Intellectual property valuation
Encyclopedia
Valuation
is considered as one of the most critical areas in finance
; it plays a key role in many areas of finance
such as buy/sell, solvency
, merger and acquisition
. Furthermore, intellectual property
(IP) valuation is considered as one of the most important management
strategic issues.
is an intangible asset
, that is, it is intangible as well as it cannot be defined or specified by its physical parameters. It is created by human intellectual or inspirational activity. Therefore, the intellectual property must be defined in some discernible method to be protected by the laws.
As a subset of intangible assets, the intellectual properties are classified into particular categories in which they have some similarities in terms of nature, feature, method of creation, and legal protection. The most widely accepted classification among the academics as well as the valuation analysts is:
analysis. It is prepared, for example, for transactions
, pricing
and strategic purposes, financing securitization
and collateralization
, tax
planning and compliance
, and litigations support.
, barriers to entry
, legal protection, IP’s profitability, industrial
and economic factors, growth projections, remaining economic life, and new technologies.
, industry
, and specific business that directly affect the value of the intellectual property
. Therefore, such information may be gathered from external and / or internal sources. Finally, the information is devoted to be turned into financial models to estimate the fundamental value of a particular type of intellectual property based on such adapted International Valuation Standards.
The valuation analysts use numerous approaches in order to reach a reasonable indication of a defined value for the subject intangible assets on a certain date which is referred to as the valuation date. The most common approaches to estimate the fundamental or fair value of the intellectual property are defined as the following:
1. Cost Approach: The cost
approach is based on the economic principle of substitution
. This principle states that an investor
will pay no more for an asset than the cost to obtain, by purchasing
or constructing, a substitute asset of equal utility. There are several cost approach valuation methods, the most common being the historical cost, replacement cost, and replication cost.
2. Market Approach: The market
approach is based on the economic principle of competition
and equilibrium
. These principles conclude that, in a free and unrestricted market
, supply and demand
factors will drive the price
of an asset at equilibrium point. Furthermore, it provides an indication of the value by comparing the price at which similar property has exchanged between willing buyers and sellers.
3. Income Approach: This approach estimates the fair value of intellectual property by discounting the future economic benefits of ownership at an appropriate discount rate.
4. Direct Approach: The direct approach is based on the current value of shares of intellectual property
in an Intellectual Property (IP) Share Market.
5. Competitive Advantage Valuation
Valuation (finance)
In finance, valuation is the process of estimating what something is worth. Items that are usually valued are a financial asset or liability. Valuations can be done on assets or on liabilities...
is considered as one of the most critical areas in finance
Finance
"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...
; it plays a key role in many areas of finance
Finance
"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...
such as buy/sell, solvency
Solvency
Solvency, in finance or business, is the degree to which the current assets of an individual or entity exceed the current liabilities of that individual or entity. Solvency can also be described as the ability of a corporation to meet its long-term fixed expenses and to accomplish long-term...
, merger and acquisition
Takeover
In business, a takeover is the purchase of one company by another . In the UK, the term refers to the acquisition of a public company whose shares are listed on a stock exchange, in contrast to the acquisition of a private company.- Friendly takeovers :Before a bidder makes an offer for another...
. Furthermore, intellectual property
Intellectual property
Intellectual property is a term referring to a number of distinct types of creations of the mind for which a set of exclusive rights are recognized—and the corresponding fields of law...
(IP) valuation is considered as one of the most important management
Management
Management in all business and organizational activities is the act of getting people together to accomplish desired goals and objectives using available resources efficiently and effectively...
strategic issues.
Background
The intellectual propertyIntellectual property
Intellectual property is a term referring to a number of distinct types of creations of the mind for which a set of exclusive rights are recognized—and the corresponding fields of law...
is an intangible asset
Intangible asset
Intangible assets are defined as identifiable non-monetary assets that cannot be seen, touched or physically measured, which are created through time and/or effort and that are identifiable as a separate asset...
, that is, it is intangible as well as it cannot be defined or specified by its physical parameters. It is created by human intellectual or inspirational activity. Therefore, the intellectual property must be defined in some discernible method to be protected by the laws.
As a subset of intangible assets, the intellectual properties are classified into particular categories in which they have some similarities in terms of nature, feature, method of creation, and legal protection. The most widely accepted classification among the academics as well as the valuation analysts is:
- CreativeCreativityCreativity refers to the phenomenon whereby a person creates something new that has some kind of value. What counts as "new" may be in reference to the individual creator, or to the society or domain within which the novelty occurs...
( e.g., trademarkTrademarkA trademark, trade mark, or trade-mark is a distinctive sign or indicator used by an individual, business organization, or other legal entity to identify that the products or services to consumers with which the trademark appears originate from a unique source, and to distinguish its products or...
s, copyrightCopyrightCopyright is a legal concept, enacted by most governments, giving the creator of an original work exclusive rights to it, usually for a limited time...
, computer softwareComputer softwareComputer software, or just software, is a collection of computer programs and related data that provide the instructions for telling a computer what to do and how to do it....
) - Innovative ( e.g., patentPatentA patent is a form of intellectual property. It consists of a set of exclusive rights granted by a sovereign state to an inventor or their assignee for a limited period of time in exchange for the public disclosure of an invention....
s, industrial designIndustrial designIndustrial design is the use of a combination of applied art and applied science to improve the aesthetics, ergonomics, and usability of a product, but it may also be used to improve the product's marketability and production...
s, trade secretTrade secretA trade secret is a formula, practice, process, design, instrument, pattern, or compilation of information which is not generally known or reasonably ascertainable, by which a business can obtain an economic advantage over competitors or customers...
s)
Rationale
There are numerous individual reasons or motivations for conducting an intellectual property valuation or economic appraisalAppraisal
Economic appraisal is a type of decision method applied to a project, programme or policy that takes into account a wide range of costs and benefits, denominated in monetary terms or for which a monetary equivalent can be estimated. Economic Appraisal is a key tool for achieving value for money and...
analysis. It is prepared, for example, for transactions
Financial transaction
A financial transaction is an event or condition under the contract between a buyer and a seller to exchange an asset for payment. It involves a change in the status of the finances of two or more businesses or individuals.-History:...
, pricing
Pricing
Pricing is the process of determining what a company will receive in exchange for its products. Pricing factors are manufacturing cost, market place, competition, market condition, and quality of product. Pricing is also a key variable in microeconomic price allocation theory. Pricing is a...
and strategic purposes, financing securitization
Securitization
Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling said consolidated debt as bonds, pass-through securities, or Collateralized mortgage obligation , to...
and collateralization
Collateralization
In medicine, collateralization, also vessel collateralization and blood vessel collateralization, is the growth of a blood vessel or several blood vessels that serve the same end organ or vascular bed as another blood vessel that cannot adequately supply that end organ or vascular bed...
, tax
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
planning and compliance
Compliance (regulation)
In general, compliance means conforming to a rule, such as a specification, policy, standard or law. Regulatory compliance describes the goal that corporations or public agencies aspire to in their efforts to ensure that personnel are aware of and take steps to comply with relevant laws and...
, and litigations support.
Factors driving the intellectual property
Intellectual property derives its value from a wide range of significant parameters such as market shareMarket share
Market share is the percentage of a market accounted for by a specific entity. In a survey of nearly 200 senior marketing managers, 67 percent responded that they found the "dollar market share" metric very useful, while 61% found "unit market share" very useful.Marketers need to be able to...
, barriers to entry
Barriers to entry
In theories of competition in economics, barriers to entry are obstacles that make it difficult to enter a given market. The term can refer to hindrances a firm faces in trying to enter a market or industry - such as government regulation, or a large, established firm taking advantage of economies...
, legal protection, IP’s profitability, industrial
Industry
Industry refers to the production of an economic good or service within an economy.-Industrial sectors:There are four key industrial economic sectors: the primary sector, largely raw material extraction industries such as mining and farming; the secondary sector, involving refining, construction,...
and economic factors, growth projections, remaining economic life, and new technologies.
Approaches
The valuation process necessitates gathering much more information as well as in-depth understanding of economyEconomy
An economy consists of the economic system of a country or other area; the labor, capital and land resources; and the manufacturing, trade, distribution, and consumption of goods and services of that area...
, industry
Industry
Industry refers to the production of an economic good or service within an economy.-Industrial sectors:There are four key industrial economic sectors: the primary sector, largely raw material extraction industries such as mining and farming; the secondary sector, involving refining, construction,...
, and specific business that directly affect the value of the intellectual property
Intellectual property
Intellectual property is a term referring to a number of distinct types of creations of the mind for which a set of exclusive rights are recognized—and the corresponding fields of law...
. Therefore, such information may be gathered from external and / or internal sources. Finally, the information is devoted to be turned into financial models to estimate the fundamental value of a particular type of intellectual property based on such adapted International Valuation Standards.
- Uniform Standards of Professional Appraisal PracticeUniform Standards of Professional Appraisal PracticeUniform Standards of Professional Appraisal Practice, commonly referred to by the acronym USPAP, can be considered the quality control standards applicable for real property, personal property, intangibles, and business valuation appraisal analysis and reports in the United States and its territories...
(USPAP) - International Valuation Standards CommitteeInternational Valuation Standards CommitteeThe International Valuation Standards Council is charged with developing robust and transparent procedures for performing international valuations through a single set of globally recognized valuation standards, acceptable to the world’s capital markets organisations market participants and...
(IVSC) (50 Countries) - US Generally Accepted Accounting Principles (GAAP)
- International Financial Reporting StandardsInternational Financial Reporting StandardsInternational Financial Reporting Standards are principles-based standards, interpretations and the framework adopted by the International Accounting Standards Board ....
(IFRS) - Financial Accounting Standards BoardFinancial Accounting Standards BoardThe Financial Accounting Standards Board is a private, not-for-profit organization whose primary purpose is to develop generally accepted accounting principles within the United States in the public's interest...
(FASB)
The valuation analysts use numerous approaches in order to reach a reasonable indication of a defined value for the subject intangible assets on a certain date which is referred to as the valuation date. The most common approaches to estimate the fundamental or fair value of the intellectual property are defined as the following:
1. Cost Approach: The cost
Cost
In production, research, retail, and accounting, a cost is the value of money that has been used up to produce something, and hence is not available for use anymore. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is counted as cost. In this...
approach is based on the economic principle of substitution
Substitution
Substitution may refer to:- Sciences :* Substitution , a syntactic transformation on strings of symbols of a formal language* Substitution of variables* Substitution cipher, a method of encryption...
. This principle states that an investor
Investor
An investor is a party that makes an investment into one or more categories of assets --- equity, debt securities, real estate, currency, commodity, derivatives such as put and call options, etc...
will pay no more for an asset than the cost to obtain, by purchasing
Purchasing
Purchasing refers to a business or organization attempting for acquiring goods or services to accomplish the goals of the enterprise. Though there are several organizations that attempt to set standards in the purchasing process, processes can vary greatly between organizations...
or constructing, a substitute asset of equal utility. There are several cost approach valuation methods, the most common being the historical cost, replacement cost, and replication cost.
2. Market Approach: The market
Market
A market is one of many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers...
approach is based on the economic principle of competition
Competition
Competition is a contest between individuals, groups, animals, etc. for territory, a niche, or a location of resources. It arises whenever two and only two strive for a goal which cannot be shared. Competition occurs naturally between living organisms which co-exist in the same environment. For...
and equilibrium
Economic equilibrium
In economics, economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...
. These principles conclude that, in a free and unrestricted market
Market
A market is one of many varieties of systems, institutions, procedures, social relations and infrastructures whereby parties engage in exchange. While parties may exchange goods and services by barter, most markets rely on sellers offering their goods or services in exchange for money from buyers...
, supply and demand
Supply and demand
Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers , resulting in an...
factors will drive the price
Price
-Definition:In ordinary usage, price is the quantity of payment or compensation given by one party to another in return for goods or services.In modern economies, prices are generally expressed in units of some form of currency...
of an asset at equilibrium point. Furthermore, it provides an indication of the value by comparing the price at which similar property has exchanged between willing buyers and sellers.
3. Income Approach: This approach estimates the fair value of intellectual property by discounting the future economic benefits of ownership at an appropriate discount rate.
4. Direct Approach: The direct approach is based on the current value of shares of intellectual property
Intellectual property
Intellectual property is a term referring to a number of distinct types of creations of the mind for which a set of exclusive rights are recognized—and the corresponding fields of law...
in an Intellectual Property (IP) Share Market.
5. Competitive Advantage Valuation
See also
- Economics and patentsEconomics and patentsPatents are legal instruments intended to encourage innovation by providing a limited monopoly to the inventor in return for the disclosure of the invention. The underlying assumption being innovation is encouraged because an inventor can secure exclusive rights, and therefore a higher probability...
- International Valuation Standards CommitteeInternational Valuation Standards CommitteeThe International Valuation Standards Council is charged with developing robust and transparent procedures for performing international valuations through a single set of globally recognized valuation standards, acceptable to the world’s capital markets organisations market participants and...
- Patent portfolio