DR.

RAM MANOHAR LOHIYA

NATIONAL LAW UNIVERSITY, LUCKNOW

ACADEMIC YEAR: 2023-24

IP MANAGEMENT

RESEARCH PROJECT ON

Methods of Intellectual Property Valuation

SUBMISSION TO – SUBMISSION BY –

Prof. Vikas Bhati Jyoti Gautam

Assistant Professor (Law) B.A. LL.B. (Hons.) Sem 9th

Dr. RMLNLU, Lucknow Enrollment no. 190101074

 ACKNOWLEDGEMENTS

I would like to express my special thanks of gratitude to my Professor Vikas Bhati gave me the
golden opportunity to do this wonderful project on the topic Methods of IP Valuation, which
also helped me in doing a lot of Research and i came to know about so many new things I am
really thankful to them.
Secondly, I would also like to thank my friends who helped me a lot in finalizing this project
within the limited time frame.
TABLE OF CONTENT

 DEFINING INTELLECTUAL PROPERTY

 INTELLECTUAL PROPERTY’S INCREASING IMPORTANCE IN CORPORATE
AMERICA INTELLECTUAL PROPERTY
 OVERVIEW OF VALUATION
 INCOME APPROACH
 MARKET APPROACH
 COST APPROACH
 CONCLUSION
DEFINING INTELLECTUAL PROPERTY

Intellectual property (IP) shares many of the characteristics associated with real and personal
property. For example, intellectual property is an asset, and as such it can be bought, sold,
licensed, exchanged, or gratuitously given away like any other form of property. Further, the
intellectual property owner has the right to prevent the unauthorized use or sale of the property.
The most noticeable difference between intellectual property and other forms of property,
however, is that intellectual property is intangible. That is, it cannot be defined or identified by
its own physical parameters. Consequently, IP must be expressed in some discernible way to be
protectable.

To be patentable, an invention must be novel, unique, useful, and nonobvious. A prerequisite to

patentability is that the invention must be capable of some practical application. This emphasizes
the importance the patent system puts on usefulness. One might say that a patent is a contract
between society as a whole and an individual inventor. Under the terms of this social contract,
the inventor is given the exclusive right to prevent others from making, using, and selling a
patented invention for a fixed period of time in return for the inventor's disclosing the details of
the invention to the public. Thus, patent systems encourage the disclosure of information to the
public by rewarding an inventor for his or her endeavors.

Under all patent systems, once this period has expired, people are free to use the invention as
they wish. The benefits of an effective patent system can be partially illustrated as follows:

 A patent rewards the investment of time, money, and effort associated with research. It
stimulates further research as competitors invent alternatives to patented inventions, and
it encourages innovation and investment in patented inventions by permitting companies
to recover their research and development costs during the period of exclusive rights.
 The limited term of a patent also furthers the public interest by encouraging quick
commercialization of inventions, thereby making them available to the public sooner
rather than later. Patents also allow for more latitude in the exchange of information
between research groups, help avoid duplicative research, and, most importantly, increase
the general pool of public knowledge.
Intellectual Property’s Increasing Importance in Corporate America Intellectual property

Ten years ago, that phrase wasn't even in the vocabulary of many CEOs, let alone a part of their
business strategies. Indeed, many chief executives still regard patents, trademarks, copyrights,
and other forms of intellectual property as legal matters best left to the corporate attorneys. But
the burgeoning knowledge economy has given rise to a new type of CEO and a new type of
business competition--one in which intellectual property, not fixed assets, have become the
principal sources of shareholder wealth and competitive advantage.

The rise of the knowledge economy means that the intellectual property owned by a company is
likely to determine its future economic success. Because intellectual property offers
differentiation between products, it often holds the key to fast growth in market share and
premium profits. Indeed, a leading product may derive its success from all seven of the major
types of intellectual property: trademarks, design rights, copyrights, patents, know-how,
confidential information for manufacture (so-called trade secrets), and finally databases (e.g.
software to manage the supply chain and targeting).

Companies are increasingly looking to acquire undervalued and underused intellectual property.
Indeed, the new millennium will see a new breed of corporate raiders, who strip-out and sell
intellectual property, just as their predecessors did with undervalued tangible assets in the 1980s.
In recent years, IP valuations have crept into a wide array of business situations, including:

 Evaluating potential merger or acquisition candidates

 Identifying and prioritizing assets that drive value
 Strengthening positions in technology transfer negotiations
 Making informed financial decisions on IP maintenance, commercialization and donation
 Evaluating the commercial prospects for early stage Research & Development (R&D)
 Valuing R&D efforts and prioritizing research projects
 Supporting a valuation for loan collateral

Thus, the quality and accuracy of IP valuations have become an important focus of senior
management. We turn now to a review of the valuation techniques frequently used to value IP.
OVERVIEW OF VALUATION

There are three basic methods of valuation, namely, cost, income and market approach.
Irrespective, of the differences in these approaches the aim of all three remains to be the same,
that is, to determine an indication of the value of IP asset at a certain date. The method adopted is
largely dependent on the stage of development of the technology or product. Empirically, the
income approach is viewed as the most economically appropriate method for IP valuation. It can
be said that one or a mixture of approaches can be adopted in a case, also for the reason of
crosschecking the assumptions that had gone into making that valuation in order to reach upon a
meaningful result. 1It is often good practice to employ multiple approaches.2With regard to the
stage of development generally it can be said that when the technology has some time from
reaching the market, then the most preferred method is the Cost approach. Reason is the
uncertainty around the technology. Once that technology is developed that uncertainty is over,
and then the market approach becomes preferred one. In case when the revenue is imminent out
of the commercial exploitation of the technology then the income approach is the most preferred
one. The three approaches have been explained in detail in the coming part.

INCOME APPROACH

Income approaches focus on the future cash flow derived from a particular piece of IP. As with
all income valuations the need to accurately forecast future cash flow is of paramount
importance. The following variables are needed when using an income approach:

An income stream either from product sales or licensure of the patent

An estimate of the duration of the patent’s useful life

An understanding of patent specific risk factors and incorporating those into the valuation

A discount rate

1
SeeMatsurra, Jeffrey H., “An Overview of Intellectual Property and Intangible Asset Valuation Models,” Research
Management Review, Vol. 14, No. 1 (Spring 2004).
2
SeeWiederhold, Gio. Valuing Intellectual Capital. New York; Springer (2014). Ch. 5, pp. 85–150. Chaplinsky,
Susan, “Methods of Intellectual Property Valuation,” University of Virginia, Darden, UVA-F-1401.
Unlike most enterprise or fixed asset valuations, intellectual property assets have their own set of
unique risk factors. Some of these risks are:

 New Patent Issuance: New patents can either make existing technology obsolete or, more
likely, allow for another competitor in the same space. If a similar patent is issued the
value of the underlying technology will decrease. One key difficulty of the patent process
is that it is nearly impossible to know what has been filed with the U.S. Patent and
Trademark Office (USPTO). Only issued patents are publicly available information and
therefore the risk posed by pending patent claims cannot be easily foreseen. Exhibit 2
lists the number of new patent applications filed and granted by the USPTO from 1970 to
2001.
 Patent Challenges/Declared Invalid: An issued patent remains open to attack for
invalidity, and it is a common defense for an alleged infringer to assert that the patent is
invalid. Typically, patents are challenged on the grounds that someone other than the
named inventor invented the claimed property, that the invention is “obvious” to persons
skilled in the relevant technology, or that the patent is not unique and too similar to
existing methods. Successful challenges can immediately invalidate the patent and
corresponding licenses. In principle, proper due diligence should turn up these potential
problems.
 Patent Infringement Suits: Licensees could be held liable and ultimately pay three times
damages. Again, due diligence should reveal any potential problems of overlapping,
uncited prior or concurrent claims.
 Trade Secrets: Some patents are virtually worthless without the necessary trade secrets.
An example of a “worthless” patent is a pharmaceutical patent for a specific drug that did
not reveal the exact “recipe” for formulating the drug. The inventor(s) of the patent need
to cooperate and share those trade secrets to maximize the value of the patent.
 Foreign Governments failure to comply with Patent Cooperation Treaties: This is a major
issue for software patents, many of which are pirated in foreign countries and sold into
the world market.

Discounted Cash Flow (DCF) Method

The discounted cash flow approach attempts to determine the value of the IP by computing the
present value of cash flows, attributable to that piece of IP, over the useful life of the asset.
Unlike an enterprise DCF valuation, terminal values are rarely used, as the useful life of a patent
is typically a finite period of time. Since 1995, patents expire 17 years after issuance or 20 years
after filing. While this does not imply that patents cannot have value after 17 years, it usually
implies some diminution of the patent’s value beyond this point. At expiration, competing
identical technologies can enter the marketplace. A good example of this is generic
pharmaceuticals, there is still value in the “name brand” product after a patent has expired, but
numerous generics typically enter the market. Valuations of patents will vary based on the
degree of post expiration cash flows assumed. For this reason, most analysts usually begin by
assuming no value is expected after expiration of the patent and then consider other assumptions.

The same methodology used to forecast free cash flows and an appropriate discount rate in an
enterprise valuation apply to an IP specific valuation. Free cash flows are forecasted for the
useful life of the patent and the discount rate is the company’s market based rate of return,
assuming that the company’s business risk is equivalent to the patent under consideration. The
forecasted free cash flows should also be adjusted for the probability of a patent’s success. The
risk factors outlined above affect the likelihood of a patent’s success.

The benefits of the DCF method are its ability to compare values among different patents, likely
availability of many of the required inputs from the firm’s financial statements and market
information. A drawback of DCF is that it does not capture the unique independent risks
associated with patents. All risks are lumped together and are assumed to be appropriately
adjusted for in the discount rate and the probability of success, rather than being broken out and
dealt with individually (i.e., such as legal risk, technological risk, piracy, etc.) Further, often
DCF fails to consider dependencies on properties held by others. In roughly 40 percent of cases,
patents depend on other patents or property held in the public domain.

Venture Capital Method

The Venture Capital valuation technique also derives a value for a patent from the cash flows
that arise over the asset’s life. It differs from the DCF method in that a fixed non-market based
discount rate is used, usually 50 percent (40-60 percent range), and there is no explicit
adjustment for the probability of success. This method does not account well for the patent
specific risk factors outlined above. Like the DCF, cash flows are assumed to be static and
independent risk factors are lumped together. In valuing intellectual property, this simplicity is
the method’s greatest drawback.

Relief from Royalty Method

Relief from royalty is based on deprival value theory and looks at the amount of income that a
company would be “deprived” of, if it did not own the intellectual property in question but was
required to rent it from a third-party instead. The royalty represents the rental charge, which
would be paid to the licensor if this hypothetical arrangement were in place. The ability to
determine an appropriate royalty rate depends upon the specific circumstances and requires the
identification of suitable comparable transactions and prices involving third parties.

Obtaining a royalty rate is only a first step however and a reliable sales forecast is also required
in order to estimate the income that flows directly from the intellectual property. As with other
income approaches, an appropriate cost of capital has to be determined.

This method is useful because the market size and expected market share are generally accessible
information. In addition, the method is also intuitive in that the value of a property is defined as a
rental charge other companies would pay to use it. One significant drawback of the relief from
royalty method is that a rental charge can always be assumed, when in reality one may never
materialize. The plain fact is that some patents may be of little value and thus are not worthy of a
rental charge.

MARKET BASED APPROACH

The question in this approach is, “what is comparable price or royalty that would be achieved by
similar technologies or IP?”.As such, it is the clearest form of determining the market value of an
IP asset is by auction. But this comes with its own difficulties, namely:

- Insufficient number of bidders

- Publicity costs;
- Time required to notify potential bidders and time required to assess the IP;
 - Involvement of the enterprise to assist purchasers to make full use of the IP or
technology;
- Proving that the technology in which IP subsists is well-developed.

This approach is also known as Transactional method and involves contemplation of market
transactions as evidence of prevailing values for the subject IP or an IP asset similar to the
subject IP.3 This approach can take two forms, namely direct and analogous. The former
involves evaluation of any past transactionthat have been entered for the subject IP itself. While
the latter considers prices paid for similar IP in similar circumstances to those assumed to prevail
at the contemplated transaction. 4

The benefit of this method lies in parties’ general familiarity with the underlying concepts of this
method due to its widespread applicability. 5Also this approach is associated with a relatively
small number of assumptions, which may be disaggregated by the parties seeking to find
aggregable terms in negotiations.

However, it can be complicated in case of IP because of the distinctive nature of each IP and in
unique ways it can give competitive and financial edge in different organizational context. it can
be said that this method would be most useful in situations where useful transactional data can be
accessed and analysed.

COST BASED APPROACH:

This approach is based on the economic principle of substitution and price equilibrium. The
underlying assumption is that an investor for the IP or associated technology will pay no more
than the cost to obtain an asset of equal utility. 6 Howsoever, this approach has been criticized 7for
its limitations, like:

3
Martin, Daryl and David Drews,supra Note 5
4
Wirtz, Harald, supra note 3 at pp. 40–48.
5
Hoffman, Jan, supra note 12
6
SeeGoldscheider, Robert, “The Classic 25% Rule and The Art of Intellectual Property Licensing,” Duke Law &
Technology Review, No. 6 (2011), p. 15. Collan, Mikael and MarkkuHeikkila, “Enhancing Patent Valuation with
the Pay-Off Method,” Journal of Intellectual Property Rights, Vol. 16 (September 2011), pp. 377–384 at p. 378.
7
See Rozek, Richard P. and George G. Korenko, supra note 8 at pp. 81–102. Also see Chaplinsky, Susan, supra note
10. Also see Hofmann, Jan, “Value Intangibles,” Deutsche Bank Research (October 19, 2005).
 i. Does not reflect the economic factors (like competitors’ activity, current demand for
the asset);
ii. Does not reflect economic life of IP;
iii. Risk is not directly factored into;
iv. Does not inform the likely price a person may be prepared to pay for the IP.

Despite these limitations, it is employed for the reasons as mentioned in the introductory part as
a preferred method when the technology has not been fully developed. It is also used when other
approaches cannot be applied 8, like, information requirements for other approaches cannot be
met. This is also useful in cases where the IP asset can be easily designed around as the
prospective buyer would contemplate redevelopment cost considerations. 9There are two methods
under this approach, namely Cost of Replacement and Cost of Reproduction. In the former an
assessment of the cost for the enterprise to replace the technology or IP with the equivalent
utility is done. It seeks to reproduce the utility and does not take into account the market demand.
While the latter is based on the premise that a replica of the IP will be made, that is, the cost to
recreate the IP in the same form.

CONCLUSION

In the conclusion, it can be said that there are various methods available for IP valuation.
Howsoever, one should be mindful of following things when undertaking the exercise of IP
valuation:

a. There must be an appreciation of the uniqueness of IP as compared with non-IP assets as

that would have a bearing upon the valuation process.
b. The kind of IP to be valued should be considered as the assumptions and objectives
would vary accordingly, say it would be a different scenario for patents as compared with
copyright and trademarks.
c. The IP valuation is based on assumptions and information-input from the enterprise to the
appraiser. Thus, correctness of the information is essential to reach upon a meaningful
result.

8
SeeDrews, David, “The Cost Approach to IP Valuation: Its Uses and Limitation,” Corporate Intelligence website
(www.corporateintelligence.com), (January 12, 2001).
9
SeeGrain Processing Corp. v. American Maize-Prods. Co., 185 F.3d 1341 (Fed. Cir. 1999).
d. Enterprise and appraiser both should clearly be mindful of the objective of the valuation
and the stage of the development of technology or the IP.
e. Accordingly, an appropriate method should be adapted. It should be pointed out that
every method can have its limitations and difficulties, may be inherent, or due to practical
reasons. Therefore, it is advisable to have a mix of approaches or as well utilization of all
the approaches in order to sometimes cross checking the underlying assumptions or to
reach upon a meaningful result.