Intellectual property (IP), such as patents, trademarks, copyrights, and trade secrets, can have significant value for a business and can be a key driver of competitiveness and innovation. By accurately valuing their intellectual property, businesses can make informed decisions about licensing, litigation, mergers and acquisitions, and other strategic initiatives.
Additionally, valuing intellectual property can help businesses to secure financing, attract investors, and enhance their overall reputation and brand image. Ultimately, valuing intellectual property is essential for businesses to protect and maximize the value of their intangible assets and to remain competitive in the marketplace.
In this article, I am going to explain the IP valuation essentials, but let’s begin with defining and types of IP.
What is IP
Intellectual property refers to the intangible creations of the mind that are protected by law, such as patents, trademarks, copyrights, and trade secrets. The forms of intellectual property provide legal protections that allow creators and owners to control and profit from their work, while also promoting innovation and creativity in society.
Intellectual property rights grant exclusive rights to the owner or creator of the work, preventing others from using, copying, or distributing the work without permission. These rights enable the owners to monetize their creations, either by selling or licensing them to others. In some cases, intellectual property rights can also help to create a competitive advantage, as they can provide legal barriers to entry and prevent others from copying or replicating the work.
Intellectual property is becoming increasingly important in the digital age, as more and more information and creative works are being created and shared online. Protecting intellectual property has become a critical issue for businesses and individuals alike, as the ease of digital distribution makes it easier for others to infringe upon intellectual property rights. As a result, there has been a growing need for laws and regulations to protect intellectual property, as well as for tools and technologies to monitor and enforce these protections.
Overall, intellectual property is a critical aspect of modern business and society. It enables creators and owners to protect and profit from their work, while also promoting innovation, creativity, and competition. By valuing and protecting intellectual property, businesses, and individuals can help to ensure that their ideas and creations are recognized and rewarded, while also contributing to the growth and development of society as a whole.
Types of IP
Patents
Patents protect inventions and give the owner the exclusive right to make, use, and sell the invention for a set period of time.
Trademarks
Trademarks protect logos, names, and other symbols used in commerce to identify and distinguish goods and services from those of others.
Copyrights
Copyrights protect original works of authorship, such as literary, musical, and artistic works, giving the owner the exclusive right to reproduce, distribute, and display the work.
Trade secrets protect confidential business information, such as formulas, processes, and designs, that give a business a competitive advantage.
Methods for IP valuation
Not let’s begin with the IP valuation methodology. In this article, we present 5 popular methods for IP valuation:
- Discounted Cash Flow (DCF) Method
- Multi-Period Excess Earnings Method (MPEEM)
- Replacement Cost Method
- Market based method
- Relief from Royalty method
Discounted Cash Flow (DCF) Method
The discounted cash flow (DCF) method is a commonly used approach for valuing intellectual property (IP). This method estimates the present value of the expected future cash flows generated by the IP asset, discounted to reflect the time value of money and the risk associated with the cash flows.
To use the DCF method to value IP, the following steps are typically taken:
- Estimate the expected future cash flows: This involves estimating the expected revenue generated by the IP asset over a certain period of time. This can be based on past performance, market trends, or other factors that may influence future cash flows.
- Determine the discount rate: The discount rate reflects the time value of money and the risk associated with the expected cash flows. The discount rate may be based on factors such as the cost of capital, the risk profile of the IP asset, and other market factors. For the purpose of the DCF method, the discount rate usually used is WACC – Weighted average cost of capital.
- Calculate the present value: The present value of the expected cash flows is calculated by dividing the expected cash flows by the discount rate.
- Adjust for terminal value: The terminal value represents the expected cash flows beyond the period for which cash flows were estimated. The terminal value is calculated using a similar process to the above steps.
- Calculate the total present value: The total present value is calculated by summing the present value of the expected cash flows and the terminal value.
- Subtract direct debt: Any financial liabilities associated with the IP asset, are subtracted from the total present value to arrive at the net present value of the IP asset.
Relief from Royalty method
This method estimates the value of the IP asset by estimating the royalty payments that would be required if the IP were licensed from a third party, and then calculating the present value of those royalty payments over a certain period of time.
To use the Relief from Royalty method to value IP, the following steps are typically taken:
- Estimate the hypothetical (comparable) royalty rate: This involves estimating the royalty rate that would be required to license the IP asset from a third party, based on factors such as the type of IP, the industry, and market conditions. For the best assessment of the royalty rate, you can use some databases such as Royalty Stat.
- Estimate the expected revenue: This involves estimating the revenue that the IP asset is expected to generate over a certain period of time, based on past performance, market trends, and other relevant factors.
- Calculate the hypothetical royalty payments: The hypothetical royalty payments are calculated by multiplying the expected revenue by the estimated royalty rate, net of corporate taxes.
- Calculate the present value: The present value of the hypothetical royalty payments is calculated by discounting the payments to reflect the time value of money and the risk associated with the payments.
- Adjust for terminal value: Similar to the DCF method, the terminal value represents the expected cash flows beyond the period for which cash flows were estimated. The terminal value is calculated using a similar process to the above steps.
- Calculate the total present value: The total present value is calculated by summing the present value of the hypothetical royalty payments and the terminal value.
- Subtract financial debts associated with the IP asset
Multi period earning excess method (MPEEM)
The Multi-Period Excess Earnings Method (MPEEM) is a widely used approach for valuing intellectual property (IP) assets, particularly in the context of valuing businesses that rely heavily on intangible assets such as customer relationships.
To use the MPEEM method to value IP, the following steps are typically taken:
- Estimate the expected future cash flows from IP that are subject to valuation: This involves estimating the expected future cash flows generated by the IP asset over a certain period of time. This can be based on past performance, market trends, or other factors that may influence future cash flows. For example, when estimating the value of customer relations you need to take only the expected earnings from those customers, assuming customer churn during years.
- Calculate the normalized earnings: The normalized earnings represent the earnings that can be attributed to the IP asset, after accounting for other factors that may influence earnings, such as taxes, interest, and non-IP related expenses.
- Calculate the excess earnings: The excess earnings are calculated by subtracting the expected return on the other assets used in generating the normalized earnings from the normalized earnings.
- Determine the present value of the excess earnings: The present value of the excess earnings is calculated by discounting the expected future excess earnings with a reliable discounting rate (WACC).
- Calculate the present value of the IP: The present value of the IP is calculated by summing the present value of the excess earnings over the expected period of earnings.
- Subtract financial debt associated with the IP asset
Replacement Cost Method
This method estimates the value of an IP asset by determining the cost of developing a similar asset from scratch, taking into account the time, effort, and resources required.
To use the Replacement Cost method to value IP, the following steps are typically taken:
- Determine the type of IP: This involves identifying the type of IP asset being valued, such as a patent, trademark, or copyright.
- Estimate the cost of developing a similar asset: This involves estimating the cost of developing a similar asset from scratch, taking into account the time, effort, and resources required.
- Adjust for markup: In order to replace IP you need to pay someone to do this. So based on the cost above, you need to count of some earnings (markup) of the party who develops IP. For example, if the labor cost and other operating costs are $100, and if the market comparable markup is 15% total replacement cost would be 115%. In order to make the best estimation of market comparable markup, you can use a database such as Tomson Reuters.
- Adjust for obsolescence: The value of the IP asset may be affected by factors such as technological advancements, changes in market conditions, or changes in consumer preferences. The estimated cost of developing a similar asset should be adjusted to reflect any obsolescence in the IP asset being valued.
- Adjust for depreciation: Like physical assets, IP assets may depreciate over time as they become less valuable or relevant. The estimated cost of developing a similar asset should be adjusted to reflect any depreciation in the IP asset being valued.
- Adjust for market conditions: The value of an IP asset may be influenced by market conditions, such as supply and demand or competition. The estimated cost of developing a similar asset should be adjusted to reflect any relevant market conditions.
Market base methods – Comparable transaction method
Market-based methods for valuing IP rely on comparing the IP asset being valued with similar assets that have been recently sold or licensed in the market.
These methods are useful when there is an active market for the type of IP asset being valued, and when there is enough information available about recent sales or licensing transactions to make meaningful comparisons. For the application of this methodology, you would need access to the relevant databases that contain reliable and comparable transactions.
Comparable transactions method involves identifying comparable IP assets that have been recently sold or licensed and using these transactions as a basis for estimating the value of the IP asset being valued. The comparable assets should be as similar as possible to the asset being valued, in terms of technology, industry, and stage of development.
How to choose the right method for your IP
Choosing the most appropriate method for valuing a specific type of intellectual property (IP) depends on several factors, such as the stage of development of the IP, the industry, and the purpose of the valuation. Here are some general guidelines for choosing the most appropriate method for valuing specific types of IP:
Patents
Patents are often valued using income-based methods, such as the Relief from Royalty method or the Multi-period Excess Earnings method. These methods consider the expected future cash flows associated with the patent and discount them to their present value. The replacement cost method can also be used to estimate the cost of developing a similar patent.
Trademarks
Trademarks are typically valued using market-based methods, such as the comparable transactions method or the royalty rate method. These methods consider the royalty rates paid for similar trademarks in the market.
Trade secrets
Trade secrets are often valued using income-based methods, such as the Multi-period Excess Earnings method or the Cost Savings method. These methods consider the expected future cash flows associated with the trade secret and discount them to their present value.
Software
Software can be valued using a variety of methods, including income-based, market-based, and cost-based methods. The income-based methods consider the expected future cash flows associated with the software, while the market-based methods consider the royalty rates paid for similar software in the market. The replacement cost method can also be used to estimate the cost of developing similar software.
Tips For Achieving Reliable IP Valuation Results
Use multiple valuation methods
To ensure the most accurate and reliable IP valuation results, it’s important to use a variety of valuation methods, including income-based, market-based, and cost-based methods. Each method provides a unique perspective on the value of the IP asset being valued, and using multiple methods can help to identify any inconsistencies or inaccuracies.
Gather relevant data
Accurate IP valuation results rely on having access to relevant data, such as financial statements, industry data, and information on comparable transactions. It’s important to gather as much data as possible to ensure that the valuation is based on reliable information.
Engage a qualified IP valuation expert
Intellectual property valuation can be complex, and it’s important to engage a qualified IP valuation expert who has experience in valuing similar assets. A qualified expert can ensure that the valuation is performed in accordance with best practices and industry standards.
Consider the specific characteristics of the IP asset
The value of an IP asset can be influenced by its specific characteristics, such as its stage of development, level of protection, and market potential. It’s important to consider these characteristics when performing the valuation to ensure that the final results are as accurate and reliable as possible.
Verify assumptions and estimates
Valuation results rely on assumptions and estimates, such as revenue projections or discount rates. It’s important to verify these assumptions and estimates to ensure that they are reasonable and accurate.
IP valuation FAQ
Q: What is IP valuation?
A: IP valuation is the process of determining the monetary value of intellectual property assets such as patents, trademarks, copyrights, trade secrets, and other intangible assets.
Q: Why is IP valuation important?
A: IP valuation is important for several reasons, including:
- Identifying the value of IP assets for licensing, sale, or acquisition purposes
- Obtaining financing or attracting investors based on the value of IP assets
- Ensuring that IP assets are properly valued for tax and accounting purposes
- Protecting the interests of IP owners by identifying potential infringement and establishing a basis for legal action
Q: What factors are considered in IP valuation?
A: Factors considered in IP valuation may include:
- The level of technological innovation and market demand for the IP asset
- The degree of exclusivity and legal protection afforded by the IP asset
- The stage of development and commercialization of the IP asset
- The potential revenue streams and profitability associated with the IP asset
- The competitive landscape and potential threats to the IP asset
Q: How is the value of patents determined?
A: The value of patents is typically determined through a combination of factors, including the strength of the patent’s legal protection, the market potential of the technology it covers, and the costs associated with developing and commercializing the technology.
Q: How is the value of trademarks determined?
A: The value of trademarks is typically determined based on the strength of the brand and the level of consumer recognition and loyalty associated with the trademark.
Q: How is the value of copyrights determined?
A: The value of copyrights is typically determined based on the potential revenue streams associated with the copyrighted work, such as licensing fees and royalties.
Q: What should be considered when selecting an IP valuation expert?
A: When selecting an IP valuation expert, it is important to consider factors such as their experience, credentials, and reputation in the field. It is also important to ensure that the expert has experience working with the specific type of IP asset being valued.
Businesses that attempt to navigate IP valuation and transactions without the help of an experienced professional may make common mistakes, such as undervaluing or overvaluing assets, or failing to properly protect their intellectual property. Consulting with an experienced IP valuation expert can help businesses to avoid these mistakes and make informed decisions that are in their best interests.
