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Intellectual property can be a business’s most important asset. How do you measure its true value?
The value of intellectual property must be analyzed in terms of the future profitability it is likely to generate. Earnings and profits can come from:
- the direct use of intellectual property in the course of the business’s activities;
- the sale of an exclusive or non-exclusive right to use the intellectual property;
- the entry barrier the intellectual property creates for competitors.
What is intellectual property?
Let’s begin by reviewing what is meant by “intellectual property.” According to the World Intellectual Property Organization, the term refers to creations of the mind: inventions; literary and artistic works; designs; and symbols, names and images used in commerce.
These creations of the mind can be divided into two main categories:
- literary and artistic property, including copyright;
- industrial property, including patented and non-patented technologies, trademarks, industrial designs and trade secrets, application and software programming codes, and algorithms.
To be valuable, intellectual property must be:
- identifiable;
- proven to exist;
- proven to have evidence of ownership;
- legally protected;
- transferable;
- capable of generating profitability that is distinctive and can be distinguished from the business’s other assets.
How do you determine the value of intellectual property?
Many factors influence the value of intellectual property. To determine this value, you need to consider not only the profitability generated directly by its use, but also the business model that could maximize future profits from this property.
The following factors affect the value of intellectual property:
- its market size;
- its market recognition;
- its economic benefits to users;
- its useful life (consider the patent date or copyright creation date);
- the entry barriers it creates (the degree to which it reduces competition);
- the added profitability it generates as compared with a generic product or brand;
- its degree of IP protection (e.g., patent strength);
- competitors’ ability to develop similar property without infringing the law;
- current product substitutes.
How do you calculate the value of intellectual property?
Intellectual property is typically valued based on the future profits it can generate for its owner, using two main methods:
- a discounting of future cash flows based on the royalty relief method, that is, by calculating an appropriate royalty percentage on future sales of the intellectual property;
- a discounting of future cash flows based on the excess earnings method, that is, earnings generated exclusively by the intellectual property.
Both methods involve estimating the profits that can be generated exclusively by the intellectual property, and applying a rate of return to those profits based on the likelihood of achieving that profitability (using mainly the valuation factors described above).
When making an acquisition or sale, obtaining financing or simply implementing a marketing strategy, a business’s intellectual property must be estimated at its fair value. Don’t hesitate to contact an advisor to help you through this complex yet crucial analysis.