How Intellectual Property Valuation Will Impact Business Transactions

Intellectual property valuation determines the monetary value of a business’s IP assets, and it drives outcomes in licensing deals, joint ventures, mergers and acquisitions, financing, and ownership disputes. The most valuable assets of a business are often the things that cannot be seen or touched: a proprietary process, a copyrighted work, brand recognition, or the competitive edge of a patent. To position a business for success, it is imperative to identify and understand the worth of those IP assets.

Consider two common scenarios. A software designer develops the first working version of a new program and later forms an LLC with two investors to develop the product. The IP was never assigned to the LLC, and now the business is being sold. What are the consequences? Or a company builds a valuable business on a proprietary process, and a dispute arises among the owners: how much of the business’s value is tied to that trade secret? Owners need answers to these questions before a deal or a dispute forces them.

Key takeaways

• IP value comes from using the asset in a product or service, licensing or selling it, or using it to keep competitors out of a market.
• Intellectual property valuation matters when raising capital, negotiating a transaction, calculating infringement damages, or setting internal research and development priorities.
• The three accepted valuation methods are income, market, and cost, each suited to a different kind of asset.

What Is Intellectual Property Valuation?

Intellectual property valuation is a process for determining the monetary value of IP assets. The value of an IP asset represents the potential future economic benefits to the IP owner or authorized user. Value may be derived from several sources, including the direct exploitation of the IP by integrating it within a product or service; the sale or licensing of the IP to a third party; and the use of IP to raise barriers to entry into a particular market, reduce the threat of substitutes, or otherwise limit competition.

An intellectual property valuation is particularly important in licensing agreements, joint ventures, mergers, and acquisitions, whether those transactions arise from negotiation or dispute. IP valuation is also beneficial for the enforcement of IP rights, the internal management of IP assets, and various financial processes.

Why Intellectual Property Valuation Matters

IP protection and management are fundamental elements of any business strategy. Intellectual property valuation can be particularly helpful in the following situations:

• Attracting investors and obtaining financing. IP valuation helps businesses communicate the value of their IP assets to capital markets and investors. IP assets, such as patent portfolios and copyright revenue streams, may be used to secure financing. Valuation of IP assets can also help startups attract venture capital investment and is required for initial public offering (IPO) documents.
• Negotiating business transactions. A thorough understanding of the value of IP assets enables more informed negotiation and decision-making across a wide range of business transactions. IP valuations often play a key role when licensing IP assets; selling or purchasing IP assets; and negotiating M&A transactions, divestitures, spin-offs, joint ventures, or strategic alliances.
• Resolving IP disputes. Knowing the value of an IP asset can help inform legal strategy when IP rights are infringed. An accurate IP valuation is necessary to calculate damages when bringing an IP infringement suit.
• Resolving ownership disputes. When owners of a closely held business part ways, the value of the company’s IP is often the most contested number in the case; whether the IP was properly assigned to the entity and what it contributes to the enterprise as a whole can determine what a departing owner is paid.
• Internal planning. Understanding the value of IP assets can also help with internal business decisions, such as where to focus research and development, how to allocate financial resources, and whether to continue maintaining certain IP protections.

How to Value IP Assets

There are several ways to put a number on an IP asset, all of which require gathering information about the asset itself, as well as the economy, industry, and specific business that directly affect its value. As explained by the World Intellectual Property Organization (WIPO), the primary methods for conducting an intellectual property valuation are:

• Income method. The income method determines the value of an IP asset based on the economic income it is expected to generate, adjusted to its present-day value. This method is most appropriate for IP assets with positive cash flows, for those whose cash flows can be estimated with some degree of reliability for future periods, and where a proxy for risk can be used to obtain discount rates.
• Market method. The market method compares the actual price paid for the transfer of rights to a similar IP asset under comparable circumstances to establish the value of the asset being valued. Because this method is fairly straightforward and relies on market information, it is frequently used to establish approximate values for determining royalty rates, taxes, and inputs for the income method.
• Cost method. The cost method determines the value of an IP asset by calculating what it would cost to reproduce or replace a similar (or identical) asset. The cost method is preferred when the IP asset can be easily reproduced and when the economic benefits of the asset cannot be accurately quantified. The drawbacks of the method include failing to account for costs incurred due to waste and any unique or novel characteristics of the asset.