We live in an informational age. Businesses are not just making profits and gaining an edge from material assets alone, but ideas as well. This explains why more companies are striving to develop new and unique ideas to stay ahead of the curve. The extraordinary thing about this shift is that businesses are now paying more attention to intellectual property (IP). IP includes intangible assets like registered trademarks, copyright, technology, database rights, confidential information, and patents that are the building blocks of brand value. They set businesses apart in the marketplace – and even make them more appealing to prospective buyers. So what is your IP worth?
IPs are essential to companies because they are intangible assets that can be financially exploited. They can also protect valuable solutions, combat counterfeit and illegitimate products, and they can help increase income and market share. Yet, very few companies know the potential of value contribution of their IP assets.
Valuing your intellectual property
You’ll need to put a value on your IP assets to license, sell, or enter into any commercial arrangements based on your IP. Valuation also helps in the internal management of IP assets, enforcement of IP rights, and different financial processes. Most importantly, valuation tells you what your business is worth – a critical aspect in any selling process.
Seeing how vital IP valuation is, it is always good to have a professional business broker help with the process. They have the right experience, resources, and knowledge to get the job done right the first time. Besides, delegating the work will give you time to focus on your core competency. You’ll also have the peace of mind of knowing you’ll get maximum value for every IP you own. But still, it essential to educate yourself about the process – so please, read on.
IP audit in IP valuation
Before you even start with valuing your IP, you want to perform an IP audit to:
- Analyze, preserve and improve IP
- Fix IP right issues
- Uncover risks that solutions conflict with a third party’s IP
- Make informed decisions on your IP worth
A range of aspects like IP types, nature of business or type of entity, etc., influence how you do an IP audit. But most audits include the following steps:
- Identifying the IP that your business owns and uses
- Determining if the subject IP has remaining useful life (RUL) and whether it’s enforceable and infringes third party rights
- Conducting some form of IP valuation – which we’ll focus on in this article
How to value your IP assets
Many methodologies exist to help you find the value of your IP. Generally, these approaches are divided into two categories: qualitative and quantitative valuation. The quantitative approach depends on measurable and numerical data to calculate how much your IP is worth. On the other hand, the qualitative approach focuses on analyzing aspects like the legal strength of the IP and its uses.
Your choice of IP valuation method at any given time will depend on factors like:
- The uniqueness of the asset
- Amount of available and verifiable data
- Purpose and context of valuation
- Your judgment
Overall, the following characteristics may influence the value of your IP
- The strength of patent claims and other IP
- How the IP will be used (Like to prevent competitive entry, to improve products, or defensively as a cross-licensing tool)
- The profitability and size of markets for products protected by the IP (and whether these products can be brought to the market)
- How much of a competitive edge the IP brings to you
- How rich and determined are other parties that may wish to challenge the IP
With that in mind, let’s now look at methods of intellectual property valuation when selling a business.
The cost-based valuation method determines your IP’s value based on the cost you incurred, creating and developing it. It also considers the amount you spent on research, trial, testing, registration, approval, certifications, overhead, labor, equipment and materials.
Different techniques are used to measure costs:
- Reproduction cost approach: estimations are done by gathering all expenses linked to the purchase or development of a replica of the IP undervaluation.
- Replacement cost approach: estimations are done based on the expenses that would go into getting the same IP asset with similar function or use.
The cost method is driven by the fact that the potential buyer won’t have to deal with these costs should they buy the intellectual property rights (IPR). They also get the peace of mind of not dealing with potential failures or difficulties protecting the IPR if they did develop their own.
Cost-based valuation is most suitable as a supplement to the income method. It is often used in situations where the subject IP is currently not producing any income. Besides, this approach doesn’t factor in potential future profits and successes as it’s based on costs incurred only.
Income-based valuation method
Income valuation values IP assets based on the amount of economic income it’s expected to generate, adjusted to its present-day value. To determine the economic income, you’ll need to:
- Predict the revenue/savings generated by the IP asset over its RUL.
- Offset those revenue/savings by costs that directly relate to the IP asset. i.e., costs like materials, labor, capital investment, capital charges, and rents.
- Consider the risk to discount the income amount to present-day value using the capitalization or discount rate.
The income-based approach needs you to have comprehensive knowledge and judgment to determine the asset’s income. Will the income be gauged as premium price driven by solutions using the IP? Or be based on royalty or rent to be collected? Will it be measured as part of the operating income of a business’s entire operations or a specific technology or brand?
The fact that this approach uses potential future scenarios makes it trickier to project up to several years. But considering aspects like competition, the state of the economy, costs, and the extent of IPR’s market can guide you in making the right valuation.
Market-based valuation method
The market method mostly applies when a true marketplace exists, and actual comparable transactions are traceable. It tries to assign an IP asset value on the open market based on data from similar market transactions. When an active market exists and can offer samples of recent transactions with enough data regarding terms and conditions, there is a reasonable indication of value.
This IP valuation method considers transaction value by looking at the following factors:
Market capitalization: the total values of physical assets are deducted from total liabilities, and net physical assets are computed. A company’s market capitalization is the number of shares issued multiplied by its price per share.
Royalty rates: factors like market potential, profit margin, capital investment requirements, and commercialization costs can be analyzed and computed by considering the rate of licensing agreements.
Market transaction or comparable valuation method: this compares the price at which the same IP has been exchanged between parties.
However, in valuing IP, it can be difficult to find the right comparable transaction. The two main reasons for this are the lack of disclosed licensure or sale activity, and by its definition, an IP must be unique.
As a business owner, it’s essential to understand what your IP is worth. IP can help you point out your business’s strengths and weaknesses and make it more profitable and attractive to potential buyers, potential licensees and investors.