Although IP valuation has entered the corporate finance mainstream, the quality of IP valuation remains variable.
A recent IAM survey revealed that 50% of IP managers found valuation to be "an essential part of IP strategy". Around 30% either had not considered IP valuation or found it to be unhelpful. Various reasons for this are advanced by valuation sceptics. Some of these have merit and raise challenges to valuers. But all of the concerns can be overcome in a well-constructed valuation that integrates an assessment of the functional, economic and legal characteristics of intellectual property.
Anecdotally, the following are key reasons for scepticism of IP valuation:
Valuations often focus on financial analysis which does not reflect the complexities of assets such as patents, trade secrets and trademarks.
- For early-stage technology, the layers of uncertainty reduce the plausibility of income-based valuations.
- For technology that is already in use, it is difficult to disaggregate the earnings of contributory assets.
- Use of data from historic transactions to value intellectual property can be superficial and misleading.
- There is a perceived lack of professional standards for IP valuations.
This article briefly explores each of these concerns in the context of patents.
Can a valuation capture the complexities of patents?
There is no doubting the complexities of the legal, functional and economic characteristics of patents. Each of these can have a profound impact on value – so a superficial valuation can be misleading. Gauging the incremental utility of new technology is hard enough. Further intricacies arise in aligning patent claims to the technology’s differentiating features, and then assessing validity and enforceability. However, these complexities are not unsurmountable. They can be carefully considered and factored into a valuation, but this requires a multi-disciplinary skillset.
A valuation is an opinion rather than a scientific calculation; but the credibility of that opinion is contingent on the building blocks that support it. The building blocks represent assumptions regarding the earnings capability, useful life and risk profile of the asset being valued. A coherent rationale should support each assumption and can include qualitative factors as well as quantitative analysis. It is the flow of commercial logic that supports each assumption and the valuation opinion that enables a user of a valuation report to ‘kick the tyres’, or test the quality of the building blocks.
What about early-stage technology?
There are extra layers of uncertainty in the value of early-stage technology. Most obvious is the probability of successfully clearing each development hurdle. In some situations there is also uncertainty regarding the extent of complementary assets that will be required to generate earnings. The degree of uncertainty regarding the development pathway is relevant to the choice of valuation methodology, but it does not invalidate the valuation process. These factors are integrated into licensing negotiations for agri-tech and biotech intellectual property, and can be factored into a valuation. However, the asset’s risk profile and the range of possible outcomes should be communicated to the reader of the valuation report.
In sectors as diverse as biotech and mining equipment, a thorough analysis of development stages and probability of success informs R&D planning as well as the IP valuation.
Understanding the links between intangible assets
Technology disrupters such as Uber have attracted discussion about the levers of their value. What is the relative value contribution of technology, brand and the network effect of the user base? Is the share price aligned with the intrinsic value of the business? Understanding the links between intangible assets is crucial – not just to IP valuation, but also to corporate strategy. The relative value of intangible assets informs corporate investment and risk management decisions. Good IP management ensures the transfer of value from short-lived technology to brand
The swings in the value of intellectual property – under different ownership and in combination with other assets – are more pronounced than most asset categories. From a valuation perspective, the first response to the asset linkages is to clarify the basis (or premise) of value. Is this the current use of the intellectual property, its market value or the special value to a particular investor? Once the basis of value is confirmed, value mapping is a useful tool to assess the relative importance of assets – and the linkages – in driving demand and efficiency.
Using market comparables
There are three approaches to valuing any asset:
- the market approach (based on comparable sales);
- the income approach (based on earnings and risk expectations); and
- the cost approach.
Within these approaches there are a variety of methods. The market approach is effective for valuing fairly homogenous assets with an active market – for instance, listed shares or real estate. Neither of these factors holds true for patents. Superficial ‘value per patent’ estimates are likely to be wildly unreliable. However, market comparables can provide broad guidance to valuation parameters if intelligently applied. Benchmarking patents is no easy task. Comparability factors should include functional attributes, stage of development, quality of claims, proof of freedom to operate, ease of enforcement and infringement detection.
Standards and guidelines
The IAM survey revealed that 45% of IP managers felt that an industry standard for IP valuation would be beneficial. The complexity of IP valuation and the need for multi-disciplinary inputs have prompted the Royal Institution of Chartered Surveyors to release a global guidance note on IP valuation. This document is not a ‘cure-all’ for IP valuation, but it provides a useful framework for valuers and users of valuation reports. The guidance note builds on the International Valuation Standards. It identifies factors that should be considered when assessing the characteristics of types of intellectual property and describes how these factors should be integrated into valuation analysis.
Increasing use of IP valuations
Although half of IP practitioners are less than enthusiastic, valuations are carried out with increasing frequency for a wide range of applications in many jurisdictions. Uses include litigation, strategy determination, M&A planning, IP financing, financial reporting and tax compliance. Although IP valuation has entered the corporate finance mainstream, the quality of IP valuation remains variable. Those briefing valuations should ensure that the supplier has the multi-disciplinary knowledge and experience of the subject asset.
If you have any further questions or require expert advice, please don't hesitate to contact us.This article first appeared on IAM.Author: Tim Heberden