IP Valuation: How to measure what you cannot see
The value of Intellectual Property (IP) assets has skyrocketed in recent decades. In some cases, the worth of an organization's IP far exceeds that of its physical resources, property or other holdings.
A valuation of your intangible assets is critical to getting the most out of this "hidden" treasure trove — particularly in times of economic uncertainty. But this task is not as simple as opening a box and counting the coins inside.
The value of IP today
According to a 2020 report, the cumulative value of the intangible assets held by companies on the S&P 500 has surged since the mid-1990s — from $3.12 trillion USD in 1995 to $9.28 trillion in 2005 and $21.03 trillion in 2018. Looking back to 1975, a time when physical assets dominated the account books, the IP of all S&P 500 organizations was worth just $122 billion USD.
Since those days, the furious pace of technological development, ever-increasing importance of brand identity in globalized trade and tightening of international accounting regulations have combined to ensure a reversal of fortunes for tangible holdings — one that has pushed intangible assets convincingly to the forefront.
Not only has the net worth of IP massively increased but over the same timeframe, so too has its relative weight. In 1995, IP constituted 68 percent of the market value of S&P 500 companies, rising to 90 percent in 2020. From these figures, and despite the chilling effect of the COVID-19 pandemic on economic growth, it is reasonable to project IP will contribute greater proportional and absolute value to the majority of publicly traded companies in the years ahead.
What are the different types of IP worth?
Specific examples, of course, vary widely from asset to asset. But it is fair to say that patents are generally worth more than the other principal types of IP: trademarks, copyrights and trade secrets.
This stems not only from the inherent value of what patents protect, that is, the authorship and exclusive ownership of a novel device or solution, but also from the effort necessary to achieve such rights. The process of receiving a patent from a government or regional IP office is often considerably longer than the application-to-approval cycle for a trademark. To give an example, it typically takes 12 – 18 months to receive a trademark registration from the United States Patent and Trademark Office (USPTO).
In contrast, the average total pendency (the period from initial filing to final disposition) for a patent at the same office is 24.4 months. It should also be borne in mind that even an unregistered trademark can provide a degree of legal protection, whereas an unfiled patent confers no such safety net. Similarly, the cost of applying for and maintaining patent rights is usually greater than the equivalent steps for trademarks registered in the same jurisdiction. That being said, there are exceptions to every rule, and when it comes to IP, trade secrets are something of a wildcard. These assets are notoriously difficult to valuate from an objective dollars-and-cents perspective.
Consider the Coca-Cola formula — perhaps the world's preeminent trade secret. Among that company's many patents, one can say almost with dead certainty that not a single one is as valuable as the flagship product's secret recipe. On the other hand, the trademark protecting the McDonald's logo is a much more valuable IP asset than the trade secret behind their special sauce. Simply put, the precise value of an IP asset of any type cannot be left to sweeping assumptions and can only be determined by a formal valuation.
How do you calculate the value of IP?
There are three main methods, each with its advantages and limitations:
- Income: This approach is the most common way to determine what IP is worth, according to the World Intellectual Property Organization (WIPO). Calculations are based on the "amount of economic income that [the asset] is expected to generate, adjusted to its present-day value." If you plan to license the asset, the royalty revenue of the licensing structure would be your baseline. However, this procedure presupposes that future income is predictable with a reasonable degree of confidence and will remain relatively stable. Additional variables are used to factor in risk, but as in all projections, a degree of uncertainty is inevitable.
- Cost: This valuation model assesses the cost of developing a particular IP asset. If you are concerned about inefficient spending in R&D and similar day-to-day operations, a cost-based valuation can help determine what expenditure could be expected to generate a similar or identical IP. This method's shortcomings are that it only applies to easily reproducible IP and does not consider an asset's novelty or economic potential.
- Market: Similar to the cost approach, a market-based IP valuation is a comparative operation. It locates the price paid by a party to obtain an intangible asset similar to that being assessed, purchased under normal conditions. According to the European Union Intellectual Property Office (EUIPO), this method can be ideal for those new to IP transactions, as it is much like the valuation of physical property. However, it can be challenging to find an equivalent IP asset for a less common product, such as a niche computer program.
Selecting the proper methodology requires a thorough understanding of the valuation context, the business environment and the intended purpose. Both market- and cost-based valuations are essentially retrospective and therefore fail to account for future earning potential. On the other hand, as a prospective calculation, the income method is susceptible to market volatility and shifts in strategic priorities.
Further variables that may factor into a valuation analysis and, consequently, the choice of approach range from the damages involved in a patent-infringement case (in a highly competitive environment) to the possibility of renegotiated licensing agreements.
Why value your IP?
An IP valuation project can be integral to a company's evolution, particularly during periods of rapid growth and expansion into new markets. Looking to your books allows you to demonstrate the economic clout of your portfolio during acquisition negotiations or showcase what you bring to the table in the event of a merger. By assessing the value of your IP assets, individually and as a portfolio, you can make better-informed strategic business decisions during joint ventures and improve your chances of securing investment capital.
The experts at Dennemeyer Consulting are always ready to provide actionable insight and counsel regarding the concrete value of your intangible assets.
A version of this article was originally published in CITMA's digital magazine on September 28, 2022.