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Intellectual Property Valuation 101

Intellectual Property Valuation 101

Synopsis:

Intellectual property is defined as legally recognized exclusive rights to creations of the mind. IdeaShares sums it up with one word: IDEAS. Ideas are the seed from which all human progress grows and develops, all originating in the thought realm. Why (and how) does one idea create value and generate benefits to its owner, where another of similar merit and worthiness will never make it to market. There are so many different possible reasons for these phenomena, but the most common is the simplest of all: Inaction. Obviously, nobody knows how many fantastic ideas were never acted on. There are as many reasons for leaving an idea in the thought realm (often forgotten) as there are for product failure. However, if the process for arriving at a reliable estimate of an idea’s potential monetary value were more widely understood and readily available, we would likely see fewer good ideas left entangled in the mind of the holder.

Granted the process for intellectual property valuation is subjective by nature, but so is the valuation of real estate when all value components are properly considered and analyzed, and yet there are millions of real estate transactions occurring every day. Whatever the reason; sale, refinance, etc., an appraiser is usually engaged to indentify the value upon which the basis of the transaction is anchored. One primary & obvious difference between real estate and intellectual property is that real estate is in the physical, tangible realm, and IP is not. Nevertheless, improvements in the construction of real estate, life saving medical technology, mass global communication and transportation, and literally every other product in the physical realm is, at is foundation, intellectual property. What is yours worth? Granted, not all intellectual property or the benefits thereof have primary importance in monetary equivalence, but that is the basis for intellectual property valuation.

Purpose:

Understanding the techniques and procedures for arriving at a reliable value for intellectual property is a key component for planning and product development. This material is not intended to supplant years of education, training and experience, as IP valuation is a highly specialized and intricate field. Additionally, it is entirely possible for a product with an initial low valuation of intellectual property, to be very successful and profitable; and there are many examples to support this fact. However, knowing how IP is valued is an excellent tool for developing business plans and pro-formas, especially when seeking investment capital.

This module is designed to provide a solid basis for a comprehensive approach to intellectual property valuation, and equip you to know what to look for, questions to ask, and the components involved in this very important practice.

Intellectual Property Rights Definition
Types of Intellectual Property (IP)

    There are primarily five forms of intellectual property, with some categories containing “branches” of that specific category: Patents, Trademarks, Copyrights, Trade Secrets and Know How. These are the most common types/forms of IP, but it is crucial to remember that intellectual property is essentially an infinite universe and requires a committed, continual attention to details and IP inventory.

Patents

    Definitions:

    A government authority or license conferring a right or title for a set period, especially the sole right to exclude others from making, using, or selling an invention.

    Black’s Law Dictionary

    A patent is a legal document which provides protection to the ideas of any individual. Usually issued by the Patent Office of a country, the patent is granted to any firm or individual. Usually, patents constitute of four different classes: Machine (a device or apparatus created by a person for the performance of a specific task, process (a process created by an individual), manufacture (any fabricated or manufactured product) or the composition of matter (any chemical mixture or compound created by a person).

    Types Of Patents

    There are several types of patents, however, the most common are utility patents, design patents, plant patent, method (or process) patents and provisional patent (SB16-is the typical from used to “anchor” or time stamp your idea/product, while preparing the utility patent application, within 12 months from filing).

    Utility patents have a 20 year life, afford the greatest protection and are often expensive. However, the expense, as is the case in most pursuits, is relevant to the outcome and value.

    Design patents afford little protection for anything other than ornamental and/or aesthetic purposes. Design patents have a 14 year life, and can be useful depending on the nature, type and purpose of the product and/or as a component of a broader patent strategy, typically inclusive of at least one utility patent.

    Method or process patent is granted (or not) as a utility patent, but affords protection for a “method” of how to use something, or a “process” of the steps of something, as in a manufactruing process. It is also possible to secure a software patent, which currently has no legal or conclusive definition. Software patents are difficult to secure, and patent prohibits awarding patents on “abstract ideas” or anything obvious to nature.

    Plant patent is a patent issued for newly invented strains of asexually reproducing plants. Tuber propagated plants or wild uncultivated plants may not be patented. A plant patent also has a 20 year life. Not all countries allow plant patents.

Trademarks

    Definitions:

    Black’s Law Dictionary A distinctive mark, motto, device, or emblem, which a manufacturer stamps, prints, or otherwise affixes to the goods he produces, so that they may be identified in the market, and their origin be vouched for.

    USPTO:

    • The term "trademark" is often used to refer to any of the four types of marks that can be registered with the USPTO. The two primary types of marks that can be registered with the USPTO are:

      • Trademarks - used by their owners to identify goods, that is, physical commodities, which may be natural, manufactured, or produced, and which are sold or otherwise transported or distributed via interstate commerce.

      • Service marks - used by their owners to identify services, that is, intangible activities, which are performed by one person for the benefit of a person or persons other than himself, either for pay or otherwise.

      • OVERALL PROCESS: The trademark registration process is a legal proceeding that may be complex and require you to satisfy many requirements within strict time deadlines (based on Eastern Standard Time); therefore, you should consider hiring an attorney before starting the process.

      • Trademark Official Gazette (TMOG) the TrademarkOfficial Gazette (TMOG) is published every Tuesday, including federal holidays. The purpose of the TMOG is to give notice of certain actions that are being taken with respect to the marks listed in the TMOG on the particular date of issue. Publication in the TMOG starts the period for opposition for some of the marks listed in the TMOG.

    • TM Is the symbol used for unregistered Trademark

    • SM is the symbol for Service Mark

    (R) (circle R) is the symbol used for Registered Trademark

    How long does a Trademark Registration last?

    The registration is valid as long as you timely file all post registration maintenance documents. You must file a "Declaration of Use under Section 8" between the fifth and sixth year following registration. In addition, you must file a combined "Declaration of Use and Application for Renewal under Sections 8 and 9" between the ninth and tenth year after registration, and every 10 years thereafter. If these documents are not timely filed, your registration will be cancelled and cannot be revived or reinstated.

    • Bass Brewery’s Logo/Label was the first Trademark to be Registered in 1875

    • Non conventional Trademarks: Color, sound, jingle (Blue Man, NBC chimes, Intel, etc.)

    • Typically multiple Trademarks are needed, desirable and required: Logos/images and mottos/phrases have separate and individual Trademark filings

    • Companies such as CocaCola, McDonads, etc. have multiple Trademarks corresponding with various ad campaigns: The Real Thing (Coke), “America Is Beautiful” Super Bowl 2014, Make It Happy Super Bowl 2015; I’m Lovin It (McDonalds), “Give A Little Love”, “Spread The Love”

    • Like other forms of intellectual property, Trademarks may be owned or licensed

      • Lego licensed its line of Star Wars products with Lucas Films, Batman with Marvel, etc.

    • Have value (often high value), depending on recognizability and Brand awareness

    • Many possible categories and classifications (again VERY complex and time sensitive)

    • Vital for Brand and market protection

    • Mandatory for long term product/brand success and must be a permanent component  of both your branding and protection strategy
Copyrights

    Definition:

    United States Copyright Office

    A form of protection provided by the laws of the United States for "original works of authorship", including literary, dramatic, musical, architectural, cartographic, choreographic, pantomimic, pictorial, graphic, sculptural, and audiovisual creations. "Copyright" literally means the right to copy but has come to mean that body of exclusive rights granted by law to copyright owners for protection of their work. Copyright protection does not extend to any idea, procedure, process, system, title, principle, or discovery. Similarly, names, titles, short phrases, slogans, familiar symbols, mere variations of typographic ornamentation, lettering, coloring, and listings of contents or ingredients are not subject to copyright.

Trade Secrets

    Definition:

    The Uniform Trade Secrets Act ("UTSA") defines a trade secret as:

    information, including a formula, pattern, compilation, program, device, method, technique, or process, that derives independent economic value, actual or potential, from not being generally known to or readily ascertainable through appropriate means by other persons who might obtain economic value from its disclosure or use; and is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

Know How

    Definition:

    USLegal.com

    Know-how means any form of technical information or assistance relating to the manufacture or placing into operation of the said products. It also means any practical knowledge, techniques, and skill that are required to achieve some practical end. It is considered an intangible property in which rights may be bought and sold. Know-how also means the technical skill which large groups of men acquire through extensively financed experimentation and cooperation.

Valuation Techniques and Procedures

    There are a variety of methodologies for intellectual property valuation: Sales Comparison, Discounted Cash Flow, Opportunity Cost, Auction and Direct Cost (or Cost Approach) are the primary valuation techniques. Which technique(s) are used depends on the Purpose and Scope of Work for the valuation.

    Scope of Work can be as varied as the relevant and material aspects of the intellectual property being valued.

    Frequently the IP being appraised consists of numerous pieces of intellectual property inclusive of patents, trademarks, copyrights and trade secrets, etc.  And therefore mandates in depth analysis of each piece individually, and cumulatively.

    Due to the unique nature of each piece of intellectual property, as well as the nearly infinite set of parameters and circumstances that exist beyond the unique IP in almost every case, there is no “secret formula” or information source that can be used to arrive at a reasonably reliable valuation conclusion.

    A definition of each of the primary valuation techniques follows, but it is vitally important to realize and understand that no single technique or system can be relied upon for every valuation application of intellectual property.

    Below are a few of the vital components that must be considered for a fully comprehensive analysis and reliable valuation results, many of which are overlooked and/or given no consideration using formulaic analyses and rules of thumb:The nature and size of the market to be served

    The competitive advantages of your solution
    The price customers are willing to pay for your solution and related value proposition
    Costs of implementing the technology or products
    The impact of the technology on the processes used by the business to service its customers
    Length of time before new competition will enter the market
    Profitability
    Growth Potential
    Strength of Technology
    Investment Risks
    Market Size
    Consequences to Overall Revenues and Costs
    Changing Economic Conditions
    Negotiating Power of Prior Participants
    Exclusivity, Geographic or other Limitations

    A variant of industry rules of thumb is the widely used “25% Rule.” This “rule” says that a reasonable royalty rate will be equal to 25% of the gross profit earned on products that use the technology. Efforts to prove the validity of this formula have shown that the formula is not valid. This should not be surprising as the rule fails to consider:

    • Differences in the classification of expenses
      Fixed expenses in cost of sales
      Impact of all selling, general and administrative costs that are affected by the product
      Consequences to overall revenues and costs
      Investment risks
      Exclusivity, geographic or other limitations

    *Fulcrum.com

    Additionally, there is an excellent article on the subject of Intellectual Property Valuation and Royalty Determination located at the following link:

    http://brandfinance.com/images/upload/ip_valuation_royalty_rates.pdf 

Sales Comparison

    Definition:

    Investopedia

    An appraisal method that compares a piece of property to other properties with similar characteristics that have been sold recently. The sales comparison approach takes into account the affect that individual features have on the overall property value, meaning that the total value of the property is a sum of the values of all of its features. Real estate agents and appraisers may use this approach when evaluating properties to sell.

    The Principle of Substitution states that a buyer will not pay more for a property than an equally desirable property. This principle is true and accurate irrespective of the property or genre.  It is just as true for intellectual property as it is for real estate, stocks, commodities or even parishable and household goods. Obviously, as we have stated many times throughout the various ISU courses, it is vitally important to know your market, market universe, competitive environment and the value your solution (patent/idea/product) is worth to the market and the users (or potential users) of your product.

    The foundational aspects and components of comparison are: 

    • Type(s) of IP being valued
      Legal rights and elements of ownership being conveyed/analyzed/valued
      Conditions of sale; i.e. arms length, license, special or mitigating circumstances surrounding the intellectual property or transaction.
      Standard or atypical financing and/or financing concessions
      Economic and market conditions (primary, secondary, tertiary markets: local, regional, national, global depending on the intellectual property and/or licensed territories)
      Characteristics/uniqueness of all properties used in the valuation process including the subject intellectual property
      Characteristics of the relevant/subject industry or industries
      Economic, technological, functional and any intangible characteristics of the subject property in comparison to comparable IP
      Tangible and intangible properties included in the valuation/transfer

     

Discounted Cash Flow

    Definition:

    Wall Street Oasis

    A Discounted Cash Flow or DCF is one of the most important methods used to value a company. A DCF is carried out by estimating the total value of all future cash flows (both inflowing and outflowing), and then discounting them (usually using Weighted Average Cost of Capital – WACC) to find a present value of that cash.

    The aim of a discounted cash flow is to estimate the total amount of cash you will receive from an investment, and if this value is higher than the cost of the investment, it is usually worth doing.

    Project Future Cash Flows - this is usually done from a 3-statement projection model or by using simple assumptions about Revenue, Tax, Depreciation, Amortization etc and calculating free cash flow from there

    Calculate the Discount Rate - this is either taken to be a simple percentage or is calculated using WACC

    Discount Future Cash Flows - either by using the Mid-Year discount or a simple discount period, it is fairly simple to calculate the present value of future cash flows

    Estimate Terminal Value - Terminal Value is then estimated either by using a terminal exit multiple (usually an EBITDA multiple) or with a Terminal Growth Rate (Gordon Growth Method)

    Find the Net Present Value - to find the net present value simply discount the terminal value (again using WACC or a simple %) and then add that to the sum of the discounted cash flow values

    *Note: A discount rate are not to be confused with a capitalization rate

     

Opportunity Cost
Direct Cost (Cost Approach)

    Definition:

    InvestingAnswers.com

    A direct cost is any cost related to the production method of a good or service. It is the opposite of an indirect cost.

    How it works/Example:

    Direct costs are variable costs associated with the inputs and labor required to produce a good or service. For instance, two direct costs associated with producing a copper pipe are the cost of the raw copper and the wages paid to the worker molding the copper into the shape of a pipe. Direct costs should not be confused with indirect costs, which are fixed costs unrelated to inputs and labor.

    Why it Matters:

    The variable nature of direct costs causes them to rise and fall proportional to increases and decreases in output.

    Direct costs refer to materials, labor and expenses related to the production of a product. Other costs, such as depreciation or administrative expenses, are more difficult to assign to a specific product, and therefore are considered indirect costs.

Cost Approach Methodologies / Techniques

    The Principle of Substitution states that a buyer will not pay more for a property than an equally desirable property. This principle is true and accurate irrespective of the property or genre. It is just as true for intellectual property as it is for real estate, stocks, commodities or even perishable and household goods. Obviously, as we have stated many times throughout the various ISU courses, it is vitally important to know your market, market universe, competitive environment and the value your solution (patent/idea/product) is worth to the market and the users (or potential users) of your product.

    Supply and Demand - Shifts in supply and demand cause costs to increase and
    Decrease and cause changes in the need for supply of different types of intellectual
    properties.

    Externalities - Gains or losses from external factors may accrue to intellectual
    properties. External conditions may cause a newly constructed intellectual
    property to be worth more or less than its original cost.

    Economic Obsolescence - A specific form of external obsolescence, economic
    obsolescence reflected in a reduction in the value of the subject intellectual
    property due to conditions external to and not controlled by the current use or
    condition of the intellectual property. The impact of economic obsolescence is
    usually beyond the control of the intellectual property owner and is, thus,
    generally considered incurable.

    Functional Obsolescence - The reduction in the value of an intellectual property
    due to its inability to perform the function or yield the utility for which it was
    originally designed.

    Technological Obsolescence - A decrease in the value due to advancements or improvements
    in relevant technology that make an intellectual property less than the ideal replacement for itself. Technological obsolescence occurs when, due to improvements in design or engineering technology, or a new replacement intellectual property is judged more productive than the intellectual property being appraised. Technological obsolescence is often considered a specific form of functional obsolescence.

Income Approach to Valuation

    The primary components to income valuation are:

    - Gross revenue
    - Net revenue
    - Net income
    - Gross Operating Income
    - Operating cash flow
    - Incidental or ancillary income (and revenues)

    The income approach is one of the preferred techniques for valuation when the property being appraised is unique to the point of having little or no comparable properties. It is also an excellent supporting technique to be used in conjunction with all other relevant approaches to value.

    The results of the income approach will be more accurate and reliable if/when revenues attributable to the actual intellectual property can be clearly identified and segregated from other existing revenues, if relevant to a corporation or ongoing concern. Under typical circumstances, the results of the income approach will obviously be given close scrutiny by an investor or buyer.

     

Discount Rate vs Capitalization Rate

    Before discounting cash flow, a reliable rate of return (ROR) must first be determined.

    An investor will likely require the ROR as a prerequisite for investment, which is framed by several prominent factors:

    - Overall level of interest rates
    - Premium for potential or realistic financial risk
    - Premium for potential or realistic business risk
    - Cost of capital

    The ROR is used to arrive at a value for an investment is referred to as a discount rate. The discount rate, under most common and acceptable practice and methodology, is established by using one of two formulas: Capital Asset Pricing Model (CAPM – relationship between risk and expected return) or the Build-Up Method (formula), which are both variations of a summation concept, which arrives at a discount rate using essential market, business and capital elements that encompass an ROR desired/required for investment.

    The formulas, elements and techniques used for arriving at a reliable value/equity/revenue potential conclusion require thorough knowledge and understanding and years of practice and implementation.  Obviously, intellectual property valuation is absolutely best left to a professional with an established reputation of integrity, professionalism and references.

    Moreover, any investor or buyer of intellectual property will be very cognizant of the aptitude and capabilities of the company and/or individual(s) that have completed the appraisal report.

Auction

    Definition:

    DictionaryReference.com

    Also called public sale. a publicly held sale at which property or goods are sold to the highest bidder.

    Everyone knows what an auction is, but there as so many different types of auctions.  The definition provided states that it is also called a public sale. However, this may or may not be accurate. There are many private auctions across the entire spectrum of goods and services. For the purposes of selling intellectual property and getting the highest sales price (bid), it is likely preferable to engage the services of a reputable IP auction company, with an established name and track record, to advertise, market and attract the largest number of qualified (registered) bidders and participants.

Identification of Intellectual Property

    It is very common for companies and even individual entities to identify all of the intellectual property they have ownership/control over.  This potential issue could be lessened or avoided altogether by simply being knowledgeable and aware of all forms of intellectual property, and remaining attentive and focused.  The most common and typical varieties are illustrated in this course, but, as stated, intellectual property is essentially an infinite universe, and can manifest in ways, and at times that cannot be predicted or anticipated.

    As with every other category pursuant to developing an idea or product, it is essential to know and understand the process as comprehensively as possible across the spectrum.  The time you invest in education will have a direct and substantive impact on both your chances for and level of success, as well as your level of achievement and satisfaction. The Latin phrase “Caveat Emptor” is well known and simply means let the buyer beware, and is also an excellent rule of thumb for entrepreneurial pursuit. Nobody but you will care as much, or attend to your project(s) as much as you. Details count, and the smallest detail can (and often does) result in success or failure!

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