Intellectual Property Valuation

Intellectual Property Valuation

What is an intellectual property valuation?

An intellectual property valuation is a specific type of intangible asset valuation.  Intangible assets are all the elements of a business enterprise that exist in addition to monetary and tangible assets (Smith & Parr, 2000, p. 15).

Intellectual property refers to patents, trademarks, copyrights and trade secrets or know-how (proprietary technology).  The owner of intellectual property is potentially legally protected from the exploitation of the property by others.

Proprietary technology can include data, technical experience, knowledge and processes and techniques.  The proprietary technology often provides economic benefit, through cost reductions, and creates a barrier to entry (Smith & Parr, 2000, p. 31 and 32).

Approaches to intellectual property valuation

In accordance with the International Valuations Standards, when preparing an intellectual property valuation, valuers must understand specifically what needs to be valued and the purpose of the valuation (Council, 2022, p. 69); valuers may perform direct  intellectual property valuations where the value of the intellectual property is the purpose of the analysis or one part of the analysis (Council, 2022, p. 70).

The three valuation approaches described in IVS 105 Valuation Approaches can all be applied to intellectual property valuation.

Market approach

The market approach can only be applied to intellectual property valuation if both of the following criteria are met:

  • information is available on arm’s length transactions involving identical or similar intellectual property on or near the valuation date, and
  • sufficient information is available to allow the valuer to adjust for all significant differences between the subject intellectual property and those involved in the transactions

The heterogeneous nature of intellectual property and the fact that intellectual property seldom transacts separately from other assets means that it is rarely possible to find market evidence of transactions involving identical assets.

Income approach

The income approach is the most common method applied to intellectual property valuation and is frequently used to value technology, customer-related intangibles (e.g., relationships), trade names and brands and operating licenses.

The methods referred to in the standard include the excess earnings method, relief-from-royalty method and the with-and-without method.

Cost approach

Under the cost approach, the intellectual property valuation is determined based on the replacement cost of a similar asset or an asset providing similar service potential or utility.

The cost approach is commonly used for intellectual property such as internally developed and internally used, non-marketable software.

The replacement cost method assumes that a participant would pay no more for the asset than the cost that would be incurred to replace the asset with a substitute of comparable utility or functionality.

Intellectual property valuation methods

Excess earnings method

The excess earnings method estimates the intellectual property valuation as the present value of the cash flows attributable to the subject intangible asset after excluding the proportion of the cash flows that are attributable to other assets required to generate the cash flows (“contributory assets”). Contributory assets are assets that are used in conjunction with the subject intangible asset in the realisation of prospective cash flows associated with the subject intangible asset.

Relief-from-royalty method

Under the relief-from-royalty method, the intellectual property valuation is determined by reference to the value of the hypothetical royalty payments that would be saved through owning the asset, as compared with licensing the intangible asset from a third party.

Conceptually, the method may also be viewed as a discounted cash flow method applied to the cash flow that the owner of the intellectual property could receive through licensing the intangible asset to third parties.

With-and-Without Method

The with-and-without method indicates the intellectual property valuation by comparing two scenarios: one in which the business uses the subject intellectual property and one in which the business does not use the subject intellectual property (but all other factors are kept constant).

Discount rates for intellectual property

According to the International Valuation Standards selecting discount rates for intellectual property valuation can be challenging as observable market evidence of discount rates for intellectual property are rare.

When assessing the risks associated with an intellectual property, a valuer should consider the following:

  • intellectual property often has higher risk than tangible assets
  • if the intellectual property highly specialised to its current use, it may have higher risk than assets with multiple potential uses
  • intellectual property used in risky (sometimes referred to as non-routine) functions may have higher risk than intangible assets used in more low-risk or routine activities
  • intellectual property with a longer life is often considered to have higher risk, all else being equal

Intellectual property valuation case study

Lotus Amity was engaged to prepare an intellectual property valuation report for tax purposes. The intellectual property was associated with the construction industry and process automation.  Process automation included customer service, logging jobs, reporting and project management, resulting in cost savings and competitive advantage. The valuation report adopted a with-and-without method and the relief-from-royalty method.

References

Council, I. V. (2022). International Valuation Standards.

Smith, G., & Parr, R. (2000). Valuation of Intellectual Property and intangible assets. Wiley.