Intellectual Property, like any other property, is worth what it will bring in the market. A look at several valuation models employed in valuing intellectual property.
Over the past few years, businesses have given more and more prominence to intellectual property, which is now regarded as one of the most important assets of any business concern. This is more so in today’s business scenario, where enterprises, across industries, rely heavily on their intellectual property for growth and development. The days are long gone; when a business’s worth would be measured solely in terms of its physical assets, land, plant, machinery and the traditional intangibles, being limited to securities and goodwill.
Today, a pharmaceutical company will rely upon its patents and trademarks to gain an edge over its competitors and the entertainment industry sustains itself on the strength of its copyrights and trademarks. It is, therefore, inevitable that the worth of these assets would be manifold for a business and that it would be imperative for businesses to ensure that these assets be utilised to their fullest extent. It is here that the question of valuing an intellectual property is raised.
Today, in almost every aspect of corporate activity, be it mergers and acquisitions, assignments and licensing, enforcement and even day-to-day activities of maintaining accounts and determining the worth of a business, it is important to value the intellectual property of the business. IP valuation basically refers to put a price on a patent or trademark or copyright.
However, while it is simple enough to understand the concept of valuation; it is rather difficult to put a price on something that is not tangible. There appears to be no strait-jacketed formula for valuing intellectual property and multiple approaches are adopted to varying degrees for each valuation. Since IP itself is of various forms and the importance of each to a business may be different; it must be borne in mind as to what the purpose of the valuation is. Due to the indefinable variables that affect the value of the IP; the purpose of valuation may give an indication as to the variables that are to be considered important.
For example, in putting a value on a trademark for the purpose of licensing to an entity to use the trademark on its goods, it would be most important to prioritise factors such as the public perception of the trademark. Its worth would be most determined by the increasing use of the trademark, which shall cause in the price and sales of the licenses products upon using the trademark. In a situation where a patent is to be valued, it may be important to consider the value of the market capitalisation that a business may lose in case the patent is lost and the exclusivity related to the patent is no longer with the business and also the time and ease with which competitors may be able to bring in products in the market with the same technology.
Hitendra Rath, Patent Attorney, Delhi High Court adds that “Intellectual property (IP) of an organisation is considered as an asset for the organisation. It is an intangible property of the organisation or of the individual. One can not evaluate IP by measuring or weighing like the physical assets of the organisation. An IP can be evaluated from its economic viability and benefit, commercialisation of the product and services, market value of the product and services. The main aspects taken into consideration for valuation of IP are the expenditure in the research and development of the product or services, the expenditure on the invention of the product, market value of the product or services, the income or the revenue generated or economic benefits from the IP.”
There are several valuation models employed in valuing intellectual property like, replacement cost, discounted revenue stream, market value and incremental value. Therefore, replacement cost is considered as the most basic and least accurate valuation model. The capitalised revenue stream is best suited to valuation of patents, used exclusively as licensing vehicles. The market value method is rarely useful due to lack of efficient markets and the difficulty in comparing intellectual properties. The incremental value model values a patent as the difference in value of an enterprise with the property and the value of the same enterprise without the property. A commercially viable, computerised model is available, known as TRUE Metrics©. Although convenient, its theoretical underpinnings are somewhat susceptible. In reality, the economic life of a product is often significantly less than the statutory term of the patent. Technological obsolescence, changing tastes and other factors may shorten the economic life of the product. The average economic life of a patent is only about five years from the date of issue.
A patented blockbuster drug, while the patent is active, gives patent holder company a large market share and company charges for its drug whatever the market will bear. Once the patent expires or is invalidated in court, a score of generics enters the market while eroding the price and market share of the company. Thus, a patent protecting particular product or process would be worth exactly the net present value of the difference between the revenues derived from the sales of this product under monopoly afforded by patent and the corresponding revenues in an unpatented environment.
Thus, the patent value of a product is the sum of incremental values of the public franchise on an annual basis over the life of the patent.
“Intellectual property (IP) of an organisation is considered as an asset for the organisation. It is an intangible property of the organisation or of the individual. One can not evaluate IP by measuring or weighing like the physical assets of the organisation. An IP can be evaluated from its economic viability and benefit, commercialisation of the product and services, market value of the product and services. The main aspects taken into consideration for valuation of IP are the expenditure in the research and development of the product or services, the expenditure on the invention of the product, market value of the product or services, the income or the revenue generated or economic benefits from the IP.”
There are several approaches to value an intellectual property. However, most of these approaches can be condensed into three broad methods, viz., market based, cost based and income based methods. Every time an intellectual property is to be valued, it is the varying combination of these methods that are applied.
The model of market value based method, the most commonly understood and easily comprehensible method may not hold good in all cases. Market approach, in the words of Gordon V Smith and Rusell L Parr, is “measures the present value of future benefits by obtaining a consensus of what others in the market place have judged it to be. There are two requisites: an active market and an exchange of comparable properties.” The market approach values an IP at the price it could be sold and is most useful in cases of trademark valuations. Under this, a trademark’s value is the amount remaining after deduction of the book value of assets from total market capitalisation.
Another method, the cost based approach, is based on the principal that an asset is worth what it costs to create or acquire it. Based on this approach, the value of an IP is equal to the cost of the inputs expended on making a particular intellectual property. While being relatively simple, the approach suffers from several drawbacks and is not suitable for most valuations. Instead, cost analysis is used as a foundation or stepping stone for other forms of analysis. Under this method, the value of IP cannot be considered its real value, as it does not take into account the economic benefits and considers costs as the equivalent of value. This approach also does not consider future risks associated with the value of the IP.
Another method is the income based method, in which, quite simply, value of the intellectual property is estimated based on the expected income due to the intellectual property during its remaining economic life. This method is frequently used to ascertain rates of royalty payable on an IP, particularly copyrights. Income based method ascribes value to an intellectual property that approaches the value of its expected future income.
According to Paul Flignor and David Orozco in a research paper for WIPO, “The most basic definition of ‘value’ is based on the ability of the asset to somehow generate future income.” According to them, value of IP can be ascertained by taking into consideration the three elements, viz., projected cash flows, the economic life of the IP, and the discount rate. Projected cash flows refer to income that the IP is likely to bring in future and economic life refers to the length of time that the IP will be able to command the price or cost premium. The discount rates refer to the expected costs associated with managing and enforcing the IP.
Hitendra Rath further elaborates, “An extensive and wideranging array of pro-development efforts has been undertaken to revamp the international IP regime. A large number of international fora are involved and support from nongovernmental organisations (NGOs), activist groups, and academics is abundant for the building value of IP.” There are several other factors to be considered in different valuations and it is therefore, essential to first consider the type of intellectual property, its circumstances, the reliance of the business on the asset, the costs involved in maintaining the asset and the purpose of the valuation. Cumulative evaluation of these factors helps in reaching at an effective valuation of an intellectual property
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