Determining the Value of Your Intellectual Property
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?
Registered and granted intellectual property rights, such as granted patents, trademark registrations, and copyright registrations, which are acquired by application to intellectual property offices, provide legal evidence of your ownership over intangible assets as well as give you the right to exclude others from use of the rights. This means several things: you have means to protect yourself against infringement by competitors, and an asset which can be profitably licensed or sold to others to provide them with rights they would otherwise not have, and consequent to these benefits an increase to the total value of your business.
The precise monetary worth of intellectual property, however, can be challenging to determine, as there are a number of factors that determine the value of the intangible assets in question. Registration or grant of an intellectual property right is sometimes a precondition to valuation, especially quantitative valuation, and enables the process of monetizing your intangible assets.
Conducting a valuation of your intellectual property has significant benefits. Assessing the value 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, ascribing a reasonable valuation to your intellectual property, if not currently accounted for, increases the overall value of your business and provides 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. See more statistics on the value and importance of intellectual property.
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 intellectual property 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 assets. 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 intellectual property 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.
- 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
- 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
- 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
- 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.
- 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
- 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:
- What is the purpose to this valuation?
- What assets will be the subject of this valuation?
- 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.
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.
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 help you determine a course of action to take with the assets in your possession which will be most profitable for you. If that course of action is monetization, also see our resource on how to monetize intellectual property.