Fair Market Value Case Study – Not Your Typical Valuation

We’re often asked about the most interesting valuation issues we’ve encountered. This is difficult to answer because each valuation has unique intricacies and difficulties. While some share similarities, no two are identical. Still, a few stand out as presenting unique valuation issues. We recently worked on one such project.

Our client was the estate of the part owner of a technology company that held a number of patents. A valuation involving just the interests of the company holding the patents would be interesting in and of itself, but this project had a twist or two that made the valuation even more complex. There were some very large corporations that apparently infringed on some of the company’s patented technology in the production of widely used products. In fact, the alleged infringement was by some of the world’s largest corporations and involved many of their best-selling products.

As a result of the apparent patent infringement, and well before the co-owner’s death, the company owners collectively sold the patent rights to a firm that planned to pursue infringement litigation (known as a trolling firm) for a percentage of the future recoveries, less certain costs and expenses. At the date of death there was a beneficial interest held in a liquidating trust set up solely for the purpose of distributing litigation proceeds.

The trolling firm reached settlements with a number of the alleged infringers and won judgments from others. The awards and settlements were in the tens of millions of dollars, with a percentage of that amount distributed to the deceased, prior to her death. However, the firm recently lost a case on appeal and there was some doubt about whether new lawsuits would be pursued. The problem faced by the estate was that it had no control over any aspect of future lawsuits. In fact, neither the trolling firm nor its lawyers were cooperative or forthcoming with information for the estate.

Our job was to determine the fair market value of the estate’s interest in the liquidating trust at the date of death. Our analysis considered:

  • The universe of potential claims
  • Value of the entire market for the potentially infringing products
  • Market share of each of the infringing companies
  • Likely royalty rates the companies would have had to pay for use of patented technology
  • Probability and cost matrix related to future litigation

By segmenting the infringing companies, using their percentage market shares for each infringing product, and applying a royalty rate, we were able to predict potential future cash flows from all possible litigation. Next, we applied a binomial lattice-type analysis that uses a probability-weighted decision-tree for each possible outcome. That is, the outcomes of each possible occurrence were assigned probabilities based on market data. The final probability-weighted outcomes were totaled to produce probability-weighted cash flows. For example suppose there are two possible outcomes for a particular occurrence one of which was a loss (or zero recovery) and the other was a $10 million recovery. Also suppose our data indicated that the probability of a loss was 80%, meaning the probability of a recovery was 20%. The probability-weighted outcome would be $2.0MM [($0 x .80) + ($10MM x .20)].

Finally, we determined the present value of the probability-weighted cash flows that addressed all of the costs associated with achieving those cash flows. So, we in the above example if the costs of pursuing the litigation were $1MM, the expected cash flow to the liquidating trust would be $1MM (the $2 MM expected recovery, less the costs associated with pursuing the matter). The present value of the cash flow would take into account the timing of the outlays and the timing of the expected recovery, and would therefore reflect something less than the $1 MM overall expected cash flow.

The final result was the fair market value of an interest in the liquidating trust. The trust which has an economic interest in, but no control over or information about, a series of potential lawsuits related to possible infringement on patents, because the patent rights are held by a trolling firm which may, or may not, pursue future litigation. Yes, that’s a mouthful, but it sure made for an interesting set of facts and an interesting valuation project.

If you have comments or questions about this article, or would like more information on this subject matter, please contact us.
Daniel Kvarnberg

Valuation
dkvarnberg@pcecompanies.com
Orlando Area Office

407-621-2100 (main)
407-621-2132 (direct)
407-621-2199 (fax)