Many companies overlook the value of intellectual property if the property doesn't seem to be regularly generating revenue. Patents, trademarks, copyrights and other proprietary processes may represent an untapped source of revenue for many companies. Having a valuation for licensing or sale of intellectual property can be a real eye‑opener for these firms and can even affect their bottom line.
Intellectual property such as patents, trade-marks and copyrights may need to be valued for several reasons, including setting damages in an infringement case or buying and selling intellectual property. An intellectual property valuation for estate and gift tax reporting is required if you are giving the property as a charitable donation.
Valuation Problems
As important as a valuation can be, patents, trademarks and copyrights are intangibles and, as such, are hard to price.
As noted earlier, a special problem arises if the intangible is not currently generating income. The technology associated with the asset may be too new to properly evaluate how much money it can make for its owner or what competitive advantages it may offer.
How To Set a Value
A valuator can use factors such as projected revenue from use of the intellectual property and the asset’s importance in a specific product or process to set a value. Although no standard formula exists for patent, trademark and copyright valuations, the courts, valuation specialists and the IRS do concentrate on factors such as:
- The significance of the property to the company's product or process,
- The sales revenues, income and cost savings the company can derive from using the property,
- The property's economic life, and
- The competitive alternatives to its use.
In addition, the IRS recognizes three main factors in valuing a patent:
1. The income that can be attributed to it or to its application,
2. Its safe interest rate at the valuation date, and
3. What the IRS considers to be its most reasonable, speculative capitalization rate, which must be calculated in an explainable and well‑reasoned way.
Valuation Process
Generally, valuation professionals follow several logical steps to determine the value of a patent, trademark or copyright. They might not conduct every step in every case, or they might do them in a different order or with variations. But reviewing them does give an idea of the valuation process. A valuator derives a patent, trademark or copyright's present value or fair market value by measuring its future returns. These are cost savings, income or royalties; which are discounted at a rate of return the valuator considers appropriate.
Company, Industry and Market
The valuator might begin by evaluating the industry and market in which the property will be used. Market size and prevailing economic conditions can help indicate how much market share the property can obtain for the company and how long obtaining that market share is likely to take. Other parts of this determination are the distribution network the company uses and its manufacturing capacity, management structure and financial status as well as the product's position in its life cycle.
Income and Revenue
Next, a valuator attempts to project how much income and revenue a company will realize from the intellectual property during its estimated useful life. In performing this projection, the valuator tries to come up with economic income rather than accounting income as measured by generally accepted accounting principles (GAAP). Economic income reflects the company's real expenses, which may be higher than those reflected by GAAP.
Benefit Base
Here, the valuator determines the benefit base; i.e. the likely economic return from the intellectual property. To do so, the valuator looks at the operational income the company can expect to bring in because of the property, taking into account expected royalty rates, cost savings or excess income associated with the property.
If the benefit base is determined via the cost savings or excess‑income approach, it will appear as a percentage of the excess income or cost savings. Under the royalty approach, it will be a percentage of the company's projected revenues. Under the income from operations approach, it will be a percentage of projected income.
Fair Market Value
Finally, the valuator calculates a present or fair market value for the property by discounting the expected benefits by an appropriate rate of return. The rate should account for the risk associated with the returns. A greater risk produces a higher rate and a lower value for the intellectual property.
Value May Be A Pleasant Surprise
Valuators may use several valuation methods to arrive at an intellectual property's value, depending on the nature of the property, the type of company that owns it, and why the valuation is needed. The result may be a pleasant surprise for a company that has been taking its intellectual property for granted.
