Alternate Approaches to the

Valuation of Intellectual Property

By Weston Anson
Print Art
February 11, 2015

EDITORIAL NOTE: This article is co-authored by Weston Anson and Joshua Cawthorn

__________

Techniques for valuing intellectual property

continue to develop, especially as access to
information becomes easier and more efficient.
The practice of valuing intellectual property has
only been around for the past few decades,
during which time the practice itself has grown
and refined.

Valuation is necessary in a number of context-specific situations, including:

In a sale, merger, joint venture or similar commercial transaction;

In a divorce (be it personal or business related);
Bankruptcy
Estate planning
When licensing IP; and
Litigation

Valuation analysts and IP professionals agree there are three standard methodologies to
value IP:

1. Cost Approach: The historical cost to develop an asset is sometimes used to

determine its value. However, the cost to develop an intellectual asset is rarely
representative of its ultimate value. This approach is less useful for intellectual
 properties used with products that have reached the market and generated
revenues. Generally, the cost approach is better suited to analysis of intellectual
properties and products that have not yet been developed commercially, or that
could be re-created quickly, as it reflects the cost a company could avoid by
purchasing, rather than duplicating, a similar development effort.
2. Income Approach: The income approach calculates the present value of future
income streams specifically attributable to the intellectual property asset. This
method utilizes forecasted financial results based on factors such as historical
financial results, industry trends, and the competitive environment.
3. Market Approach: The market approach values intellectual properties by comparing
the subject asset to publicly available transactions involving similar assets with
similar uses. This provides a reasonable indication of value if an active market
exists that can provide examples of recent arm’s-length transactions, with adequate
information regarding terms and conditions.
4. Relief from Royalty Approach: In the relief from royalty approach, a hypothetical
situation is created to estimate what a business would pay to license its own
intellectual property assets in an arm’s-length transaction. The value is then
calculated as the present value of the avoided hypothetical royalty charges.

The decision of which approach to use is generally based on four factors: (i) how unique is
the asset; (ii) how much data is available and verifiable; (iii) what is the context, purpose or
objective of the analysis; and (iv) the judgment of the analyst which (one would hope) is
based on extensive earlier experience.

In addition to the traditional methods used to value intellectual property, several

alternative methods are available. Some are modifications of the orthodox approaches
with which most are familiar, but many other choices exist to value these complex assets.
Below is a brief summary of these; a detailed explanation of each methodology could fill
websites. Instead, this serves as a brief introduction to alternative intellectual property
valuation approaches.

Continuing Developments
As part of a still developing discipline, there are at least 25 alternative valuation techniques
to be employed. I would encourage an interested reader to continue doing research on the
methods shown here, if the details provided below are insufficient. This article is intended
to serve as a cover of alternative IP valuation methods and not meant to provide a detailed
explanation or how-to manual for valuing intangible assets. Some things in life offer the
luxury of “one size fits all,” however, the orthodox valuation measures that most of us are
familiar with — namely the income, market, and cost approach — are often modified even
slightly to meet the needs of both the IP that is being measured, the data available, as well
as the context of the valuation. The methods being explained below are frequently
associated with a certain IP asset. An example of this is the Venture Capital Method, which
is a technique that derives a value for a patent from the cash flows that arise over the
asset’s life. Although it is similar to the income approach that utilizes a discount cash flow
analysis (DCF), it possesses two differentiating factors: a fixed, non-market based discount
rate is used and there is no explicit adjustment for the probability of success. We have
broken them up into two groups: generally accepted and specialized/proprietary.

Group A – Generally Accepted

Brand Contribution Methodology: The Brand Contribution Methodology is another market-
based methodology for valuing IP. The contribution made by the brand may be separated
from the profit contributed from other elements of the business in multiple ways: 1)
comparing costs charged by a manufacturer and distributor of the unbranded equivalent
(also known as the “utility product”); 2) if one eliminates the value added by other assets,
the appropriate return on capital employed with respect to the product may be deducted
(this includes assets such as physical distribution systems, fixed assets, etc.); 3) the rate of
return (or “profitability”) of the business can be compared with the rate of return of a
comparable unbranded business (which is known as the “premium profits” method); and
4) comparing the premium price earned by the brand over the retail price of its comparable
generic equivalent (known as the “retail premium” method).

Replacement Cost: When using the Cost Approach to value an intellectual asset, two
separate methods under the cost approach shall be considered: the Replacement Cost
method and the Reproduction Cost method. The Replacement Cost method aggregates the
amount of money necessary to develop a replacement of the IP that provides the same
functionality or utility, in the same stage of development as the IP being valued, as of the
valuation date. It is important to note that the Replacement Cost measures the amount of
money in today’s dollars, rather than the amount of money that was spent historically to
develop the IP so inflation is accounted for. The logic behind this method is to calculate the
amount, in today’s dollars, to provide an equivalent substitute. Finally, calculating the cost
of an IP using the Replacement Cost method excludes the costs associated with any failed
or ineffectual models.

Reproduction Cost: The Replication Cost method is very similar to the Replacement Cost
method, but differs slightly in that it measures the aggregate costs necessary to develop an
exact duplicate of the IP being valued, in the same stage of development as the IP being
valued, as of the valuation date. Just like with the Replacement Cost, this calculation is
done in today’s dollars to appropriately factor in for inflation. And unlike the Replacement
Cost method, the Reproduction Cost method includes costs with associated prototypes.

Technology Factor Method: As the number of digital intangible assets rise, using The
Technology Factor Method becomes all the more common because it is applicable only to
technology. By measuring a technology’s contribution to a business’ total revenue, an
asset’s value can be determined. Specifically, the Technology Factor Method is another
method that is similar to the DCF method with respect to the calculation of an IP’s risk-free
net present value. Once the NPV has been calculated, it can then be multiplied with an
associated risk factor (what we will refer to as the “technology factor”). The Technology
Factor value incorporates the intellectual property’s strengths and weaknesses associated
with the related legal, market and economic risks.

Venture Capital Method: Analyzing the value of future cash flows over an asset’s life is a
common technique used to value intellectual property, which is precisely how the Venture
Capital method works. Although similar to the common DCF method, it is different in that a
fixed, non-market based discount rate is used (generally, a rate of between 40 to 60 percent
used). Additionally, no specific adjustment is made to account for the probability of success
(e.g., a patent’s success). Unfortunately, the Venture Capital method’s weakness is such
that it does not account well for specific risk factors associated with patents. Moreover, it
assumes cash flows are static and the independent risk factors (new patent issuance,
patent challenges or declared in valid, patent infringement suits, trade secrets, foreign
governments’ failure to comply with Patent Cooperation Treaties, etc.) are marshaled. It is
the simplicity of this method that harms its accuracy/credibility.

The Concept of Relative Incremental Value: This methodology works when one is trying to
represent some percentage of value of an individual asset that is associated with a larger
trademark or patent portfolio. For example, if an underlying trademark or brand has a
value of $100 million, and the domain name associated with it is generating 10% of
revenues (e.g.), then one can allocate a relative value of 10% of the total or, $10 million
dollars for the domain name.

Decremental Cost Savings Valuation: This is the method that quantifies a decrease in the
level of costs being experienced by the IP owner / operator. If, in fact, the IP owner can
quantify lower levels of capital or operating costs connected directly with the ownership of
the IP; then those lower costs can be a direct measurement of the value of the specific IP.

Enterprise Value Enhancement: The valuation analyst establishes the value of the IP
owner’s overall business enterprise value as a result of owning the IP – and then compares
that to the business enterprise value if the owner did not, in fact, have or control the IP or
was not able to use it in its business enterprise. The value of the IP then would be the
difference between the total business enterprise value and the business enterprise as
calculated without the IP.

Imputed Income Analysis: A subset of traditional income approach methods, this imputed
income analysis can be used quite effectively in valuing a domain name or sub brand
attached to a trademark; or in valuing flanker patents for a core patent portfolio. In the case
of a domain name, value is established by looking at the activity generated by the domain
name and associated website assets, relative to the overall value of the core trademark and
brand bundle. Therefore, one is able to estimate through imputation the relative value of a
domain name to its parent trademark.

Income Capitalization or Direct Capitalization Methodology: This is a method sometimes

used to estimate the value for intellectual property that has no predetermined statutory
expiration (like trademarks) and for which net income (royalties or profit) is not expected to
vary greatly over time (due to contractually-defined license fees, for example). This involves
taking an estimate of expected annual royalty stream (or profit) and multiplying this
amount by a factor known as the capitalization rate.

Income Differential Analysis: This particular variation simply means that a company
manufacturing and selling a product with a particularly strong trademark or unique
technology will receive more income than a competitive company producing the same
product but without the addition of the specific IP, such as the trademark or patent.

Liquidation Value: Found most often in bankruptcy situations, as the name implies
liquidation value for any piece of IP is the lowest price that the asset is virtually guaranteed
to be sold in a distressed situation. Used almost solely in bankruptcy, other distressed
situations or time critical contexts, litigation value scenarios arise most often in a Chapter 7
bankruptcy.

Premium Pricing Analysis: Of all the variations to the income approach, this is perhaps the
most easily understood – because the value of an asset is established by looking at the
difference in the price that it can command in the market, typically at wholesale, compared
to the average product in the market. The difference between these two prices is the price
premium. This, then, is projected out on an annual basis and a net present value
established.

Profit Split Methodology: A form of the income approach, it can be tricky to apply
accurately: because the profit split method attributes a share or portion of a company’s
profitability to a particular intangible asset. This method requires that the valuation analyst
have the ability to understand the IP to such an extent that he or she can isolate and
expressly separate the intangible asset’s profit generation potential from all the other
business assets – and then allocate that portion of profit split to the company’s operations
and capitalize that value over a number of years.

Group B – Specialized/Proprietary
Auction Method: There are several market-based methods of valuing IP using recent
comparable or similar IP transaction between independent parties (“arm’s-length
transactions”). One of these methods is called the “Auction Method.” If a hypothetically
perfect auction market existed, several potential buyers that each had all available
information regarding the IP would compete with each other to bid on the IP. Through this
auction process, a market-based price of the IP would be determined through bidding.

DTA (Decision Tree Analysis) Based Methods: While many people are familiar with the DCF
methods of valuing intellectual property, it comes with inherent weaknesses because it
relies on selecting discount rates appropriate to the risk associated with the various stages
in a property’s life. Not only does it require calculating the possible cash flows which might
occur, DCF methods do not account for the various possibilities open to project managers
(for example, the levels of risk if a patent lapses or is abandoned at differing stages along
the process). Unfortunately, there is no “exact science” to be applied for these and
experience is necessary to influence these decisions.

Assumptions can be built into the DCF model in an attempt to account for the possible
outcomes as the result of management decisions. Using what is known as Decision Tree
Analysis, a limited number of such managerial decision possibilities can be accounted for.
It is important to note, however, that the Decision Tree Analysis should be based on an
underlying DCF analysis of each branch. The recommended way to perform such analysis is
to begin with the final decisions and work backwards in time, which will result in a present
value.

The Decision Tree Analysis Method offers a big advantage over the DCF analysis: it factors
the value of flexibility associated with a project. However, assumptions still need to be
made regarding the discount rate (as does the DCF method). It is important to use a
discount rate appropriate with the level of risk involved at each stage of a managerial
decision associated with the development of a brand or IP.

The Brand Value Equation Methodology (BVEQ™): In this methodology, a core value for the
trademark is calculated, and then each of the individual other assets attached to the core
asset have their values calculated. Therefore, the sum of the core brand value plus the
incremental assets becomes a total brand value. Expressed in an equation it as follows:
BVEQ = CBV + IVE1 + IVE2… IVEn

The Competitive Advantage Technique: This technique is best used when the subject
company has a complex portfolio of intellectual property and works on the supposition
that the IP is giving its owner an advantage over its competitors because of proprietary
patents, technology, trademarks, software or other intangibles.

Monte Carlo Analysis of Value: This is a method to evaluate how possible future outcomes
can affect the decision of whether or not to use a new piece of IP based on possible value –
remember that this methodology is most useful in valuing early stage, non-commercialized
technology; and, in particular, where there are many unknowns and numerous scenarios
about the future development of the technology.

Options Pricing Technique (The Black-Scholes): Patent licensing shares at least one
attribute with all other relevant business decisions: it involves risk. Where decisions
involving financial risk are concerned, sound management principles suggest considering
ways and vehicles to hedge that risk. One of the central vehicles to hedge risk in modern
finance is an “Option.” A patent can be seen as the right to invest in or to license (or enforce
through litigation) an underlying technology or product line, during the term of the patent.
Therefore, an un-commercialized patent can be valued from this “options” perspective
using, for example, methods such as those derived from the famous “Black-Scholes”
model.

Snapshots of Value Approach: This is similar in nature to the business enterprise value
approach in that the snapshots value is based on establishing two different values for a
company: one, based on the assumption that the company has full access to the ownership
of the intellectual property and intangibles, and the second snapshot of value based on the
fact that the company does not have these assets. Measuring the difference between the
two snapshots establishes the value of the IP or intangible asset portfolio.

Subtraction Method of Value or Benchmark Method of Value: Establishing the value of a

company against another company by comparing them on a so-called benchmark basis is
the premise of this method of value. In one instance, the benchmark value will be a
company that owns a particular trademark or patent and the second value for a
comparable company that does not have that same asset.

The ValCalc Methodology: A proprietary approach employed by our firm, it is a variation on

the return on assets employed approach (see above). ValCalc establishes the economic
return that each intangible asset class should be earning. Calculations of adequate return
are applied also to all classes of tangible assets within a company. Then the return for each
intangible asset is calculated as a result.
Valmatrix Analysis Technique: This proprietary system was developed by our firm more
than two decades ago and employs a matrix of the twenty most important predictors of
value for a trademark, patent or piece of software. The predictors for each of these types of
IP are, of course, unique. They are used in a common manner, however: To score a given IP
asset against its peers on a numerical scale. Value is therefore established relative to
similar trademarks or patents.

An important side note for the interested reader: whenever possible, we recommend the
use of multiple valuation techniques when performing a valuation analysis. This is
especially true with intangible assets because active markets may not exist and
assumptions need to be relied on in making valuation conclusions. Moreover, uncertainty
may develop if one depends on a single methodology to value an IP asset (especially a
particularly complex family of technologies or brand assets). History has taught us that, as
with any new practice, the evolution of methodologies will be ever-lasting.

Conclusion
Valuing and analyzing intellectual property is still at a premature stage, the field itself
hardly more than a few decades old. As the process continues to evolve and experts refine
a multitude of methodologies, the art of valuing IP will continue to witness developments,
innovation, revision, and diligent progression of techniques to value intellectual property
and intangible assets. In all probability, the techniques listed above will either be outdated
or refined further to become industry standards.

Take, for example, the notorious Georgia-Pacific factors. For a long time, these standards
were implemented as a reliable damages quantification method in patent litigation.
However, in a 2012 interview between SRR Journal and Chief Judge Rader (considered to
be one of the leading authorities in IP litigation), has said they “were never meant to be a
test or a formula for resolving damages issues” and determined them to be “merely a list of
things to consider.” Conclusions such as this made by authorities such as Chief Judge
Rader alter the landscape of valuation calculation, ruling a once-standard technique to be
just a “relic” and “a flawed methodology.”

While we cannot make any definite suppositions about which techniques will escalate to
the forefront of IP valuation, it is safe to assume that some of these methods will become
obsolete while others will move the ranks to mainstream.

Image Source: Deposit Photos.

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valuation, Value, Value analysis
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