Introduction
The currently available valuation methods of Intellectual Property (IP) can be grouped into three categories, which are the market approach, the cost approach and the income approach. All three are commonly used, although the income approach can be considered as the most fundamental of the valuation methods.
Income Method
The income method category of valuing IP, also known as discounted cash flow, excess price, residual income, and relief of royalty, can be defined as “the ability of the asset to somehow generate future income” (Flignor & Orozco, 2006). Such category has three main components, which are projected cash flows, the economic life of the IP, and the discount rate (Flignor & Orozco, 2006). This category can be differentiated into several methods, listed as follows:
- Quantifying incremental levels of economic income, i.e. the owner will remain the owner of the property.
- Quantifying lower levels of economic cost, i.e. the same as the previous one, although avoiding required investments, or operating expenses.
- Estimation of relief of a hypothetical royalty or rental payment.
- Estimation of the difference in the value of the overall business, between the value of the business owning the IP and not owning the IP. (Financial Consulting Group, 2000a)
Additionally, it can be stated that such category of methods is subjective, in which “particular care [is] required to assess all the business and financial dynamics that impact the expected incremental cash flows” (Flignor & Orozco, 2006).
Market Method
The general characteristic of the market approach is its comparative nature, in which such approach can be defined as using “marketplace sales or licensing transactions in identifying comparable royalty rates and prices” (Anson, Suchy, Ahya, & American Bar Association. Section of Intellectual Property Law., 2005, p. 66). In that regard, the market approach is sometimes called sales comparison. In comparing the values, the true value is the value that another party would pay to obtain or rent the IP in the real world (Anson, et al., 2005). The process of applying the market method can be ordered as follows (Financial Consulting Group, 2000b):
- Researching corresponding markets for information.
- Verifying the obtained data for accuracy and market conditions.
- Selection of relevant units of comparison, and developing a comparative valuation analysis for each unit.
- Comparing the researched IP sales with the subject IP using the elements of the comparison, adjusting the researched property to the subject property.
- Combine value indications into a single value indication or range of values.
Cost Valuation Method
The cost approach can be divided into two different styles in valuing IP, i.e. Historical cost basis, and the replacement or reproduction cost (Anson, et al., 2005, p. 33). The historical cost basis values the asset at its historical cost and depreciates it based on a reasonable life estimate (Anson, et al., 2005, p. 33). The replacement cost, on the other hand, can be defined as the cost of developing an asset with similar functionality, outside of the scope of legal protection (Flignor & Orozco, 2006). The costs in the latter include, in addition to hard cost, e.g. materials, and soft costs, e.g. engineering, design, etc, developer’s profit and entrepreneurial incentives. Generally, the cost approach is based on the principle of substitution, where an analogy is drawn in order to indentify the minimum value of intangible assets considered.
Works Cited
Anson, W., Suchy, D. P., Ahya, C., & American Bar Association. Section of Intellectual Property Law. (2005). Fundamentals of intellectual property valuation: a primer for identifying and determining value. Chicago, IL: American Bar Association, Section of Intellectual Property Law.
Financial Consulting Group, L. C. (2000a). Intellectual Property Valuation: Part Four. SmartPros. Web.
Financial Consulting Group, L. C. (2000b). Intellectual Property Valuation: Part Two. SmartPros. Web.
Flignor, P., & Orozco, D. (2006). Intangible Asset & Intellectual Property Valuation: A Multidisciplinary Perspective. IP Thought. Web.