IP Valuations

Intellectual property (IP) is an integral part of today’s business environment, and an increasing amount of value is becoming associated with a firm’s ‘intellectual’ assets  – such as trade marks, patents, designs and copyrights.  

IP valuation is the process of auditing a firm’s IP to reach a figure that reflects its overall worth to the firm. This information can then be used when making strategic decisions when exploiting that IP. But while this sounds easy enough, valuing IP is as difficult as it is useful. 

What are the benefits of IP Valuation?

The benefits of formal IP valuation are obvious: by assigning a value to intellectual property, a business becomes more attractive to potential buyers and investors. More specifically, the benefits include:

• Determining, with greater accuracy, the overall value of a business;
• Identifying untapped value and revenue opportunities;
• Providing a basis for comparison - an effective tool when choosing between market opportunities;
• Gaining taxation benefits (such as tax deductions);
• Providing security and incentive for lenders and investors.

There are also legal reasons for determining the value of a company’s intangible assets – under national and international financial reporting and compliance standards; all asset values (including intangible assets such as IP) must be disclosed during business dealings such as:

• Bank financing
• Securitisation;
• Mergers and acquisitions;
• Financial reports and taxation calculations etc.

How is IP Valued?

There is no “one size fits” all solution to IP valuation. Unlike traditional valuation methods that derive a figure based on cash generated from assets, IP valuation methods acknowledge the unique characteristics of IP. For example, sometimes the benefit is not derived from how much money the IP asset makes, but rather how much money it saves. 

There are three principal approaches to IP valuation: the cost approach; the market approach; and the income approach. The appropriate valuation method often depends upon the type of IP and the purpose of valuing it. Each method has limitations, and applying multiple approaches is often the most effective way to reach a realistic figure. 

The Cost Approach

Stated simply, the cost approach derives the value of the intangible asset by estimating the cost of replacing or reproducing the asset. The cost approach incorporates factors such as the expense of research and development (R&D) into the “value” of the asset. The general idea is that a buyer will not pay more for an asset than the amount they would spend producing it themselves.

Although this method is a useful guide for assets that do not generate an income (for example, patents with no current commercial use), the cost approach would not appropriately value income-generating assets. There is also the issue of how much value should be placed on something as intangible (but valuable) as the “novelty” of certain IP. 

Income Approach

The income approach estimates the ability of the IP asset to generate income – for example, from the sale of patented articles, licences or from royalties. This method seeks to calculate future sales and income by assessing factors such as:  product life; market size; likely income; risk of failure; competition; inflation; changing technology etc.    

The main pitfall of this methodology is the risk involved in “predicting the future”. Unseen factors such as interest rates or future legislation may invalidate the valuation.  There is also the difficulty of selecting an appropriate time period within which to assess the “life” of the IP.

The Market Approach

The market approach determines the real market value of an asset by comparing it to sales of similar assets.  Under this approach the value of the IP asset is derived from transactional data concerning sales of comparative IP assets.

Philosophically speaking, the market approach is probably the most realistic way to value IP – after all, something is only as valuable as what someone else will pay for it.

However the main challenge with this approach is that IP transactions are often confidential  (as in the case of licensing agreements), and pricing information is rarely disclosed to the public. And in the case of unique and/or novel technology, there may not be any similar IP to compare prices with.

For these reasons, this method is most useful where there is a clear market and an abundance of current pricing data that can be analysed. 

What is the best method to value my IP?

This article has identified three basic approaches to IP valuation, however there are numerous methods based on these, such as: price premium; production cost saving; relief from royalty, residual earnings etc.  Ultimately, the process of IP valuation can be described as an “evaluative” exercise, rather than a purely accounting one. It is a chance for companies to identify and audit these intangible assets, verify their value, and utilize this information in their management and exploitation.