Tag: Indian Financial System BU BBA 4th Semester NEP Notes

Intellectual property rights valuation or IPR Valuation is one of the most critical areas of finance that comes into play during the sale and purchase of companies and during solvency, merger, and acquisition transactions. Intellectual property is intangible assets that are either already patented or a patentable product, process, or service, or a trademark, copyright, or brand. It’s the unique creation of the organization, responsible for its distinction in the market. Though intangible, it’s often a major driver of success for an organization. Valuation of Intellectual Property Valuation Rights fundamentally means the process of arriving at a fair value of a Company’s Intellectual Property that can be monetized and can leverage the overall selling price of the company. For a profitable sale transaction, it’s extremely important to place the selling price at such a rate that it’s sold at the best possible value. The IPR valuation process helps to achieve a part of this justifiable selling price.

Reasons of intangible assets valuable to a business

• Registered patents prevent competitors from launching similar, competing products and potentially pushing the business aside within the market.
• Holding the rights to a product design enables an organization to create a singular offering to their market, and price their products accordingly.
• The company’s position and profile as an innovative business are boosted.
• For design-only businesses, the license for IP, utilized by third parties to manufacture and sell their products, provides a major and valuable income stream.

Essentially, holding assets can increase revenue or reduce business costs, and once they generate an income for the business being sold, a variety of valuation methods will be utilized.

There is no particular method of valuation that’s suitable for each business sale, however the foremost appropriate one depends on a variety of things, including whether the intellectual property rights (IPR) are fully developed and functioning.

Valuation Based on Replication Cost

This is the cost that the acquirer would have to incur in order to replicate the intellectual property. There is also a time component to this calculation, in that the acquirer might require years of effort in order to create the intellectual property. If the acquirer wants access to the property immediately, it should be willing to pay a premium to buy it from the acquiree.

Valuation Based on Market Price

This is the price that third parties would pay for the intellectual property if it were put up for bid in a fair market, with multiple bidders. An acquirer may want to pay more than this amount in order to avoid a bidding war with potential competitors.

Valuation Based on Discounted Cash Flows

This is the present value of the cash flows currently generated by the intellectual property, with certain assumptions included regarding possible changes in those cash flows over future years. The rate at which these cash flows are discounted to a present value is subject to interpretation and negotiation.

Valuation Based on Relief from Royalties

This approach is based on the cost that the acquirer would otherwise incur if it were required to pay a royalty for access to the intellectual property. This approach may not work if access to the intellectual property cannot be obtained through a licensing arrangement.

Intellectual property assets such as patents are the core of many organizations and transactions related to technology. Licenses and assignments of intellectual property rights are common operations in the technology markets, as well as the use of these types of assets as loan security. These uses give rise to the growing importance of financial valuation of intellectual property, since knowing the economic value of patents is a critical factor in order to define their trading conditions.

Cases of application

Valuation of patent rights is one of the main activities related to intellectual property management within an organization or company. Indeed, knowing the economic value and importance of the intellectual property rights assists in the strategic decisions to be taken on the company’s assets, but also facilitates the commercialization and transactions concerning intellectual property rights.

There are several business situations where valuation is required:

Valuation of a company for the purposes of a merger, acquisition, joint venture or bankruptcy

Most of the technological companies are highly based on intangible assets and investment in knowledge, research and innovation. According to studies, expenditures on knowledge, through investments in R&D or software, have grown at a higher rate than expenditures in tangible assets. This change in investments has consequently been reflected by a heavy importance of intangible assets and patents in companies. Therefore, to know the value of companies it is essential to know the value of their intellectual property.

Negotiations to sell or license intellectual property rights

As in other business transactions, organizations negotiating agreements to sell or license intellectual property and patent rights commonly have to agree on a price. Knowing the value of the intellectual property rights is essential to reach such an agreement, but also to make sure the parties are engaging in a good deal.

Support in situations of patent conflict or dispute

In scenarios of patent conflict, such as patent infringement proceedings or alternative dispute resolution mechanisms, quantification of damages is often a necessary step of the process. The correct valuation of the intellectual property right at stake is therefore essential to guarantee a fair recovery of the damages.

Fund raising through bank loans or venture capital

Valuation of the intellectual property to be used as security for bank loans or to attract venture capital and investors is essential. Several studies reveal that, in particular, owning patents and a proper intellectual property management play a crucial role in the decision of venture capitalists.

Assisting internal decision making for patent protection strategies

Valuation also plays a role on decisions concerning the patenting strategies and country selection for registration of intellectual property rights, or can assist organizations to identify weaknesses such as ownership uncertainties that have an impact in the value of the intellectual property rights and on decisions for the exploitation of such assets.

For accounting and taxation purposes

Organizations are required to report on their assets, including their intangible assets. Valuation is therefore a necessary step, as well as in situations of tax planning involving intellectual property.

Defining the objectives and context of the valuation is essential, since it determines the strategy as well as the type of valuation method that should be used. This is therefore the first step to take when performing a valuation.

Methods

Different approaches of patent valuation are used by companies and organizations. Generally, these approaches are divided in two categories: the quantitative and qualitative valuation. While the quantitative approach relies on numerical and measurable data with the purpose to calculate the economic value of the intellectual property, the qualitative approach is focused on the analysis of the characteristics and potential uses of the intellectual property, such as the legal, technological, marketing or strategic aspects of the patented technologies. Qualitative valuation deals also with assessing the risks and opportunities associated to the intellectual property of the company.

Quantitative approach

Several methodologies are used on the quantitative approach, but generally they can be grouped in four methods:

• Cost-based method
• Market-based method
• Income-based method
• Option-based method

Cost-based method

This method is based on the principle that there is a direct relation between the costs expended in the development of the intellectual property and its economic value. Two different techniques are mainly used to measure costs:

• Reproduction cost method: Estimations are performed by gathering all costs associated with the purchase or development of a replica of the patent under valuation.
• Replacement cost method: Estimations are performed on the basis of the costs that would be spent to obtain an equivalent patent asset with similar use or function.

Market-based method     

The market-based valuation method relies on the estimation of value based on similar market transactions (e.g. similar license agreements) of comparable patent rights. Given that often the asset under valuation is unique, the comparison is performed in terms of utility, technological specificity and property, having also in consideration the perception of the asset by the market. Data on comparable or similar transactions may be accessed in the following sources:

• Company annual reports.
• Specialized royalty rate databases and publications.
• In court decisions concerning damages.

Option-based method

Differing relative to the above methods, an option-based methodology takes into consideration the options and opportunities related to the investment. It relies on option pricing models (e.g. Black–Scholes) for stock options to achieve a valuation of a given intellectual property asset. In these cases, patents may be valued using the techniques developed for financial options, as applied via a real options framework. The key parallel is that a patent provides its owner the right to exclude others from using the underlying invention, so both patents and stock options represent a right to exploit an asset in the future, and to exclude others from using it. The patent (option) will have value to the buyer (owner) only to the extent that the expected price in the future exceeds the opportunity cost of earning just as much in a risk-less alternative. Thus patent rights can be thought of as corresponding to a call option and may be valued correspondingly.

Qualitative approach

This method does not rely on purely financial analytical data. In fact, the valuation in this method is performed through the analysis of different indicators with the purpose of rating the patent right, i.e. of determining its importance quality in terms of aspects that can impact the value of an intellectual property asset, covering legal aspects, the technology level of the innovation, market details and company organization. Commonly, the method is implemented through questionnaires comprising all these different criteria. Examples of questions included in such questionnaires can be:

• How would you define the patented technology innovation compared to the actual state of the art?
• Which level of its life cycle has the patent reached?
• What is the geographic coverage of the reference market?

Branding is a recently emerged marketing strategy where the focus is on building a corporate brand instead of just a product brand. Branding strategy, however, is usually developed by the CEO and higher management of an organization. It’s above the pay grade of the marketing staff because it involves the whole image of the corporate brand.

A brand is just limited to the name, logo or design of the company; brand equity goes much deeper than the surface and monetary value of a company. It’s the promising and emotional value of your company perceived by the people.

Brand equity is the perceived value of a customer based on their attachment, memories and emotional experience with the brand.

Brand value, on the other hand, is the calculation of brand in monetary terms; or the worth of brand in the market.

Brand equity shows you the success of a brand because more people would talk about it. The brand value will provide you the actual finances, sale value of the brand in the market.

Factors determining brand equity are as follows:

1. Brand loyalty
2. Brand awareness
3. Perceived quality
4. Brand associations in addition to perceived quality
5. Other proprietary brand assets such as patents, trademarks and channel relationships.

1. Brand Loyalty:

Brand loyalty central construct in marketing, is a measure of the attachment that a customer has to a brand. It reflects how likely a customer will switch to another brand, especially when that brand makes a change, either in price or in product features. As brand loyalty increases, the vulnerability of the cus­tomer base to competitive action is reduced.

2. Brand Awareness:

People will often buy a familiar brand because they are comfortable with the brand. Or there may be an assumption that a brand that is familiar is probably reliable, in business to stay, and of reasonable quality. A recognized brand will thus often be selected over an unknown brand. The awareness factor is particularly important in contexts in which the brand must first enter the consideration set. It must be one of the brands that are evaluated.

3. Perceived Quality:

A brand will have associated with it a perception of overall quality not necessarily based on the knowl­edge of detailed specifications. Perceived quality will directly influence purchase decisions and brand loyalty, especially when a buyer is not motivated or able to conduct a detailed analysis.

It can also sup­port a premium price which, in turn, can create gross margin that can be reinvested in brand equity. Fur­ther, perceived quality can be the basis for a brand extension. If a brand is well regarded in one context, the assumption will be that it has high quality in a related context.

4. Brand Association:

The underlying value of a brand name is often based on specific associations linked to it. Associations such as Ronald McDonald can create a positive attitude or feeling that can become linked to a brand such as McDonald’s. If a brand is well positioned on a key attribute in the product class (such as service backup or technological superiority), competitors will find it hard to attack.

5. Other Proprietary Brand Assets:

The last three brand equity categories we have just discussed represent customers’ perceptions and reactions to the brand; the first is the loyalty of the customer and the fifth category represents other proprietary brand assets such as patents, trademarks and channel relationships. Brand assets will be most valuable if they inhibit or prevent competitors from eroding a customer base and loyalty.

These assets can take several forms. For example, a trademark will protect brand equity from competitors who might want to confuse customers by using a similar name, symbol, or package. A patent, if strong and relevant to customer choice, can prevent direct competition. A distribution channel can be controlled by a brand because of a history of brand performance.

Standard of value

The most commonly used standards of value are Fair market value and Fair Price Value. It is important when undertaking an IP valuation exercise. Fair market value (Market value) can be defined as the price at which an asset or service passes from a willing seller to a willing buyer. It is assumed that both buyer and seller are rational and have a reasonable knowledge of relevant facts. Fair value (Fair price) is seen as appropriate for use in post transaction purchase price allocation. It is based on the assumptions that market participants would use when pricing the asset. Whereas fair market value is seems to be more appropriate when used in the premise of value in exchange, fair value is often based on premise of value in-use. As mentioned earlier. in common situation, IP valuation is a process to evaluate the fair market value of an IP asset.

Purpose of valuation

In order to determine the premise for calculation of value, it is necessary to understand the purpose for valuation. For instance, valuation from the perspective of market value and investment would be completely different. In commercial situations, market value is the appropriate premise. International Value Standards define market value as “The estimated amount which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s‐length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently, and without compulsion.”

Valuation methods

The methodology applied and assumptions made while applying particular valuation method affects the value of IP assets. Market Method is the ost effective form of valuation. Cost method is usually refrained by companies since it ignores the novel characteristic of IP. This method is helpful for R&D costs.

Nature and strength of IP asset

The competitive strength of an IP asset determines the comparative valuation that it shall hold in the market. The factors such as customer responsiveness and market distribution of a product or availing service determine its IP value. The threat of new entry and substitutes affect the value of IP assets.

Licensing and Franchising

A thorough understanding of the IP Assets ensures an informed negotiation and decision making regarding the terms and conditions at the time of licensing-in or licensing-out of IP especially in determining fair and robust royalty rates. In the case of franchising too, both the franchisor and the franchisee require a thorough understanding of the value of the trademark(s) and trade secrets and know- how of other IP assets. Examples; Mc Donald’s , Pizza Hut, Dominos, Haldiram, Bikanerwala.

Merger & Acquisition, Joint Venture or Strategic Alliance

The primary reason for considering an M & A transaction is the value of the IP assets of the target company. IP valuation enables the parties to take an informed decision on the acceptable cost of capital or deciding on financial leverage strategy to be followed. It also influences positively the resulting company’s value and share price. The strategy of world class companies such as Volkswagen group and Tata group enunciates the IP valuation technique to adopt brands. The Volkswagen Group owns Audi, Bentley, Skoda, Lamborghini, Buggati , Porsche and many other well-known brands. Tata group owns Jaguar and Land Rover.

Investment in Research and Development (R&D)

IP valuation helps in budgeting and resource allocation decisions. For example, if a company is spending a significant amount of money on internal R&D but is losing ground to competitors due to slow or late product introductions, it may need to rethink its R&D strategy and processes. IP valuation also provides strategic guidance for new product development, brand-extensions, line-extensions, managing foreign filing and prosecution costs, etc.

Financial Reporting

The recognition of the increasing share of IP assets in the total market value of enterprises has contributed to the change in the way the accounting community has begun to treat IP assets in financial reporting. The international accounting standards board (IASB) now recognizes acquired and identifiable intangible assets (i.e., IP assets) and requires all acquired IP assets to be recognised as assets, separately from goodwill, on the balance sheet of the business acquiring the IP assets. For instance, when a brand is acquired, IP valuation is done for the initial valuation as well as the periodical impairment tests for the derived values to be included in the balance sheet.

Optimizing Taxation

In devising ways to optimize the tax to be paid by a company, its assets, including its IP assets, require to be valued. IP assets create numerous opportunities for tax planning in both third party transactions as well as internal strategies such as cross-border transfer pricing and centralizing the ownership of IP assets in IP holding companies. The internal revenue service or other tax authorities would like 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 a company. Valuation of IP assets helps in assessing fair transfer prices for the use of IP assets, including brands, to subsidiary companies.

Insurance of IP assets

A completely new market is opening up for the insurance of IP assets with a number of major insurers in the developed countries creating products tied to the capital value of IP assets, especially trademarks/brands. Valuation is of extreme importance as far as Insurance is concerned.

Determination the value of your Intellectual Property

Evaluation of IP can be a challenging process. The most suitable method for IP assets depends upon the premise of purpose to be derived from the result, assets subjected to valuation and the specific section for which the valuation is prepared.

The two effective ways of valuation are:

Market based

This is the most commonly used approach, this approach is based on the comparison with the actual price paid for a similar IP asset under comparable circumstances. The calculation would be accurate if there exists appropriate information on the nature and extent of rights transferred, circumstances of transaction for eg; license agreed in litigation settlement. The process initiates with research of an appropriate market to obtain the transaction information about sales, licensing of subject IP. The second step is to select relevant units of comparison such as “per drawing”, “per location”. “per customer” and develop a comparative analysis for the units considering factors such as profitability, risk, Industry, company structure, strength of IP rights, etc.

Income Method

It values the IP on the basis of amount of financial income that IP is expected to generate. In order to evaluate, project the revenue flow over remaining useful life of asset and offset those revenues by the cost related to asset. The risk has to be discounted from the amount of income by using discount rate or capitalization rate. The method is most suitable for capturing value of IP that generates stable cash flows. However, the method does not consider independent risks associated with an IP asset and lumps all the risks together to be adjusted in discount rate.

Patent monetization is an important part of managing an IP portfolio. But before pursuing a particular patent monetization strategy, it is important to have a general sense of the value of the portfolio. In all, the complexities and nuance of patent valuation is a complicated undertaking, requiring a great deal of experience, expertise, and judgment. As such, the many approaches that a patent valuation expert might employ, and the information he or she might rely upon, are beyond the scope of an introductory article. However, this article will enable skilled IP attorneys to develop a solid sense of the valuation process, and to make informed decisions as to how and when to engage an expert.

Potential for Producing Revenue and Profitability

Some patents possess value because they are directly responsible for added revenue. The patented technology might be so important to the product that it drives additional purchases or commands a premium price. Similarly, the subject of the patent might drive sales of related, but unpatented, products. Examples include derivative sales (replacement parts, supplies, and maintenance services) and convoyed sales (sales often made in conjunction with the patented product).

Other patented technologies do not directly contribute to revenue, but might nonetheless be valuable to the patent owner. For example, the patented technology might make it less expensive to manufacture a product, directly reducing the cost of doing business and improving the owner’s bottom line. Others represent an add-on technology that doesn’t directly increase revenue but allows the patent owner to keep up with the feature offerings provided by competitors.

Patents may also be valuable to the patent owner in circumstances where there is not a clear connection to profitability. Patents can, in some circumstances, also be used to great effect for strictly defensive purposes. For example, the patent owner might rely on the patent to stake out a technological realm within which the owner could potentially sue for infringement, but which may also ward off competitors contemplating a lawsuit by raising the prospect that the owner would institute a countersuit.

Years of patent life remaining. Most investors would not want a patent that has limited years of patent protection (e.g. one that is more than 16 years old). However, a patent that was too recently issued (e.g. within the past three years) is unlikely to have been litigated. The average age of patents when they are litigated is three years old. It is better to acquire a patent after it has been proven valid during litigation or has passed through the period when challenge to its validity is most likely. As a sweeping generality, those patents that are most valuable are between 10 and 13 years old.

Number of inventors listed on a patent. A higher number of inventors listed on a patent indicates that the patent is of higher quality than a patent that has a lower number of patent inventors listed. The reason is that more intelligent scientists or engineers believed in and dedicated their time to championing–the technology behind the patent. However, having numerous inventors listed on a patent can be a source of vulnerability: if these inventors are deposed or cross-examined when their patent’s validity is challenged, it becomes more likely that one of the inventors will mention the existence of prior art. Also, failing to list an inventor on a patent risks giving rise to litigation.

Anticipated licensing revenue. A standard procedure in patent valuation is determining the net present value of royalties that will be received as a result of licensing the patent. One benefit of developing a highly delineated model of projected royalties is that very specific factors can be taken into account.

Ability to trigger sales of end products. Patents are most valuable when they cause consumers to buy more of the product or newer versions of the product. For instance, some ten years ago Intel and Microsoft were able to spark sales of personal computers when they introduced new semiconductors and software. Consumers willingly retired perfectly good PCs as they raced to embrace PCs with the greatest processing power and snazziest software. Similarly, patents that increase the utility for existing or new users are generally very valuable. Examples of this can be found in the patents behind the features on cell phones. Finally, patents are valued dearly when the patented feature is a primary factor in the demand for the product. This is to say that the patent is the product. Examples of this contention include the primary patents underpinning many pharmaceuticals, Velcro and Post-It notes.

Ability to generate add-on sales. A licensee may derive important ancillary benefits associated with selling products with embedded cutting-edge technologies. The benefits may be in the form of greater traffic generation to its web-site, catalogs, or stores. A more direct example of generating add-on sales would be a patent that improves on the functionality of ice skates could also contribute to higher sales of protective gear. In such instances, the licensor should seek higher licensing fees from the licensee since the licensee will enjoy spill-over benefits associated with selling the cutting-edge technologies.

Ability to generate sales in new markets. Licensors typically seek lower royalty rates from licensees who will sell the related products in a new market compared to the royalty rates they seek from competitors who will challenge the licensors in their existing markets. While the royalties per unit from the former licensee will be lower, there are two factors that are accretive to patent value in this scenario. First, the total royalties generated by a licensee pioneering a new market are likely to be substantial. Secondly, licensees penetrating new markets do not pose the profit denigration issues for licensors that competing licensees represent.

Stage of development. Typically, the earlier in the commercialization stage a technology is, the lower the licensing value. This is because there are significant risks in the technology never being brought to the market and if the technology eventually becomes market-ready, this will only be achieved at great expense. In the scenarios in which the licensee would have to make much of this investment, the licensing fees would be less lucrative for the patentee.

Quality of law firm. Services such a PatentCafe rate and rank law firms on their history of writing patents that successfully sustain invalidity challenge. Patents drafted by law firms that score highly on such rosters are generally of higher quality than patents that score poorly on such surveys.

Quality of patent examiner. Patents that are granted by patent examiners with longer tenures and more impressive records of granting patents that successfully sustain invalidity challenge are statistically more valuable than patents without such lineage.

Size of portfolio being sold. Our research indicates that each patent family will receive the highest price when between 25 and 76 patent families are included in a patent portfolio. Portfolios with more than 76 patent families are discounted because the buyers believe that the sellers are purging a lot of their mediocre patents in the portfolio sale. On the other side of the spectrum, selling too few patents yields a discounted value per patent because of the natural aversion that patent managers have to seek significant funds (e.g. $3 million) from their Boards of Directors in order to buy a small number of patents (e.g. two).