his book, The Long Tail, Chris Anderson articulates how in a world without friction (i.e. the Internet), even those with the most arcane tastes, can find something they want, growing the overall size of the market. He posits that there is more money to be made across the entire breadth of the market, as opposed to a narrow, deep market as the music industry used to be.

The music industry isn't dead, record companies and MTV are.

But have we, as consumers, ended up winning or losing in this deal? I would suggest that we've won big-time.

Trent Reznor, from NIN comments on Ghosts I-IV: "The end result is a wildly varied body of music that we're able to present to the world in ways the confines of a major record label would never have allowed..."

The probability of my selecting a Nine Inch Nails CD and paying $15.95 to see whether I liked it or not would have been pretty small. Or Radiohead for that matter.

But give me a chance to experience and experiment with new tastes in a low-risk way, and I'm all over it. Does it get any better?

That's my .02!

Martin Suter

(martin.suter@iplicensing.net)

Incubating Licensing Concepts in Business School

Allen Kupetz, Executive-in-Residence, Crummer Graduate School of Business at Rollins College, is the kind of professor that was exceedingly rare when I was in university. Allen wants his MBA students to gain a deeper appreciation for the “real” business world, and is not shy about bringing in local subject matter experts to share their insights with his class. I’m very fortunate to be Allen’s “go-to” guy on the topic of licensing.

Tomorrow, I have the opportunity to speak with his “Technology Entrepreneurship” class about IP Licensing, both as a catalyst to start a company as well as a means of commercializing early-stage technology. If they’re like me, there’s little chance that they’ll be filing patents on their own inventions, so I’m hopeful that introducing them to sources of IP and describing what it takes to get a deal done will be interesting. My goal for the talk is to expose them to the world of licensing, as a means of harnessing their entrepreneurial aspirations…stuff that you’ll never find in a textbook.

The academic world needs more guys like Allen and fewer textbooks.

That’s my .02!

Martin

(martin.suter@iplicensing.net)

The Battle Over Purple Play-Doh

One of the most contentious areas in licensing negotiations is in the area of ownership of derivative IP. The most effective articulation of the issue that I have seen was by Jill Riola, a highly capable licensing attorney working at Akerman Senterfitt in Orlando. During negotiations with a team of attorneys from a Fortune 500 firm that was licensing our IP, she brought it back to first principles:

·         We own our IP (blue Play-Doh)

·         You own your IP (red Play-Doh)

·         We are granting you the right to create purple Play-Doh, using our blue in combination with your red

·         But you do not own purple Play-Doh, because by definition, purple must contain some blue.

Furthermore, when viewed this way, all of the terms contained within the licensing agreement, including restrictions on Field of Use, royalty rates, etc., apply for all shades of purple Play-Doh.

We could get down in the weeds and occasionally lose sight of the issue, so it was amusing to watch how Jill would bring it back to first principles. “If it’s blue Play-Doh it’s ours…You own all of the red you can develop, but if it’s purple, you don’t own it, and you owe us if you sell any.”

Agree on who owns what Play-Doh upfront, and the specifics of the agreement will be much easier to draft later.

That’s my .02!

Martin

(martin.suter@iplicensing.net)

Play-Doh is a registered trademark of Hasbro, Inc. Its use herein is strictly to illustrate a legal concept. No endorsement by Hasbro is expressed or implied.

 

Conflicting Goals in Asymmetrical Deals: Market Exclusivity

How many people have considered that Microsoft is, at its core, a licensing company? And the licensing deal that essentially created the entire industry was the non-exclusive license to IBM for DOS in the 80’s. How different a company would Microsoft have been had they signed an exclusive licensing deal? Chances are that it wouldn’t still be around. Bill Gates certainly wouldn't have become the richest guy in the world. As a licensing guy, I can only speculate on whether it was IBM's negotiating naivete or Microsoft's chutzpah that led to the deal being structured as it was.

Having sat on both sides of the table on various occasions, I have frequently found myself in a position where I’ve been able to help get to consensus because I understand where the conflicts may be and have been able to work through them.

Licensees almost always contend that they require some form of market exclusivity for competitive advantage. “Why would I sign a deal with you today if, tomorrow, my competitors can do the same thing?”

Licensors are thinking the exact opposite, “I can’t put all my eggs in one basket? I want to capture as much of the market opportunity as is possible, not be limited to a fraction of it.”

Perhaps even more importantly, what is the impact on the company’s potential for a liquidity event for its investors? Remember, once you’ve granted exclusive rights to a 3^rd-party, that prevents not only you, but any acquiring company, from pursuing that space. This may take a whole category of company off the list of potential acquirers at a later date. Try explaining that one to your investors!

So how do you reconcile these two positions?

The “need” for market exclusivity can often be a catalyst for M&A discussions, especially if the technology being licensed is the core franchise around which you’ve begun to build the company, or if the breadth of market exclusivity on the table prevents you from extracting value in other markets. But once again, these can be tricky waters to navigate. A technology acquisition requires you to consider valuation through a very realistic lens. The acquiring company will do an estimated build cost (# of person years x fully loaded cost per person year, around $200K per), and then offer a multiple based on their assessment of the value of time-to-market and your IP position, typically 3X-7X. As the inventor/entrepreneur, you need to be very realistic about their ability to get close enough to replicating that which you’ve built. Pride can get in the way, but do you really believe that Microsoft/Qualcomm/Oracle/Cisco engineers couldn’t do it?

If M&A discussions aren’t an option, then, in most cases, non-exclusivity should be the preferred path. One of the things, that the licensee doesn’t want to happen, is to invest its time and resources creating demand for a key feature, only to have a competitor come in and erode their margins selling the same widget at a reduced cost. A concession, that can help address this, is a form of price protection. In this type of clause, the licensor will agree to not license for license in comparable deals. The concept of comparability is key here. The consideration must be for similar product types, in similar quantities over a similar time period. If a subsequent licensee is pays a lesser royalty rate (or other form of consideration), a reduction in royalty rate will be accorded to the original licensee as well.

So, you’ve now heard that M&A is not an option at this time and non-exclusive rights aren’t either. Under what conditions can exclusivity make sense? My answer is twofold: Money solves a lot of problems, and that it is possible to tightly constrain the scope of a license, thus preserving your ability to license to others or for an acquiring company to practice in any field but the restricted field for which you’ve granted exclusivity.

How do you constrain the license grants? By placing boxes around the grants…I’ll explain more next time.

That’s my .02!

Martin Suter

(martin.suter@iplicensing.net)

Licensing – Gut Check Time!

So you’re now thinking that licensing makes sense as a means of accelerating the time-to-market and monetizing your leading-edge technology. You’ve identified the gorilla as well as the chimps in your space, and managed to get the attention of at least one of them. They’ve probably begun posturing and now they’re coming to the table to discuss terms. For most companies, this is a classic “Oh shit!” moment.

As I blogged previously, before you agree to sit down, it is imperative that you have established clear guiding principles. Your internal stakeholders must understand, talk through and agree to a position on the major issues. These are the “non-negotiables”, and can help prevent bad decisions from being made in the heat of a negotiation. Each of these must be taken seriously, as getting them wrong can have a huge impact on valuation and even exit potential.

Issues to lose sleep over

·         Exclusivity vs. non-exclusivity

·         Derivative works

·         Field of Use, Territory

·         Indemnification

·         Consideration (cash flow, NPV, etc.)

Each of these merits its own discussion. As my plane is now on final approach, I’ll have to get to these in future blogs.

That’s my .02!

Martin Suter

(martin.suter@iplicensing,net)

Before Taking the Plunge, Consider the Big Three

If I had to impart any words of advice to a company that is seriously looking at licensing as a go-to-market model, it would be the following three things:

1.       Understand all of the implications of a licensing strategy, including its impact on valuation and potential liquidity events for the shareholders;

2.       Develop guiding principles outside of the deal;

3.       Assess every deal through a strategic filter.

The first of these is critically important and requires the full buy-in from the Board and investors. Don’t assume that they automatically appreciate what these are. Licensing has implications for valuation and exit potential, and while the benefits are many (focuses scarce resources on core technology development, time to market, leverages existing channels to market, non-dilutative cash inflow, etc.), the risks are also real. But many of these risks can be partially or wholly mitigated by a rational approach to the deal, and it is incumbent on you to show them how.

Which leads us to the second imperative: Develop guiding principles outside of the deal. Get the Board to sign off on these and empower you to negotiate the deal within the deal framework that’s been discussed. The last thing you want is the Board “helping” you to negotiate a deal in real-time or proffering opinions at the eleventh hour. Given the implications of a bad deal, there are certain things that will not be negotiable. These may be dealbreakers, but it’s far better to know going in where you have the support of the Board and often, this makes for easier negotiations. At worst, you can cut bait.

Lastly, every deal should be looked at in a strategic context. Does it make sense to grant any rights, even non-exclusive, in the Field of Use that is likely going to be the driver for a liquidity event? Granting rights in niche markets is very different than granting rights in a core market.

In future blogs, I’ll discuss some of the issues that are worth losing sleep over.

That’s my .02!

Martin

(martin.suter@iplicensing.net)

In Dealmaking, Patience is a Virtue

The corporate DNA in most large companies is such that getting to signed paper can often be a lengthy business development process. Early stage companies have agility built into their DNA. Reconciling these two extremes can be extremely challenging. The pay-off can be significant, and as I previously blogged, may help to bring in money to the company at key inflection points in a company’s development.

Two deals that I have been involved with highlight both ends of this spectrum. In 2000, I negotiated a deal with Microsoft for Netware to Active Directory migration tools. Notwithstanding the 2+ years building relationships, creating mindshare and credibility internally, once the decision was made to ship “their own” tools, it took a matter of weeks to get to signature. Obviously, this deal didn’t come out of the blue, as the groundwork we had been laying was critical, but the deal itself was virtually frictionless.

The second is probably more representative of what it takes to get a deal done. While at MeshNetworks  I began the dance with Motorola in Feb. 2003. Mesh had done a good job of building visibility and mindshare as a company with an emerging, potentially disruptive technology. Motorola Ventures, its internal VC group, identified Mesh as “interesting” from an investment and potentially from a strategic perspective. What began as a nominal equity investment with an optional second tranche in the mid-seven figure range, slowly began heating up.

In March, we began a technical due diligence and validation process with Motorola’s emerging technology group, which was a great thing, as they floated above the product groups that are nose down trying to get existing products out the door. Supporting this effort consumed hundreds of person hours, in addition to travel costs. Throughout this process, we needed to continually justify to ourselves, to our Board and investors that this was worth doing.

By summer, we had come through most of the technical evaluations and began to push for a commercial discussion. Some posturing around deal terms began, which required a real gut-check to convince ourselves that this remained worth doing. In late September, we got down to more substantive discussions and by late November, had a non-binding MOU. Getting from there to signature took a further 4 ½ months of page turns in rooms full of Motorola Legal and business folks, but finally on April 9, 2004 we had a deal.

This process brought us much closer to Motorola, during which time they had an in-depth look at us. It also gave us the chance to better understand how Motorola was structured, and more importantly, where there was strategic alignment across the portfolio. On December 21, 2004, 750 days after we began to dance and nine months after the licensing deal, we closed an M&A deal with Motorola.

Was it worth it? Absolutely.

That’s my .02!

Martin

(martin.suter@iplicensing.net)

Asymmetrical Licensing as a Go-to-Market Strategy

In my last blog, I described some of the real challenges facing start-ups that need to get a technology to market. Of course, there are categories of companies for which the front-end load of R&D costs to productise is lower (e.g. software vs. hardware), however the challenges of funding the commercialization of a product are relatively common across all categories.

Frequently, a start-up may attract seed funding on the basis of the team, an idea, and a vague view of some massive, future market opportunity. For this, the founders give up a big chunk of the company, and embark on delivering a proof-of-concept. This critical milestone is typically the trigger mechanism for another round of funding designed to get the company closer to product and customer traction. Ideally, this proof-of-concept is leveraged into customer/partner/market interest, with sufficient “buzz” to secure enough money at a reasonable valuation, so the founders and the seed guys aren’t crushed.

The problem, is the disconnect between where the company’s really at in the eyes of new investors (“So you've got no product, no customers, limited market proof points...but we DO like you”), and the eyes of the company and the seed guys (“Hey, this stuff really works. You should be blown away by the technical accomplishment”).

So, therein lays a challenge. Facing massive dilution from new investors, likely alongside liquidation prefs, other onerous terms and a promise to hold additional funds in reserve to ensure later financing is available, the early stage guys and the founders face a difficult decision. Lose control of the company to later stage investors in order to get to revenues or...What other options do they have?

An important option that remains, IMO, largely misunderstood, is the licensing of technology to an 800 lb gorilla as a non-dilutative means of generating revenues and helping you to monetize your technology. Frequently, their strengths are your weaknesses: money, customers, sales coverage (direct and channel), manufacturing/supply chain relationships, global support, brand, etc. Trying to displace an 800 lb gorilla that is intent on maintaining market share on your own, is like me trying to budge a sumo wrestler. It ain’t gonna happen.

However, if you think about what you bring to the table when viewed thru the eyes of the big guys: innovation, agility, de-risking of technology development, competitive advantage and time-to-market, all of which are worth something to the right partner. Their motives may be offensive (moving into a new market with a disruptive technology to displace an incumbent), or defensive (preserving dominant status in beachhead markets with next generation technology). In either case, knowing where the hot buttons are will be key to getting to the negotiating table.

Structured correctly and presented with conviction, technology licensing can be a means to generate early revenues, get market traction and acceptance without requiring a massive shareholder dilution post-proof-of-concept.

What do these deals look like? What are the issues? Stay tuned…I’ll get to that soon.

That’s my .02!

Martin Suter

(martin.suter@iplicensing.net)