What is Intellectual Property and how do you value it?  

Intellectual Property or IP as it is more commonly known can account for the single most valuable asset that a business has but many business owners are unsure about what is classified as IP and, just as importantly, how much their IP is worth.

What is Intellectual Property? 

Intellectual property (IP) can be defined simply as the ownership of any idea or design by the person who came up with it. In business, that can be anybody working for the company. In essence, IP are intangible assets that are creations of the mind and every business has them. Examples include trademarks, brands, designs, software, databases, copyrights, patents and trade secrets. Legal protection for such ideas are referred to as intellectual property rights or IPR.

It is important to realise the value of IP when seeking funding to grow a business, for any joint ventures, in the cases of mergers and acquisitions and also during bankruptcy.

Why is it valuable?

The reason why IP can be so valuable depends on its nature. For example: registered designs and patents gives their owners an advantage in their chosen market because they prevent competitors from launching similar products. And when a company holds the rights to a product design it is able to provide their customers with a unique offering which means they can price those products appropriately.

An important point to remember though is that not all IP is valuable. So, unless the IP helps to increase, maintain or create cash flow then there may be no financial value attributed to it.

How do you value Intellectual Property?

Valuing tangible assets such as premises, machinery and stock is relatively straightforward. But how can you put a price on something that is intangible? How can you determine the worth of a brand that you started from scratch and have invested so much time, resources and money into?

Also, to complicate matters further, IPR can change in value. When a patent was registered it may have been a unique solution to a problem but as time goes by competitors will have found other solutions to the same problem and thereby reducing the value of that original patent. Conversely, a patent can become a world leader when marketed effectively and its worth increases considerably over time.

There are several methodologies available to value IP depending on the stage of development the IPR has reached, the purpose of the valuation and the availability of information. Here is a brief outline of the three main methods:

 The Cost method

The valuation here is based on the costs incurred through developing or creating an IPR. It also values what the cost might be to develop or recreate a similar product or service. The cost method assumes that a potential buyer can avoid these costs by buying the IPR. This method can result in savings of time and expenditure and lends itself to an overall assessment when purchasing a business, and the consideration of assets when they are at an early stage in their development.

The Market Value method

This approach is about knowing the valuation of a product based on its recent performance in the market. This may be a more reliable method of ascertaining how much people are prepared to pay for IPR. Working out the sale or licensing of similar products in the market will give a standard to go by.

Although market valuations of IPR are a good guide it can be difficult to find data on IP transactions because they are usually confidential. IP transactions are difficult to generalise and although there are sources of data for certain sectors, they tend to provide a wide range of figures for sales and licences which are only broadly comparable.

The Income or Economic Benefit method

This method looks at the revenue IPR may generate for a business in the future. It considers both the future income, which a right may generate during its economic life, and the costs of generating that income. Risk and financial costs are factored into the equation. The end result is described as the ‘Net Present Value’ or NPV. This system enables a buyer to look at investment based on whether the NPV is positive or negative. This is an easy method to use but remember that the assessment is based on likely future events instead of past performance. Difficulties include it being hard to predict the income over several years and to estimate the economic life of the IPR.

The three methods above have been summarised and are by no means a comprehensive explanation. To find out more about IP please email: info@businessbutleruk.com

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