Need of IP Valuation
Valuation by its very nature is a tricky idea. Suppose you are owner of a company involved in business of knowledge based industries like Software/bio-technology/Semiconductor area. You have conceptualized and made prototype of your product and now you want to raise fund for your future product development and marketing. Or, you have a great product which has seen success in early deployment in market. You want to sell the product to get the benefit of your hard work for the past few years. But you are confused about what value you should put for your company or product. The asset you have, most of cases in forms of patent, copyright or a software or design, is very much intangible in nature. There is no clear asset lifetime, it does not have any depreciation or it does not have clear end of life value. Valuation of this intellectual property is important for the businesses and through a series of posts, we’ll try to explore various methods of IP valuation.
Intellectual property, when patented, becomes a crucial asset because it gives owner exclusive right to develop and market a product based on that IP for a certain duration. You will see the need of Intellectual Property Valuation in several situations:
- You want to provide license of your IPs to another company which allows user to use the IP in its own product, but it does not give user any right to modify or sell the IP to a third party
- You want sell the IP, where the buyer gets the right to use as well as make changes in the design related to the IP and sell the original/ modified IP to third party
- You have a company having IP(s) and want to get acquired or merges with another company. In this scenario valuation needs to be done for a portfolio of IPs the valuation heavily depends on the relationship between the IPs in the portfolio
- You are talking with VCs to raise fund to develop and market products based on your IPs
- You want to include the IPs in your balance sheet and also want to amortize the value of the IP in your P&L statement
- You want to optimize taxation particularly due to the fact that in many countries knowledge based industries enjoy a tax holidays or tax concession in their early years of operation
- You have encountered infringement of your IP and you want to demand right compensation
- You need to take insurance on your IP
Methods of IP Valuation
There are several methods of IP valuations. In this section we will give a brief overview and comparison of those methods. We will also try to set a framework to guide which methods can be used in which scenarios
| Cost based methods | Market based methods | Option based methods | |
Valuation Methodology | The value of the IP is derived by the future cash flows which can be directly/ indirectly contributed by the IP for the economics life of the IP | The value of the IP is determined by the cost one needs to incur if similar asset needs to be developed at current prices | The valuation of the IP is determined by the amount paid to acquire similar asset in the market in similar business scenarios | It uses option pricing model to determine IP valuation |
Typical models used | Discounted cash flow models, venture capital method and relief from royalty method | Reproduction cost model, Replacement cost model | Value of similar asset | Real options, Monte Carlo Simulation, Binomial Tree model, Black Scholes mode |
Advantages | More analytical in nature and examines the economical benefits, economic life and appropriate discount rate for the IP | Required information can be gathered easily as they come directly from accounting sheet | Gives more accurate prediction of the economic benefit which an IP will be able to generate | Uses much deeper analysis techniques as it takes account uncertainty of potential cash flow |
Disadvantages | Subjected to the lot of assumptions (like future cash flow attributed to the IP, economic lifetime, appropriate discount rate) and the valuation can differ significantly with the changes in those assumptions | Does not account the economic benefit arises out of that IP as well as the time for which the economic benefit will be applicable. Also it does not include the risk involved in future | Difficult to gather data for comparable transaction as most of the cases those are confidential in nature | Very complex and needs strong mathematical understanding to use it |
Typical Usage Scenarios |
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We will explore each of these methods in detail in our upcoming posts.
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