ORIENTATION PROGRAM ON INTELLECTUAL PROPERTY FOR

MANAGEMENT STUDENTS FROM IIPM (INDIA)

May 3, 2007, Geneva

Valuation of Intellectual Property Assets

Christopher M. Kalanje, Consultant, Creative Industries Division, WIPO

IP VALUATION

• Valuation is a process of determining value or worth of an asset

• Valuation often combines objective and subjective considerations

• IP valuation is a relatively new area• IP valuation is triggered by various

factors

IP Valuation contd.

• A Final valuation would depend on the following basic premises of value– Value in exchange: worth of the

underlying IP asset in terms of its capacity to be exchanged in terms of money

– Value in continued use: worth of the underlying IP asset to its owner on the basis that it continues to generate income to the owner

IP Valuation contd.

– Acquisition value: strategic potential of the underlying IP asset e.g uses in M & A

– Value in place: worth of the underlying IP asset as it is. i.e. the said IP asset is not in current use in the production of income

Value Basis of IP Assets

• Traditionally IP assets were treated as Goodwill– Goodwill=the amount paid for a

business in excess of the fair value of its identifiable net assets at the date of acquisition (see Peguin dictionary of accounting)

• Advent of knowledge economy and high market value of companies as opposed to book value enhanced interest on value of IP

Value Basis of IP Assets contd.• IP assets have distinctive

characteristics which makes it possible to value them separately from other intangible assets

• These characteristics include– Independently identifiable– Legally protected and enforced– Transferable– Economic life

Value Basis of IP Assets contd.• Factors influencing value of IP

assets– High price

• Large potential market• Strong IPR (well written claim)• Exclusive license• Stage of technology (e.g. invention near

commercialization stage)• Option on leveraging

Value Basis of IP Assets contd.

– Low price• Non-exclusive license• Huge investments needed• Still far from commercialization (needs

further development)• No option for sub-licenses

IP Valuation Triggers

• As IA in particular IP take the central stage in determining the value of enterprises decision makers have to answer the following– Are returns on R&D satisfactory?

– Are patents worth renewing?

– Are brands worth defending? etc.

IP Valuation Triggers contd.• Enterprises need to formulate a

strategy which would make IP assets more profitable

• IP valuation is imperative in facilitating decision making process on strategy to pursue

• Several factors (triggers) lead to IP valuation

IP Valuation Triggers contd.• These include

– Sale or Purchase of IP Assets– Licensing– Merger & Acquisition– Cost saving– IP asset donation– Joint venture arrangements/strategic

alliances– Financing

Methods of IP Assets Valuation

• Valuation models may be broadly divided into two– Static models

• Estimate value of accumulated intellectual assets at a point in time

• Does not differentiate temporal differences in the accumulated IP

• Does not differentiate the differences among different categories of IA at the time of valuation

Methods of IP Assets Valuation contd.

Static valuationmodels

Mkt value - Book valuemodel

More info: Valuation of Intellectual capital and Real Option Models by Sudarsanam, S. et alhttp://www.realoptions.org/papers2004/SudarsanamIntellCap.pdf

Methods of IP Assets Valuation contd.

– Dynamic models

• Take into consideration the temporal difference in the accumulated intellectual assets (e.g. time value of money and riskiness of the forecast cash flow)

• Value investments in intangibles each at a time

Methods of IP Assets Valuation contd.

DynamicModels

Discounted Cash Flow

Real Option Models

Methods of IP Assets Valuation contd.• Basic Methods

– Cost Approach: Estimates the value of underlying IP asset basing on historical cost incurred in developing the asset• Replacement cost• Reproduction cost

Methods of IP assets Valuation contd.

– Market Approach (sales comparison approach):• Based on the value of similar or

comparable assets that have been exchanged, at arm’s length, in active market

• second variant uses standard industrial royalty rates

Methods of IP assets Valuation contd.

– Income Approach: Based on the income-producing capability of underlying IP asset• Seeks to establish the net present value

(hence use of discounted cashflow)• Decision tree analysis (DTA)-based on an

underlying DCF analysis and moves further to take into consideration flexibility available.

Methods of IP assets Valuation contd.• Net present value

– Calculating the future value of intellectual asset (investment) at present time

– NPV= A(1 + r)-n i.e. NPV = A[1/(1 + r)n]

where: NPV= net present value (i.e. DCF); A= amount expected at year n; r = risk factor

Methods of IP assets Valuation contd.• Other IP valuation methods include

– Monte Carlo simulation analysis– Option pricing theory

Accounting Challenges

• Rationale behind Accounting– Historically evolved

to report tangible assets/liabilities

– Quantitative stock of performance

– Documentation of past financial position

• Impact on Type of Language developed for IP– Silence about a lot

of a firm’s IP due to inherent definitions and assumptions in accounting

Accounting Challenges contd.

• Rational– Factual, precise,

objective, – comparable

information– Determines

perception of a firm’s management

and other market participants

• Impact on Type of Language developed for IP– Internally and

externally generated IP is treated differently

– Goodwill

Finally

Methods of IP assets Valuation contd.

MODERN VALUATION ANALYSIS IS EFFECTIVELY MODERN VALUATION ANALYSIS IS EFFECTIVELY DCF APPLIED TO THE BUSINESS ENTERPRISE DCF APPLIED TO THE BUSINESS ENTERPRISE UNDER UNDER CONSIDERATIONCONSIDERATION•The Net Present Value (NPV) of a strategy or business is the The Net Present Value (NPV) of a strategy or business is the

sum of itssum of its expected free cash flows to a horizon (H) discounted by its expected free cash flows to a horizon (H) discounted by its cost of cost of capital (r) capital (r)

NPV = NPV = Year 1 Cash FlowYear 1 Cash Flow + + Year 2 Cash FlowYear 2 Cash Flow ... to ... to say Year 5 say Year 5 Cash FlowCash Flow (1 + r) (1 + r) ² (1 (1 + r) (1 + r) ² (1 + r)H+ r)H

PLUSPLUS

The terminal value which is the value of the business at a The terminal value which is the value of the business at a horizon (HV)horizon (HV)HV = HV = Cash FlowCash Flow (r - growth)(r - growth)Also discounted back to present valueAlso discounted back to present value

Methods of IP assets Valuation contd.• Trademark remaining useful life

continue in perpetuity after after period 5

• economic income (royalty income) grows at 3%

• 15% is risk-adjusted discount rate

Methods of IP assets Valuation contd.

Discouted Cash Flow Analysis, Trademark Valuation Example

Present value discount rate 15%Expected long-term growth rate 3%In economic income

Period 1 Period 2 Perio 3 Perio4 Perio 5 Terminalvalue

Projectedeconomic income 100.00 103.00 106.00 109.00 113.00 966.00PV factor using15% discount rate 0.8696 0.7561 0.6575 0.5718 0.4972 0.4972

PV over discreteprojection period

87.00 78.00 70.00 62.00 56.00

PV of terminalvalue

480.00

Cumulative PV 833.00

Source: Meinhart, T. Intellectual Property Discount Rate and Capitalization Rates (ed) Reilly, R. & Schweihs R. The Handbook ofBusiness Valuation and Intellectual Property Analysis