Understanding the value of Tanikei intellectual property (IP) is a very important part of successfully managing the resources effectively. Unless the valuation information it rely upon in the decision making process is accurate, however, mistakes are likely to be made. The best way to avoid making mistake based on inaccurate or incomplete value information is to understand how the conclusions of value were derived.
The first thing to determine when attempting to value intellectual property (IP) or intangible assets is the reason for understanding the analysis in the first place. Why do you need to know the value of the assets? The most obvious situations are those in which a third party has an interest in the value of assets. For example, the Internal Revenue Service and other tax authorities will want to know as much as possible about the basis for any value determination used when allocating portions of the purchase price associated with the acquisition of other companies.
The second order of business is identifying the context of the analysis. The context in which intellectual property is viewed is the single most important determinant of the value. Typically, the value of the intangible asset is likely to worth more to a large manufacturer in a relevant industry than to a small business entrepreneur. This is due primarily to the existence of complementary factors such as skilled labor, abundant capital, an effective marketing program and proven distribution channel. Because these factors differ from one scenario to the next, the same asset will have different values when viewed in the context of a large corporation, a joint venture or a company going through reorganization.
At this point, the basis of measurement needs to be defined. Everyone probably has some idea what the term value means when referring to IP. In general, it is a measure of the benefits received from utilizing the assets, while value in this sense can be attributed to many different aspects: increased market share, higher price, etc., in practice the value of the IP will be the result of either additional revenue or cost savings.
When calculating intellectual property value, there is a difference between the overall value provided by the IP and what is known as its "fair market value." The appropriate definition to use under the circumstances will have a significant impact on the conclusion reached.
A formal valuation of intellectual property most likely will refer to a standard of fair market value. This is the standard of value to which the analysis and all assumptions necessary in the valuation exercise have been held. It differs in some very important aspects from a strict calculation of the benefits derived from using the IP.
Fair Market Value:
Fair market value is the price at which an asset exchanges between a willing buyer and a willing seller, neither being under compulsion to act and both having reasonable knowledge of all relevant facts.
With a fair market value standard, it is assumed that a hypothetical transaction takes place. The price associated with this hypothetical transaction is the determinant of the asset's value. This standard requires that the buyer and the seller be willing to transact and be under no compulsion to act. No compulsion to act simply means that neither the buyer nor the seller is required to enter into the transaction or is under any pressure to do so. Their participation is not due to a legal ruling or a bankruptcy, for example.
Here is an example of fair market value. Suppose an inventor has developed a process that would allow a manufacturer to save $1million when compare to the expense currently incurred during his manufacturing process. The benefit of the technology is therefore in the form of a cost saving and the value of the development amounts to the $1million in savings. However, $1million is not likely to be considered the fair market value. According to the definition, fair market value is the price at which the asset would change hands. There is no incentive for the manufacturer to pay the inventor $1million for the development when his benefit also equals to $1million. The true fair market value will likely be somewhere between $0 and $1million, and will be determined by the various inputs that have an impact on a true negotiation. These will include items such as the competitive environment and the existence of alternative methodologies that provide the same benefit.
Methodologies:
Once the assets to be valued have identified, the context of the valuation including the appropriate timeframe has been determined, the proper measurement of value has been selected and the purpose for performing the valuation has been identified, it is time to consider which valuation methodologies to utilize.
There are three valuation categories the most widely recognized: the Cost approach method, the Market approach method and the Income approach method. Each of these has strengths and limitations that make them more or less appropriate depending on the specific circumstances of each analysis.
The Cost Approach Method:
The cost approach method seeks to determine the value of IP aggregating the costs involved in its development. This may seem fairly simple. However, there is more to it than merely adding up all of the receipts for expenditures associated with the R&D. Indeed, there are two distinct Cost Approach methods: Historic Cost, Replication Cost and Replacement Cost.
Historic Cost
This valuation methodology measures the amount of money spent in the development of the intellectual property at the time it was developed. But unless the intellectual property was developed in the recent past, an historic cost measure tends to be unreliable due to the impact of inflation and the changes that occur in technology over time. In addition, it is not always possible to provide accurate information on the resources spent for such quantification.
Replication Cost
This measures the amount of money that would need to be spent in current cost terms in order to develop the intellectual property in exactly the same way and to achieve the same final state as it currently exists. This includes costs incurred on any unsuccessful or inefficient prototypes.
Replacement Cost
This measures the amount of money that would need to be spent in current cost terms in order to develop the intellectual property as it currently exists, but excludes the costs relating to unsuccessful or inefficient prototypes.
Market Approach Methods:
The market Approach to IP valuation is similar to valuation techniques used for assets such as real estate and paintings. With real estate, the value of a four-bedroom house close to goods schools can be accurately estimated by researching recent transactions featuring comparable homes in the same neighborhood. Similarly, intellectual property value is determined by comparing the IP to comparable assets that recently exchanged under similar circumstances.
An advantage of this approach is that it can be applied to a wide variety of intangible assets in a wide variety of circumstances. It is equally valid when applied to an established trademark or an early stage technology. As long as there is transactional data for comparable assets, the market approach will prove to be effective.
Conceptually, a market comparables approach should offer a good indication of a patent's value, as it reflects the exchange of value between two parties. However, in valuing patents it is difficult to find a suitable comparable transaction. The two primary reasons for this are the lack of disclosed sale or licensure activity and by its definition, a patent must be unique.
Unfortunately, transactional data on intangible assets is rarely published and therefore it is difficult to gather enough data to provide a significant number of comparable transactions. The bottom line is that the market information can be very useful in analyzing and valuing intellectual property, but it seldom is comprehensive enough to provide the basis for a satisfactory conclusion of value on its own.
Income Approach Method:
The Income Approach Method utilizes the ability of the intellectual property to generate cash flow. While the Cost Approach has specific applications in certain situations and with certain types of intangibles, and the Market Approach has its own limitations, the Income Approach is generally applicable to most situations and intangible assets.
This approach is based on discounted cash flow theory and defines the value of the subject property as the present value of the anticipated net economic benefits to be achieved over the duration of the property's useful life. When using the income approach to value intellectual property, future income or cash flow related to the business, business segment or product line under consideration is estimated. The forecasted cash flow is then discounted via present value calculations to determine the current value of the operation. At this point, it is necessary to ascertain the portion of this value that is attributable to the intellectual property.
When using the Income Approach, particular attention is paid to five main parameters that determine value: revenue or income associated with the use of the IP; expected growth characteristics of the identified revenue or income; expected duration of the revenue or income; risk associated with gathering the estimates of revenue or income; and the proportion of the revenue or income that is attributable to the subject IP.
These parameters are based on observations of relevant markets, including size, growth trends, market share dynamics among participants and overall market risk characteristics. Comprehensive knowledge of the attributes of the specific intangibles is also important, including stage of development, unique characteristics such as bankruptcy or market leadership, and relevant pricing information associated with the products that feature the subject IP.
