Foresight Valuation Group

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Trade Secret Damages Expert Blog: Flexible Approach Gone Wrong

Posted on Modified on by Lynn Dudinsky

This is the third blog in our series on trade secrets and the methodologies utilized in calculating trade secret misappropriation damages. In the previous blog, we discussed the Wellogix, Inc. v. Accenture, L.L.P. case where the flexible approach to trade secret damages calculations was utilized by the expert to determine compensatory damages based on the investment value of Wellogix. In this blog, we are reviewing the Waymo, LLC, v. Uber Technologies, Inc. case which provides a cautionary tale of what can happen when a expert does not align his or her opinion with the requirements of the flexible approach to trade secret damages.

In this case, Waymo filed suit against Uber after a former manager of Waymo’s self-driving car project allegedly misappropriated Waymo’s trade secrets in the creation of his new company, Otto, which was quickly acquired by Uber for nearly $700 million to further the development of Uber’s self-driving car initiatives. Waymo’s complaint alleged a number of causes of action, including the violation of Defense of Trade Secret Act against Uber. The facts of this case have been widely publicized given the companies involved and the $2.7 billion in damages requested by Waymo. Rather than restating the facts and procedural background of this case, this blog is focused on the damages methodology and how the failure to adhere to the principles described in the previous blogs led the Judge to exclude the damages expert’s testimony and opinion.

The information contained in this blog is derived from United States District Judge Willian Alsup’s November 2, 2017 order following Uber’s motion to exclude Waymo’s damages expert and to exclude evidence of financial information presented by the expert, which was granted in part and denied in part. Judge Alsup’s order included an analysis of the following factors that must be present for a witness to testify: (a) the expert’s scientific, technical, or other specialized knowledge will help the trier of fact to understand the evidence or to determine a fact in issue; (b) the testimony is based on sufficient facts or data; (c) the testimony is the product of reliable principles and methods; and (d) the expert has reliably applied the principles and methods to the facts of the case.

As discussed in the previous blogs in this series, the courts, especially in trade secret cases, have recognized that the various forms of damages in misappropriation cases necessitate the use of a flexible approach to calculating damages for claims of misappropriate of trade secrets. However, the flexible approach to calculating damages does not require the court to ignore the factors described by Judge Alsup that must be present for an expert witness to testify. In this case, Judge Alsup concluded that the expert’s opinions must be excluded because they do not qualify as expert testimony and because they are substantially more prejudicial than probative. The following discussion focuses on Judge Alsup’s opinion regarding what factors were not met by the expert and why the failure to meet these factors could not be overcome by reliance on the flexible approach.

The first factor outlined by Judge Alsup is the requirement that the expert’s scientific, technical, or other specialized knowledge will help the trier of fact to understand the evidence or to determine a fact in issue. Regarding this factor, Judge Alsup stated that the evidence relied upon by Waymo’s damages expert “can speak for itself, and his only contribution would be to pile on a misleading façade of expertise.” This conclusion is based on Judge Alsup’s belief that the expert “essentially parroted” the opinion of another Waymo expert and “applied no ‘specialized knowledge’ by simply multiplying” the time savings opinion of the other expert by a dollar figure pulled from an internal Uber presentation. The failure to meet the requirement of specialized knowledge to assist the trier of fact is summarized by Judge Alsup when he stated that “[s]traighforward application of grade-school arithmetic to uncomplicated numbers is well within the ken of the average juror.” Due to the lack of specialized knowledge utilized by the expert, Judge Alsup believed that the expert’s analysis was “nothing more than lawyer argument dressed up as expert opinion” and therefore ruled that the expert’s opinion should be excluded due to “its danger of confusing the issues, misleading the jury, and causing unfair prejudice.”

Judge Alsup also highlighted the requirement that the expert’s testimony is based on sufficient facts and the product of reliable principle and methods. This requirement was not met, according to Judge Alsup’s order, on multiple occasions when the expert relied upon the full value of an acquisition to opine on the value of one or more misappropriated trade secrets. Judge Alsup noted that the expert agreed that the full value of these acquisitions included a number of benefits outside of the trade secret, such as employees, tangible property, and certain legitimate forms of intellectual property. However, the application of the full value of the acquisition to a single trade secret was described by Judge Alsup as “absurd” since the expert “did no work whatsoever to account for the value of those legitimate benefits.” This approach of using the full value to determine damages was discussed in the previous blog where we highlighted the efforts of the expert in the Wellogix case to overcome any argument that the selected methodology was the least speculative and could be relied upon by the jury. The failure by Waymo’s expert to conduct a similar analysis led Judge Alsup to exclude his testimony.

CPA Global: IP in IPO Webinar: Q&A Answers

Posted on Modified on by Efrat Kasznik

In our recent webinar: “IP in IPO: IP Valuation Lessons from Recent public Exits”, hosted by CPA Global, we discussed the role that IP plays in startup valuations, and the types of IP assets that were created by startups who recently went public. This webinar features a study we have been conducting and updating since 2015, which covers Unicorns (startups with valuations exceeding $1 Billion) and their IP positions.  Since some of the Unicorns went public in 2018-2019, we continue to explore what types of IP issues frequently emerge pre-IPO, and how are companies dealing with them, and what impact- if any – does IP have on Unicorn valuations. We recommend listening to the webinar first before reading this blog, which documents our responses to the Q&A session following the webinar.

Q: How has the new court application of 35 USC Section 101 (e.g., Alice Corp) against software patents impacted software-focused IPOs?

A: The Alice decision (and ensuing Supreme Court decisions and PTAB developments) have created a lot of confusion and uncertainty in the market with regards to subject matter eligibility and the overall validity of patents covering software inventions.  That being said, the correlation between these developments and software company IPOs is not an easy one to draw.  For once, as my webinar demonstrated, many of the Unicorns going public (all of which are in the general Software area) have managed to grow their valuations into the billions of dollars without having patents.  Whatever the reason may be for the lack of patents (one might argue Alice has something to do with it, others might argue different reasons), these companies could grow significantly without patents, and some of them even managed to exit in a successful IPO without increasing this patent portfolio proportionally to the increase in their valuation.  So I would argue that the Alice decision had nothing to do with Software company IPOs.

Q: Do you have any suggestions for how to prepare or develop a patent portfolio so that it will have a higher valuation, and hence contribute more as a business asset?

A: As I explained in my webinar, there are legal sides to a company’s patenting strategy, and there are business sides to that same strategy.  The legal side is best handled by lawyers, they can search and determine where patent protection should be pursued based on prior art and the patent landscape in the market.  From a business/valuation perspective, a patent portfolio will have value if it is well-aligned with the assets that bring the most value to the business.  In companies where Technology is the most valuable asset (usually correlated with heavy investment in R&D, like pharma and biotech) patents can have more value compared to companies where Brand is the main asset (consumer products, as an example).  Also, in companies where Trade Secrets are deemed to be the best mode of protection, patents can have less value compared to companies where a patent is the preferred mode of protection.  Once it has been determined that it makes sense to invest in creating a patent portfolio as a way to increase the value of the company, the key is to have a good combination of offensive and defensive goals, geographical distribution, technology coverage, etc.

Q: Do you have any suggestions or advice for unicorn startup companies that may have a relatively high number of active patent assets for its valuation?

A: I would argue that you need to worry about having “too many” assets at a later stage in your lifecycle.  While a Unicorn could theoretically sell or divest of its IP assets, it is not recommended to do that particularly in the pre-exit stage.  A Unicorn (particularly pre-exit) is still in a building mode.  There may be industries the company would like to enter in the future, where the patents could benefit them in leveraging freedom to operate with incumbents/competitors.  Additionally, if they haven’t exited yet, a patent portfolio can be much more valuable to a potential buyer than it is to the Unicorn, so there is no downside to having more patents as the company is still figuring out its exit strategy.  The only downside to having more patents is having to pay maintenance fees, plus incurring additional prosecution costs to grow the portfolio.  However, as that should not be a financial hurdle for most Unicorns, I would recommend Unicorns (pre-exit and even post-exit) to hang on to their patents!

Q: For Unicorns, have you looked at timeframe of litigation data? do unicorns acquire inorganic assets?  Is there a timeframe when NPEs approach unicorns? (Pre-IPO? Etc)

 A: The studies presented in the webinar did not specifically look at litigation, or any other reason for buying.  The only tracking we did was for the timeline and the time leading to the IPO exit event.  Unicorns buy patents for a variety of reasons, and I am sure that litigation-related reasons (either litigation avoidance, or freedom to operate, or counter-suing in a pending litigation) play a role in those decisions.  What I find as a general observation (I don’t have empirical proof of that) is that often times patent acquisitions are highly correlated with the people running the patent function at an organization.  Particularly when you see changes in strategy, such as a buying program put in place (see Uber as an example) it’s usually driven by new leadership put in place to manage the patent portfolio creation activities, and they come from a place with higher awareness to the strategic advantages of patents.
As far as your second question about when NPEs are approaching Unicorns, anecdotal evidence indicates that t is usually done at a time when the Unicorn  – or any other startup for that matter – has crossed a critical mass of revenues and users (“crossing the chasm” is the phrase most commonly used to describe that phase in a startup’s lifecycle) and is at a vulnerable point that could be leveraged to reach a resolution that is more favorable for the NPEs.  In that regard, it is not different from any other litigation strategy, and the fact that there’s a unicorn involved that has no patents does not really create a disadvantage with an NPE, because NPEs cannot be countersued anyways so having your own patents does not help defend against an NPE.

Q: You mentioned that IP evaluation may not correlate with company’s value but is there anything you can do to fill in this gap?

 A: What I said with regards to IP valuation is that there is no place on the financial statements of a company where you can find the value of its internally-generated IP assets.  The accounting rules in the US and around the world don’t require companies to value their IP on the balance sheet.  The “Gap” I was referring to is a reporting gap.  There are ways to fill in the gap, but they all involve engaging in a special valuation of the IP assets of the company.  This IP valuation is not going to be part of any business valuation because business valuations are not targeted at valuing assets separately.  In order for the IP valuation to be informative and realistic, the valuation itself needs to be preceded by a careful assessment of the assets, followed by a strategy phase, where the valuation firm is working with management to identify the possible monetization scenarios to be included in the valuation.

Q: Is the later acquisition of patents a result of actual need for additional IP? or is it driven by third-party patent holders going after deep pockets and a way to avoid lawsuits? 

A: A later acquisition of patent (a phenomenon I was referring to as  “backfilling”) takes place usually as a result of a threat or perceived threat to the company’s freedom to operate (FTO).  The kind of patents that you buy, as opposed to filing organically, are those that are available in the secondary market and those usually have value since there is some infringement associated with them.  The actual need to IP to support current products is usually met by internal filing and sometimes through an acquisition of an operating business (not a patent acquisition, but a business acquisition).

Q: Is there a traditional patent valuation methodology (cost, market, etc.) you prefer for startups, and why?

A: The valuation method selection is secondary in importance to the valuation context and scenario.  First there needs to be a determination whether the startup has created enough IP to warrant a separate valuation.  Something of value needs to have been created or accumulated (think along the lines of the slide showing the three types of assets: technology, data and brand) and/or some IP protection needs to have been developed around these assets.  The next question is what is the business model of the startup, and what IP assets bring the most value in that context.  Then comes the question of how the Ip assets bring value to the startup, which would prescribe the valuation scenario.  And only after all of that has been determined, comes the question of the valuation method.  The method really depends on the data available, and I have applied all three of these based on the circumstances.

Q: How do you distinguish between the value high quality patents (those of key importance to the business) vs. other patents in looking at financials? The high quality patents can be worth far more than the rest of the portfolio.

The process that I described in the webinar for arriving at a Price per Active Asset is a process of normalization, so two companies can be compared to one another.  In order for this comparison to be meaningful, the normalization process needs to be uniform across the board.  So for every company, we divided their equity value by the number of active US assets (pending and issued).  Underneath this is an assumption that patent portfolios have a certain distribution and that this distribution is the same in most companies.  There’s no practical or subjective way to rank the asset in a portfolio without getting into months of analysis for each company, so for purposes of an industry-wide data analysis the normalization that we did is the easiest way to get to a point of comparability between companies.

Q: Have you looked at unicorn patent strategy by jurisdiction? Do you have any recommendation on how they should strategize internationally?

A: We have not really done that since we only looked at US assets and only checked for US Unicorns (which tend to have a majority of their assets be US assets).  There are not that many non-US Unicorns, and if there are then I would guess that China may be the next country of origin for Unicorns, and I would also venture to think that China-based Unicorns are also going to have the majority of their assets as US assets (this is just a guess, I haven’t checked the data).  I would not expect to find much difference between jurisdictions because the patenting patterns that I pointed out are ore a function of the industry (Software) then a function of geography.  I don’t really have any recommendations for foreign filings for Unicorn companies that would be any different from the generally recommended best practices for foreign filings for other companies.

Q: To what extent does a valuation of one or more patents equate to their capability to capture a significant share of a significant market over any other IP solution?

If I understand the question correctly, you want to know the marginal contribution of one additional patent to increasing market share, as opposed to any other type of IP protection.  I am not sure I can answer this question as stated, because the main point I was trying to make in the webinar was that for Software companies there is no observed correlation between having patents and having a large market share, or a large valuation.  The value that patents can bring to a Software company is not directly measured by market share (a you can more easily do in pharma or biotech companies, for example).  You need to look for the value in their strategic positioning, that is not always evident in market share, like: having an improved bargianing position vis-à-vis its competitors, reducing risk to their freedom to operate, etc.  As far as other types of IP protection, I would argue that a strong Brand can actually translate into higher market share in software companies, and a brand is protected by Trademarks and Copyrights, not so much by patents.  The other one that can increase market share is Data, which again is not protected by patents.

Q: Is there a minimum valuation for a small company to be able to go public? What (minimum) revenue range is considered acceptable?

A: Not really, as you can see if you look at some of the Life Sciences IPOs which are very small, and are often still in R&D stages.  As far as software companies, which were the focus of my talk, companies tend to stay private much longer than they used to, so it’s often the problem that companies due to go public but are trying to avoid it, for various reasons.  Keep in mind that, as venture-backed startups, companies have pressure from VC investors to get to an exit event at a certain value, so there is that pressure on the one hand.  Companies tend to go public when they would like to get access to funds through the capital markets, as they have exhausted their private funding options.  It’s usually a leverage for additional growth.  Finally,  the SEC have their own rules as to the safety and stability of the company, and regardless of their size or revenue, the SEC will do their own diligence and often times ask companies to restate their earnings as a condition to listing in a stock exchange.

Q: are patents still important today when majority of assets are data and trade secrets? and when most startups are concerned with being first in the market, etc.?

A: The answer varies by industry.  For Software companies there is no observed correlation between having patents and having a large market share, or a large valuation.  The underlying assets that bring value, such as Brand or Data, are often not subject to patent protection and are better protected by other types of IP.  A strong Brand can actually translate into higher market share in software companies, and a brand is protected by Trademarks and Copyrights, not so much by patents.  The other one that can increase market share is Data, which again is not protected by patents.

Trade Secret Damages Expert Blog: The Investment Value Approach to Damages Calculation

Posted on Modified on by Lynn Dudinsky

This is the second blog in our series on trade secrets and the methodologies utilized in calculating trade secret misappropriation damages. In the previous blog, we discussed the DSC Communications v. Next Level Communications case which provided an example of the flexible approach to the calculation of trade secret damages. In the DSC Communications case, the court awarded DSC damages based on the entire acquisition price of Next Level as it was the “least speculative method of deriving the value of the alleged trade secrets.” In this second blog of the series, we are reviewing the Wellogix, Inc. v. Accenture, L.L.P. case where the flexible approach to trade secret damages calculations is once again referred to by the United States Court of Appeals in their review of the lower court’s decision to award damages based on the investment value of the company.

Wellogix, Inc. (Wellogix) was the Plaintiff suing Accenture and SAP for alleged misappropriation of Wellogix’s trade secrets. Wellogix was the developer of software for the oil and gas industry that modernized the process by which oil companies estimated the costs related to the construction of oil wells, known as complex services. Wellogix was the only company offering complex services software at the time; however, the software was not a standalone solution and required 3rd party software to perform accounting functions. Due to this requirement, Wellogix entered into an agreement with SAP to integrate Wellogix’s complex services software with SAP’s accounting software and in the process, Wellogix provided SAP with its source code. Wellogix also entered into a number of agreements with consulting firms, including Accenture, to promote its complex services software.

Following the development of the complex services solution, Wellogix participated in a number of pilot programs with various oil companies. In one pilot program, Wellogix and Accenture worked together to provide BP America, Inc. (BP) with access to the features of the software solution. While this and one other pilot with BP were considered a success, BP ultimately discontinued the projects and instead sought to implement a global software solution for BP’s entire system, not just complex services, and hired Accenture to identify and select the software provider. Without notifying Wellogix, Accenture worked with SAP to develop the complex services component of the global software for BP, and in doing so, allegedly accessed Wellogix’s source code that had been provided during a previous pilot program subject to confidentiality agreements. When Wellogix became aware of these events, it filed suit against BP, Accenture and SAP alleging that they had stolen and misappropriated Wellogix’s trade secrets. In the lower court case, the jury returned a verdict in Wellogix’s favor, awarding $26.2 million in compensatory damages and $68.2 million (reduced to $18.2 million) in punitive damages. The appellate court reviewed the record to determine whether there was sufficient evidence to support the jury’s verdict and the resulting damages awards. Of particular interest is the appellate court’s opinion on the compensatory damages awarded by the jury.

In our previous blog in this series, we introduced the flexible approach to calculating damages for claims of misappropriation of trade secrets that was described in the Bohnsack case. The court in this case also referenced the Bohnsack case when it described the variety of forms that damages in misappropriation cases can take. The court quoted one such form that was described in Bohnsack as the “value that a reasonably prudent investor would have paid for the trade secret.” (Bohnsack, 668 F.3d at 280) This form of damages is especially important in this case because Wellogix presented evidence that it was worth approximately $28 million based on an investment of $8.5 million by investors in exchange for a 31% equity stake in Wellogix. The timing of the investment also benefited the damages analysis as it occurred in the same year that Accenture and SAP allegedly misappropriated Wellogix’s trade secret.

It is important to note here that the damages were not based on the amount invested into the company, $8.5 million, but rather on the full investment value of company that was derived from the invested amount and the resulting equity stake. It is also important to note here that the court relied upon evidence presented by Wellogix demonstrating that Accenture’s misappropriation created a competitive disadvantage that caused Wellogix’s value to drop to zero and also caused Wellogix to lose out on potential deals with other oil and gas companies. The damages expert as well as the software expert played a pivotal role in this case and provided a useful framework for calculating damages for venture backed companies that have suffered from theft of trade secrets.

In response to Accenture’s arguments that the damages were too speculative since they were based on the decisions of venture capitalists relying on projections designed to yield a return on investment, the damages expert provided counter arguments that shed light on the validity of this approach and the steps a company seeking venture funding should take to protect the investment value approach in future trade secret litigation. In regards to the projections that led the venture capital investors to value the company and their investment, the expert provided evidence that the venture capitalists audited Wellogix’s financials, spoke with Wellogix’s partners and customers and performed additional due diligence to determine the competitive landscape.  This level of analysis by the venture capital investors on the financials of Wellogix enabled the court to determine that the jury was reasonable in relying upon the investment value. Additionally, the expert emphasized the timing of the investment which occurred “right about the time that the theft occurred” which helped to establish the value of Wellogix prior to the theft.  In an effort to substantiate the loss in value following the theft, the software expert testified that for the reasons described above, “the total value of Wellogix went to zero” following the alleged misappropriation.

Based on the information described above, the court determined that reasonable jurors could find that the above testimony established the market value of Wellogix immediately before and after the alleged misappropriation. Relying upon the flexible approach described in Bohnsack, the court then determined that there was sufficient evidence to support the compensatory damages award. As described in our previous blog post, courts rely upon the flexible approach to calculating damages in trade secrets cases where traditional measures of damages are inapplicable, and the only evidence of damages is based on information that the opposing party characterizes as “speculative”. In such cases, it is important for the expert to acknowledge the speculative nature of their damages theory and to identify factors that demonstrate that their selected methodology results in the least speculative method for damages calculations. In relying upon the efforts of the venture capitalists to validate the projections used to make an investment decision that was intended to provide a significant return on their investment, the expert in this case overcame the speculative nature of projections and was able to render an opinion that the court found to be reasonable under the flexible approach.

In the upcoming blog in this series, we will explore the Waymo v. Uber case where the damages methodology utilized did not meet the requirements of the flexible approach, resulting in the exclusion of the expert’s testimony and opinion.

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