The Methods of Intellectual Property Valuation: Best Practices and Considerations

The intellectual property rights are intangible in nature and it gives exclusive rights to the inventor or creator for their invention or creation. These rights are associated with intangible property properties owned by a person or any company and it is protected against use without the consent of the owner. If we consider the present scenario of globalization, Intellectual Property Rights is the pivot point in overall global trade practices across the world. According to Universal Declaration of Human Rights (UDHR), everyone has their right to protect their material interests resulting from any literary, scientific, or artistic production. All these rights boosts the innovative and creative environment by giving benefits to the creator. Intellectual Property Rights covers a huge range of assets produced by human through their creative minds and thus it takes much amount of time, effort, ideas and importantly monetary speculations. The present blog highlights the methods which are widely used in Intellectual Property valuation, focusing on the all future incomes generated by the IP asset. It contains all the methods suitable for IP assets with its proper stable and expectable income streams.

RELEVANCE OF THE INTELLECTUAL PROPERTY VALUATION:

Intellectual Property valuation is the crucial process which determines the overall monetary value of the IP assets such as patents, trade secrets, copyrights, trademarks. The Intellectual Property valuation is also much essential for enforcing all the IP rights and as well as the documented valuation of assets for case of infringement or pursuing or claiming damages. This IP valuation is much relevant in various other contexts which includes mergers and acquisitions, licensing, etc. Proper fair competition is maintained for IP assets in M&A with accurate IP valuation that results in negotiating fair licensing agreements. This valuation helps in identifying and managing the overall potential risks by assessing the valuation of IP assets and by passing proper strategic decisions regards to asset monetization, and defensive measures against infringement.

Valuation of IP additionally is necessary for planning of taxes and compliance, particularly in the cases where IP assets are used as surety for financing. Valuation of IP provides total valuable insights in the legal proceedings by establishing the value of the Intellectual Property assets involved. The relevance of Intellectual Property valuation is evident in methods differently used for determining the value, including the cost – based approach, market – based approach, and the income – based approach.

PROCESS OF IP VALUATION:

Intellectual Property must undergo a rigorous valuation procedure that involves a comprehensive knowledge of Intellectual Property assets and its future prospects. Assessing its prospects is the most crucial and important part of evaluating any Intellectual Property as it involves many number of critical elements such as its potential to increase profits, to boost its productivity, and much to refer to its utility.

Another important component in determining the Intellectual Property’s worth is the consumer behavior. If the Intellectual Property has the ability to alter customer behavior or to generate new demand then the value of that Intellectual Property might increase dramatically. Factors that are more important for valuation of this IP is its potential for future development, scalability, and the integration with other technologies.

According to WIPO ( World Intellectual Property Organization), there are some requirements to be made within the ambit of this IP valuation i.e., It needs to stand out differently from others subject to its precise identification and different description, the existence of asset should be very well supported by concrete documentation like contract, license, financial statement, etc., it need to be made at certain period, its income stream should stand out differently from other firm’s assets, it should be able to and ought to be sold independently from another company’s assets, it should be capable of having ability to be destroyed or terminated at certain point of time.

DIFFERENT METHODS OF VALUATION:

1. COST – BASED APPROACH

This cost – based approach calculates the cost of enjoyment of any asset by determining the cost of its recreation. For determining the proper fair value, this method of cost – based approach needs to take into account a few additional factors or elements such as opportunity cost, depreciation, deterioration due to financial or economic undesirability, etc. to calculate a fair value. The same things can be achieved using two different approaches: replacement or reproduction cost which is known as historical cost which totally seeks to measure the cost of creating an identical asset, with the same utility, and reproduction cost, also referred to as historical cost, which totally aims to assess the cost of creating an identical asset.

Also due to lack of consideration for the uniqueness of the IP, its totally potential to generate unanticipated revenue, risk, and uncertainty, the total cost of approach is not widely employed and is rarely the only method used in Intellectual Property valuation. Even the trends and growth rates, which greatly impact value, are not considered either. In fact, many commentators, practitioners and professionals think it doesn’t really matter for Intellectual Property pricing since:

1. The legal protection of Intellectual Property makes recreation difficulty; and
2. Without the legal protection such cost for many Intellectual Property assets is effectively zero.

Challenges such as ignores future value doesn’t consider the future economic benefits that the Intellectual Property may generate, potentially undervaluing highly profitable assets. Also, it doesn’t account for all the technological obsolescence which could minimize the value of Intellectual Property over time. It is much more difficult to accurately and precisely captures the costs of intangible contributions.

2. MARKET – BASE APPROACH

This is totally based on the idea the idea that market transactions of intellectual property indicate value. Alternatively referred to as the transactional method, it is basically the price paid by a willing buyer would pay to acquire an identical asset under comparable conditions. And also if done correctly and with sufficient data at hand, it should establish the fair market value of the subject Intellectual Property. In fact, this method is where arm’s length standard and fair market value, two of the most widely used valuation standards, originated.

However, the unusual or uniqueness of Intellectual Property also gives rise to some issues, such as the challenge of locating comparable assets; more often than not the reference transactions need to be corrected for the dissimilarities, which inevitably attract subjectivity. Moreover, the exchange of Intellectual Property in the marketplace is usually exchanged in conjunction with the sale of a company or division, and even in those cases, the price of the intellectual property component is rarely published independently. Nonetheless, it is one of the simpler methods, and with the availability of sufficient market – derived sale or license transactional data is available.

Also, the tax authorities usually favour this market – based approach for deals with affiliates and it is also used for deriving inputs for such income approach.

The overall challenges for market – based approach depends on finding comparable transactions which can be difficult, especially for the unique or highly specific assets.

The crucial challenge this approach relies on current market conditions, which can be totally volatile and it may not even always accurately reflect the intrinsic value of the Intellectual Property. Also, homogeneity as a challenge is often unique, making it challenging to search comparable transactions which provide a reliable benchmark.

3. INCOME – BASED APPROACH

The Income – based approach determines the value on the money and the overall benefits it will bring to a company during its useful economic life. This approach is probably the most fundamental approach with regards to valuation since the overall inherent of any asset can be defined as its income – generating capacity. This techniques involve forecasting potential future Intellectual Property related revenue, incomes, overall risks and costs. All these is required in order to calculate the net present value (NPV) which might be positive or negative. Income – based approach has its another three methods such as DCF – Discounted Cash Flow, earnings ant its capitalization, and the royalty relief approaches. 3 components are important in this approach which are- projected cash inflows and outflows, the economic life of the Intellectual Property giving estimation of profits, and the discounted rate. One can use this approach for scenarios such as selling or buying of a business, licensing an Intellectual Property asset. One of the pros of this approach is that it is flexible to different types of Intellectual Property at all the different stages of development. One of the cons is that it relies on hypothetical future forecasts, rather than real data.

The challenges that are faced by this approach is that, this method involves the detailed financial modeling which can be totally complex. Accuracy heavily depends on assumptions made about future revenues, incomes which can be uncertain and speculative.

CONCLUSION

Intellectual Property is a topic of utmost importance in contemporary trade. Not only does it help in effectively exploiting the IP via licensing securitization and raising money for future investment which is a huge advantage for new start – ups, lower level industries, but it also solidifies the the relevance and economic strength in modern era. Despite having various benefits, the implementation is still much lower in India. Agricultural sector finds it difficult to implement the same for maintaining stronger positions in market. Also there is much more lack ow awareness among class of assets. Also there is lack of legislation, rules and proper guidelines governing the valuation of the IP assets which means uniformity of the overall process is jeopardized.

Author: Paras Adesara, a student at Marwadi University, Rajkot, Gujarat , in case of any queries please contact/write back to us via email to [email protected] or at IIPRD.