IP licensing: how to structure a good deal

Purpose of the study: How to best structure an IP licensing agreement taking account of embedded optionalities and other terms negotiated between licensor and licensee via a case study involving a prototypical options-based business model (biotech industry).

Methodology: Binomial lattice simulation.

Findings: It shows how IP management practices would change depending on who pays for the development costs, controls the continuation/development or abandonment option and thereby appropriates most of the embedded options value. It presents alternative (iso-value) menu licensing term choices (different combinations of royalty vs. fixed upfront fee or milestone payments) that are fair and optimal in properly accounting for the optionality embedded in R&D development and related licensing structures.

Research limits: An extension of our study lies in the collection of a dataset of remuneration structures of (market-based) licensing transactions in the biotech-pharmaceutical industry so as to empirically validate our pricing technique.

Practical implications: Real options thinking leads to different perspectives on how patent licensing agreements should be structured properly accounting for which party controls the embedded optionality.

Originality of the paper: It proposes a comprehensive real options approach to:

(a) appraise the IP asset capturing the value of optionality embedded in the underlying drug R&D program;

(b) consider licensor and licensee perspectives in negotiating the terms of the IP licensing agreement, providing guidelines on how to determine its optimal remuneration structure reflecting a fair sharing of project value and embedded optionality among the parties;

(c) offer a tool for IP portfolio management that helps a licensor prioritize internal R&D projects accounting for managerial flexibility and optimal licensing design under uncertainty.

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