Understanding the value of your company’s Intellectual Property (“IP”) can be a complex but rewarding process. There are many situations where you may need to ascertain the value of your IP; when selling it, using part of it as security, or where the IP needs to be quantified for the purposes of awarding damages in court proceedings. It is also important to correctly declare the value of your IP when reporting to your local taxation authority.
Obtaining a valuation can also assist you in commercialising your IP, enabling you to maximise your profits, for example, through licensing your IP or franchising.
This article will outline three common methods of valuing IP:
- The cost approach;
- The market approach; and
- The income approach.
The cost approach is based on the principle that an investor will not pay more for an asset than the cost to develop or purchase an asset of similar utility. The cost of the asset can be calculated in two ways:
- The amount required to replace or purchase the asset (replacement cost); or
- The amount required to create an exact replica of the asset (reproduction cost).
These costs are generally determined at the date of valuation, and may not necessarily take into account particular historical expenditures which have already been incurred.
In terms of valuing IP, there are many different types of costs to factor into the calculation, including design and manufacturing costs and the legal costs of registering the IP.
The cost approach is appropriate for valuing newly-developed IP, since there will be a relatively low level of economic activity to consider and there is no data from marketplace activity.
The market approach bases the valuation of IP on a hypothetical transaction in a free and unrestricted market. In this case, the calculation relies on data from similar transactions involving similar IP.
However, the sale or licensing of bundles of IP is a relatively recent phenomenon and as such comparable data is somewhat limited.
The market approach is appropriate for internal valuation purposes within a company when proposing a transaction involving IP or when IP is the subject of litigation.
The income approach is based on the principle that the value of an asset is intrinsic to its expected economic benefit. This approach seeks to value the IP by projecting the revenue that the IP will make in the future. Once this value is established, the amount is adjusted in order to determine the present value of the IP.
The question of future revenue depends on the particular type of IP under consideration. For instance, the exclusive right to a patent may expire after a specified term and this factor needs to be taken into consideration in terms of forecasting the future revenue from the patent.
Appreciating the worth of your IP will allow you to properly protect one of your most vital business assets and make it work for your business. Valuing IP can be complex so if you wish to ascertain the financial value of your company’s IP, we recommend that you seek professional advice.