By Efrat Kasznik and Luca Escoffier
The valuation of Intellectual Property (IP) such as patents, or of non-patented technologies, is still considered by many to be more of an art than a science. While IP valuation might appear to be a routine task for a technology/patent broker, in fact most of the time it can be really difficult to value a patent or technology even for those who transact those assets on a regular basis.
In this article, we set out to explore the usage of standard valuation methods by IP brokers, hoping to shed some light on why brokers rely or don’t rely on IP valuation methods in their transactions, and which valuation methods and/or tools are used the most. By “valuation” we refer to the process of attaching a monetary value to a patented or nonpatented technology. It is therefore a quantitative assessment. Conversely, when we look at regulatory, technical, commercial and other hurdles that the technology may encounter before entering a market, we are making a qualitative assessment. This latter approach, more properly defined as “evaluation”, is not related to the calculation of a number, but to conclusions drawn after an analysis of the qualitative attributes surrounding the technology.
During October 2011, we ran a survey through our private network and LinkedIn groups, asking what were the major valuation methods being utilized by IP brokers, if any; the respondents to our survey are distributed as follows:
• Sixteen (16) responses have been received and tabulated;
• Three (3) continents are represented in the survey (America, Europe, Oceania);
As presented in Figure 1, the majority of the surveyed brokers do not use standard valuation methods; Figure 2 shows that the majority of the respondents are from the European continent. However, since almost all of them operate globally, we could not find a distinction in the use of valuation methods among the different geographic areas.
Below are some additional interesting findings from our survey:
• The top reason quoted for not relying on IP valuation methods is that every technology is unique, which therefore standard methods fail to capture.
• Those brokers using IP valuation methods are primarily relying on the discounted cash flow (DCF) method to calculate the net present value of future cash flows generated by the technology in question, and also take into consideration its market volume and market share.
• As a matter of practice, IP brokers do not rely on valuation software tools and stick to more conventional valuation methods or to a case by case approach. In interpreting the results of our survey, it is important to understand what are the standard IP valuation methodologies, how the IP transaction marketplace has evolved, and how the two intersect with each other.
IP Valuation methods
IP valuation methods fall into three categories:
Market, Income, and Cost-based methods. Market methods rely on prices of comparable transactions in the marketplace, involving similar assets. Income methods rely on a measurement of future income from the asset, adjusted for risk and time. The most common example would be the DCF methods, already mentioned before, which measure the net present value of future income from the IP asset or technology, such as royalty rates. Cost methods are based on a measure of what it would take to create a similar asset, including all labor and material costs that go into that. In practice, the income methods are used the most, which is consistent with our survey results, due primarily to the lack of good comparable market transaction data. We will discuss the reasons for that lack of data below.
The valuation of intangible assets is a relatively new analytical practice that evolved over the last two decades, emerging from the increased levels of patent litigation in the 1990’s and the need to value patents and other intangibles in the context of litigation damages. The valuation of intangibles has moved into financial reporting, with the passing of new accounting regulations around purchase price allocation in M&A deals (under both US-GAAP and IFRS), and the need to calculate the price of intangibles that are included in an acquisition. IP valuation is also heavily used in tax reporting, with the emergence of IP holding companies and transfer pricing compliance regulations that require the valuation of IP portfolios involved in transactions for tax purposes.
The IP marketplace has been quickly evolving into a very dynamic transaction market over the last decade. Contributing factors included: the availability of patents following the dot-com bubble and corporate bankruptcies; the emergence of enforcement as a business model by non-practicing entities (NPEs or “Patent Trolls”); and the presence of large buyers such as Intellectual Ventures and other patent funds and aggregators. This ecosystem gave rise to a class of patent intermediaries, such as patent brokers. Most of the transactions facilitated by brokers are done in private circumstances where the reporting of the transaction is not required, nor is it supported by a formal valuation analysis. This explains why the reliance on standard IP valuation methods is not widely reported by the brokers surveyed in our study. Instead, IP brokers rely on a combination of “rules of thumb” assessments, and some very basic valuation, usually done without the help of a third party valuation expert. Since many brokered transactions are not reported, there is no solid database of prices, which explains why IP brokers rely on income based methods, such as the DCF, and not on market-based comparable transactions. This situation is likely to persist, unless some radical changes are made to the reporting requirements, which result in widely available pricing data for IP transactions.
Finally, due to the highly specialized nature of IP valuation, it is a task that is not well suited for automated software valuation tools. It is therefore not surprising that just one of the surveyed IP brokers mentioned relying on software valuation tools. There are a limited number of tools1 for the evaluation and valuation of technologies and IP in the market today, including a free software tool offered by the European Patent Office called IPscore www.epo.org/searching/free/ipscore.html.
Based on our brief review of the tool, though, it is more focused on the evaluation process, and its financial valuation capabilities appear to be limited. With the level of complexity associated with IP valuation, this is likely to remain the domain of valuation experts, rather than software packages.
1 One has been formulated by one of the present authors. For more info, see Luca Escoffier, Reinterpreting Patent Valuation and Evaluation: The Tricky World of Nanotechnology, TTLF Working Paper No. 8 www.law.stanford.edu/program/centers/ttlf/papers/escoffier_wp8.pdf