Valuation of IP: Arriving at a Number

Intellectual Property can provide business and competitive value to a business if it is identified at the right time, appropriately protected, strategically used in business and marketing, properly asserted and carefully maintained and managed. A business that takes all the said steps with respect to its patents, trademarks, trade secrets, copyrights, industrial designs and other forms of IP in an integrated manner builds value for its IP and business. In technology, knowledge and creativity driven companies, IP forms substantial portion of financial value of businesses.

By its nature, it is logical to state that IP adds value to a business, but it is very difficult to quantify that value or put a number to that value. Over the years, several methods have been used to value intellectual property, and new valuation techniques are being added by the day. Despite the evolution of novel valuation methods, the traditional valuation techniques are still applied for valuing IP. Some commonly used valuation methods include:

1.Cost Method: A method that looks at the cost for developing the IP. It includes production cost and replacement cost among others.

2.Income Method: A method that assesses the value of IP based on past and future income. One of the income methods, Discounted Cash Flow method is commonly used to forecast present value based on potential income, discount rate and risk ratio.

3.Market Method: This method uses market context, transactions in the market, market potential and other factors to arrive at IP value.

4.Royalty Relief Method: A method that uses probable royalty for an IP to assess its value.

In addition to the aforementioned, there are more than twenty five other methods of IP valuation. Such methods include: Option, Technology Factor, Venture Capital, User Utility, etc. As stated earlier, more methods are evolving by the day.

Normally, the appropriate method for valuation is chosen based on the purpose of valuation. It is not uncommon for more than one method to be applied to arrive at an average value. Some reasons for valuing IP:

  1. Sale of IP;
  2. Licensing of IP;
  3. Merger and Acquisition;
  4. Research Collaboration, or Joint Venture;
  5. Dissolution of the business, or split;
  6. Internal purposes ranging from determining best invention of the year for inventor incentive program to finding the value of a team or department;
  7. Showing IP value to investors;
  8. Raising funds or investment; etc.

Though there is a certain amount of objectivity in the process of valuation, valuation is largely subjective, and two valuers often arrive at different values for the same IP. Also, once the valuation is performed, it does not necessarily mean that the said IP will fetch that value. Valuation is merely an internal tool to arrive at a financial value, which will be a starting point for a transaction or activity.

The financial value given after a valuation exercise often differs substantially with the value the IP has in the market. For example, a hair growth formulation developed by one of our clients was valued at ten million dollars, but no one was willing to buy it even for hundred thousand dollars. In another case, a mobile application used in the restaurant was valued at twenty million dollars, but fetched only one million dollars.

Value of IP is very market sensitive, and changes in the market and economy in general can have a telling impact on value of IP. For example, a pharma patent of our client, which was valued at thirty million dollars during an initial negotiation dropped substantially owing to change in global pharma patent strategy. In another instance, the value of IP of one of our clients in green technologies fell substantially after government started promoting a different technology.

Sometimes, the value can also go up unexpectedly. In one instance, one of our client’s patents in automobile communication technology went up by almost ten times after car manufacturers started focusing on smart cars.

In licensing transactions, the value of IP is normally driven by the bargaining position of a party. The value of an economically strong, non-desperate party will be much higher than an economically weak and desperate party. We notice this very often among our start up clients looking to license their technology to large companies. The same happens in the content licensing arena, based on whether the creator, producer, or record label is well known. In one instance, a song album of one of our clients had to be licensed at a substantially low value as that was the first transaction for our client, and striking the deal was important to approach other licensees.

While collaborating or venturing jointly, parties often negotiate IP ownership terms, and start talking about value of IP each party brings to the table along with other resources. In these instances, both parties are not willing to carry out a professional valuation exercise as that does not make business sense, and often determine the value based on perception and consensus.

Investment and funding is very important for a company’s growth, and IP plays a very important role in firstly, attracting investors, and secondly, in reducing the dilution rate. While it is important to protect and position IP appropriately to maximize investment and minimize dilution, it is very difficult to convince an investor of value of IP without an objective valuation exercise. Investors often push the value down, and the company attempts to push it up as much as possible. It is not uncommon for investment proposals to fail based on disagreement on value of IP. Sometimes the opposite also happens, and an investor, who has a better view of the market, may place a higher value on IP. For example, IP of one of our clients, a leading mattress company, was placed at eighty percent of the company’s total value, and the client was very surprised, but very happy.

Ecommerce and online businesses, including content businesses, are often valued based on the number of hits they get, number of registered customers/followers, etc. We have noted in several transactions, especially those involving investment and acquisition, that financial value of an ecommerce start-up or company can get a substantial hike if it has taken appropriate steps to protect its IP assets such as patents, trademarks, copyrights, etc., and the company has a good set of terms and conditions, privacy policy, take down policy, user agreements, etc. One standard method used for assessing value based on hits is multiplying the number of hits with a perceived value per hit. For example, if SiNApSE Blog, a content based website, gets ten thousand hits and perceived value for each hit is twenty dollars, the value of the website will be two hundred thousand dollars. IP protection, revenue generation potential, uniqueness of the content, number of followers, etc, are used as factors to determine the perceived value per hit.

Some factors that influence value, and are often the subject of contention are:

  1. Life of IP;
  2. Strength of IP;
  3. International reach of IP;
  4. Existence of competing IPs;
  5. Number of competitors;
  6. Potential licensees;
  7. Enforceability of IP;
  8. Shelf life of IP; etc.

To conclude, valuation of IP is an important step for various transactions, but the methods are fraught with several subjective elements. Nevertheless, it is advisable to carry out a valuation exercise to arrive at a logical number for a specific purpose.

If you wish to learn more about IP valuation, write to BananaIP at [email protected].

BananaIP’s renowned IP valuation experts will review your query and answer your questions at the earliest possible.


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