25 Ways to Value IP

There are 50 ways to leave your lover and the number of ways to value IP is rapidly catching up. Already 25 acceptable methods have been identified in this fast-evolving area of valuation speciality. Here's an excellent summary from IPWatch

Valuation analysts and IP professionals agree there are three standard methodologies to value IP:

1. Cost Approach: The historical cost to develop an asset is sometimes used to determine its value. However, the cost to develop an intellectual asset is rarely representative of its ultimate value. This approach is less useful for intellectual properties used with products that have reached the market and generated revenues. Generally, the cost approach is better suited to analysis of intellectual properties and products that have not yet been developed commercially, or that could be re-created quickly, as it reflects the cost a company could avoid by purchasing, rather than duplicating, a similar development effort.
2. Income Approach: The income approach calculates the present value of future income streams specifically attributable to the intellectual property asset. This method utilizes forecasted financial results based on factors such as historical financial results, industry trends, and the competitive environment.
3. Market Approach: The market approach values intellectual properties by comparing the subject asset to publicly available transactions involving similar assets with similar uses. This provides a reasonable indication of value if an active market exists that can provide examples of recent arm’s-length transactions, with adequate information regarding terms and conditions.
4. Relief from Royalty Approach: In the relief from royalty approach, a hypothetical situation is created to estimate what a business would pay to license its own intellectual property assets in an arm’s-length transaction. The value is then calculated as the present value of the avoided hypothetical royalty charges.

The decision of which approach to use is generally based on four factors: (i) how unique is the asset; (ii) how much data is available and verifiable; (iii) what is the context, purpose or objective of the analysis; and (iv) the judgment of the analyst which (one would hope) is based on extensive earlier experience.

In addition to the traditional methods used to value intellectual property, several alternative methods are available. Some are modifications of the orthodox approaches with which most are familiar, but many other choices exist to value these complex assets. Below is a brief summary of these; a detailed explanation of each methodology could fill websites. Instead, this serves as a brief introduction to alternative intellectual property valuation approaches.

Continuing Developments

As part of a still developing discipline, there are at least 25 alternative valuation techniques to be employed. I would encourage an interested reader to continue doing research on the methods shown here, if the details provided below are insufficient. This article is intended to serve as a cover of alternative IP valuation methods and not meant to provide a detailed explanation or how-to manual for valuing intangible assets. Some things in life offer the luxury of “one size fits all,” however, the orthodox valuation measures that most of us are familiar with — namely the income, market, and cost approach — are often modified even slightly to meet the needs of both the IP that is being measured, the data available, as well as the context of the valuation. The methods being explained below are frequently associated with a certain IP asset. An example of this is the Venture Capital Method, which is a technique that derives a value for a patent from the cash flows that arise over the asset’s life. Although it is similar to the income approach that utilizes a discount cash flow analysis (DCF), it possesses two differentiating factors: a fixed, non-market based discount rate is used and there is no explicit adjustment for the probability of success. We have broken them up into two groups: generally accepted and specialized/proprietary.

Group A – Generally Accepted

Brand Contribution Methodology: The Brand Contribution Methodology is another market-based methodology for valuing IP. The contribution made by the brand may be separated from the profit contributed from other elements of the business in multiple ways: 1) comparing costs charged by a manufacturer and distributor of the unbranded equivalent (also known as the “utility product”); 2) if one eliminates the value added by other assets, the appropriate return on capital employed with respect to the product may be deducted (this includes assets such as physical distribution systems, fixed assets, etc.); 3) the rate of return (or “profitability”) of the business can be compared with the rate of return of a comparable unbranded business (which is known as the “premium profits” method); and 4) comparing the premium price earned by the brand over the retail price of its comparable generic equivalent (known as the “retail premium” method).

Replacement Cost: When using the Cost Approach to value an intellectual asset, two separate methods under the cost approach shall be considered: the Replacement Cost method and the Reproduction Cost method. The Replacement Cost method aggregates the amount of money necessary to develop a replacement of the IP that provides the same functionality or utility, in the same stage of development as the IP being valued, as of the valuation date. It is important to note that the Replacement Cost measures the amount of money in today’s dollars, rather than the amount of money that was spent historically to develop the IP so inflation is accounted for. The logic behind this method is to calculate the amount, in today’s dollars, to provide an equivalent substitute. Finally, calculating the cost of an IP using the Replacement Cost method excludes the costs associated with any failed or ineffectual models.

Reproduction Cost: The Replication Cost method is very similar to the Replacement Cost method, but differs slightly in that it measures the aggregate costs necessary to develop an exact duplicate of the IP being valued, in the same stage of development as the IP being valued, as of the valuation date. Just like with the Replacement Cost, this calculation is done in today’s dollars to appropriately factor in for inflation. And unlike the Replacement Cost method, the Reproduction Cost method includes costs with associated prototypes.

Technology Factor Method: As the number of digital intangible assets rise, using The Technology Factor Method becomes all the more common because it is applicable only to technology. By measuring a technology’s contribution to a business’ total revenue, an asset’s value can be determined. Specifically, the Technology Factor Method is another method that is similar to the DCF method with respect to the calculation of an IP’s risk-free net present value. Once the NPV has been calculated, it can then be multiplied with an associated risk factor (what we will refer to as the “technology factor”). The Technology Factor value incorporates the intellectual property’s strengths and weaknesses associated with the related legal, market and economic risks.

Venture Capital Method: Analyzing the value of future cash flows over an asset’s life is a common technique used to value intellectual property, which is precisely how the Venture Capital method works. Although similar to the common DCF method, it is different in that a fixed, non-market based discount rate is used (generally, a rate of between 40 to 60 percent used). Additionally, no specific adjustment is made to account for the probability of success (e.g., a patent’s success). Unfortunately, the Venture Capital method’s weakness is such that it does not account well for specific risk factors associated with patents. Moreover, it assumes cash flows are static and the independent risk factors (new patent issuance, patent challenges or declared in valid, patent infringement suits, trade secrets, foreign governments’ failure to comply with Patent Cooperation Treaties, etc.) are marshaled. It is the simplicity of this method that harms its accuracy/credibility.

The Concept of Relative Incremental Value: This methodology works when one is trying to represent some percentage of value of an individual asset that is associated with a larger trademark or patent portfolio. For example, if an underlying trademark or brand has a value of $100 million, and the domain name associated with it is generating 10% of revenues (e.g.), then one can allocate a relative value of 10% of the total or, $10 million dollars for the domain name.

Decremental Cost Savings Valuation: This is the method that quantifies a decrease in the level of costs being experienced by the IP owner / operator. If, in fact, the IP owner can quantify lower levels of capital or operating costs connected directly with the ownership of the IP; then those lower costs can be a direct measurement of the value of the specific IP.

Enterprise Value Enhancement: The valuation analyst establishes the value of the IP owner’s overall business enterprise value as a result of owning the IP – and then compares that to the business enterprise value if the owner did not, in fact, have or control the IP or was not able to use it in its business enterprise. The value of the IP then would be the difference between the total business enterprise value and the business enterprise as calculated without the IP.

Imputed Income Analysis: A subset of traditional income approach methods, this imputed income analysis can be used quite effectively in valuing a domain name or sub brand attached to a trademark; or in valuing flanker patents for a core patent portfolio. In the case of a domain name, value is established by looking at the activity generated by the domain name and associated website assets, relative to the overall value of the core trademark and brand bundle. Therefore, one is able to estimate through imputation the relative value of a domain name to its parent trademark.

Income Capitalization or Direct Capitalization Methodology: This is a method sometimes used to estimate the value for intellectual property that has no predetermined statutory expiration (like trademarks) and for which net income (royalties or profit) is not expected to vary greatly over time (due to contractually-defined license fees, for example). This involves taking an estimate of expected annual royalty stream (or profit) and multiplying this amount by a factor known as the capitalization rate.

Income Differential Analysis: This particular variation simply means that a company manufacturing and selling a product with a particularly strong trademark or unique technology will receive more income than a competitive company producing the same product but without the addition of the specific IP, such as the trademark or patent.

Liquidation Value: Found most often in bankruptcy situations, as the name implies liquidation value for any piece of IP is the lowest price that the asset is virtually guaranteed to be sold in a distressed situation. Used almost solely in bankruptcy, other distressed situations or time critical contexts, litigation value scenarios arise most often in a Chapter 7 bankruptcy.

Premium Pricing Analysis: Of all the variations to the income approach, this is perhaps the most easily understood – because the value of an asset is established by looking at the difference in the price that it can command in the market, typically at wholesale, compared to the average product in the market. The difference between these two prices is the price premium. This, then, is projected out on an annual basis and a net present value established.

Profit Split Methodology: A form of the income approach, it can be tricky to apply accurately: because the profit split method attributes a share or portion of a company’s profitability to a particular intangible asset. This method requires that the valuation analyst have the ability to understand the IP to such an extent that he or she can isolate and expressly separate the intangible asset’s profit generation potential from all the other business assets – and then allocate that portion of profit split to the company’s operations and capitalize that value over a number of years.

Group B – Specialized/Proprietary

Auction Method: There are several market-based methods of valuing IP using recent comparable or similar IP transaction between independent parties (“arm’s-length transactions”). One of these methods is called the “Auction Method.” If a hypothetically perfect auction market existed, several potential buyers that each had all available information regarding the IP would compete with each other to bid on the IP. Through this auction process, a market-based price of the IP would be determined through bidding.

DTA (Decision Tree Analysis) Based Methods: While many people are familiar with the DCF methods of valuing intellectual property, it comes with inherent weaknesses because it relies on selecting discount rates appropriate to the risk associated with the various stages in a property’s life. Not only does it require calculating the possible cash flows which might occur, DCF methods do not account for the various possibilities open to project managers (for example, the levels of risk if a patent lapses or is abandoned at differing stages along the process). Unfortunately, there is no “exact science” to be applied for these and experience is necessary to influence these decisions.

Assumptions can be built into the DCF model in an attempt to account for the possible outcomes as the result of management decisions. Using what is known as Decision Tree Analysis, a limited number of such managerial decision possibilities can be accounted for. It is important to note, however, that the Decision Tree Analysis should be based on an underlying DCF analysis of each branch. The recommended way to perform such analysis is to begin with the final decisions and work backwards in time, which will result in a present value.

The Decision Tree Analysis Method offers a big advantage over the DCF analysis: it factors the value of flexibility associated with a project. However, assumptions still need to be made regarding the discount rate (as does the DCF method). It is important to use a discount rate appropriate with the level of risk involved at each stage of a managerial decision associated with the development of a brand or IP.

The Brand Value Equation Methodology (BVE_Q™): In this methodology, a core value for the trademark is calculated, and then each of the individual other assets attached to the core asset have their values calculated. Therefore, the sum of the core brand value plus the incremental assets becomes a total brand value. Expressed in an equation it as follows:

BVE_Q = CBV + IVE₁ + IVE₂… IVE_n

The Competitive Advantage Technique: This technique is best used when the subject company has a complex portfolio of intellectual property and works on the supposition that the IP is giving its owner an advantage over its competitors because of proprietary patents, technology, trademarks, software or other intangibles.

Monte Carlo Analysis of Value: This is a method to evaluate how possible future outcomes can affect the decision of whether or not to use a new piece of IP based on possible value – remember that this methodology is most useful in valuing early stage, non-commercialized technology; and, in particular, where there are many unknowns and numerous scenarios about the future development of the technology.

Options Pricing Technique (The Black-Scholes): Patent licensing shares at least one attribute with all other relevant business decisions: it involves risk. Where decisions involving financial risk are concerned, sound management principles suggest considering ways and vehicles to hedge that risk. One of the central vehicles to hedge risk in modern finance is an “Option.” A patent can be seen as the right to invest in or to license (or enforce through litigation) an underlying technology or product line, during the term of the patent. Therefore, an un-commercialized patent can be valued from this “options” perspective using, for example, methods such as those derived from the famous “Black-Scholes” model.

Snapshots of Value Approach: This is similar in nature to the business enterprise value approach in that the snapshots value is based on establishing two different values for a company: one, based on the assumption that the company has full access to the ownership of the intellectual property and intangibles, and the second snapshot of value based on the fact that the company does not have these assets. Measuring the difference between the two snapshots establishes the value of the IP or intangible asset portfolio.

Subtraction Method of Value or Benchmark Method of Value: Establishing the value of a company against another company by comparing them on a so-called benchmark basis is the premise of this method of value. In one instance, the benchmark value will be a company that owns a particular trademark or patent and the second value for a comparable company that does not have that same asset.

The ValCalc Methodology: A proprietary approach employed by our firm, it is a variation on the return on assets employed approach (see above). ValCalc establishes the economic return that each intangible asset class should be earning. Calculations of adequate return are applied also to all classes of tangible assets within a company. Then the return for each intangible asset is calculated as a result.

Valmatrix Analysis Technique: This proprietary system was developed by our firm more than two decades ago and employs a matrix of the twenty most important predictors of value for a trademark, patent or piece of software. The predictors for each of these types of IP are, of course, unique. They are used in a common manner, however: To score a given IP asset against its peers on a numerical scale. Value is therefore established relative to similar trademarks or patents.

An important side note for the interested reader: whenever possible, we recommend the use of multiple valuation techniques when performing a valuation analysis. This is especially true with intangible assets because active markets may not exist and assumptions need to be relied on in making valuation conclusions. Moreover, uncertainty may develop if one depends on a single methodology to value an IP asset (especially a particularly complex family of technologies or brand assets). History has taught us that, as with any new practice, the evolution of methodologies will be ever-lasting.

Conclusion

Valuing and analyzing intellectual property is still at a premature stage, the field itself hardly more than a few decades old. As the process continues to evolve and experts refine a multitude of methodologies, the art of valuing IP will continue to witness developments, innovation, revision, and diligent progression of techniques to value intellectual property and intangible assets. In all probability, the techniques listed above will either be outdated or refined further to become industry standards.

How to Value Software

Having working software in hand will ensure a significant time premium when it comes to developing time-critical apps.

Valuing Intellectual Property, which is intangible in many ways, is becoming a relevant area of study in the domain of initial public offerings (IPOs) or mergers and acquisitions (M&A). Valuation of Intellectual Property is similar to valuation of real (tangible) properties in that the outcome of both exercises is to establish the current worth of the asset. However, it is different from the valuation of real property in that it is a type of commodity whose value is derived from the information it contains or represents. Information goods are, by nature, non-excludable (in that people who have not paid for the goods can still use it) and non-rival (in that the commodity can be used by more than one person at the same time). Intellectual property assets are further different in that they are essentially either commercial or product-based assets. Under commercial assets are included IPRs including trademarks, trade names, brands, GIs and character names. Within product-based assets are included patents, copyright, design, etc. The most important difference of an Intellectual Property asset compared to a real property is that its life is governed by statute (patent rights only last 20 years and so on) and is regulated heavily by market demand.

Value is not a specific figure but rather an alignment of assumptions. Typically, we use three components for valuation – cost-based, market-based and revenue-based – also thought of as value past, present and future. Timing and context are critical components of the assessment. For example, the complexity and customization needed to create an asset may cause a high level of cost variability and outcome uncertainty. Similarly, given sufficient time, multiple alternatives can be explored, but if deadlines are tight, the need to have a working solution requires a value premium. We will look at each of these elements to provide a reasonable approximation of the value boundaries.

Intellectual capital can incorporate both intellectual properties, such as patents, trademarks and licensing, as well as human capital such as employees. For acquisition purposes, the degree to which intellectual assets are formalized or codified increases the likelihood of retaining the value. If the employee experiences or methods are documented, those assets are more readily leveraged and potentially non-linear (highly scaleable). If those experiences or methods are known only to the employees, leverage or reuse will be more restrictive and will require additional employment agreements to capture those assets. Note that this estimate range cannot include the potential options value for market timing, for example, if the underlying asset (let'€™s say software) is necessary to win a contract or deliver to a deadline within a 3-6 month time-frame. In such a situation, the time premium can easily double the estimated value, depending on the opportunity.

Cost-based valuation can take into consideration the contracts that the seller has in place with the rest of his clients, to estimate an upper bound on the development costs, based on budgets for management'€™s involvement in contractor's time (and that would assume the project/product represented the majority portion of the firm'€™s time and effort during the year).

Market-based value focuses on alternative offerings that can provide the same functionality in the same or necessary timeframe. If the underlying functionality of what is being acquired is custom configured to the buyer’s offering, it is then outside the scope to find comparable acquisitions.

The only reasonable alternatives will be to consider redeveloping the code adaptations provided by the seller or to consider simply purchasing the rights to those licensing restrictions. But the difficulty here is timing. Given sufficient systems evaluation, it is likely that the seller€™s adaptations to the buyer€™s code can be recreated, but it is worth examining whether it can be done within a short enough timeframe and with the necessary reliability to meet the seller€™s strategic needs.

A second alternative will be to purchase only the rights to the specific portfolio that the buyer is interested in. The first step in this case will be to estimate a baseline bid plus a necessary premium for the time value of strategic enablement. We estimate that such a premium is dependent on negotiations, which are influenced by both available alternatives, as well as income opportunity differentials (that is, the positive income associated with immediate sales versus the potential time delays for alternatives). Clearly, the availability of alternative development resources for a given timeframe can provide greater leverage in negotiations. However, as we noted up front, even with significant resources, it is often difficult to scale development in a linear fashion. Without enough time or adequate alternatives, the premium can be outside normal valuation bounds.

Revenue-based valuation is the third component, which alludes to what future value and asset can create. As mentioned in the introduction, there is a contingency or options value based on the ability to enter markets immediately with a working solution. The option can be parameterised by estimating the value of the contract, the decision timeframe, the portion of the offering dependent on the underlying software and approximating the estimate of success variability for the contract. In addition, although future revenue can be ascribed to a particular product, from a practical standpoint, the time horizon is necessarily limited because the product itself can undergo modification and within the same time horizon, other alternatives can be developed or acquired (think of these as an augmented discount rate). For example, if the buyer’s launch was delayed by a year (to acquire alternatives), assuming no other changes (unrealistic), the upper-bound difference (cost) will vary. Of course, the strategic impact of such a delay can be severe, especially if pursuing a first-mover advantage. So, the actual value to prevent the delay can be much higher. Obviously, not all revenue in a service offering is attributable to a single software component. So one can more accurately adjust the revenue estimation based on a percentage component, and with necessary adjustments for other costs.

Software can present a particular timing estimation problem. Although software development methodologies can improve delivery consistencies, the rapid change of technology frequently creates faster and more efficient implementation tools, compared to the original development. Moreover, having an existing solution provides a working template for implementation, which can also accelerate the ability to provide an alternative. On the downside, however, most software development has limited scalability. Even with an extensive budget, doubling the number of developers will rarely reduce the development time significantly. A properly scoped original project is unlikely to be done significantly faster, even if more resources are made available. Therefore, for a time-critical application, having working software in hand, can command a significant time premium to the value, as has been discussed above

Source  ANU VAIDYANATHAN

IP Valuation Overview

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 and knowledgeable companies are increasingly using licensing routes to transfer these assets to low tax jurisdictions.

Nevertheless, 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 and IPRs are often under-valued, under-managed or under-exploited.  Despite the importance and complexity of IPRs, there is generally little co-ordination between the different professionals dealing with an organization’s IPR.  For a better understanding of the IPRs of a company, some of the questions to be answered should often be:

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?
One of the key factors affecting a company’s success or failure is the degree to which it effectively exploits intellectual capital and values risk. Management obviously need to know the value of the IPR and those risks for the same reason that they need to know the underlying value of their tangible assets; because business managers should know the value of all assets and liabilities under their stewardship and control, to make sure that values are maintained. Exploitation of IPRs can take many forms, ranging from outright sale of an asset, a joint venture or a licensing agreement. Inevitably, exploitation increases the risk assessment.

Valuation is, essentially, a bringing together of the economic concept of value and the legal concept of property. The presence of an asset is a function of its ability to generate a return and the discount rate applied to that return. The cardinal rule of commercial valuation is: the value of something cannot be stated in the abstract; all that can be stated is the value of a thing in a particular place, at a particular time, in particular circumstances. I adhere to this and the questions ‘to whom?’ and ‘for what purpose?’ must always be asked before a valuation can be carried out.

This rule is particularly significant as far as the valuation of intellectual property rights is concerned. More often than not, there will only be one or two interested parties, and the value to each of them will depend upon their circumstances. Failure to take these circumstances, and those of the owner, into account will result in a meaningless valuation.

For the value of intangible assets, calculating the value of intangible assets is not usually a major problem when they have been formally protected through trademarks, patents or copyright. This is not the case with intangibles such as know how, (which can include the talents, skill and knowledge of the workforce), training systems and methods, technical processes, customer lists, distribution networks, etc. These assets may be equally valuable but more difficult to identify in terms of the earnings and profits they generate. With many intangibles, a very careful initial due diligence analysis needs to be undertaken together with IP lawyers and in-house accountants.

There are four main value concepts, namely, owner value, market value, fair value and tax value. Owner value often determines the price in negotiated deals and is often led by a proprietor’s view of value if he were deprived of the property. The basis of market value is the assumption that if comparable property has fetched a certain price, then the subject property will realize a price something near to it. The fair value concept, in its essence, is the desire to be equitable to both parties. It recognizes that the transaction is not in the open market and that vendor and purchaser have been brought together in a legally binding manner. Tax value has been the subject of case law worldwide since the turn of the century and is an esoteric practice. There are quasi-concepts of value which impinge upon each of these main areas, namely, investment value, liquidation value, and going concern value.

Methods for the Valuation of Intangibles

Acceptable methods for the valuation of identifiable intangible assets and intellectual property fall into three broad categories. They are market based, cost based, or based on estimates of past and future economic benefits.

In an ideal situation, an independent expert will always prefer to determine a market value by reference to comparable market transactions. This is difficult enough when valuing assets such as bricks and mortar because it is never possible to find a transaction that is exactly comparable. In valuing an item of intellectual property, the search for a comparable market transaction becomes almost futile. This is not only due to lack of compatibility, but also because intellectual property is generally not developed to be sold and many sales are usually only a small part of a larger transaction and details are kept extremely confidential. There are other impediments that limit the usefulness of this method, namely, special purchasers, different negotiating skills, and the distorting effects of the peaks and troughs of economic cycles. In a nutshell, this summarizes my objection to such statements as ‘this is rule of thumb in the sector’.

Cost-based methodologies, such as the “cost to create” or the “cost to replace” a given asset, assume that there is some relationship between cost and value and the approach has very little to commend itself other than ease of use. The method ignores changes in the time value of money and ignores maintenance.

The methods of valuation flowing from an estimate of past and future economic benefits (also referred to as the income methods) can be broken down in to four limbs; 1) capitalization of historic profits, 2) gross profit differential methods, 3) excess profits methods, and 4) the relief from royalty method.

1. The capitalization of historic profits arrives at the value of IPR’s by multiplying the maintainable historic profitability of the asset by a multiple that has been assessed after scoring the relative strength of the IPR. For example, a multiple is arrived at after assessing a brand in the light of factors such as leadership, stability, market share, internationality, trend of profitability, marketing and advertising support and protection. While this capitalization process recognizes some of the factors which should be considered, it has major shortcomings, mostly associated with historic earning capability. The method pays little regard to the future.

2. Gross profit differential methods are often associated with trade mark and brand valuation. These methods look at the differences in sale prices, adjusted for differences in marketing costs. That is the difference between the margin of the branded and/or patented product and an unbranded or generic product. This formula is used to drive out cashflows and calculate value. Finding generic equivalents for a patent and identifiable price differences is far more difficult than for a retail brand.

3. The excess profits method looks at the current value of the net tangible assets employed as the benchmark for an estimated rate of return. This is used to calculate the profits that are required in order to induce investors to invest into those net tangible assets. Any return over and above those profits required in order to induce investment is considered to be the excess return attributable to the IPRs. While theoretically relying upon future economic benefits from the use of the asset, the method has difficulty in adjusting to alternative uses of the asset.

4. Relief from royalty considers what the purchaser could afford, or would be willing to pay, for a licence of similar IPR. The royalty stream is then capitalized reflecting the risk and return relationship of investing in the asset.

Discounted cash flow (“DCF”) analysis sits across the last three methodologies and is probably the most comprehensive of appraisal techniques. Potential profits and cash flows need to be assessed carefully and then restated to present value through use of a discount rate, or rates. DCF mathematical modelling allows for the fact that 1 Euro in your pocket today is worth more than 1 Euro next year or 1 Euro the year after. The time value of money is calculated by adjusting expected future returns to today’s monetary values using a discount rate. The discount rate is used to calculate economic value and includes compensation for risk and for expected rates of inflation.

With the asset you are considering, the valuer will need to consider the operating environment of the asset to determine the potential for market revenue growth. The projection of market revenues will be a critical step in the valuation. The potential will need to be assessed by reference to the enduring nature of the asset, and its marketability, and this must subsume consideration of expenses together with an estimate of residual value or terminal value, if any. This method recognizes market conditions, likely performance and potential, and the time value of money. It is illustrative, demonstrating the cash flow potential, or not, of the property and is highly regarded and widely used in the financial community.

The discount rate to be applied to the cashflows can be derived from a number of different models, including common sense, build-up method, dividend growth models and the Capital Asset Pricing Model utilising a weighted average cost of capital. The latter will probably be the preferred option.

These processes lead one nowhere unless due diligence and the valuation process quantifies remaining useful life and decay rates. This will quantify the shortest of the following lives: physical, functional, technological, economic and legal. This process is necessary because, just like any other asset, IPRs have a varying ability to generate economic returns dependant upon these main lives. For example, in the discounted cashflow model, it would not be correct to drive out cashflows for the entire legal length of copyright protection, which may be 70 plus years, when a valuation concerns computer software with only a short economic life span of 1 to 2 years. However, the fact that the legal life of a patent is 20 years may be very important for valuation purposes, as often illustrated in the pharmaceutical sector with generic competitors entering the marketplace at speed to dilute a monopoly position when protection ceases. The message is that when undertaking a valuation using the discounted cashflow modelling, the valuer should never project longer than what is realistic by testing against these major lives.

It must also be acknowledged that in many situations after examining these lives carefully, to produce cashflow forecasts, it is often not credible to forecast beyond say 4 to 5 years. The mathematical modelling allows for this in that at the end of the period when forecasting becomes futile, but clearly the cashflows will not fall ‘off of a cliff’, by a terminal value that is calculated using a modest growth rate, (say inflation) at the steady state year but also discounting this forecast to the valuation date.

While some of the above methods are widely used by the financial community, it is important to note that valuation is an art more than a science and is an interdisciplinary study drawing upon law, economics, finance, accounting, and investment. It is rash to attempt any valuation adopting so-called industry/sector norms in ignorance of the fundamental theoretical framework of valuation. When undertaking an IPR valuation, the context is all-important, and the valuer will need to take it into consideration to assign a realistic value to the asset

Source Kelvin King, founding partner of Valuation Consulting