How do you put a price on an invention?

July 1, 1999
A telecommunications giant is interested in purchasing my invention, which is at a stage still requiring proof of concept. Shouldn`t the valuation be around $4 million, given that seed-stage funding is typically $1 million for 20%-25% of the company?
1304qa Chang New

Question:

A telecommunications giant is interested in purchasing my invention, which is at a stage still requiring proof of concept. Shouldn`t the valuation be around $4 million, given that seed-stage funding is typically $1 million for 20%-25% of the company?

Answer:

You have a very creative way of looking at it, resulting in what I consider a very aggressive number. Given the high valuation Wall Street places on telecom-related companies, I suppose anything is possible.

Your situation is comparable to granting an exclusive license. Recently, the most frequently quoted example in our industry is a nonexclusive license for fiber gratings, which sets a low six-figure fee up front, plus a small royalty based on sales. One could reasonably argue that an exclusive license should be worth several times that.

Another method is to consider the economic value to the buyer. The consideration can be based on the market size of your invention, or it can be based on how many more high-value systems could be sold due to the competitive advantage provided by your device. One can also look at the costs, either for the company to come up with this invention or for the inventor to develop the concept. Because innovation is a random process, these methods are not really applicable.

At the end of the day, a fair price is what the buyer and seller can agree upon. My advice is to be reasonable and proceed quickly so you don`t miss the market window. After all, very few inventions are so fundamental that people couldn`t work around them.

Question:

What is the current funding situation for start-up companies?

Answer:

Here`s what I`ve learned about this at a recent investor meeting organized by a big Silicon Valley VC firm. Investments continue to pour into traditional VC funds at an ever-increasing rate. VC firms are competing with each other instead of sharing deals and are often offering more money than what is being asked for to get a higher percentage of ownership. There were 700 VC-backed deals reported last year, and it`s estimated that 4-5 times that number were backed by individual investors (angels). Established high-tech companies are also competing in the same arena, starting their own VC funds and forming spin-off companies. Photonics is hot, but biotechnology is not, and the Internet is going to be a disaster. The quality of business plans and presentation skills are up, making evaluation by investors more difficult.

My own observations are consistent with this view. Raising money is a very binary process. An amateur won`t be able to get past the receptionist at a VC firm, and yet VCs are willing to throw money at you if you have a good business plan with a viable business model. This feeding frenzy in the photonics field, as in the Internet industry, has also resulted in many half-baked ideas getting funded by inexperienced angels and third-tier VCs. We can expect many failures in our industry a couple of years down the road.

Question:

My professor and I share a patented invention. We have very different ideas about starting a company. What are our options?

Answer:

You can either start a single company or compete. For the first option, you can come to an agreement and let one of you be the leader or hire a CEO and let that person have the final say in any decision. A single company is the better option if both of you want to maintain the professor-student relationship. You`ll have to hire an outsider to be the CEO if both of you have strong personalities or do not have confidence in each other`s judgment. Hiring a CEO is obviously a compromise, but this is better than becoming enemies and competing with your professor. If you do decide to form separate companies but still value the relationship, the two companies can be consciously structured to address different market segments. With a common core technology, you may even be able to find the synergy to form a strategic alliance. An example of that is the case of the son of the Haagen Dazs founder, who started a company selling ice cream to a different clientele. For sure, you want to maintain an open dialog to avoid second-guessing and distrust.

Question:

I changed my mind about joining a company three weeks after I accepted an offer. How should I handle this?

Answer:

People make honest mistakes. You should make a final decision and inform the company promptly so they can fill the vacancy. As a good-will gesture, you may want to provide some honest feedback about the reasons for your decision. Looking at the positive side, it would have been a lot worse for you to discover the incompatibility three months after joining the company.

About the Author

Milton Chang

MILTON CHANG of Incubic Management was president of Newport and New Focus. He is currently director of mBio Diagnostics and Aurrion; a trustee of Caltech; a member of the SEC Advisory Committee on Small and Emerging Companies; and serves on advisory boards and mentors entrepreneurs. Chang is a Fellow of IEEE, OSA, and LIA. Direct your business, management, and career questions to him at [email protected], and check out his book Toward Entrepreneurship at www.miltonchang.com.

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