The importance of Intellectual Property Valuation
Like other forms of property, you can buy, sell and license intellectual property. Therefore, it is important you understand the value of your trademark, patent or design, and complete an Intellectual Property Valuation.
For valuation purposes, the intangible assets must be readily identifiable, documented and capable of being separated from the other assets employed in the business. Intangible assets that exist but that cannot be specifically identified are included in goodwill. The intangible asset should generate some measurable amount of economic benefit to its owner; this economic benefit could be in the form of an income increment or of a cost saving.
Why Value Intellectual Property?
Changes in the global economic environment have influenced the development of business models where IP is a central element establishing value and potential growth. In addition to these systemic changes, international accounting practices place pressure on firms to recognize and value all identifiable intangible assets of a firm as part of a transaction (in a merger or acquisition, for example). As a result of these trends, a proper and correct intellectual property valuation, followed by measures to protect that value, have become a key element of the success and viability of a modern firm.
Methods for the Valuation of Intellectual Property
Acceptable methods for intellectual property valuation are; the market-based method, the cost-based method and the income approach.
Market Based Method
The market-based method draws comparisons to publicly traded companies or private companies that are similar to the subject company. The market approach uses empirical evidence of value using databases for private businesses and companies. A major disadvantage with the market method is that it ends up comparing general information in the market, it is unable to consider specific factors leading to a specific transaction. Furthermore, the market-based approach is usually an inappropriate method as, by its very nature, intellectual property is unique.
Cost-Based Valuation Method
The cost-based method uses the costs incurred by the business in the creation and development of their IP. It also considers the potential cost of recreating such an IP asset or developing a product that is similar in nature.
These costs might include:
- Research and development
- Equipment and materials
- The cost of labour
- Prototype creation
- Trailing and testing the product
- Obtaining approval and certification from the relevant regulatory bodies
- Registration of the intellectual property
- Overheads with regards to utilities, accommodation and support staff
The concept behind the cost method of valuation is that a business purchaser would not have to incur these costs if they buy the IPR. Furthermore, in doing so they would not have to suffer the financial and/or operational consequences of failing to successfully develop their own IPR, or deal with the potential difficulties in protecting it if they did develop their own.
One of the downsides of this method of valuation is that potential future profits are not incorporated into the calculation – it is based solely on the costs incurred, which does not take account of possible future success in the marketplace.
Income Approach. Discounted Cash Flow
The theory of the income approach is that the value of the intellectual property is the present value of the future economic benefits (income stream) it’s expected to provide. The economic benefits can be determined from historical results or future projections. When using the discounted future cash flow method, forecasts are typically prepared for five years and then these economic benefits are converted to the present value using a discount rate.