IP Valuation: Rules, challenges, and methods

Be it any great invention or a breakthrough, it all starts from an innovative idea or a concept. Intellectual Property (IP) represents these ideas and creations, including logos, designs, and brand names. Although intangible, IP holds significant value for businesses. 

As per the report from WIPO, In 2022, Patent filing grew by 1.7% and reached up to 3.46 million worldwide. Applications for utility models – a special patent right – grew by 2.9% to 3 million applications.

IP comprises four primary forms: Patents, Trademarks, Copyrights, and Trade Secrets, each granting creators exclusive rights to their creations for a specified period. To anyone starting a business, understanding the valuation, methods, rules, and challenges associated with IP is crucial. Let’s cover it all.

What is IP Valuation?

IP valuation is the process of assigning prices to IP assets(patents, trademarks, copyrights, and trade secrets). Whether buying, selling, or licensing IP, conducting an IP valuation is crucial for understanding its value.

 Organizations undertake IP valuations for various reasons, including:

• Negotiating IP licensing agreements.
• Franchising opportunities.
• Establishing transfer pricing.
• Securing funding.
• Business sales.
• Mergers and acquisitions.
• Bankruptcy proceedings.
• Forming joint ventures.
• Tax planning and compliance.
• Providing litigation support.

The valuation involves analyzing various factors like the uniqueness of the IP, its market demand, potential future income it can generate, and the legal protection in place. 

IP valuation helps assign prices not only to the IP but also to the true value of a business. Because IP often represents a business’s most valuable asset, identifying its cost is important for an accurate business strategy.

What are the Methods of IP Valuation?

The nature of the IP, its functional status, and many more factors determine the valuation method to arrive at a value for the asset. Below are the common traditional Methods of IP valuation.

Market – Based Method:

The Market method is the most practical and logical method of IP valuation. This approach uses real-world transaction data to determine the asset’s potential value. The process takes place by comparing an IP asset with those with a similar nature in the market.

It considers various factors like the nature of the asset, its remaining tenure, purpose, profitability, etc. This method of IP valuation is beneficial if the asset lacks historical data, and similar to publicly traded companies, market multiples (P/E ratio and P/S ratios) can also be used.
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Income Method:

Companies commonly use the income method to perform IP valuation, assessing the expected future income generated from intellectual property. Valuing the “income” attributable to the asset becomes a complex task in this approach, requiring decisions on assessing and quantifying it.

The income method suggests that the value of an intellectual property asset is determined by how much money it’s expected to make in the future, considering its present worth. This method is beneficial, particularly when valuing IP assets that generate major revenue sources such as patents, trademarks, and copyrights.

Cost Method:

The idea underlying the cost method is that the value of an IP asset equals the cost of replacing or reproducing it. It determines how much an IP asset would cost to make or replace it and then adjusts it for depreciation. 

This valuation technique considers Research and Development costs and legal and registration fees. Unlike the Income method, this method is useful in valuing IP assets that do not generate major revenues, like trademarks.

What are the Rules to follow in IP Valuation?

Following certain rules and guidelines in IP valuation ensures a fair and accurate assessment of the value of IP intangible assets. Some of them are below:

RULES AND GUIDELINES FOR IP VALUATION

Rule 1) It must be distinct and identifiable. Separating IP assets from other assets is the first step, making it easy to recognize and account for.

Rule 2) To ensure transparency, one must properly document the method, assumptions, and data resources used to determine IP asset value.

Rule 3) The asset should have a clear creation date.

Rule 4) It must be legally enforceable and transferable.

Rule 5) There should be a defined point in time for potential destruction or termination.

Rule 6) The 25% rule is a rule of thumb for Fair Royalty rate calculation. According to this rule, the company using the intellectual property pays the owner (licensor) 25% of the gross profits from the product or service sales while keeping 75% for themselves.

Rule 7) For intellectual property to have legal standing, it must be supportable by lawful means, and its transferability can occur through sales, licensing, or any legal arrangements.

Rule 8) Its income stream should be distinguishable from other business assets.

Rule 9) The IP assets should be capable of being sold on their own without being tied to the sale of any other business assets.

Rule10) There should be tangible proof of the existence of the asset. This evidence could include a contract, a license, or a registration document.

Remember that, along with following the above guidelines, a periodic valuation review is necessary to align with the current economic conditions and circumstances surrounding the IP.

What are the Challenges faced during IP valuation?

Though IP valuation is crucial for businesses to know its complete worth, it has drawbacks regarding its scope, usage, and a few others. Below is the list of challenges that a company faces during IP valuation.

Intellectual property values can significantly shift due to fluctuating market trends, evolving consumer preferences, technological advancements, or shifts in business models. Monitoring these dynamic factors is essential to ensure an up-to-date and precise valuation.

In fast-changing fields like technology and software, the value of intellectual property (IP) can drop quickly because of new advancements, highlighting the need to accurately assess the risk of becoming outdated.

A trademark registration usually takes 1 year, and patents also need considerable time for experts to validate the new idea. 

An attorney will examine a trademark or patent six months after applying. 

In developed countries like the United States, other companies can object to the trademark within 30 days of it being made public. 

All these steps take time, and the company might have to wait before it can start selling in more places, especially if a few people know the products outside of where it is based.

Valuing intellectual property, particularly patents, poses challenges due to its dependence on uncertain future income and market-based methods of IP valuation. Additionally, establishing the necessary information for valuation remains pending.

Unlike Tangible assets, like buildings or machines, certain intellectual Property (IP), like newly created patents or emerging brands, may not have a history of how well they’ve done in the past. This makes it tricky to predict how much money they might make or how valuable they are in the future.

Cracking the Code: Mastering Rules and Methods of IP Valuation

Although performing IP Valuations helps in knowing the total worth of a business, complete information to do the valuation might only be available if it involves intangible assets. Considering the various complex concepts, an Individual Valuation Expert’s support will help arrive at an accurate value. 

During Merger & Acquisitions, IP valuation could be useful for negotiations. It is also beneficial to align with regulatory compliance, accurate financial reporting, Tax planning, and many more. A business needs to be proactive in understanding IP assets’ scope, methods of IP valuation, and the challenges they might face to make informed decisions. Have an expert beside you to crack the code and get a precise value.