This article on ‘Various Methods of IP Valuation‘ was written by an intern at Legal Upanishad.
The article will be focusing on the methods or approaches for the valuation of an asset of IP.
The asset of any business such as technology or intellectual property is an essential element for establishing the brand. The awareness of the value of such assets and their contribution is essential to plan any form of business strategy. It is also determined as a valuation of IP.
What is termed as an IP Valuation?
The valuation of an IP asset incorporates the legality of such asset with the economic value. Now, one of the essentials of industrial valuation is the context. The value of an asset is unable to be defined without its context. When we say context, it is always considered in relation to the variables like time and place. For tangible assets, there are various well-equipped methods to determine their context.
Intellectual property applications comprise a vast category in every field with individual legal and regulatory mechanisms. Even in the case of Patents, there is an assortment in relation to nature, time, purpose, etc. however, the terms and conditions for the exchange of IP vary diversely and there is no established market for a change of IP assets. Also, the niceties of the exchange of such IP assets are hardly known to the public. Hence, there is a need for a more advanced and specialized approach to the valuation of IP.
Why do we need an IP Valuation?
IP assets are an intangible form of property that belongs to any business. One of the most favourable elements of IP assets is that they are legally protectable and enforceable. Such assets possess the ability of individual identification, and transferability and do have some economic life duration.
For selling, licensing, or entering into any commercial agreements related to IP, it is essential to put some value over the IP asset. It is also important for some form of rights enforcement that is useful for the internal management and financial processes of the IP asset.
Importance of IP Valuation
An IP value of any asset originates from the rights which the owner of such IP asset excludes to its competitors from the usage of the asset. To possess a quantifiable value, any IP asset shall be capable of generating a measurable and adequate amount of economic profits for the owner of such asset and shall also be capable of enhancing the acquired value of other similar assets.
The known value of any IP asset signifies the possible great economic profits in the future which will be given to the owner.
Essentials to possess a value
The value of any IP asset can only be determined if it satisfies some of the crucial conditions to be met:
- There shall be an individual and separate identity which can be recognized.
- There shall be some evidence in a tangible form that could prove the existence of the asset.
- Such assets shall be created at some identifiable period.
- Such assets are legally valid and enforceable.
- The income generation of such assets shall be identifiable.
- The selling criteria of the asset shall differ from the other categories of assets belonging to the business.
- Such assets shall be such that they could be destroyed or terminated whenever the situation arises to do so.
Techniques for the Valuation of IP Assets
There exists various reason which necessitates the requirement to have some strategies for IP valuation. Such strategy formulated shall be capable of including the nature of the IP asset, its subject, and the acceptable approaches for the valuation. In a broad sense, the valuation of an IP asset can be performed in two approaches which are the qualitative approach and the quantitative approach the valuation.
Qualitative method for the Valuation of IP asset
The qualitative method of valuation possesses the ability to be accommodated with a large no. of factors but does not provide any monetary answer. The use of this method is confined to only the internal management of the IP. The qualitative method of valuation is mainly adopted by Japan and Denmark. It is not applicable in our country.
Quantitative method of the valuation of IP asset
The quantitative method of valuation shows a monetary aspect of an IP asset. Although, there are certain terms as well as combinations that are a bit ambiguous and confusing. There are only a few classifications where the quantitative methods fall. Some of the most effective quantitative methods of valuation of IP assets are discussed below:
Cost-based quantitative method of the valuation of IP asset
The cost-based quantitative method provides the value of an IP asset by determining the cost incurred for the recreation asset. The method shall include some additional components in order to determine the value of IP assets. Those additional factors can be the cost of opportunity, a situation of depreciation, or economic or financial deterioration.
Under the Cost-based quantitative method, there are two bifurcations to involve more prompt valuation. It is a replacement cost-based method and reproduction cost-based method. Both the methods are discussed below:
Replacement cost-based method of the valuation of IP asset
The replacement cost-based method is established on the substitution principle. In this method, the investors of the business will not pay more amount than the cost for obtaining the same benefit from two assets. Although, this replacement method is not universally known. The use of this method is very rare for valuation. It is thought by the practitioners that the valuation of the IP is important as, without any legal protection, the cost and value of the asset will be zero.
Reproduction cost-based method of the valuation of IP asset
The reproduction cost-based method is inherently found inconsistent because there exists a very little correlation between the incurred cost for creation and its utility value mainly in the matter of IP assets.
Market method of the valuation of IP asset
The market method depends upon the market deals of IP assets that show the value of the assets. It is also known transactional method. Under this method, it is moreover a particular price that the buyer pays for purchasing the asset of the same value under the same circumstances. If the purchase made by the buyer is done with ample data, it will create an ideal value for IP assets in the market. It is basically the price paid by a buyer to purchase a similar IP asset in a similar form of circumstances.
But still, the idiosyncratic nature of IP assets creates some problems, and also the exchange of such IP assets in a market seems to be the exchange of the company. But still, the price is hardly disclosed individually for the IP component. This method seems to be a naïve method. Since it has the ability to create sufficient market sales and licensing, it can help in guiding the pricing strategy
Income method of the valuation of IP asset
The income method seems to be the most important and effective method for valuation because the intrinsic value of an IP asset can be best determined by its ability to generate income. The method values an IP asset based upon the current value of the cash flows which the IP asset is efficient in creating income for future endeavors.
Most importantly there are three components of the Income method. Those three components are the projected flow of cash, the economic lifecycle of the IP, and the discount rate.
Despite the inherent strength of the method, it is a method that contains a high level of subjectivity due to the estimated projection. Moreover, despite the general view of the risks involved in the valuation, only the systematic component will be considered.
The biggest fallout of the method is that it cannot determine the risks individually. With this, it could be led to some wrong adjustments at a discount rate. However, the method is used in those cases where there is a positive generation of the income and estimation of the future is accurate. In the case of financing and security, the income method is the most favorable method for valuation.
The valuation of IP asset is a very important subject area in today’s scenario. It helps in effectively exploiting the IP and generating income for the future. The IP asset’s financial value is a boon for the new startups.
- Valuing intellectual property assets. WIPO. https://www.wipo.int/sme/en/value_ip_assets/.
- IP Valuation methods. November 2020. Royalty Range. https://www.wipo.int/sme/en/value_ip_assets/.
- Shubham Borkar and Neha Rani. 17 January 2019. India-What is Intellectual Property Valuation. Mondaq. https://www.mondaq.com/india/trademark/772158/what-is-intellectual-property-valuation.
- Intellectual Property Valuation Methods. CENSORS IP EXPERTS. https://www.consor.com/articles/value-of-intellectual-property-and-intangible-assets/.