AN OVERVIEW OF IP ASSET VALUATION

Valuation of Intellectual Property Assets

Christopher M. Kalanje, Consultant, Creative Industries Division, WIPO

IP VALUATION
Valuation is a process of determining value or worth of an asset Valuation often combines objective and subjective considerations IP valuation is a relatively new area IP valuation is triggered by various factors

IP Valuation contd.
A Final valuation would depend on the following basic premises of value
Value in exchange: worth of the underlying IP asset in terms of its capacity to be exchanged in terms of money Value in continued use: worth of the underlying IP asset to its owner on the basis that it continues to generate income to the owner

IP Valuation contd.
Acquisition value: strategic potential of the underlying IP asset e.g uses in M & A Value in place: worth of the underlying IP asset as it is. i.e. the said IP asset is not in current use in the production of income

Value Basis of IP Assets

Traditionally IP assets were treated as Goodwill
Goodwill=the amount paid for a business in excess of the fair value of its identifiable net assets at the date of acquisition (see Peguin
dictionary of accounting)

Advent of knowledge economy and high market value of companies as opposed to book value enhanced interest on value of IP

Value Basis of IP Assets contd.

IP assets have distinctive characteristics which makes it possible to value them separately from other intangible assets These characteristics include
Independently identifiable Legally protected and enforced Transferable Economic life

Value Basis of IP Assets contd.

Factors influencing value of IP assets
High price
Large potential market Strong IPR (well written claim) Exclusive license Stage of technology (e.g. invention near commercialization stage) Option on leveraging

Value Basis of IP Assets contd.

Low price
Non-exclusive license Huge investments needed Still far from commercialization (needs further development) No option for sub-licenses

IP Valuation Triggers
As IA in particular IP take the central stage in determining the value of enterprises decision makers have to answer the following
Are returns on R&D satisfactory? Are patents worth renewing? Are brands worth defending? etc.

IP Valuation Triggers contd.

Enterprises need to formulate a strategy which would make IP assets more profitable IP valuation is imperative in facilitating decision making process on strategy to pursue Several factors (triggers) lead to IP valuation

IP Valuation Triggers contd.

These include
Sale or Purchase of IP Assets Licensing Merger & Acquisition Cost saving IP asset donation Joint venture arrangements/strategic alliances Financing

Methods of IP Assets Valuation

Valuation models may be broadly divided into two
Static models
Estimate value of accumulated intellectual assets at a point in time Does not differentiate temporal differences in the accumulated IP Does not differentiate the differences among different categories of IA at the time of valuation

Methods of IP Assets Valuation contd.

Static valuation models

Mkt value - Book value model

More info: Valuation of Intellectual capital and Real Option Models by Sudarsanam, S. et al http://www.realoptions.org/papers2004/SudarsanamIntellCap.pdf

Methods of IP Assets Valuation contd.

Dynamic models
Take into consideration the temporal difference in the accumulated intellectual assets (e.g. time value of money and riskiness of the forecast cash flow) Value investments in intangibles each at a time

Methods of IP Assets Valuation contd.

Discounted Cash Flow

Dynamic Models
Real Option Models

Methods of IP Assets Valuation contd.

Basic Methods
Cost Approach: Estimates the value of underlying IP asset basing on historical cost incurred in developing the asset
Replacement cost Reproduction cost

Methods of IP assets Valuation contd.

Market Approach (sales comparison approach):
Based on the value of similar or comparable assets that have been exchanged, at arm s length, in active market second variant uses standard industrial royalty rates

Methods of IP assets Valuation contd.

Income Approach: Based on the incomeproducing capability of underlying IP asset
Seeks to establish the net present value (hence use of discounted cashflow) Decision tree analysis (DTA)-based on an underlying DCF analysis and moves further to take into consideration flexibility available.

Methods of IP assets Valuation contd.

Net present value
Calculating the future value of intellectual asset (investment) at present time NPV= A(1 + r)-n i.e. NPV = A[1/(1 + r)n]

where: NPV= net present value (i.e. DCF); A= amount expected at year n; r = risk factor

Methods of IP assets Valuation contd.

Other IP valuation methods include
Monte Carlo simulation analysis Option pricing theory

Accounting Challenges
Rationale behind Accounting
Historically evolved to report tangible assets/liabilities Quantitative stock of performance Documentation of past financial position

Impact on Type of Language developed for IP

Silence about a lot of a firm s IP due to inherent definitions and assumptions in accounting

Accounting Challenges contd.

Rational
Factual, precise, objective, comparable information Determines perception of a firm s management and other market participants

Impact on Type of Language developed for IP

Internally and externally generated IP is treated differently Goodwill

Finally

Methods of IP assets Valuation contd.

MODERN VALUATION ANALYSIS IS EFFECTIVELY DCF APPLIED TO THE BUSINESS ENTERPRISE UNDER CONSIDERATION
The Net Present Value (NPV) of a strategy or business is the sum of its expected free cash flows to a horizon (H) discounted by its cost of capital (r) NPV = Year 1 Cash Flow + Year 2 Cash Flow ... to say Year 5 Cash Flow (1 + r) (1 + r) (1 + r)H PLUS The terminal value which is the value of the business at a horizon (HV) HV = Cash Flow (r - growth) Also discounted back to present value

Methods of IP assets Valuation contd.

Trademark remaining useful life continue in perpetuity after after period 5 economic income (royalty income) grows at 3% 15% is risk-adjusted discount rate

Methods of IP assets Valuation contd.

Discouted Cash Flow Analysis, Trademark Valuation Example
Present value discount rate Expected long-term growth rate In economic income Period 1 Projected economic income PV factor using 15% discount rate PV over discrete projection period PV of terminal value Cumulative PV 833.00 15% 3% Period 2 Perio 3 Perio4 Perio 5 Terminal value 966.00 0.4972

100.00 0.8696 87.00

103.00 0.7561 78.00

106.00 0.6575 70.00

109.00 0.5718 62.00

113.00 0.4972 56.00

480.00

Source: Meinhart, T. Intellectual Property Discount Rate and Capitalization Rates (ed) Reilly, R. & Schweihs R. The Handbook of Business Valuation and Intellectual Property Analysis