IP Valuation

Why should IP be integrated in your business plans?
If creating IP, take steps for protecting, managing and enforcing it, to get best possible commercial results If using IP belonging to others, consider buying it or acquiring rights to use it to avoid dispute and litigation According to a PricewaterhouseCoopers¶ analysis of US market, intangible assets and goodwill constituted 74% of avg. purchase price of acquired companies in 2003, with 22% being Intangible Assets

Intangible assets (IA) are the IPRs owned by the company including licenses, contracts, nonnon-compete agreements and so on Legal protection of IA turns them into exclusive property rights which can be commercialized and also gives competitive edge

IP as a business Asset
Use IP protection as an investment. Market value of a company based on  Assets  current business operations  expectations of future profits. The last constitutes IP assets Only legally protected rights have value Enhancement of market value Generates income by licensing, sale or commercialization of IP protected products

Value of company increases in the eyes of investors and financing institutions In the event of a sale, merger or acquisition IP assets raise value A good IP portfolio a defensive mechanism against potential competition Audit IP assets ± which ones to acquire and maintain, license, enforce, use as a collateral or security for debt finance

Nature of IP
Copyright/Related Rights
protects reproduction & performance in arts/software

Industrial Design Patents
protect products, business processes protects look of products, packaging, aesthetics

Trade Secrets Mark/ Geographical Indication
protects, logo, slogans, symbols protect business plans, know how, client portfolio, tacit knowledge, processes

Only IP that generates direct cash flows in a commercial transaction is considered

Protection against Unfair Competition

IP is an intangible asset, ...
Transferability
IP is transferable to a new or similar business context

Knowledge Content
Background of users & context determine relevance of IP to business

Perishability
Over time IP may become outdated, e.g. technology cycles

Nature of IP

Non Rivalry in Consumption
IP can be used simultaneously by different people without diminishing in its worth

Spontaneity
Successful IP creation is risky since there is a creative & a business element to it

Partial Excludability
IP guarantees a firm exclusivity and freedom to operate in the market

« which Accounting finds difficult to grasp
Rationale behind Accounting ‡ Historically evolved to report tangible assets/liabilities ‡ Quantitative stock of performance ‡ Documentation of past financial position ‡ Factual, precise, objective, comparable information ‡ Determines perception of a firm¶s management and other market participants 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 ‡ Internally and externally generated IP is treated differently ‡ Goodwill

How Accounting Concepts Impact Business
Concept
Internally Generated IP is immediately expensed, Acquired IP is valued at its acquisition cost, amortized or subject to an impairment test Fair value: ³Amount at which an asset could be bought or sold in a current transaction between 2 willing parties, other than a liquidation.´ Intangible Asset: ³« identifiable, controlled by an enterprise as result of past events & should generate future economic benefits for the firm.´ Goodwill: ³price a market participant is ready to pay in excess of the value of a firm¶s tangible assets.´

Impact
The same IP may be perceived to be worth nothing or 100 Mn $ Implies a benchmark, yet worth of IP depends also on context & background Much IP won¶t qualify since it has an indirect impact on cash flows Difficult to make worth of IP explicit & compare Goodwill of different firms

Advantages of Reporting IP
F O R M A N A G E R S

‡ Communicates the value of IP to investors
‡ Shows what IP the company owns ‡ Puts a value to the IP ‡ Explains how the IP relates to business segments F I O N R V E ‡ Get information on how IP drives growth S ‡ Receive adequate inputs for earnings/sales forecasts T ‡ Can better estimate risks/revenues of an investment O ‡ Can better understand the nature of a business R ‡ Increases predictability while decreasing volatility S

The IP Reporting Process
Build IP Business Culture
Create IP ownership Create

IP Ownership

Understand IP Ownership

Report IP

Generate Superior Results

‡Align IP portfolio to overall business strategy ‡Explain to all in the firm why IP matters

‡Ensure market position through IP ownership

‡ Use a reporting ‡Set system ownership in demonstrating correlation to the value of expected IP to your ‡Establish an results business enabling IP policy and ‡ Understand environment legal scope of IP

‡ Audit IP

$$$ or ¥¥¥ or £££

The story of Apple iPod - smart use of IP strategies to gain control over market Coke, Microsoft, Intel, IBM, McDonald¶s ± priceless brand value In the last ten years - smart companies have effectively used the IP system to create, extract or leverage the value of their intangible assets

Intellectual capital is recognized as the most important asset of many of the world¶s largest and most powerful companies It is the foundation for the market dominance and continuing profitability of leading corporations It is often the key objective in mergers and acquisitions

The role of intellectual property rights (IPRs) and intangible assets in business is insufficiently understood Accounting standards are generally not helpful in representing the worth of IPRs in company accounts IPRs are often under-valued, underunderundermanaged or under-exploited under-

Despite the importance and complexity of IPRs ± a neglected area Questions to be answered:  What are the IPRs used in the business?  What is their value (and hence level of risk)?  Who owns it (could I sue or could someone sue me)?  How may it be better exploited (e.g. licensing in or out of technology)?  At what level do I need to insure the IPR risk?

A key factor ± company¶s success or failure ± how effectively it exploits its intellectual capital and values risks Management need to know the value of IPs as much as they know the value of tangible assets Because business managers need to know the value of all assets under their control and stewardship

What is Valuation
Valuation is bringing together of the economic concept of value and the legal concept of property IP valuation ± value of a thing in a particular place, at a particular time, in particular circumstances Failure to take into account these factors will make IP valuation meaningless

Value concepts
Owner value ± Properietor¶s view of value if he were to be deprived of it Market value ± Assumption if comparable property has fetched a certain price, then the subject property will realize a price near to it Tax value ± different countries have different tax laws

Fair Value
The concept develops from the desire to be equitable to both parties It recognizes that the transaction is not in the open market and that the vendor and purchaser have been brought together in a legally binding manner Neither of them is under any compulsion to act and both have reasonable knowledge of all relevant facts

Why undertake Valuation of IP Assets
It helps the IP owner to  Use  Protect  Insure  Sell  Leverage  Exchange ‡ IP assets in a most cost effective way

Situations
Licensing 
Before licensing an IP ± accurately know

its value  Helps the Licensor to put a value  Helps the Licensee to compare with competitors

Mergers & Acquisitions 
Increasing contribution of Intangible Assets to

overall market value of enterprises  Each party submits to the other (after signing CA/NDA) an IP Due Diligence Report

‡ Cost Saving  Some IPs ± prohibitively expensive to

maintain  Some maybe below a benchmark value  Cost ± benefit analysis ± whether to maintain, license or allow it to lapse

Donation of IP Assets  Some countries have tax benefits attached to donations to non-profit organizations, nonlike Universities  If an IP asset no value to a company ± does not mean valueless  It might need further development  It might suit the NPO  To reap tax benefit ± value IP

Sale or purchase of IP Asset  IP assets can be identified, segregated and totally decoupled from the rest of the assets  Can be sold and bought independently of each other  Good to know a fair value of the asset  Helps in taking an informed decision by the parties involved

‡ Joint Venture/Strategic Alliance 

To determine the share of each enterprise

in a new entity
Litigation Support 

Substantial increase in IP infringement

cases  Analyze the damage caused and estimate the value that the owner should be paid  Knowledge of value crucial in determining the course of action to be taken by the owner

‡ Collateralization and Securitization  Banks in some countries have started accepting

IP assets as collaterals for giving loans  Venture Capitalists also accept IP assets as security for a start up venture

Securitization  Refers to pooling of revenue ± generating assets and issuing securities backed by them  Can raise a bank loan without loosing control over securitized assets  With more reasonable terms ± including payment over a longer period of time  E.g. Securitization based on the future music royalty streams of a portfolio of songs of David Bowie

How is valuation done ?
It is not like finding the price of a standardized products like a car or a cycle Local newspaper or a local dealer will not tell the price Uniqueness ± image that the trademark is carrying or the technological solutions that the patent is protecting Fair Market value ± Depends on various inputs like competitive environment and the existence of alternative methodologies

Parameters for Assisting Valuation
Competitiveness  An idea capable of IP registration ± not immune to competition  Alternate methods of achieving the same results ± patent  Competition among brands  Competition from generic manufacturers

Quality of Provenance ± The source of IP has a bearing on its ultimate value  A device, for e.g., which considerably reduces CO2 emissions in an industry will have considerable value in the market  In one case this device is made by an established company ± they already have resources to manufacture, distribution network and goodwill in the market  In the second case ± by a lone inventor in his workshop ± will require considerable inputs for both manufacturing and distribution  The value will be more in the former case

Transactional  The lone inventor decides to license to the company in the first case  The price obtained by the inventor would probably be higher than if he marketed himself  This will be lower than value to the company  E.g. If Bill Gates were to have licensed DOS exclusively to IBM ± IBM would have made more money  The aggregate value of Windows/DOS would have been lower

‡ Intent  Withhold a new technology ± increase the

life of existing technology  To restrict competition ± prevent technology to enter market  If a big organization ± cannot be forced into a sale of its IP or no commercial strategy to change its IP policy ± a valuation not appropriate

Function  A patent used for protecting the central concept  Peripheral patents to protect the basic one ± only have value along with the core patent  The value of these patents will be less than those of the others

Valuation Methodologies
Possible only if such assets can be specifically identified and clearly segregated from other assets IP assets are and will always remain hard to appraise It is as much art as science It determines the monitory value of an IP asset and is based on existing methods used in tangible property

Income Approach
Focuses on the consideration of the income producing capability of the IP asset Relevant for patents, trademarks and copyrights It estimates the present value of a stream of revenue that would result from the use of underlying IP asset during its economic life Economic life may differ from duration of IP protection This is the most popular method

Five parameters to be kept in mind:  Revenue or income associated with the use of the IP  Expected growth characteristics of the identified revenue or income  Expected duration of the revenue or income  Risk associated with generating the estimates of revenue or income  The proportion of the revenue or income that is attributable to the subject of IP

Producing an accurate forecast of revenue depends on:  Competitive & economic environment in place during the appropriate timeframe for the valuation  Need to accurately predict property¶s remaining economic life  Forecast not beyond a patent¶s life  2-3 life expectancy span for a trademark which has been in use for 25 years is conservative

Income Approach - Relief from Royalty Method
Company determines the royalty rate of an IP asset it currently holds, if it were to buy from someone else Having determined this, it goes on to calculate the amount of money, in the present value, that it was relieved from paying ± if it had to buy or license the IP asset Most convenient method ± shortcomings ± may or may not provide true value

Income Approach - Incremental Income Method
Discounted Approach Incremental Income Approach  Forecasting year-by-year future streams of year-byincremental income ± resulting from use of the IP asset ± and then discounting those into present value  Trademarks ± segregating the additional gross income from increased sales revenue due to the trademark  Patent ± segregating the savings from expense reductions in operations due that patent that reduces material usage

Income Approach - Incremental Income Method
Capitalization of Incremental Income approach  Focuses on actual income generated through the use of the IP asset  Uses such information as an indicator of future potential growth

The Market Approach
It is based on comparing the value of sales of earlier similar/comparable IP assets in the market To make such comparisons, there must be:  An active public market  An exchange of comparable properties  Easy access to price information

The Market Approach
A variant of this approach  Uses a `standard¶ or `established¶ range of royalty rates in that sector  This approach is rarely used because there is rarely an active market in which relevant information is readily available  Normally used to check accuracy of other methods

Cost Approach
Seeks to establish the value by calculating the cost that a company would incur if it were to develop a similar asset either internally or acquire externally Reproduction Cost ± level of expenditures needed to reproduce exactly the same asset ± used for litigations Replacement Cost ± measures the expenditures necessary to develop a device of similar utility or determine a target price prior to negotiations or replace the existing intangibles

There are many practical challenges in determining what costs to include or exclude Costs include ± employee costs, overhead and management costs, labor costs, opportunity costs ± how other costs have been ignored to develop this IP Possibility of obsolescence This approach useful for early-stage technology earlyNo economic activity review Main drawback ± it does not recognize any economic benefits associated with market activity ± used as a supplement to income approach

International valuation Standards
The valuation process necessitates:  Gathering information  Understanding economy  Industry  Specific Business that directly affects the value of Intellectual Property  Such information may be gathered from external/internal sources  Information converted to financial models

Uniform Standards of Professional Appraisal Practice (USPAP) International Valuation Standard Committee (IVSC) US Generally Accepted Accounting Principal (GAAP) International Financial Reporting Standards (IFRS) Financial Accounting Standards Board (FASB)

Limitations of IPR Valuation
Depends upon the use of an interlocking series of estimates, assumptions and judgments Highly limited as to accuracy of results Accurate assessment in one field of IP property ± new ideas come up Discomfort - dynamic nature of IP

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