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Valuing IP

Valuation of any sort is often part science and part art. The fact that relevant data can be so scarce for intellectual property means that valuing it is arguably even more art than science. There are, however, many occasions when IP does need to be valued, for example when listing a company (or just looking for investment or finance) or for estate planning.

The basics of IP valuation

Ultimately the valuation of any asset requires an answer to three key questions.

How unique is the asset?

The more unique the asset the harder it is to find points of comparison with existing valuations.

How much data is there regarding the value of the asset (and how reliable is it)?

With tangible assets it may be possible to base a valuation on the value of its component parts, for example fine jewellery is a combination of precious metals, gemstones and workmanship. Two of these three can be valued fairly easily. The third is more challenging.

What is the purpose of the valuation?

Valuations for different purposes may lead to different results, which may be equally valid. For example an insurance valuation may look at the cost of replacing an used item with a new equivalent. This may produce a different result to a sale valuation for the item in its actual state.

The answers to these questions will be used by the valuer to form a basis for their final conclusion, which is also, often, based on their experience and judgement. When it comes to valuing IP, there are basically three standard approaches they can take.

A cost-based valuation

The premise underlying this approach is essentially that the value of the whole can never be greater than the sum of its parts. In other words, the value of the intellectual property can never be more than the cost of creating or reproducing it. There are some forms of IP for which this approach is blatantly unsuitable, for example the brand logos of major companies, which may well have been created literally decades ago and which are now essentially visual images, which can be reproduced through a variety of media. It can, however, work reasonably effectively for others, particularly those which were created as a result of recent research and development, in which case the costs associated with this could form a meaningful basis for a valuation. Even here, however, the IP could end up being undervalued since this method ignores the possibility that its value will increase in the future.

A market-based valuation

This method is basically the same as the method commonly used for valuing tangible assets. It looks for comparable sales and uses those as the basis for a valuation of the asset. While this has the potential to provide the most realistic valuation, in the real world there are two major challenges to this approach. Firstly there may be a limited market for the relevant form of IP, with the result that it may be extremely difficult to make meaningful comparisons. Secondly even where a market exists, data on sales may well be confidential. Hence, while this method may be technically the best for many purposes, it can also be the hardest method to implement in practice.

An income-based valuation

This technique aims to put a value on the IP by looking at the income it generates (or, conversely, the money it saves). Again, how feasible this is in practice depends on a variety of factors. In an ideal scenario, the IP will have existed for a number of years and will be creating a constant source of income (or savings). In the real world, however, newly-created IP (such as a new patent or brand logo) may have to be valued using a number of “best guess” assumptions. Even so, income projections tend to be made over a short time frame, say 4-5 years.

 

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