Valuing Intellectual Property
Intellectual property is often one of the largest assets a business has. It can also be the foundation of a business’s market dominance and profitability. As such, when selling your company, these intangible assets can be very valuable. Particularly in mergers and acquisitions, it is often the key objective of the buyer to obtain intellectual property. That being said, one buyer may value the intangible assets more than another party and thereby be willing to pay a higher price for the business. Below we will discuss what intellectual property includes, why it is valuable, reasons to value it, and lastly, how to value the intellectual property.
What is intellectual property?
Intellectual property is a subset of intangible assets and can be legally protected and enforced. They are easily identifiable, transferable, and have economic life and value. Intellectual property includes:
- Trade secrets
Why are intangible assets valuable?
- Registered patents or designs prevent competitors from launching similar or competing products.
- Rights to a product or design allow a business to offer unique products to their target market at a premium price.
- The right for a business to license its intellectual assets. The business can then give these rights to a third-party to manufacture and sell their products. This can provide a valuable income stream for the business holding the license.
- Intellectual property can increase revenue or reduce costs.
Reasons to Value your Intellectual Property
- Licensing process: Assessing the value of your intellectual assets can help simplify the licensing and assignment process.
- Determining royalty rates: Determining royalty rates is also a key reason to obtain a valuation. Knowing the value can help determine how much a third-party should pay to use the intangible asset(s).
- Transacting: When buying, selling, or transferring your company, knowing the value of your intangible assets increases the overall value of your company.
- Obtaining financing: Intellectual property can provide collateral for loans.
- Finding investors: For startups and new companies, valuable intellectual assets increase the chance of outside investors.
- During bankruptcy: During bankruptcy, divorce, or reorganization, a valuation is often required by the court. This helps in the process of properly disposing of assets and helping reorganize the company if necessary.
- Estate planning: If intellectual property is part of your estate, a valuation can help in planning for tax expenses, dividing ownership rights, and creating an effective estate plan.
- Providing litigation support: A high-profile purpose for valuing intellectual assets is to compute damage awards for infringement lawsuits.
Methods to Value Intellectual Property
The exact value of the intellectual property can be difficult to determine. Several factors impact the value. As such, a valuation expert uses several methods to determine the value of the intellectual property. No method is perfect for every situation.
The cost approach is a method that determines the value based on the cost to develop the asset historically or the future cost it would take to recreate the asset in the current market. This means that an investor will value the intellectual asset no greater than the cost to obtain or reproduce an asset of equal utility.
This method is less useful for intellectual assets currently in use for products that have reached the market and generated revenues. This is because the cost to develop the intellectual asset is rarely representative of its overall value.
Most commonly, the cost approach is best when valuing intellectual property and products that have not yet been fully developed. Intellectual asset costs may include direct costs such as material, design, marketing, legal, engineering, and indirect costs such as development time, overhead costs, and profit distributions.
Income or Economic Benefit Approach
The income or economic benefit approach estimates the fair market value of the asset by discounting the value of future income the intellectual asset would generate. This is one of the most widely used approaches to valuing intellectual property. It utilizes forecasted future earnings based on historical financials, industry trends, and the competitive environment.
The market approach values intellectual property by looking at comparable market transactions of similar assets. However, this method is only applicable when reliable, and reasonable data exist in the active market and comparable transactions can be found.
Until recently, most intellectual assets were not bought, sold, or licensed frequently enough to determine a value based solely on direct market-based comparables. As such, a valuation analyst often analyzes and adjusts the existing comparables to arrive at a fair conclusion of value.
Deciding which approach is best comes down to four facts (1) how unique the asset is, (2) how much data is available and verifiable, (3) the context and purpose of the analysis, and (4) the judgment of the valuation analyst based on extensive earlier experience. Often an analyst uses numerous approaches to reach a reasonable conclusion of value for the subject intangible assets as of the specified valuation date.
Valuing intellectual property is a challenging process. Through obtaining a business valuation, you can understand the worth of these assets. Doing so can provide guidance for effective decision making. It can also help a business owner determine what assets are most profitable and how to monetize them.