Introduction to Intellectual Property Valuation

Intellectual property (IP) valuation is performed for a myriad of reasons.  All IP valuation begins with understanding the subject asset. IP is a subset of the broader group of intangible assets and all of the forms of intangible assets have certain common attributes.  For example, intangible assets don’t have physical substance and they are typically the last asset to appear in a traditional business as a business grows and also the first to lose value in periods of stress.

Intellectual property is unique among intangible assets, as these intangible assets are legally protected from unauthorized exploitation by others.  IP generates value from the ability of the owner of the IP to exercise their exclusive rights of ownership by using, selling, or licensing the IP. Intellectual property includes patents, trademarks and trade names, copyrights, and trade secrets, and typically refers to creations of the mind, such as inventions; literary and artistic works; designs; and symbols, names, and images used in commerce.

The broader bucket representing all intellectual assets represents codified knowledge and know-how, of physical descriptions of specific knowledge to which a company can assert ownership rights, such as contracts, permits and licenses, and non-compete agreements, in addition to the legally protected assets included in the set of intellectual property.  Not all intellectual assets are protected or defined by law the way IP is.   In general, intellectual capital is the broad collection of the cumulative knowledge of a business.  It allows for knowledge transfer and leverage, which creates a competitive advantage for the business.

Patents are exclusive rights granted over an invention or industrial process, and they protect against unauthorized use of the product. Patents give their owners the right to decide if, how, and when, their invention can be used by someone else.  A patent provides the owner exclusive rights for making, using, selling, or offering to sell their invention. To get these legal protections, owners must publicly disclose technical information about their invention in a published patent document. Patent protection was designed to encourage innovation by rewarding inventors for using their time and resources to come up with new and useful discoveries.

Trademarks are images used in commerce that are intended to distinguish one company’s goods or services from those of other companies.  In other words, trademarks convey information about a company’s (or product’s) reputation.

Trademarks can be applied to words, logos, phrases, shapes, symbols, fragrances, sounds, and colors.  In many places, laws protect trademarks for brand names. The laws also protect slogans and devices used to identify and distinguish a brand’s services or products.  Trademarks have different levels of protection, depending on a range of variables. These include the identifying product or service, how aware consumers are of the mark, and the geographic location where the trademark is used.

Copyrights are the rights creators have to their own artistic and literary works. Copyright protection is given to “original works of authorship.” Copyrights confer the right to reproduce work, create derivative works, distribute works, and publicly perform their works on the creators of those works. Copyright doesn’t cover abstract ideas, concepts, systems, discoveries, or principles. A work must be fixed in a tangible form for it to be copyrightable. Types of works that may be copyrighted include books, paintings, music, movies, sculptures, computer programs, advertisements, technical drawings, maps, databases, dramas and plays, graphics, and pictorial works.  Certain minimum requirements must be met to qualify for copyright protection.

Trade secret laws are designed for the protection of sensitive business information.  The breadth of trade secret protection depends on whether the information provides a company with an advantage over its rivals, its secrecy, and its being unknown to competitors.  A trade secret could be a secret recipe for a food product or a confidential marketing plan that introduces a new product. These secrets have independent economic value based on the confidentiality surrounding them. They retain their value as long as they’re not disclosed to the public or a competitor who can gain an advantage from knowing them. The holder of the secret uses all reasonable efforts to keep the information confidential.  In the UK, the Trade Secrets Directive protects trade secrets, which are defined in the directive as follows:

• is secret in the sense that it is not, as a body or in the precise configuration and assembly of its components, generally known among, or readily accessible to, persons within the circles that normally deal with the kind of information in question;
• has commercial value because it is secret; and
• has been subject to reasonable steps under the circumstances, by the person lawfully in control of the information, to keep it secret.

Most intangible assets, IP included, are capable of generating more than one value stream, simultaneously, which can add complexity to IP valuations.  IP is commonly valued for several purposes, including litigation, licensing, merger and acquisition diligence or strategy, financial reporting, bankruptcy or liquidation, financing, joint ventures or collaboration agreements, and technology transfer agreements.  In certain contexts, the value is determined by legal authority, relevant laws (tax laws), or empirical experiences.

IP valuation is the process of identifying and measuring the financial benefit and risk of an IP asset.

IP typically has value if it is separable from other business assets and generates cash flow (or has the potential to generate cash flow) or protects the cash flow from other business assets from market competition (e.g., a blocking patent).

There can be considerations specific to the type of IP asset that impact value conclusions.  Patent value may be split by field of use (technology sectors, products, or geography) as well as patent claim types. Patents may lose value over their term of protection, and only hold value in jurisdictions they remain valid in. Further, depending on the scope of the patent claims, the value may be limited to one selected component or service in the value chain of the related offered product or service and not provide value to the entire product or service.  Patents only hold value if they remain valid, which includes ensuring maintenance costs are paid. A patent has a limited life.  In the U.K., patents have a twenty-year term from the date of filing.

Trademark or brand value may increase or diminish over time, based on the market value of the trademark and goodwill associated with the trademark in use.  Value in a registered trademark may be limited to the geography and field-of-use categories of the registration.  A trademark may have value as long as use is maintained, and registrations are renewed.  In the UK, trademark registration confers protection for ten years, and it must be renewed every ten years to stay in force.

Copyright value may lie in independently splitting the various forms of copyright use, such as the right to copy, distribute, publish, or perform and copyright value may lie in derivative works. Copyright protections typically have a lengthy duration.  In the UK, a copyright for written, dramatic, musical, and artistic work lasts for 70 years after the death of the author, a copyright for a sound and music recording last for 70 years from when it is first published, a copyright for a film lasts for 70 years after the death of the director, screenplay author, and composer, a broadcast copyright lasts for 50 years from the date of first broadcast, and a copyright on the layout of published editions of written, dramatic, or musical works lasts for 25 years from the first date of publication.

The additional context surrounding IP valuation matters.  In the case of early-stage, pre-commercial IP, the length of time to bring IP to market is important to IP value.  For example, an early-stage IP asset that is closer to market will have a greater value, all else held equal, than an early-stage IP asset that has significant hurdles to clear before it generates revenue.  Likewise, IP assets with greater financial support for the development process will typically have a higher value, all else held equal, than IP assets with limited support during the research and development phase.

Once an IP asset is brought to market, where the asset sits in the IP adoption curve matters.  Sometimes even breakthrough technology can be “too early for the market,” and the asset fails to gain market traction beyond the early adopters, and never becomes fully commercialized.  This occurs at a point commonly referred to as “the chasm.”  Early adopters (visionaries) are looking for breakthrough technology, and they are willing to pay well to be first with the new technology. The marketing strategies that win this group, however, won’t work so well for the up-and-coming early majority. The early majority tends to be pragmatic and risk-averse.  This risk, too, must be taken into account when valuing IP.  Likewise, if the IP has wide acceptance and even late adopters have adopted it, there may be limited economic life remaining for the IP.

There are three approaches to value: the cost approach, the income approach, and the market approach.  The cost approach is based upon the principle of substitution, which states that no prudent investor would pay more for a company than it costs to re-create or buy it.

The income approach is predicated on the value of future cash flows that the asset will generate over its remaining expected life.

The market approach is predicated on the theory that the value of the asset reflects the price at which comparable assets are purchased under similar circumstances.

Within the approaches to value, certain methods are better suited to valuing IP than others.  Within the market approach, the only routinely useable method is the comparable transaction method.  However, it can be difficult to find sufficiently comparable transactions with adequately transparent data.   Given this, it is a best practice to corroborate any market approach result with another method, whenever possible.   The cost approach is most useful in the case of IP which has no cash flow directly attributable to it and no potential for cash flow.  However, in cases such as this, the IP may have significant and measurable benefit to its owner, such as in the case of a blocking patent.  When that is the case, the income approach is most appropriate, specifically the with-and-without method.  Note that if the income approach is not appropriate for valuing IP, the IP itself may have no market value.  The income approach is most commonly used to value IP, with the relief from royalty method and/or the multiperiod excess earnings method present in the bulk of analyses, even where other methods are used. Notably, real option methodology or another probabilistic approach that captures the benefit of the ability to make decisions impacting future commercialization of IP, and is more appropriate for use in the valuation of early-stage IP than other methods are.

In upcoming articles, we’ll take a further look at specific valuation scenarios, including IP valuations for financial reporting, IP valuations for strategic purposes (i.e., an IP carve out/sale or lending purposes or future monetization of the assets), and IP valuations in distressed company scenarios.

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