Intellectual P Valuation

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            213-251-2400        

 
email: david@myaacg.com
 
David Hahn, CVA, ASA, MAFF, CM&AA, CCIM, MBA

Intellectual Property & Intangibles Valuation

Five Categories of Intellectual Property & Intangible Assets

  • Marketing-related: Trademarks, trade/brand names, service marks, logos and non-compete agreements
  • Customer-related: Customer contracts and relationships, customer lists, databases, open purchase orders, distributors and sales routes
  • Contract-based: Franchise and licensing agreements, permits and contracts and supplier contracts
  • Technology-based: Process and product patents, patent applications, proprietary processes and technology, engineering drawings, technical documentation, computer software and copyrights, formulas and recipes
  • Artistic-related: Musical composition, literary composition and film copyrights


  • Background

    Because businesses are often worth far more than the sum of their hard assets and working capital, a crucial aspect of our valuation services involves assigning value to intangible assets. These assets must be valued for purchase price allocation purposes when a business is acquired. This allocation is required under ASC 805 (formerly SFAS 141), "Business Combinations." In addition to real estate and plant equipment valuations, we have extensive experience valuing intangible assets, and establishing the useful lives of such assets.

    Among the various types of intangible assets/Intellectual Property to which we have assigned value are:

  • Patent Valuation, copyrights and licenses
  • Customer lists and relationships
  • Non-compete agreements
  • Favorable financing
  • Software
  • Trained and assembled workforces
  • Contracts
  • Leasehold interests
  • Unpatented proprietary technology
  • In-process R&D
  • Databases

    Trademark Valuation, trade names

    Intangible assets such as brands, intellectual property and licenses now comprise a greater percentage of the economic value of successful businesses than ever before. Some economists argue that intangibles represent the main performance drivers in the current transition from a traditional financial economic structure to a new knowledge-based economy.

    The value of identifiable intangible assets are important to:

    - Shareholders and their advisors, for use in assessing the true worth of their companies Management, as a useful tool for measuring performance, for taxation purposes and in the event of an acquisition or disposal under ASC 805 (formerly SFAS 141).

    - Financiers, for use in assessing the borrowing capacity of a company when arranging funding facilities. Sophisticated lending institutions now recognize the value of certain intangible assets as security for loans.

     

    Valuation Methods for Patent

  • Research and development can be one of a company's most significant and important investments. It sparks innovation, drives technological advancement, energizes product development and promotes efficiency improvements. Because of this, companies seek legal protection of the resulting ideas and processes in the form of patents. A patent grants the assignee exclusive right to the invention for a specified period of time. Like other intangible assets, it is sometimes necessary to obtain patent valuations. Our business valuation team examines the value of intangible assets every day and understands the key factors that impact the value of a patent.

    Patent valuations are needed for a variety of matters including to support transfer of ownership (licensing or assignment) of the business or patent, collateralized financing, financial reporting and taxation matters. A valuation of patents may also be needed to support litigation matters, such as quantifying patent infringement damage.

    To select the appropriate methodology, we first seek to understand the use of patent valuations. This context is important because the approaches to value can result in very different value conclusions.



    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

    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.



    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.



    Real Options Method

    The Real Options Method (ROM) recognizes that a patent has intrinsic value based on its

    projected cash flows discounted at the opportunity cost of capital for the owner of the patent. Additionally, the ROM incorporates the value associated with the uncertainty inherent in a business and the active decision making required for a patent-based business strategy to succeed.

    The ROM values these items using the Black-Scholes option-pricing model. The primary advantage of the ROM is that it accounts for the value associated with the uncertainty of cash flows and the ability to manage the patent investment. Like the DCF or Venture Capital methods, the ROM values the stream of cash flows but it also accounts for acquired knowledge. This method provides a more complete evaluation than either the DCF or the Venture Capital method, which only capture cash flows and static fixed costs.

    The primary disadvantage of the ROM is that there is often an inexact mapping of the

    assumptions underlying option pricing theory and the real option application. For example, is the standard deviation of the growth rate of patent cash flows log-normally distributed? Likewise, the Chicago Board Option Exchange commits to pay an investor using traded options the exercise price of the option. No party assures that the fixed costs projected in the exercise price under the ROM are obtainable to the firm. The “break-through” aspect of the Black-Scholes model was the observable and reliable nature of the inputs into the model.

    The accuracy of the model inputs relies on the efficient capital market assumptions that underlie the traded option, bond, and stock markets. Real investments are typically infrequently traded and therefore their prices lack the reliability of market prices. As such, these limitations place some doubt on the accuracy of the economic values projected under the ROM.

    Other disadvantages of using the ROM to value patents include the fact that patents

    contain adverse rights, not affirmative rights which run counter to the notion of “having an option.” Further, as noted earlier, the option value of a patent can be reduced or eliminated by a third party filing and contesting the claim.



    Other Valuation Approaches

    As with many types of valuation, other methods exist to value IP, which we touch on

    only briefly here.



    Market Comparables

    Conceptually, a market comparables approach should offer a good indication of a

    patent’s value, as it reflects the exchange of value between two parties. However, in valuing patents it is difficult to find a suitable comparable transaction. The two primary reasons for this are the lack of disclosed sale or licensure activity and by its definition, a patent must be unique.



    Historic Cost

    This valuation methodology measures the amount of money spent in the development of the intellectual property at the time it was developed. But unless the intellectual property was developed in the recent past, an historic cost measure tends to be unreliable due to the impact of inflation and the changes that occur in technology over time. In addition, it is not always possible to provide accurate information on the resources spent for such quantification.



    Replication Cost

    This measures the amount of money that would need to be spent in current cost terms in

    order to develop the intellectual property in exactly the same way and to achieve the same final state as it currently exists. This includes costs incurred on any unsuccessful or inefficient prototypes.



    Replacement Cost

    This measures the amount of money that would need to be spent in current cost terms in order to develop the intellectual property as it currently exists, but

    excludes the costs relating to unsuccessful or inefficient prototypes.



    Trademark Valuation
    Trademarks are important and often valuable intangible assets that help companies to distinguish goods and services. They exist so that entities have legal protection of a name, symbol, design, letter or word. Trademarks create value by inspiring loyalty, motivating purchasing and commanding premium pricing. And the value of a trademark can be monetized to generate cash to further growth and investment through licensing or collateralization. Valuation of trademarks is essential for many business transactions including any merger or acquisition, bankruptcy, trademark sale or purchase and to establish royalty rates for licensing. Appraisals can also be used for tax reporting or as support in various litigation matters. Our trademark valuations are always backed by proven valuation methodologies and withstand the scrutiny of courts.



    Brand Valuation

    A "brand" is much more than a name. What makes it unique is that it provides purchasers with both the tangible and intangible benefits of owning a product. At their best, brands can be extraordinarily powerful, capable of motivating buying behavior and capturing a premium price for goods and services. It is because of this that brand valuation has become increasingly important. Companies now buy and sell brands like any other physical asset, and they are managed meticulously to ensure that brand value is not eroded. We help companies understand the underlying worth of these intangible assets through accurate and well-researched brand valuations that enable our clients to make better informed decisions. There are numerous reasons to conduct formal brand valuations. A company may request the information to assist it in making decisions regarding whether to license or sell the brand. If it decides to license, the appraisal can be used to set the basis of the licensing agreement to calculate adequate profit be made on the transaction. Brand valuations can also be leveraged to obtain additional financing, for financial reporting, in tax management and for business planning purposes.

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