In an increasingly flat world defined by globalization and fast technology driven markets, most of the talk across seminars, conferences, workshops and some boardrooms today revolves around creating value out of intangibles. Intangibles, especially Intellectual Property (IP), are recognized as one of the most valuable asset of an enterprise. A well—identified, managed IP in an enterprise can help it in attracting new investment, in new research and product development, in hiring the best and brilliant minds, and in expanding across geographies, while surpassing competition.
Success is no longer just dependent on ownership and management of tangible assets.
If one were to look at the recent events in the banking system of developed economies, a key reason for the banking system to be so close to a complete meltdown could be attributed to the poor understanding amongst key stakeholders of the complex financial instruments. In a similar vein, intangibles running an entire global market would require identifying, understanding, managing, nurturing and leveraging such intangible assets before it is too late.
When we take an historical view, over the past three decades many enterprises have attained leadership position through effective IP management. During this period, intangibles have started occupying a higher proportion of many corporate balance sheets than ever before. In this context, it becomes extremely important to identify ways to exploit the IP, assess the risks and rewards associated with it, and decide the best strategy to manage it. To determine these, the holder needs to assess the current and the potential value of the IP under each scenario.
If one were to look at India, over the past decade, India has been on the forefront of putting IP frameworks in place, with a number of inspiring legislations in place to protect and promote IP management. The increase in awareness of IP amongst scientists and enterprises is also seen in the increased filings for patents and trademarks at the Indian Patent Office (IPO). By 2010, filings for patents are expected to touch 100,000 per year, while trademark filings would increase to about 150,000 per year.. As India moves towards a knowledge and increasingly IP-based economy and is emerging as a globally sought-after IP destination, this article aims to be a primer that touches upon some of the new and traditional concepts associated with valuing the intangibles.
Measuring, protecting and maximizing the value of IP is of paramount importance for companies of all sizes and across most industries. Valuation is of high significance as it helps in valuing IP in the in-licensing/out-licensing processes, sale of IP and alliance/JV decisions, for employee inventor compensation related to technology transfer and for patent pooling.
Before valuing IP, the valuer has to gain an understanding of the purpose and context of valuation. The value of an IP depends on the expected future cash flows derived from use or exploitation of the IP. Today there are nearly 50 methods of valuation of IP. But there is no standard approach followed. One size fits all approach does not work in case of valuation of IP as it is unique by nature. Conducting an IP valuation that makes sense to more than a few experts is a Herculean challenge. It is a matter of high subjectivity involving various assumptions, perceptions and judgment, making it complex and difficult to get consensus on the best method of valuation applicable.
As rightly quoted by Aristotle “It is a sign of an educated mind not to expect more certainty from a subject than it can possibly provide”, we cannot arrive at value with certainty but valuation requires an intermediate perspective between ignorance and certainty and requires skill, experience and judgment. It is time and context based. The best that can be said about current methods of IP valuation is that they are better than nothing. But how much is a question of substantial disagreement.
There are many proprietary and specialized approaches to IP valuation. These range from subtraction theory of value, to a profit-split approach, to VALMATRIX® and Brand Value Equation (BVETM) proprietary methodologies.
Some of the key traditional approaches to valuation include the following:
Two different styles are often applied in valuing IP on cost basis.
(i) Historical Cost basis
(ii) Replacement or reproduction cost basis
In the first style, the asset is valued based on the cost incurred in developing the IP. The second style considers current prices to calculate the costs of replicating the asset today. One point of caution is that we should not forget to include the opportunity cost of delayed market entry in calculating the cost.
This method does not reflect any potential earnings out of the IP and hence is not highly appreciated in many cases and is least applicable when the asset is old or hard to recreate Its correlation to the utility or the market value is least.
However, this may be the only data found or suitable to the context in some cases. In any event, this approach often (but not always) provides the floor price or minimum value. One example of such an application is to make decisions of licensing out during one of the stages of clinical trials.
Under this approach, IP is valued by comparing recent sales or transactions involving similar assets in similar markets. Such an approach would require an active market, sufficient number of similar exchanges/transaction and publicly available price information. Some of the common sources for such market data include Royalty source, Royalty stat, Knowledge express.
Apart from the major problem being finding of a comparable asset, it also ignores the deal leverage. However, in practice, when the data is available, the market approach is practical, logical and applicable to all types of intangible assets. Also, when reliable data is available, market approach is considered the most direct and systematic approach to value.
This approach is based on determination of future income streams expected from the asset under valuation. This is one of the widely used approaches as the information necessary to determine value using this approach is usually relatively accurate and often readily available. The parameters required in this approach include future income stream, duration of the income stream and risks associated with generation of the income stream. As per this approach, an asset will be worth the present value of future economic benefits that will accrue to its owner. Future income attributable to the IP is projected for an estimated duration of the income stream taking into consideration the risk associated with generating the projected income stream.
The main advantage of this method is that a sensitivity check can be done on the assumed parameters that go into valuation of the property.
There are four variations to income approach:
Price Premium Method:
Price premium method measures excess over guideline company earnings of companies that do not possess the IP being valued.
Production Savings Method:
This method gives importance to the contribution of IP to inputs which result in cost savings for the entity possessing IP.
Relief from Royalty:
This is a commonly used method when the revenues attributable to the IP over its economic life can be separated from other sources of revenue. Royalty rate of a comparable asset is considered and this rate is applied to the projected revenues attributable to the IP. An appropriate tax charge is then applied and the resultant cash flows are discounted to the present value to realize the ultimate value of the IP.
When the earnings attributable to the IP cannot be separately estimated, this method is of higher significance. In this method, the operating earnings after taxes are estimated, the fair return on average balances of other assets are subtracted and net present value of resultant cash flows is considered as the value of the IP.
There are some other IP specific valuation methods including “The Twenty Five Percent Rule”, Ranking and Rating, Monte Carlo Analysis and Real options.
As per the “Twenty Five Percent Rule”, the licensor should receive 25% of licensee’s gross profit attributable to the licensed technology. This percentage could be adjusted upward or downward on a case to case basis to reflect respective investment and risk in licensed technology. This method is better for process than product technology.
Ranking & Rating methodology is a qualitative approach where the IP is ranked and rated on some important parameters. This is more useful qualitative method for comparative analysis between various intellectual properties and is a good tool for the management to take some important strategic decisions for better management of IP.
Monte Carlo simulation is a process where a probability is assigned to a set of random values within a range and these values are assigned to the variables used in the valuation process. These variables could be price variables like price premium and additional units sold or cost variables like cost of goods sold and Selling & General administrative expenses. Calculation of net present value of the cash flows derived on the basis of the variables is repeated for a number of times and multiple NPVs are then plotted by frequency of occurrence, to obtain most likely NPV. But the point to be noted here is that the NPV values are no better than the range of extreme values selected.
Real option is viewed as an option to develop the IP further or to abandon it or sell it depending on future technology and market information. This method is most useful for IP investments with long-term returns and high risks because it recognizes that risk of IP investment is not uniform over time as additional technical and market information becomes available.
This has been a brief overview of methods that are commonly used for IP valuation but care should be taken not to over simplify the process involved. The valuer should identify the primary methodology that best satisfies the valuation criteria and where possible should support or cross check the valuation with other acceptable methodologies. In other words, an enterprise should take steps to understand the tools, means, methodologies and techniques that could help them to deal with and quantify both the upside potential and downside risk related to these situations. In addition to developing an awareness of the various methods and approaches available for valuing the IP, it is crucial that the IP team should understand which of those methods best suit their company's unique circumstances, and then get mastery over the science and art of applying them correctly.
While making an outline of the path to enlightenment, it is important that steps should be taken by the IP Finance team to attain the critical goals along the path. The failure to understand and master IP valuation by the IP finance team would result in poor performance and umpteen suboptimal decisions, while the acquisition of the essential skills would ensure a bounty harvest of the value vested in an IP. In the current economic climate, the team that makes the right calls on key decisions would emerge stronger post-recession, and would be perfectly-placed to enter the global IP marketplace of the near future.
- This article has also been published in the July 2009 Edition of The Society for Technology Management (STEM) newsletter
- Prabhu Ram is Manager-Technology Management Practice with Sathguru Management Consultants, responsible for several key innovations arising from publicand private sources globally. He has over 10 years of rich experience in IntellectualProperty and Technology Management in multi-cultural environments acrossgeographies. He holds a M.Sc. in Life Sciences from Calicut University, India and Associateship in Information Science (AIS with specialization in Intellectual Property) from National Institute for Science Communication and Information Resources, CSIR, India. He is an active member of AUTM Communications Committee, and is on the editorial board of the AUTM journal, Tomorrow's Technology Transfer. He is widely published in the field of Technology Transfer and IP Management.
- Sujana Hari is an Associate Consultant-Finance with Sathguru Management Consultants, with a keen insight on business management, investment analysis, corporate finance and strategy. She is highly focused on valuation of new innovative technologies. Sujana is a B.Tech. from Jawaharlal Nehru Technological University, India and a Post Graduate in Business Management (PGDBM with specialization in Finance) from Bharathidasan Institute of Management, India.