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Determining the Value of Your Intellectual Property

In developed countries around the world, there is an ever-growing shift toward the knowledge economy, or industries based on innovation and intangible assets. As of 2008, intangible assets have composed 31.2% of all wealth in Canada, and the proportion continues to steadily increase. In the United States, intellectual property-intensive industries account for over 1/3 of the national GDP; the figure is even more staggering in the European Union at 39%.

In such a climate, businesses that base their operations on intangible assets and innovation have a higher likelihood of thriving. Intellectual property can help you legally protect and capitalize on these inventions.

Contrary to popular belief, the number one reason firms acquire intellectual property is not for litigation purposes, but to have legal and transferable proof of ownership to some of their most important intangible assets. Intellectual property valuation can help you determine the true value of your business and capitalize on assets that you may not have been aware of possessing. It is estimated that approximately two thirds of businesses in the United States have intangible assets that are potentially eligible for intellectual property protections and the advantages they entail.

What are the advantages of intellectual property valuation?

Intellectual property registration provides legal validation of your ownership over intangible assets. This means several things: it is a protection against potential infringement by competitors, a tangible method of licensing or transferring your rights to other businesses for profit, and an increase to the net worth of your business.

The monetary worth of intellectual property, however, is very hard to determine, as there are numerous factors that determine the value of the intangible assets in question. Registration is typically a pre-condition to valuation, especially quantitative valuation, and enables the process of monetizing your intangible assets.

However, conducting a valuation of your intellectual property has significant benefits. Assessing the worth of your patent, trademark or copyright may simplify the licensing or assignment process, and help you determine the royalty rates that should be paid to you as a result of using your intellectual property assets. Further, valuation can increase the overall value of your business and provide you with collateral for loans or mortgages.

Significantly for newer businesses, an accurate and substantiated valuation of intellectual property assets is statistically likely to increase outside investment into your venture.

The difference between quantitative and qualitative valuations

The value of intellectual property can be determined by many factors, but the overarching principle guiding valuation is how much of a competitive advantage over others in the industry your IP provides. When determining the worth of intellectual property, two methods of valuation have traditionally been used.

Quantitative valuation relies on measurable data or numerical information to produce an estimate of the value of your asset(s). It attempts to answer the question by providing a monetary value or contribution that the intellectual property provides, whether directly to the business or indirectly by increasing the value of other parts of the operation or appeal to investors. Sample metrics can include similar market transactions in the industry, assessing the cost incurred in obtaining the intellectual property in question, and the cost of replacing the gains made by the IP in question with another method.

Qualitative methods of valuation attempt to provide a non-monetary estimate of the value of intellectual property by rating it on the basis of its strategic impact, brand loyalty held by consumers, its impact on the company's future growth, and other intangible metrics that do not rely solely on numbers.

These two types of valuation should not be treated as mutually exclusive; depending on the needs of your business, you may employ a variation of methods that fall into both of these categories. Quantitative and qualitative attempt to tackle the question of firm value from different viewpoints, which may both come in useful depending on the audience in question and the reason for valuation.

Quantitative Methods

Cost-based

  • Maintains that a link exists between the costs incurred in the process of developing IP and its final value
  • Quantifies amount that would be required to replace IP and any gains it has made
  • Based on principles of substitution and price equilibrium
  • Traditional cost method calculates all expenses incurred in obtaining IP (fees, legal services, human resources) and tethers it to a specific date to account for later inflation
  • Variations on the cost method include reverse cost method (determining the cost of acquiring IP in question at present time), prospective cost method, cost savings method

Market-based

  • Studying market transactions of assets that are similar/comparable to the asset(s) being evaluated
  • Similarity in utility, as well as perception within the market, must be assessed before this approach can be effective
  • Comparative income differential method (comparing price of similar assets with and without the IP protections) falls under this category
  • A number of conditions exist to determine that similarity is sufficient for the method to be valid

Income-based

  • Attempts to calculate the present value of future profits that will come to the firm as a result of the IP asset
  • This method can be hindered by the need to separate income generated purely by the IP asset from income generated by the company or product at large; further, inflation and liquidity can complicate calculating present value
  • Discounted cash-flow method discounts future economic gains from the IP asset appropriately to reflect present economic conditions
  • Other methods that fall under this umbrella are excess profits method and relief-from-royalty method; both depend on selecting rates in the present to then calculate future results

Options-based

  • Uses options-pricing theory to value IP; usually based on approaches described above but able to be more flexible to factor in the unique nature of IP assets
  • Three possible methods used: decision tree method, Monte Carlo method and the real options method (often tethered to specific sectors in which IP assets are commonplace)
  • Methods focus on illustrating a variety of possible outcomes to highlight the uncertainty of the economic market and the different scenarios that could occur in the future

All of these approaches typically result in a monetary value. However, no method is complete in encompassing all variables that factor into a valuation.

There exist other, less commonly used methods of quantitative valuation that often encompass elements of the larger umbrella methods described above but may focus on obtaining specific metrics. Such methods include the brand value equation method, liquidation value and income differential analysis. Depending on the purpose you have for your prospective IP valuation, one or more of these methods may be helpful.

Qualitative Methods

Rating/scoring

  • Multi-parameter scoring system that is used to arrive at a numerical value of the IP asset; depends on non-quantifiable factors
  • There are several popular scoring rubrics that subscribe to this method; most measure strategy, technological advancement and brand strength, as well as evaluating the risks and opportunities that are involved with the asset
  • The rating/scoring system can also be used for IP asset classification, as seem in the PRISM method, determining the type of function IP plays for the company and assigning a strategy based on the determination made

Value indicators based

  • Based on collection and analysis of IP-related information and analysis of that information via a statistical methodology
  • Includes rating methods like IP Quotient (IPQ), which primarily rate patents based on the strength of the portfolio and the variables that affect patents to give a qualitative rating of their strength
  • Allows for internal comparisons to be drawn on the basis of indicators

Competitive advantage

  • Assesses the competitive advantage that is brought by intellectual property by comparing it to other non-branded companies in the market
  • Evaluates intellectual property on a number of characteristics (often a mix of qualitative and quantitative elements) to determine the brand's performance and strength

Because of their largely non-monetary nature, qualitative methods are often used for internal and/or strategic purposes. They can be used to understand the profitability of an IP portfolio and evaluate opportunities and risks, and to develop an overall strategy for your business. Qualitative methods often tend to be based on common-sense indicators as well, making them viable for presentations to non-expert audiences and audiences without a strong financial grasp on the complicated quantitative measures that yield valuation metrics.

Which method is best for me?

The method that will best serve your intellectual property needs is highly dependent on the goals you have set as a result of valuation. Whether your valuation will be used for internal or external purposes, the type of audience that the valuation results will be presented to and the scope of valuation necessary are all important factors to consider.

Before proceeding with selecting a method, it is important to ask three crucial questions:

  1. What is the purpose to this valuation?
  2. What assets will be the subject of this valuation?
  3. For whom is this valuation being prepared?

Once you have established answers to these questions, you may proceed to selecting the valuation method(s). It is often beneficial to select more than one method of valuation to ensure that the results are corroborated, and, if necessary, that both a quantitative and a qualitative measure is provided.

Intellectual Property Valuation Pyramid

The above pyramid is a commonly used method of valuation coined by Flignor and Orozco (2006), where each level of analysis is crucial to further analysis on the above levels. It breaks down the process of selecting a method of valuation for an IP asset into four levels, going from establishing the basic considerations to arriving at the method(s) that fulfil valuation goals. At level four, a deliverable solution is implemented and evaluated to see if it has met the goals originally established at level one.

The Flignor and Orozco model, however, is limited in prescribing whether to choose a quantitative or qualitative valuation, and does not comment on how a choice should be made; rather, it provides a framework of steps to follow when conducting a valuation.

A 2010 study entitled "Intellectual property valuation: how to approach the selection of an appropriate valuation method" provides a more comprehensive framework of the factors based on which a valuation method should be selected. It presents the process as a flow chart, in which the first step is determining the purpose of the valuation (i.e. transaction, legal, financial) and the specific area for which the valuation is necessary (i.e. intellectual property dispute, accounting purposes, securitization). The next step is to determine the specific audience, as well as their financial competency and desired result (i.e. monetary value or qualitative value). The final step is identifying the type of intellectual property to then determine a method of valuation from those described above.

You can purchase a copy of this study for further information here.

Although this is by no means a comprehensive framework and circumstances particular to your intellectual property asset should be given strong consideration, this should be a good start in determining what method is best.

Conclusion

Determining the value of intellectual property can be a challenging process, but obtaining a valuation can result in significant benefits for your business. Following the valuation models described above to break down the process into simple steps, and establishing a clear purpose and audience for the valuation, can make valuation manageable.

An accurate estimate of the worth of your intellectual property can guide your business decisions and determine a course of action to take with the assets in your possession which will be most profitable for you.