India: What Is Intellectual Property Valuation?

Last Updated: 17 January 2019
Article by Shubham Borkar and Neha Rani

The resources of a business such as technology, copyright, trademarks and other IP are the building blocks of Brand Value. Knowledge of the value contribution of these resources and the linkages between them is essential for business strategy, IP management and IP valuation. In the era of stiff competition amongst brands, the competitive advantage attributes to the development, integration and reconfiguration of intangible resources. Yet, very few companies have the knowledge of potential of value contribution of their IP assets. The prime reason firms acquire intellectual property is not for litigation purposes, but to have legal and transferable proof of ownership to some of their most important intangible assets. Intellectual Property valuation can help you determine the true value of your business and capitalize on assets that you may not have been aware of possessing. It is estimated that approximately two-thirds of businesses in the United States have intangible assets that are potentially eligible for Intellectual Property protections and the advantages they entail.

There is seldom a non linear relationship between the cost of creating IP and its value. It possesses high risk of wasted investment but it can be counter balanced by the high potential that IP assets hold if they are commercialized. A brand is sometimes used in reference of trademarks and associated goodwill or designs, formulae and copyright. At times it is treated as a combined business unit comprising of both- tangible and intangible assets. Ultimately, Wealth is the sum of working capital, fixed capital and intangible assets.

How can we derive Wealth out of IP?

Value from an IP asset is derived through direct exploitation like sale and licensing of the IP or even by not exploiting an IP asset (i.e., by merely owning it), for example, by minimizing the negotiating power of customers, offsetting supplier power, mitigating rivalry, raising barriers to entry by competitors, reducing the threat of substitutes, etc.

What are the factors that influences IP Valuation ?

  1. Standard of value

The most commonly used standards of value are Fair market value and Fair Price Value. It is important when undertaking an IP valuation exercise. Fair market value (Market value) can be defined as the price at which an asset or service passes from a willing seller to a willing buyer. It is assumed that both buyer and seller are rational and have a reasonable knowledge of relevant facts. Fair value (Fair price) is seen as appropriate for use in post transaction purchase price allocation. It is based on the assumptions that market participants would use when pricing the asset. Whereas fair market value is seems to be more appropriate when used in the premise of value in exchange, fair value is often based on premise of value in-use. As mentioned earlier. in common situation, IP valuation is a process to evaluate the fair market value of an IP asset.

  1. Purpose of valuation

In order to determine the premise for calculation of value, it is necessary to understand the purpose for valuation. For instance, valuation from the perspective of market value and investment would be completely different. In commercial situations, market value is the appropriate premise. International Value Standards define market value as "The estimated amount which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm's‐length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently, and without compulsion."1

  1. Valuation method(s)

The methodology applied and assumptions made while applying particular valuation method affects the value of IP assets. Market Method is the ost effective form of valuation. Cost method is usually refrained by companies since it ignores the novel characteristic of IP. This method is helpful for R&D costs.

  1. Nature and strength of IP asset

The competitive strength of an IP asset determines the comparative valuation that it shall hold in the market. The factors such as customer responsiveness and market distribution of a product or availing service determine its IP value. The threat of new entry and substitutes affect the value of IP assets.

Why do you need to conduct a valuation your IP assets?

  1. Licensing and Franchising

A thorough understanding of the IP Assets ensures an informed negotiation and decision making regarding the terms and conditions at the time of licensing-in or licensing-out of IP especially in determining fair and robust royalty rates. In the case of franchising too, both the franchisor and the franchisee require a thorough understanding of the value of the trademark(s) and trade secrets and know- how of other IP assets. Examples – Mc Donald's , Pizza Hut, Dominos, Haldiram, Bikanerwala.

  1. Merger & Acquisition, Joint Venture or Strategic Alliance

The primary reason for considering an M & A transaction is the value of the IP assets of the target company. IP valuation enables the parties to take an informed decision on the acceptable cost of capital or deciding on financial leverage strategy to be followed. It also influences positively the resulting company's value and share price. The strategy of world class companies such as Volkswagen group and Tata group enunciates the IP valuation technique to adopt brands. The Volkswagen Group owns Audi, Bentley, Skoda, Lamborghini, Buggati , Porsche and many other well know brands. Tata group owns Jaguar and Land Rover.

  1. Investment in Research and Development (R&D)

IP valuation helps in budgeting and resource allocation decisions. For example, if a company is spending a significant amount of money on internal R&D but is losing ground to competitors due to slow or late product introductions, it may need to rethink its R&D strategy and processes. IP valuation also provides strategic guidance for new product development, brand-extensions, line-extensions, managing foreign filing and prosecution costs, etc.

  1. Financial Reporting

The recognition of the increasing share of IP assets in the total market value of enterprises has contributed to the change in the way the accounting community has begun to treat IP assets in financial reporting. The international accounting standards board (IASB) now recognizes acquired and identifiable intangible assets (i.e., IP assets) and requires all acquired IP assets to be recognised as assets, separately from goodwill, on the balance sheet of the business acquiring the IP assets. For instance, when a brand is acquired, IP valuation is done for the initial valuation as well as the periodical impairment tests for the derived values to be included in the balance sheet.

  1. Optimizing Taxation

In devising ways to optimize the tax to be paid by a company, its assets, including its IP assets, require to be valued. IP assets create numerous opportunities for tax planning in both third party transactions as well as internal strategies such as cross-border transfer pricing and centralizing the ownership of IP assets in IP holding companies. The internal revenue service or other tax authorities would like to know as much as possible about the basis for any value determination used when allocating portions of the purchase price associated with the acquisition of a company. Valuation of IP assets helps in assessing fair transfer prices for the use of IP assets, including brands, to subsidiary companies.

  1. Insurance of IP assets

A completely new market is opening up for the insurance of IP assets with a number of major insurers in the developed countries creating products tied to the capital value of IP assets, especially trademarks/brands. Valuation is of extreme importance as far as Insurance is concerned.

How to determine the value of your Intellectual Property ?

Evaluation of IP can be a challenging process. The most suitable method for IP assets depends upon the premise of purpose to be derived from the result, assets subjected to valuation and the specific section for which the valuation is prepared.

The two effective ways of valuation are:

Market based

This is the most commonly used approach, this approach is based on the comparison with the actual price paid for a similar IP asset under comparable circumstances. The calculation would be accurate if there exists appropriate information on the nature and extent of rights transferred, circumstances of transaction for eg; license agreed in litigation settlement. The process initiates with research of an appropriate market to obtain the transaction information about sales, licensing of subject IP. The second step is to select relevant units of comparison such as "per drawing", "per location". "per customer" and develop a comparative analysis for the units considering factors such as profitability, risk, Industry, company structure, strength of IP rights, etc.

Income Method

It values the IP on the basis of amount of financial income that IP is expected to generate. In order to evaluate, project the revenue flow over remaining useful life of asset and offset those revenues by the cost related to asset. The risk has to be discounted from the amount of income by using discount rate or capitalization rate. The method is most suitable for capturing value of IP that generates stable cash flows. However, the method does not consider independent risks associated with an IP asset and lumps all the risks together to be adjusted in discount rate.

Conclusion

Caliban Darklock had said that "The only thing you really own is what you create; and the only thing you can create without needing someone else to give you raw materials first, is intellectual property".

The result of IP assets in generating finances is not just a short term strategy. The companies with strong IP assets have increased likelihood of success by way of greater investment, lower probability of bankruptcy and better chances of successful exit through initial public offerings.

IP Valuation has never received the importance that it deserves. One of the factors affecting a business's success or failure is the degree to which it exploits its IP Assets and values it. Valuation is a complex process and requires skilled professionals to evaluate the assets. There are various companies that provide assistance and consultance for it. Khurana & Khurana Advocates and IP Attorneys has a dedicated IP Valuation Team comprising of Chartered Accountants and IPR Specialist having vast experience in valuation. This IP Valuation Exercise usually takes around 2 weeks time. Cost to undertake IP Valuation exercise largely depends upon how big the brand is, how many products does it cover, years of existence,in plain words the amount of data that is needed to be analysed.

In a 2015 study conducted by an International firm Ocean Tomo, data showed that in a span of 20 years, more value has been attributable to intangible assets than to tangible assets – from a market value share of 17% in 1975, it grew to 87% in 2015.2 This increasing trend in the value of intangible assets suggests that indeed, intangible assets accelerate value, growth and development of an enterprise.

Footnote

1 International Valuation Standards, (Seventh Edn.), pg 27.

2 Intangible Asset Market Study, http://www.oceantomo.com/intangible-asset-market-value-study/.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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