Patent valuation

Last updated

Intellectual property assets such as patents are the core of many organizations and transactions related to technology. Licenses and assignments of intellectual property rights are common operations in the technology markets, as well as the use of these types of assets as loan security. These uses give rise to the growing importance[ as of? ] of financial valuation of intellectual property, since knowing the economic value of patents is a critical factor in order to define their trading conditions. [1]

Contents

Cases of application

Valuation of patent rights is one of the main activities related to intellectual property management within an organization or company. Indeed, knowing the economic value and importance of the intellectual property rights assists in the strategic decisions to be taken on the company's assets, but also facilitates the commercialization and transactions concerning intellectual property rights.

There are several business situations where valuation is required: [2]

Valuation of a company for the purposes of a merger, acquisition, joint venture or bankruptcy

Most of the technological companies are highly based on intangible assets and investment in knowledge, research and innovation. According to studies, expenditures on knowledge, through investments in R&D or software, have grown[ as of? ] at a higher rate than expenditures in tangible assets. [3] This change in investments has consequently been reflected by a heavy importance of intangible assets and patents in companies. Therefore, to know the value of companies it is essential to know the value of their intellectual property.

Negotiations to sell or license intellectual property rights

As in other business transactions, organizations negotiating agreements to sell or license intellectual property and patent rights commonly have to agree on a price. Knowing the value of the intellectual property rights is essential to reach such an agreement, but also to make sure the parties are engaging in a good deal.

Support in situations of patent conflict or dispute

In scenarios of patent conflict, such as patent infringement proceedings or alternative dispute resolution mechanisms, quantification of damages is often a necessary step of the process. The correct valuation of the intellectual property right at stake is therefore essential to guarantee a fair recovery of the damages.

Fund raising through bank loans or venture capital

Valuation of the intellectual property to be used as security for bank loans or to attract venture capital and investors is essential. Several studies reveal that, in particular, owning patents and a proper intellectual property management play a crucial role in the decision of venture capitalists. [4]

Methods

Different approaches of patent valuation are used by companies and organizations. Generally, these approaches are divided in two categories: the quantitative and qualitative valuation. While the quantitative approach relies on numerical and measurable data with the purpose to calculate the economic value of the intellectual property, the qualitative approach is focused on the analysis of the characteristics and potential uses of the intellectual property, such as the legal, technological, marketing or strategic aspects of the patented technologies. Qualitative valuation deals also with assessing the risks and opportunities associated to the intellectual property of the company. [5]

Quantitative approach

Several methodologies are used on the quantitative approach, but generally they can be grouped in four methods: [6]

  • Cost-based method
  • Market-based method
  • Income-based method
  • Option-based method

Cost-based method

This method is based on the principle that there is a direct relation between the costs expended in the development of the intellectual property and its economic value. Two different techniques are mainly used to measure costs:

  1. Reproduction cost method: Estimations are performed by gathering all costs associated with the purchase or development of a replica of the patent under valuation.
  2. Replacement cost method: Estimations are performed on the basis of the costs that would be spent to obtain an equivalent patent asset with similar use or function.

In both methods, present prices are taken into account, i.e. the expenditures as of the valuation date and not the historical costs when these actually happened. [7] For assessing costs, two cost sources of two sorts should be included: direct expenditures, such as costs with materials, labor and management; and opportunity costs, relating to the lost profits due to delays in market entrance or investment opportunities lost with the aim of developing the assets. [7]

Income-based method

This method is based on the principle that the value of an asset is intrinsic to the expected income flows it generates. After the income is estimated, the result is discounted by an appropriate discount factor with the objective to adjust it to the present circumstances and therefore to determine the net present value of the intellectual property. There are different methods of calculation of the future cash flows, such as:

  1. Discounted cash flow method: This method aims to estimate future cash flows, which are projected and after discounted by applying an appropriate discount factor. The main source of information to estimate the cash flows is generally the business plan of the company that exploits or intends to exploit the asset.
  2. Relief-from-royalty method: In this method the value of the asset is considered as the value of the royalty payments from which the company is relieved due to its ownership of the asset. Hence, the appropriate royalty rate must be determined, allowing the estimation of the future royalty income stream. A discount rate is applied to determine the present value of the asset. [8]

Option-based method

Differing relative to the above methods, an option-based methodology takes into consideration the options and opportunities related to the investment. [9] It relies on option pricing models (e.g. Black–Scholes) for stock options to achieve a valuation of a given intellectual property asset. In these cases, [10] patents may be valued using the techniques developed for financial options, as applied via a real options framework. [11] The key parallel is that a patent provides its owner the right to exclude others from using the underlying invention, so both patents and stock options represent a right to exploit an asset in the future, and to exclude others from using it. The patent (option) will have value to the buyer (owner) only to the extent that the expected price in the future exceeds the opportunity cost of earning just as much in a risk-less alternative. Thus patent rights can be thought of as corresponding to a call option and may be valued correspondingly. [10] See Contingent claim valuation, as well as Business valuation § Option pricing approaches, for further discussion.

See also

Related Research Articles

The discounted cash flow (DCF) analysis, in financial analysis, is a method used to value a security, project, company, or asset, that incorporates the time value of money. Discounted cash flow analysis is widely used in investment finance, real estate development, corporate financial management, and patent valuation. Used in industry as early as the 1700s or 1800s, it was widely discussed in financial economics in the 1960s, and U.S. courts began employing the concept in the 1980s and 1990s.

Real options valuation, also often termed real options analysis, applies option valuation techniques to capital budgeting decisions. A real option itself, is the right—but not the obligation—to undertake certain business initiatives, such as deferring, abandoning, expanding, staging, or contracting a capital investment project. For example, real options valuation could examine the opportunity to invest in the expansion of a firm's factory and the alternative option to sell the factory.

Transfer pricing refers to the rules and methods for pricing transactions within and between enterprises under common ownership or control. Because of the potential for cross-border controlled transactions to distort taxable income, tax authorities in many countries can adjust intragroup transfer prices that differ from what would have been charged by unrelated enterprises dealing at arm’s length. The OECD and World Bank recommend intragroup pricing rules based on the arm’s-length principle, and 19 of the 20 members of the G20 have adopted similar measures through bilateral treaties and domestic legislation, regulations, or administrative practice. Countries with transfer pricing legislation generally follow the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations in most respects, although their rules can differ on some important details.

In accounting, book value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. Traditionally, a company's book value is its total assets minus intangible assets and liabilities. However, in practice, depending on the source of the calculation, book value may variably include goodwill, intangible assets, or both. The value inherent in its workforce, part of the intellectual capital of a company, is always ignored. When intangible assets and goodwill are explicitly excluded, the metric is often specified to be tangible book value.

An intangible asset is an asset that lacks physical substance. Examples are patents, copyright, franchises, goodwill, trademarks, and trade names, as well as any form of digital asset such as software or cryptocurrency, including stablecoins in duress. This is in contrast to physical assets and financial assets. Intangible assets are usually very difficult to value.They suffer from typical market failures of non-rivalry and non-excludability. Today, a large part of the corporate economy consists of intangible assets, reflecting the growth of information technology and organizational capital.

A royalty payment is a payment made by one party to another that owns a particular asset, for the right to ongoing use of that asset. Royalties are typically agreed upon as a percentage of gross or net revenues derived from the use of an asset or a fixed price per unit sold of an item of such, but there are also other modes and metrics of compensation. A royalty interest is the right to collect a stream of future royalty payments.

<span class="mw-page-title-main">Valuation (finance)</span> Process of estimating what something is worth, used in the finance industry

In finance, valuation is the process of determining the value of a (potential) investment, asset, or security. Generally, there are three approaches taken, namely discounted cashflow valuation, relative valuation, and contingent claim valuation.

<span class="mw-page-title-main">Fair value</span> Financial estimation of potential market price

In accounting, fair value is a rational and unbiased estimate of the potential market price of a good, service, or asset. The derivation takes into account such objective factors as the costs associated with production or replacement, market conditions and matters of supply and demand. Subjective factors may also be considered such as the risk characteristics, the cost of and return on capital, and individually perceived utility.

Rational pricing is the assumption in financial economics that asset prices – and hence asset pricing models – will reflect the arbitrage-free price of the asset as any deviation from this price will be "arbitraged away". This assumption is useful in pricing fixed income securities, particularly bonds, and is fundamental to the pricing of derivative instruments.

In finance, the intrinsic value of an asset or security is its value as calculated with regard to an inherent, objective measure. A distinction, is re the asset's price, which is determined relative to other similar assets. The intrinsic approach to valuation may be somewhat simplified, in that it ignores elements other than the measure in question.

Business valuation is a process and a set of procedures used to estimate the economic value of an owner's interest in a business. Here various valuation techniques are used by financial market participants to determine the price they are willing to pay or receive to effect a sale of the business. In addition to estimating the selling price of a business, the same valuation tools are often used by business appraisers to resolve disputes related to estate and gift taxation, divorce litigation, allocate business purchase price among business assets, establish a formula for estimating the value of partners' ownership interest for buy-sell agreements, and many other business and legal purposes such as in shareholders deadlock, divorce litigation and estate contest.

<span class="mw-page-title-main">Capital budgeting</span> How an organization allocates its cash and resources

Capital budgeting in corporate finance, corporate planning and accounting is an area of capital management that concerns the planning process used to determine whether an organization's long term capital investments such as new machinery, replacement of machinery, new plants, new products, and research development projects are worth the funding of cash through the firm's capitalization structures. It is the process of allocating resources for major capital, or investment, expenditures. An underlying goal, consistent with the overall approach in corporate finance, is to increase the value of the firm to the shareholders.

Valuation using discounted cash flows is a method of estimating the current value of a company based on projected future cash flows adjusted for the time value of money. The cash flows are made up of those within the “explicit” forecast period, together with a continuing or terminal value that represents the cash flow stream after the forecast period. In several contexts, DCF valuation is referred to as the "income approach".

The following outline is provided as an overview of and topical guide to finance:

Intellectual property valuation is a process to determine the monetary value of intellectual property assets. IP valuation is required to be able to sell, license, or enter into commercial arrangements based on IP. It is also beneficial in the enforcement of IP rights, for internal management of IP assets, and for various financial processes.

In mathematical finance, a replicating portfolio for a given asset or series of cash flows is a portfolio of assets with the same properties. This is meant in two distinct senses: static replication, where the portfolio has the same cash flows as the reference asset, and dynamic replication, where the portfolio does not have the same cash flows, but has the same "Greeks" as the reference asset, meaning that for small changes to underlying market parameters, the price of the asset and the price of the portfolio change in the same way. Dynamic replication requires continual adjustment, as the asset and portfolio are only assumed to behave similarly at a single point.

Intangible asset finance, also known as "IP finance", is the branch of finance that uses intangible assets such as intellectual property and reputation to gain access to credit. Like other areas of finance, intangible asset finance is concerned with the interdependence of value, risk, and time.

Brand valuation is the process of estimating the total financial value of a brand. A conflict of interest exists if those who value a brand were also involved in its creation. The ISO 10668 standard specifies six key requirements for the process of valuing brands, which are transparency, validity, reliability, sufficiency, objectivity; and financial, behavioral, and legal parameters.

<span class="mw-page-title-main">Corporate finance</span> Framework for corporate funding, capital structure, and investments

Corporate finance is the area of finance that deals with the sources of funding, and the capital structure of corporations, the actions that managers take to increase the value of the firm to the shareholders, and the tools and analysis used to allocate financial resources. The primary goal of corporate finance is to maximize or increase shareholder value.

A patent box is a special very low corporate tax regime used by several countries to incentivise research and development by taxing patent revenues differently from other commercial revenues. It is also known as intellectual property box regime, innovation box or IP box. Patent boxes have also been used as base erosion and profit shifting (BEPS) tools, to avoid corporate taxes.

References

  1. ↑ European IPR Helpdesk (2013). Fact Sheet - Intellectual Property Valuation. European Commission.
  2. ↑ Hungarian Patent Office (2008). The valuation of Intellectual Property. IP4INNO. Archived from the original on 2013-12-03. Retrieved 2013-09-08.
  3. ↑ OECD Observer (2007). Policy Brief - Creating Value from Intellectual Assets (PDF). Organisation for Economic Co-Operation and Development (OECD).
  4. ↑ Kamiyama, S., J. Sheehan and C. Martinez (2006). "Valuation and Exploitation of Intellectual Property". Technology and Industry Working Papers - OECD Science, OECD Publishing. 085.{{cite journal}}: CS1 maint: multiple names: authors list (link)
  5. ↑ Lagrost, C., D. Martin, C. Dubois and S. Quazzotti (2010). "Intellectual property valuation: how to approach the selection of an appropriate valuation method". Journal of Intellectual Capital, Emerald Group Publishing Limited. 11 (4).{{cite journal}}: CS1 maint: multiple names: authors list (link)
  6. ↑ Flignor, P., D. Orozco “Intangible Asset & Intellectual Property Valuation: A Multidisciplinary Perspective”, 2006
  7. 1 2 Drews, D., ”The Cost Approach to IP Valuation: Its Uses and Limitations”, IP Metrics Intellectual Property Valuation, 2001
  8. ↑ Chaitali Ahya (2005). Intellectual Property Valuation: A Primer for Identifying and Determining Value. American Bar Association. p. 35. ISBN   978-1-59031-430-2.
  9. ↑ Kamara, A., “Introduction to real options”, CFO Forum, 2002
  10. 1 2 See for example: Robert Pitkethly (1997). The Valuation of Patents: A review of patent valuation methods with consideration of option based methods and the potential for further research, Judge Institute Working Paper WP 21/97; Markus Reitzig. Valuing patents and patent portfolios from a corporate perspective: theoretical considerations, applied needs and future challenges - Ch. 15 in Derek L. Bosworth and Elizabeth Webster (2006). The Management of Intellectual Property. ISBN   1845421124
  11. ↑ See Aswath Damodaran: Applications Of Option Pricing Theory To Equity Valuation and Option Pricing Applications in Valuation; Fernando Torres MSc. Conceptual Patent Value Framework, The Patent Value Guide.
This page is based on this Wikipedia article
Text is available under the CC BY-SA 4.0 license; additional terms may apply.
Images, videos and audio are available under their respective licenses.