IP Valuation Models: Everything You Need to Know
IP valuation models use methodologies to determine the monetary value of assets.3 min read
IP valuation models use methodologies to determine the monetary value of assets.
What are Intellectual Property Valuation Models?
Intellectual property (IP) has legal recognition and protection thanks to the United States' intellectual property laws. Other intangible assets have recognition under commercial and contract law, but the small group of assets involves IP. This group includes, but is not limited to, the following:
- Brand names
Once you look at the IP and asset portfolios, you can determine which IP methodology to use.
The basis for IP valuation involves substitution. The IP's value isn't greater than the cost to get the asset elsewhere. To determine this, take into account the cost of obtaining the asset by purchasing it today or replacing it with an equal one.
There are several different cost approach methods to consider. Replacement costs deal with the price to create or purchase an IP, while reproduction costs deal with constructing an exact replica. To narrow down your choices consider the following:
- Hard costs, which includes materials and acquiring assets.
- Soft costs, which includes design time, engineering time, and overhead.
- Market costs, which includes advertising costs.
Since the cost approach deals with substitution, valuation cannot be greater than the amount of money someone would pay for a replacement or reproduction.
The IP market approach compares assets to recent sales, transactions, and sales that involve similar markets and assets. The greater the similarity, the more suitable the transaction. This approach works best with an active marketplace that existed for decades, such as real state and raw materials.
However, most intangible assets haven't been bought or sold often enough to have market-based comparables. As a result, it's difficult to have enough information on the similar transactions.
Based on future income generated from the IP, the income approach methodology is widely used. It's one of the more complex methodologies since you must measure the asset's income. Keep in mind the future, duration, and risk of the income stream.
A common mistake in the income approach is the lack of differentiation between total business income and IP value income. Make sure you separate the IP income stream, also known as a discount rate, from the business value. You must project future income and estimate the risk of generating an income stream.
Relief from Royalty Approach
Another option is relief from royalty approach, which is oftentimes oversimplified and not applied correctly. If used correctly, it works well in combining the income and market approaches.
This methodology calculates the present value of a stream of royalties that the IP owner would receive. This assumes that you don't own the patent, copyright, or trademark so you avoid paying a royalty. It incorporates a projected or past revenue and relies on comparable royalty rates.
There are several levels of the Valuation Pyramid where you define and value the asset, determine how to use it, and figure out who is the assumed buyer. There are several levels of the pyramid.
- Foundation. This houses the key assumptions for the IP valuation.
- IP profile. This defines the legal, business, and economic aspects of the IP asset.
- Methodology. This is where you perform financial analysis to determine a financial result.
- Solution. This is the final outcome to resolve a specific business issue.
Just like the pyramid, there are a few facets of IP methodology. The Transactional Method involves the price paid for something similar either through a direct acquisition or the right to use something, like a license.
There are usually two steps in this method: screening and adjustments. Screening involves selecting transactions using information on pricing, terms, and scope. Adjustments involve a change in the valuation. Be careful when it comes to adjustments because if you use too many, it limits the comparability and can compromise the credibility.
If you opt for IP valuation, you should perform it thinking about the end result. The final aspect is to resolve a business issue meaningfully. There are three categories to consider the solution.
- Planning recommendation. Related to the new use of the IP, planning recommendation involves whether or not to get involved with an IP sale.
- Compliance. Referring to the IP financial reporting, compliance is a regulatory requirement. It concerns the business reporting requirement in the tax code.
- Dispute resolution. This is in reference to IP infringement settlement claims.
If you need help with IP valuation models, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Stripe, and Twilio.