INTELLECTUAL PROPERTY VALUATION: UNDERSTANDING THE

CONCEPTS

A. Introduction

To put it simply, Intellectual Property (hereinafter, referred to as IP) valuation is an

estimation of present value of the future income that it is expected to generate. In other
words, it is the prediction of the result of an assumed transaction of that IP. This process
relies upon assumptions and, therefore, cannot be said to be mathematically precise. It is
between the enterprise and the appraiser and is largely dependent upon the assumptions and
information inputs being provided by the enterprise to the appraiser. At this point, it would be
prudent to understand the difference between cost, price and value. They are mistakenly
considered to be the synonyms but that is not the case. They are terms with different meaning
and each had a role in the IP valuation. It can be said that cost is about identifying
information which concerns the production process while price, reflects information about a
transaction at a particular time between parties influenced by the relevant market place.

B. Nature of IP and valuation

Uniqueness of IP asset vis-à-vis non-IP lends to it a commercial and strategic value. 1 This
also means that this uniqueness would render application of certain valuation methods
impracticable. Irrespective of the method of valuation they are philosophically as well as
mechanically the same as applicable in case of non-IP assets, nevertheless the specifics would
vary in the context of IP given the differences in the nature of IP 2 and the market in which the
transactions relation to IP occurs as compared to a non-IP asset. 3 Thus, what is required is a
consideration of variables for in any IP valuation, so the approach would vary depending
upon the kind of IP or on account of the purpose of valuation 4 as well as the stage of the
development the IP is in at that point of time. This is also for the reason of unique character
of an IP asset but also due to its interplay with the organization or the enterprise. 5Further,
there is an absence of an efficient marketplace. For eg., market in case of equity or bonds act
swiftly and publicly while on the other hand IP transactions do not take place in a centralized
1
See Barney, Jay, “Firm Resources and Sustained Competitive Advantage,” Journal of Management, Vol. 17
No. 1 (1991), pp.99-120, Kenneth W., “The Economic Underpinnings of Patent Law,” The Journal of Legal
Studies, Vol. 23, No. 1 (January 1994), pp. 247-71.
2
IP differ from non-IP asset on account of excludability and rivalrous consumption.
3
See Wirtz, Harald, “Valuation of Intellectual Property: A Review of Approaches and Methods,” International
Journal of Business and Management, Vol. 14, No. 1 (Spring 2004).
4
See Cromley, J. Timothy, “20 Steps for Pricing a Patent,” Journal of Accountancy (November 2004)
5
See Martin Daryl and David Drews, “Intellectual Property Valuation Techniques,” The Licensing Journal
(October, 2006).
market environment and are often conducted in secrecy. 6 Even when they are public, they can
be extremely complex or obscure. This implies that market values are not often readily
observable for IP. Also, there is a presence of intermediaries in the form of IP licensing
agents and brokers, IP auction houses, securitization firms for royalty etc. may help in
reducing the transaction costs, but they also fragment the market. Thereby, it hinders
observation of values as might have happened in a centralized system. 7 This makes IP
valuation an area of study distinct from other valuation areas. And an assessment of IP
financial value thus requires attention to the particulars of the subject matter, i.e., IP asset and
the context of the valuation.

C.Methods of valuation

C.1 Overview:

There are three basic methods of valuation, namely, cost, income and market approach.
Irrespective, of the differences in these approaches the aim of all three remains to be the
same, that is, to determine an indication of the value of IP asset at a certain date. The method
adopted is largely dependent on the stage of development of the technology or product.
Empirically, the income approach is viewed as the most economically appropriate method for
IP valuation.8 It can be said that one or a mixture of approaches can be adopted in a case, also
for the reason of crosschecking the assumptions that had gone into making that valuation in
order to reach upon a meaningful result.9 It is often good practice to employ multiple
approaches.10 With regard to the stage of development generally it can be said that when the
technology has some time from reaching the market, then the most preferred method is the
Cost approach. Reason is the uncertainty around the technology. Once that technology is
developed that uncertainty is over, and then the market approach becomes preferred one. In
case when the revenue is imminent out of the commercial exploitation of the technology then

6
See Millien, Raymond and Ron Laurie, “A Summary of Established & Emerging IP Business Models,”
Proceedings of the Sedona Conference, Sedona, AZ (2007).
7
See Kelley, Anne, “Practicing in the Patent Marketplace,” The University of Chicago Law Review, Vol. 78
(2011), pp. 115–137.
8
See Rozek, Richard P. and George G. Korenko, “What Is an Idea Worth?” The Intellectual Property Debate:
Perspectives from Law, Economics and Political Economy, Meir Perez Pugatch, Ed. Cheltenham; Edward Elgar
Publishing, 2006, pp. 81–102. Flignor, Paul and David Orozco, “Intangible Asset & Intellectual Property
Valuation: A Multidisciplinary Perspective,” World Intellectual Property Organization (2006).
9
See Matsurra, Jeffrey H., “An Overview of Intellectual Property and Intangible Asset Valuation Models,”
Research Management Review, Vol. 14, No. 1 (Spring 2004).
10
See Wiederhold, Gio. Valuing Intellectual Capital. New York; Springer (2014). Ch. 5, pp. 85–150.
Chaplinsky, Susan, “Methods of Intellectual Property Valuation,” University of Virginia, Darden, UVA-F-1401.
the income approach is the most preferred one. The three approaches have been explained in
detail in the coming part.

C.2 Three Financial Approaches: COST, MARKET AND INCOME

The three approaches

C.2.a COST BASED APPROACH:

This approach is based on the economic principle of substitution and price equilibrium. The
underlying assumption is that an investor for the IP or associated technology will pay no
more than the cost to obtain an asset of equal utility. 11 Howsoever, this approach has been
criticized12 for its limitations, like:

i. Does not reflect the economic factors (like competitors’ activity, current demand
for the asset);
ii. Does not reflect economic life of IP;
iii. Risk is not directly factored into;
iv. Does not inform the likely price a person may be prepared to pay for the IP.

Despite these limitations, it is employed for the reasons as mentioned in the introductory part
as a preferred method when the technology has not been fully developed. It is also used when
other approaches cannot be applied13, like, information requirements for other approaches
cannot be met. This is also useful in cases where the IP asset can be easily designed around as
the prospective buyer would contemplate redevelopment cost considerations. 14 There are two
methods under this approach, namely Cost of Replacement and Cost of Reproduction. In the
former an assessment of the cost for the enterprise to replace the technology or IP with the
equivalent utility is done. It seeks to reproduce the utility and does not take into account the
market demand. While the latter is based on the premise that a replica of the IP will be made,
that is, the cost to recreate the IP in the same form.

C.2.b MARKET BASED APPROACH

11
See Goldscheider, Robert, “The Classic 25% Rule and The Art of Intellectual Property Licensing,” Duke Law
& Technology Review, No. 6 (2011), p. 15. Collan, Mikael and Markku Heikkila, “Enhancing Patent Valuation
with the Pay-Off Method,” Journal of Intellectual Property Rights, Vol. 16 (September 2011), pp. 377–384 at p.
378.
12
See Rozek, Richard P. and George G. Korenko, supra note 8 at pp. 81–102. Also see Chaplinsky, Susan,
supra note 10. Also see Hofmann, Jan, “Value Intangibles,” Deutsche Bank Research (October 19, 2005).
13
See Drews, David, “The Cost Approach to IP Valuation: Its Uses and Limitation,” Corporate Intelligence
website (www.corporateintelligence.com), (January 12, 2001).
14
See Grain Processing Corp. v. American Maize-Prods. Co., 185 F.3d 1341 (Fed. Cir. 1999).
The question in this approach is, “what is comparable price or royalty that would be achieved
by similar technologies or IP?”. As such, it is the clearest form of determining the market
value of an IP asset is by auction. But this comes with its own difficulties, namely:

- Insufficient number of bidders

- Publicity costs;
- Time required to notify potential bidders and time required to assess the IP;
- Involvement of the enterprise to assist purchasers to make full use of the IP or
technology;
- Proving that the technology in which IP subsists is well-developed.

This approach is also known as Transactional method and involves contemplation of market
transactions as evidence of prevailing values for the subject IP or an IP asset similar to the
subject IP.15 This approach can take two forms, namely direct and analogous. The former
involves evaluation of any past transaction that have been entered for the subject IP itself.
While the latter considers prices paid for similar IP in similar circumstances to those assumed
to prevail at the contemplated transaction.16

The benefit of this method lies in parties’ general familiarity with the underlying concepts of
this method due to its widespread applicability. 17 Also this approach is associated with a
relatively small number of assumptions, which may be disaggregated by the parties seeking
to find aggregable terms in negotiations.

However, it can be complicated in case of IP because of the distinctive nature of each IP and
in unique ways it can give competitive and financial edge in different organizational context.
it can be said that this method would be most useful in situations where useful transactional
data can be accessed and analysed.

C.2.c INCOME BASED APPROACH

The objective of this approach is to determine future income measured in present value that
can be expected from the IP or associated technology. It is in relation to target IP, and thus
income generated by other related intangible assets is not relevant. The logic of this approach
is that a rational prospective buyer of the subject IP would pay up to the present value of all

15
Martin, Daryl and David Drews, supra Note 5
16
Wirtz, Harald, supra note 3 at pp. 40–48.
17
Hoffman, Jan, supra note 12
future anticipated benefits attributable to the asset. This approach has three essential
elements:18

i. Determining the potential income: It is influenced by whether the income

stream is expected to be constant or not? Whether the measure relates to
revenue to be earned or savings to be achieved? Whether the projected income
will be generated by the use of IP, ownership of IP, licensing of IP or decision
not to use the IP?
ii. Determining the projection period: projection period considers the period over
which the IP will generate income for the enterprise but also those which
would generate different levels of income.
iii. Assessing the risk, that is, discount rates: Discount rates is income expected to
be received in the future which must be recalculated to a figure that reflects
value in the present-day terms. The rate that converts projected future income
to present value of that income is referred to as discount rates. In general, the
appropriate discount rate will account for risks inherent to the forecasted cash
flows as well as the time value of money. 19 From a financial perspective, the
discount rate should reflect the opportunity cost of capital used in generating
the cash flows. The logic is that, if the capital were not being used to support
the IP commercialization, then it would have been used for a project with a
similar risk profile and generate the “Opportunity cost” return.20

D. Conclusion

In the conclusion, it can be said that there are various methods available for IP valuation.
Howsoever, one should be mindful of following things when undertaking the exercise of IP
valuation:

a. There must be an appreciation of the uniqueness of IP as compared with non-IP assets

as that would have a bearing upon the valuation process.

18
See Hofmann, Jan, supra note 12 at pp. 7–8. Also see Damodaran, Aswath. Strategic Risk Taking: A
Framework for Risk Management. Upper Saddle River: Wharton School Publishing, 2008. Flignor, Paul and
David Orozco, supra note 8.
19
See Matsurra, Jeffrey H., supra note 9 at pp. 1–10.
20
See Damodaran, Aswath, “Present Value,” NYU Stern School of Business
(http://pages.stern.nyu.edu/~adamodar/pdfiles/cf2E/tools.pdf.).
b. The kind of IP to be valued should be considered as the assumptions and objectives
would vary accordingly, say it would be a different scenario for patents as compared
with copyright and trademarks.
c. The IP valuation is based on assumptions and information-input from the enterprise to
the appraiser. Thus, correctness of the information is essential to reach upon a
meaningful result.
d. Enterprise and appraiser both should clearly be mindful of the objective of the
valuation and the stage of the development of technology or the IP.
e. Accordingly, an appropriate method should be adapted. It should be pointed out that
every method can have its limitations and difficulties, may be inherent, or due to
practical reasons. Therefore, it is advisable to have a mix of approaches or as well
utilization of all the approaches in order to sometimes cross checking the underlying
assumptions or to reach upon a meaningful result.