Valuing IP is a critical part of any IP assignment or licence, or start-up company transaction.
An assignor or licensor or technology owner does not want to receive less than what the IP is worth. Correspondingly, the assignee, licensee or investor of the technology does not want to pay more for the IP than what the IP is worth.
Both parties want the financial terms of their IP trading transaction to accord with the value of the IP.
There are three basic valuation approaches or methodologies:
1. Cost based (Historical Cost)
2. Market based (Replacement Cost, Industry Standards, Comparables Analysis)
3. Income based (Discounted Cash Flow)
These approaches are described below.
Historical cost is a methodology intended to ascertain what the actual cost has been to bring the IP into existence. It is therefore not strictly a valuation methodology, since the cost of creating the IP bears no relationship to its value. Its value may be less than its historical cost, or, it is hoped, its value may be greater than that. Nevertheless, valuing the historical cost can be an important decision making tool.
Replacement cost is a methodology similar to historical cost, but this time, rather than valuing the actual cost of bringing IP into existence, instead the cost of recreating the IP is assessed. This can be a useful cost to ascertain, since if the replacement cost is less than its market value, an assignee or licensee may prefer to recreate the IP, rather than to pay the market value. Of course, doing so is subject to considering the advantage of having the IP immediately, rather than waiting for the time to recreate it, and it is also subject to the ability to recreate it without infringing the original IP.
Industry Standards value IP by reference to what the market has determined to be a “standard value” for IP. For example, the royalty rate paid for
· a new compound at the late pre-clinical stage of development
· a musical composition
· a novel
· a merchandising licence
· a franchising licence
all lie with certain parameters established by the market, and it would be unusual for the royalty rate to exceed, or to be lower than those industry standards parameters.
Comparables analysis is a methodology that identifies comparable IP transactions, ascertains the financial terms of those transactions, and compares the subject of those transactions to the IP to be valued. The closer the similarity between the comparable IP, and the IP to be valued, the more persuasive the financial terms of the comparable transaction are as an indicator of the value of the IP being valued. Correspondingly, the less similar the IP is to be IP to be valued, the less persuasive those financial terms are as an indicator of the value of the IP being valued. This methodology is mostly used for valuing royalties.
Discounted cash flow analysis values IP from the premise that the value of IP is related to the earnings that the products derived from the IP will generate over time. It looks at the profit that the products derived from the IP will earn over the remaining life of the IP, such as the unexpired term of a patent, multiplies the answer by a discount rate to take into account the present value of future earnings, factors in probability factors, to arrive at a lump sum value of the IP. This methodology can be used for valuing IP as a lump sum amount, as well as royalties.
1. "Intellectual Property Valuation Reporting Standard" published by the Hong Kong Business Valuation Forum.
2. This guidance note “Valuation of Intellectual Property Rights” published by the Royal Institution of Chartered Surveyors (RICS) is to clarify the legal, functional and economic characteristics of IP that should be considered and reported on in an IP valuation.
3. This booklet contains an excellent checklist to help value IP, as well as providing more information on IP valuation methodologies. (Source: Intellectual Property Office, United Kingdom)
4. The World Intellectual Property Organization publishes a number of excellent papers on IP valuation. (Source: WIPO)