Module 5

MODULE 5

VALUATION OF INTELLECTUAL PROPERTY- OBJECTIVE,
PROCEDURE AND REQUIREMENTS

5.1 VALUATION OF INTELLECTUAL PROPERTY

Intellectual Property is one manifestation of an intangible asset. There are
well established practices for valuing intangible assets although 'there is
currently no Indian accounting standard that comprehensively addresses the
accounting treatment of intangible assets. It has been noted that the
valuation of intangible assets is 'complex and widely misunderstood1. This
material does not purport to educate the reader so that the reader can
undertake a valuation of intellectual property (IP). The learning for that task
is well beyond the scope of this book. If an enterprise has a need to value its
IP or associated technology then an appropriate professional appraiser
should be engaged. Brands and trademarks are valuable intangible assets2
which, when established and used, are capable of producing revenue in their
own right and which can be valued independently of other assets and of
management and employees. This material contains an overview of

1 see W Lonergan, The Valuation of Businesses, Shares and other Equity, 3rd ed, Business and Professional
Bublishing, 1998, p 257
2 In 1998, Sussanah Hart and John Murphy [Interbrand] edited a book titled, Brands – The New Wealth Creators,
because it was widely recognised that against the changing economic and financial background, commercial entities
need to broaden their understanding of “what the assets of business are”.

applicable brand valuation methodologies for accounting [balance sheet]
and other purposes3.

Intellectual Property consists of a collection of legally protected rights such
as Patents, Trademarks, Copyright, Design, Trade Secrets etc. Each type of
intellectual property has different features and is applied to a different type
of intellectual creation of the mind. Intellectual Property has generally been
understood through patents as patents have been used by various businesses
across the globe for strengthening their competitive position, generate
revenue and improve access to financing.4

IP Valuation is a process by which a business entity or any other person
values the intellectual property that he possesses. Just like tangible asset is
given a value, IP valuation helps in giving a value to the intangible asset.
This value is required for multiple purposes.

Mainly to enable an enterprise to efficiently engage an appraiser and be
placed in a position of knowledge when negotiating valuation issues with
other commercial parties to a transaction; explain the fundamental
principles of IP valuation (so that the reader can readily understand the
process and valuation report received from the appraiser).

3 This methodology was developed by Interbrand in conjunction with Ranks Hovis McDougall and has since been
used by, among many others, Grand Metropolitan. United Biscuits, Nabisco, BSN and Lion Nathan. It has been
used in a host of applications besides the balance sheet including mergers and acquisitions, fund-raising, brand
strategy development and brand licensing. This methodology is by no means the only discourse available, others are
detailed towards the end of the material as annexures.
4 Shikegi Kamiyama & Jerry Shechan & Catalina Martinez, Valuation and Exploitation of Intellectual Property, 7
(STI Working Paper 2006/5, Statistical Analysis of Science, Technology & Industry) available at
http://www.oecd.org/dataoecd/62/52/37031481.pdf

There is a very basic dilemma facing the enterprise and its appraiser: does
the target IP or technology give the enterprise a benefit beyond the year in
which investment in that IP or technology was incurred? The valuation
process endeavors to provide to the enterprise an indication of the answer.

Unlike the valuation of residential real estate, valuation of IP has an
uncertain reputation because it involves the making of forecasts, the
defining of something that cannot be seen and relies upon estimates of the
IP having an economic life. Nevertheless, it is now well recognised that IP
and other intangible assets play an increasingly important role in driving
income for businesses. Consequently shareholders, investors, lenders,
employees and advisers to enterprises are increasingly interested in the
value of those assets.

The most common form of valuation of IP is an estimate of the appropriate
royalty rate that should be payable in consideration for the licensing of IP.
This is a form of the income approach and that approach is discussed in this
material. The determination of royalty rates and the factors that lead to that
determination is a well-trodden area that deserves its own discussion.

The discussion in this material will not extend to issues that are relevant to
valuation but which may arise indirectly such as inter-company transfers,
bankruptcy or valuation for taxation purposes. While enforcement of IP is a
fundamental plank in the commercialisation of IP this material does not
canvass the methods or different factors considered by courts in determining
damages and account of profits arising from infringement of IP. that aspect
entails a detailed examination of the law which is not the intent of this book
and calculation of values are influenced by the negotiating powers of the

parties stemming from the strengths of their case and the risks inherent in
proceeding to trial.

5.2 REASONS FOR VALUATION

5.2.1 The Growing role of Intellectual Property in the world today:

Intellectual Property has mutated from being used as a defensive mechanism
to being used as a strategic tool in the world today. This evolution increased
the importance of IP valuation.

5.2.2 IP as a defence mechanism:

Initially firms used to patent a product to prevent other firms from copying
their product or patenting or blocking a technology that may be essential for
competitors from entering the market.5 Patenting was also done to prevent
lawsuits.6 Patenting one’s own product eliminated the chance of infringing
someone else’s patent as the patent would only be granted if the product was
new and unrelated to existing patents. This ensured that a lawsuit could not
be filed by someone on the ground that its patent had been infringed and the
firm that got its product patented saved itself from payment of damages.

5.2.3 IP as a Strategic Tool:

Over time IP’s use by businesses evolved. From being used as mere defence
mechanisms, IP started being exploited in various ways such as

5 Ibid
6Ibid

1. Securing superiority – For securing superiority, IP started being used
in expansion of alternative product designs and for carrying out enforcement
against an infringer7

2. In business and management strategies- As a part of business and
management strategy, IP started being used as source of profits by securing
the ideal IP portfolio and by using IP actively in business assets such as
licensing8

3. Being used financial assets- IP also started being used for extracting
external sources of finance such as investing assets for financial institutions9

As the use of IP evolved from securing superiority to being used in business
and management strategy, the importance of IP valuation gradually
increased.10 With IP having the potential to be used as a financial asset IP
valuation has now become absolutely essential.11 Intellectual Property now
maybe used in negotiations, to enhance reputation, generate license revenue
and to measure performance.12 Though IP is evolving it must be understood
that these uses are cumulative and not mutually exclusive.13

5.2.4 IP Valuation and its link to Intellectual Asset Management:

As importance of IP valuation has increased, the concept of Intellectual
Asset Management14 has gained prominence as firms try to exploit more and

7 Kamiyama & Shechan & Martinez, supra note 1 at 8
8 Ibid
9 Ibid
10 Ibid
11 Ibid
12 Kamiyama & Shechan & Martinez, supra note 1 at 7
13 Ibid
14 Hereinafter IAM

more IP.15 IAM is a concept by which the business value of the intellectual
assets of a company is increased through comprehensive valuation and
management.16 Thus, IP valuation is closely interlinked with IAM.17

Firms use IAM to evaluate their IP portfolios. For example a firm may use
IAM to evaluate its patent portfolio. IAM would include tasks such as
identifying those patents which are not needed for internal development of
the firm but are viable enough to be licensed to other firms in a way that
does not affect the profitability of the firm.18 And identifying patents which
can be donated back to society as they cannot be licensed nor are they
required by the firm for internal development.19 Licensing out patents that
aren’t needed by the firm shall help increase licensing revenue for the firm
while donating back unnecessary patents shall generate cost savings and tax
benefits.20 With the help of this identification and analysis the firm ensures
that all the patents that it has are properly utilized. By employing patents as
a part of the management strategy either the firm is using the patents in its
own processes, earning revenue from them through licenses or is saving its
costs and taxes. To put it simply, IAM helps in utilizing IP as an active part
of business like any other tangible asset.

The benefits of IAM can be tremendous and this is evident from what
happened at Dow Chemicals. Dow Chemicals employed IAM and its
licensing revenue increased from 25 million US Dollars to 125 million US

15 Kamiyama & Shechan & Martinez, supra note 1 at 8
16 Ibid
17 Ibid
18 Ibid
19 Ibid
20 Ibid

Dollars per year along with saving 50 million US Dollars in intellectual
property costs.21

Thus we see that the world is moving towards utilizing intellectual property
as an integral part of its business.

There is a wide range of reasons for valuation of IP. An enterprise may wish
to value its IP or technology to form a sensible foundation for determination
of licensing royalties, obtain financing, establish potential damages for IP
infringement proceedings or assist decision making of the enterprise. If a
present value can be placed on the IP or the associated technology then the
enterprise may be in a better position to determine whether to place its
limited resources towards the development and commercialisation of that
IP.

There may also be legal and accounting standards that require the proper
valuation of the IP. If IP is properly recorded as an asset then it must be
valued so that it can be reflected in the financial statements of the enterprise.
Changes introduced to the United States accounting standards on 1 January
2002 (fast 141 and 142) mean that Indian subsidiaries of United States
companies (or Indian companies that must lodge financial reports in the
United States) must test the value of their intangible assets every year.
Similar trends may occur in India. The introduction of new taxation laws
relating to the consolidation of transactions within corporate group structure
may also be increasing the demand for valuation.

21 Kamiyama & Shechan & Martinez, supra note 1 at 9

Typically the transfer of IP involves the transfer of an entire business or
entity. It is rare for the IP to be exchanged on its own other than through a
licensing transaction. It usually involves assessing the potential of a
combination of tangible and intangible assets that give the 'IP' its true value.
This may be a patent and the know-how held by the researchers coupled
with working capital, the workforce of the enterprise or other intangible
assets. This complicates the valuation process because the other assets of
the enterprise also need to be valued or accounted for in the valuation
process.

Of course, if none of the above applies the taxman is waiting around the
corner. Transfer of the IP may trigger capital gains tax or stamp duty
liabilities where the value of the IP must be declared.

Therefore IP valuation is necessary for the following purposes

5.2.4.1 Company Valuation:

A company’s overall valuation includes valuation of both tangible assets
such as plant, machinery etc. and intangible assets such as IP. So IP is a
fundamental component of a company’s overall valuation.

If a company enters into a transaction such as buying, selling or transfer of
asset in a licensing arrangement or merges into another company or acquires
a third company or establishes a joint venture, then in each of such
transactions IP valuation would be necessary.22 An IP valuation helps the

22 Pro INNO EUROPE, INNO ACTIONS, Student Handbook Valuation of Intellectual Property, available at
http://www.ipcentar.uns.ac.rs/pdf/IP.pdf (Last visited 19th May, 2012). Also see Paul Flignor & David Orozco,

party to the transaction to know the value of the IP that is being transacted
and that shall help come to a correct estimate regarding the licensing fees or
the amount that has to be paid for the merger, acquisition and joint venture.23
In other words, an IP valuation shall help establish the price at which the
company shall be willing to enter into the proposed transaction.24

Company valuation is also necessary in a situation of bankruptcy or
reorganization. Assessment of company’s value at this stage shall again
include valuation of IP assets.25 IP valuation shall help the Bankruptcy court
to properly dispose of the assets and reorganize the company.26

If IP is not valued when a company valuation is necessary then the company
shall get a price less than what it deserves in its transactions. So valuation
of IP is extremely important.

5.2.4.2 Taxation Planning and Compliance:

If a particular legal entity is aware of the value of its IP then calculating tax
deductions and complying with tax regulations becomes easier for it.27 For
example, various US Tax Code provisions require IP and intangible asset
valuation for tax planning and compliance.28

Intangible Asset and Intellectual Property Valuation: A multidisciplinary perspective, available at
http://www.wipo.int/sme/en/documents/ip_valuation.htm (Last visited 19th May, 2012)
23 Pro INNO EUROPE, INNO ACTIONS, Student Handbook Valuation of Intellectual Property, available at
http://www.ipcentar.uns.ac.rs/pdf/IP.pdf (Last visited 19th May, 2012)
24 Paul Flignor & David Orozco, Intangible Asset and Intellectual Property Valuation: A multidisciplinary
perspective, 2, available at http://www.wipo.int/sme/en/documents/ip_valuation.htm (Last visited 19th May, 2012)
25 Supra note 20
26 Flignor & Orozco, supra note 21 at 2
27 Supra note 20
28 Flignor & Orozco, supra note 21 at 3

These include areas such as charitable donations of IP, the sale or license of
IP across tax jurisdictions etc.29 If the IP is valued then compliance with
these regulations shall become easier.

5.2.4.3 Financial Reporting and Accounting:

IP Valuation is also necessary for accounting purposes and financial
reporting such as disclosing intangible assets on the public financial
statements.30 This valuation is generally done to comply with a regulation
or guideline that is in place. For example the Financial Accounting
Standards Board of 2001 established guidelines regarding reporting of
intangible assets that were acquired through acquisitions.31 These
regulations specified the valuation, amortization and report of intangible
assets.32 The report that had to be submitted had to specify the value and the
change in the value of subject assets.33

5.2.4.4 Litigation Support and Dispute Resolution:

IP Valuation is necessary in litigation and dispute resolution.34 In situations
such as IP infringement or breach of contract where damages need to be
computed IP valuation would be of great use as it shall help in calculating
the amount of damages that need to be awarded.

29 Ibid
30 Flignor & Orozco, supra note 21 at 2
31 Ibid
32 Ibid
33 Ibid
34 Ibid

5.2.4.5 Internal Management:

For a business to be successful it needs to be managed properly.
Management of business includes management of its IP. If IP is properly
managed and exploited then the chances that the business shall do well is
high. Various decisions regarding business management such as that of
research, development, legal and industrial protection application and
commercialization involve risk.35 If IP valuation takes places then these
risks can be understood, dealt with and cost effective decision making can
be facilitated.36 All of this shall help manage the business better internally
and in making it successful.

5.2.4.6 Helps in financing of business:

Intellectual Property can be used to raise finance. If IP is to be used as
collateral for a bank loan or if securitization is to take place on the basis of
intellectual property or if venture capital financing is to take place, then the
intellectual property that is being used for these purposes needs to be
properly valued.37 In absence of proper valuation of IP none of these
transactions can take place. Each of these types of raising finance has been
used before in different parts of the world. Some examples of use of IP for
raising finance are mentioned below to indicate the potential of intellectual
property in this area.

35 Supra note 20
36 Ibid
37 Supra note 20, Also see Paul Flignor & David Orozco, Intangible Asset and Intellectual Property Valuation: A
multidisciplinary perspective, 3, available at http://www.wipo.int/sme/en/documents/ip_valuation.htm (Last visited
19th May, 2012)

Ex 1: IP as Bank Collateral:

There have been instances where banks have taken intellectual property as
collateral. For example, in 1995, the Development Bank of Japan
implemented a loan system that allowed the use of patents, patent
applications, copyrights of computer programmes and contents as
collateral.38 After the passing of this policy, the Bank granted more than 250
loans to venture firms with the Bank assessing the present value of cash
flows to be generated by the intellectual property.39 The German Federal
Financial Supervisory Authority has also accepted patents as the sole
security for bank lending.40

Ex 2: IP Backed Securitisation

This involves the transfer of intellectual property by the owner of IP for
securitisation and the receipt of capital receipts from investors in the form
of lump sum payment.41 This type of financing has been seen in the music
industry and in pharmaceuticals.42 In 1997, musician David Bowie
securitized his future royalty streams from his 25 albums to raise 55 million
US dollars.43 While Royalty Parma in order to diversify its holdings and
mitigate the risks associated with diversification, securitized a set of 13
patents that it had.44

38 Kamiyama & Shechan & Martinez, supra note 1 at 20
39 For further information on this programme, see www.dbj.go.jp/japanese/venture/venture_intellectual.html
(Japanese).
40 Kamiyama & Shechan & Martinez, supra note 1 at 20
41 Kamiyama & Shechan & Martinez, supra note 1 at 21
42 Ibid
43 In March 2004, the bond was downgraded from A3 to Baa3 due to the downturn in sales of recorded music.
See http://launch.yahoo.com/read/news/12174412.
44 Kamiyama & Shechan & Martinez, supra note 1 at 21

Ex 3: Using IP for Venture Capital Financing:

Intellectual Property can also be used for venture capital financing. Owning
a patent is extremely significant as it indicates that a person has a novel and
distinct invention which shall enable it to distinguish his good from others
in the market.45 Moreover, a patent can also be used to exclude others from
implementing their invention in the market place.46 Possession of such an
IP helps in venture capital financing as people willing to invest in any
business want security of their investment as well as a great probability of
the investment to succeed. If the person seeking investment has a patent then
it gives him an edge attracting venture capital.

5.3 VALUATION OF WHAT?

A critical element to valuation is a clear understanding of what is to be
valued. When addressing IP that may encompass the legal IP rights,
reference is often made to the technology in which the IP subsists or the
business of the enterprise that relies upon the IP or technology. Commonly
the utility of the IP will be realised in some physical form or application and
its value will be closely associated with that embodiment. For this reason
this material will refer to valuation of the IP and the associated technology
in the same context. However, the appraiser will need to consider whether
there are other forms of 'assets' that contribute to that technology other than
the IP.

45 Kamiyama & Shechan & Martinez, supra note 1 at 21-22
46 Ibid

It is also imperative that the appraiser understands the date at which the IP
is to be valued. As the discussion will show, the techniques for valuation are
dependent upon information. The availability and quality of information is
influenced by time. The presence of certain market conditions may vary, the
costs incurred in the past need to be placed into the present context and
income streams expected in the future need to be represented at a present
date. Ultimately, the appropriate date will flow from the purpose of the
valuation and it should be a factor agreed by the appraiser and the enterprise
at the outset of the valuation task.

5.4 WHO CONDUCTS VALUATION AND HOW TO ENGAGE
THAT PERSON

India law does not regulate who can or cannot value intangible property. It
is a matter of skill, experience and the purpose for which the valuation is to
be undertaken. If the valuation is required for a commercial transaction then
the criteria for choosing the appraiser will be determined by the parties to
that transaction. If the purpose is related to determining the financial status
of the enterprise then appropriate accounting standards may impact on who
is able to perform the valuation.

As we will see from the discussion in this material an appraiser must have a
grasp of a wide range of disciplines - economic, accounting, financial, legal
and management principles to name but a few. An appraiser needs to be able
to understand the market in which the IP has appeal and the skill to dig out
a wealth of information that everyone else in the industry wants to keep
secret. In short, the appraiser needs to have experience; it is essential.

The appraiser will be expected to apply appropriate professional standards
in performing the valuation. In India there is no standard that specifically
addresses the valuation of IP. In 1998 the International Accounting
Standards Committee (IASE) published IAS 38 setting out a new standard
on the accounting for intangible assets and the International Valuation
Standards Committee has issued a guidance note concerning intangible
assets.47

Aside from allowing for specific skills and standards relevant to valuation
of IP, on one view the engagement of an appraiser should not be any
different from engaging any other adviser or consultant. The enterprise
should seek referrals from other businesses that have used the services of
the appraiser. The effort in appointing the appraiser should match the risk
associated with the valuation. If the enterprise anticipates that the valuation
is important to the future business operations, such as attracting venture
capital or determining the preferred option between alternative licensees,
the enterprise may wish to seek tenders or make detailed enquiries about the
appraiser.

5.5 CONTRACT

A written contract should govern the appointment of the appraiser. The
appraiser may have its own standard form consultancy or services contract.
It may be in the form of a letter. Irrespective of the form of the engagement
document it is important that the contract clearly specifies the deliverable
that is to flow from the performance of the valuation services. This is usually

47 see <www.appraisalinstitute.org>.

a valuation report. The appraiser will determine the form and style of the
report but the contract should identify some fundamental issues to be
addressed in the report.
5.6 THE OBJECTIVE

• A statement of the objective for the valuation:
• defines the IP that is to be appraised;
• defines the legal rights relating to the IP that is to be appraised;
• identifies the standard against which the valuation is to be determined;
• Identifies the date at which the IP is to be appraised.
5.7 THE PURPOSE FOR THE VALUATION
A statement of the purpose for the valuation identifies:
• the reasons for the valuation;
• how and when the valuation is to be used;
• The people that are expected to rely upon and use the valuation.

5.8 STANDARD OF VALUE

The purpose of the valuation will affect the standard that is to be applied in
determining the valuation. If the IP is to be valued for the purpose of
understanding an indication of the return or price that the enterprise can
achieve by commercialising that IP then the most common standard will be
'fair market value'. This form of measurement has been tentatively
recommended for the valuation of intangible assets by the IASC and the
AASB. This standard applies a scenario that there is a willing hypothetical
transferee and transferor of the IP. The resulting valuation is therefore a
hypothetical answer. The actual transaction will involve factors that were
not envisaged in applying the fair market value standard.

5.9 PREMISE OR ASSUMPTIONS

The appraiser and enterprise should clearly understand the factual
circumstances that are assumed to exist for the purposes of the valuation.
For example, are the parties of equal bargaining strength? Is the industry in
an upswing?

The premise should account for circumstances that are realistic for the
specified purpose. If the premise reflects circumstances that are reasonably
probable, the use of the IP is legal, physically possible and financially
feasible and such use results in highest profit or other value (in present day
terms) for the enterprise then the valuation will be based on the highest and
best use of the IP.48 The appraiser will apply his or her professional

48 : see Robert F Reilly and Robert P Schweihs, Valuing Intangible Assets, McGraw Hill 1999, P 62.

judgment to determine whether the circumstances required by the enterprise
represent the highest and best use of the IP.

5.10 THE VALUATION DATE

It is not a step of brilliance to realise that the date of valuation may be made
as at a date that is before, at the same time or after the time that the valuation
is undertaken. The appropriate date will be determined by the purpose of the
valuation or possibly to accord with a legislative requirement.

5.11 APPRAISAL FEES AND PAYMENT

The appraiser will usually perform the appraisal services on the basis of time
spent in performing the task and seek to be engaged on a daily or hourly rate
basis. The appraiser should also give an estimate of the likely cost of the
appraisal. It is in the enterprise's interest to lock in that estimate either as a
fixed price or a 'fee not to be exceeded'. The appraiser will often prefer not
to do so unless the appraiser can be relatively certain of the elements of the
task to be undertaken. For this reason, if the appraisal will involve
significant researching into a new market the appraiser may prefer to be
engaged on a phased basis where the first phase is a scoping study.

It is also usual for an appraisal firm to render its invoices on a periodic basis,
such as every month, and may delay delivery of the final report until all prior
invoices have been paid. The enterprise should seek to structure payments
so that instalments are paid upon completion of specified milestones. The
negotiation of these issues will be determined by the relative bargaining
strengths of the parties.

5.12 OTHER PERTINENT REQUIREMENTS

The document engaging the appraiser should also specify the following:

• the milestones to be achieved in the appraisal process and the timing
for completion of those milestones;

• The specific individuals who are to perform the appraisal, particularly
if the enterprise has selected the firm of appraisers on the basis that
certain individuals will perform the appraisal.

• The engagement document should clearly state that the appraiser must
treat. As confidential all reports prepared by the appraiser and all
information provided by the enterprise. At the end of the engagement
the appraiser should return to the enterprise all information previously
provided by the enterprise.

All IP created by the appraiser in the course of preparing the report
(including the report itself and any earlier drafts) should vest in the
enterprise. This will ensure that the enterprise legally controls the reports.
The appraiser may wish to include a provision that clarifies that the
appraiser retains ownership of any templates used in the course of
performing the appraisal.

It is also usual for a standard engagement document proposed by the
appraiser to disclaim any liability if the enterprise were to use the valuation
or the report for any purpose other than the purpose specified in the contract
or for any liability arising from information provided by the enterprise.

The appraiser may wish to be indemnified for any claim made against the
appraiser arising from anything other than the wrongful conduct of the
enterprise. The enterprise may wish to consider placing a cap on such
liability to the appraiser although that will be dependent upon the bargaining
strength of the enterprise. Not surprisingly, the enterprise should seek to be
indemnified for any claim made against the enterprise arising from the
wrongful conduct of the appraiser as well as ensuring that the appraiser has
appropriate and current professional indemnity insurance.

5.13 PRINCIPLES OF VALUATION

In its simplest form, valuation is the estimation of present value of the future
economic income that the IP is expected to generate. Ultimately a valuation
is no more than a prediction of the result of an assumed transaction. It is not
mathematically exact. It relies upon assumptions.

Texts on valuation of intangible assets often emphasise the distinction that
should be made between the concepts of cost, price and value. They are not
synonymous or interchangeable but each may have a role in the process of
valuing intangible assets. Cost will usually identify information concerning
the production process. Price reflects information about a transaction at a
particular time, between certain parties influenced by the relevant
marketplace.

The valuation methods described below all involve establishing
assumptions for the purpose of the appraisal and collection of information.
The assumptions made for the purpose of valuation are critical and, as noted
above, those assumptions should be agreed between the enterprise and the

appraiser. To some extent the assumptions made will depend upon the
nature of information that cannot be acquired.

The appraiser will rely heavily upon the enterprise for information to
perform the appraisal. This material will identify some of the types of
information that the appraiser may require in order to value the IP of an
enterprise.

5.14 METHODS OF VALUATION

There are three fundamental forms of valuation: cost, income and market.
Although the income approach is the predominant methodology applied by
appraisers each of the other methodologies plays a part in enabling an
enterprise to identify 'out of the park' results and inconsistencies that may
be applicable to the enterprise, the technology or the IP. The objective and
purpose of the valuation will directly affect which method will have the
greatest relevance to the valuation.

All three approaches endeavour to achieve the same objective: to determine
an indication of the value of IP asset at a certain date. These methods are
not new and have been developed since tangible property was first
considered in a commercial context. All three methods can be used to assist
in the valuation of IP. More than one method can be used to cross check the
application of the principles to allow for any idiosyncrasies arising from
assumptions made or data collected.

The AASB is undertaking a review of the existing Indian Accounting
Standards for valuation of intangibles with a view to achieving consistency

with international practices. The timing for these reviews is unclear. The
resulting revised standards are likely to have a significant impact on the
preferred approach by Indian appraisers of IP and enterprise, particularly
those enterprises that will be subject to the Corporations Act requirements
that require companies to apply AASB standards.

The appropriate methodology will largely be determined by the stage of
development of the technology or product. If the technology is some time
from reaching the market then the cost-based approach will involve fewer
variables. At that stage the purpose of the IP or technology may not be clear.
That uncertainty fades away as the technology is developed. The market
approach may then become more appropriate. If revenue is imminent then
the income approach becomes feasible.

The process for valuation will often involve some form of due diligence
being undertaken upon the technology and the IP that subsists in that
technology. This can require a team of advisers such as lawyers,
accountants, technical experts and marketing personnel.

5.14.1 COST-BASED APPROACH

This method is based upon economic principles of substitution and price
equilibrium: the investor for the IP or associated technology will pay no
more than the cost to obtain an asset of equal utility (rather than
functionality).

The cost approach may be useful:

• where the target IP is new and exchangeable for another intangible
asset such as software where different code may be written to create
the same function;

• Where the workforce is the main component that makes the IP
worthwhile. This may be so where the IP is in the form of know-how
or the IP related assets require ongoing input by personnel for that IP
asset to be contributing to the business of the enterprise. An example
of this may be operational manuals, policies and records. The
appraiser must assess whether the IP is the subject of the valuation or
whether the intangible asset being valued is in fact the workforce or
the know-how held by that workforce;

• as a guide to reproduction at an earlier time;

• to assist in preparation of balance sheets;

• to value highly specialised property such as software, engineering
drawings or distribution networks;

• where royalty rates are set as a fair rate of return on the cost-based
value of the IP;

• when estimating the amount of damages suffered by the owner of the
IP in an action for infringement of its IP rights;

• to acquire insurance for the IP against the cost of recreating the IP or
the associated technology;

• To estimate the remaining useful life of the IP or associated
technology.

The cost approach, however, does have its limitations. It does not reflect the
economic factors that apply to the technology such as current demand for
like assets and competitor activity. It does not reflect the economic life of
the IP and risk is not directly factored into the cost approach. Obsolescence
must be separately calculated to ensure the valuation is made on present day
terms. Of greatest significance in the context of commercialisation of IP, the
cost approach will not inform an enterprise or an appraiser of the likely price
a person may be prepared to pay to acquire the IP.

The application of the cost method involves consideration of the costs of
materials, labour, overheads, and an appropriate margin for profit on such
cost elements that encompasses an incentive for the entrepreneur to
undertake the development. To the extent that this involves accounting for
historical costs the dollar value of those past costs needs to be given a
present day value by applying a factor for inflation such as the consumer
price index.

The costs should be specifically associated with the development of the IP.
This may present difficulties where the research plan and budget resulted in
more than one form of IP, one of which is not the subject of the valuation.
The appraiser will continue to allocate costs incurred until the asset has been
developed to a commercial stage. The appraiser will need to make
assumptions if the development of the technology is at an early stage.

The total cost may need to be discounted to allow for the fact that the IP
may be specific to a business of the enterprise and its full value to the
transferor may not be fully achieved when owned by the transferee. Also,
an asset used in a profitable business is likely to achieve a higher valuation
that reflects the contribution of that asset to the profit earning capacity of
the enterprise.

There are two standard methods of applying the cost approach, known as
cost of replacement and cost of reproduction.

5.14.1.1 Cost Of Replacement

The test applied by this approach is to assess the cost for the enterprise to
replace the technology with the equivalent utility or functionality. This
approach seeks to reproduce the utility, but not necessarily in the same
format as the IP that is the subject of the valuation. This approach does take
account of market demand in part because if there is no demand for the
constituent elements of the technology then that will be factored into the
cost of that element in determining the total replacement cost of the
technology.

It may be appropriate to use the cost of replacement method to:

• choose between developing the technology in-house or licensing
another person to do so;

• determine the minimum or 'floor' royalty that the licensor would
accept;

• Measure partial loss for insurance purposes.

This approach can involve the assumption that the IP, or the technology in
which the IP subsists, has utility greater than what is the subject of the
valuation. If so, the appraiser needs to make allowance for this in the
valuation.

5.14.1.2 Cost Of Reproduction

The cost of reproduction method is used on the premise that a replica of the
IP will be made. That is, what would it cost to recreate the IP in the same
format as the IP that is the subject of the valuation? This method may be
useful to compare with valuations determined by other approaches to the
valuation of the target IP and to measure partial loss for insurance purposes.

The appraiser, when determining costs incurred in the making of the IP or
associated technology, will consider whether the IP was developed in
accordance with established guidelines rather than by a trial and error
process. If no such guidelines existed then the appraiser will allow for costs
inherent in a trial and error process.

5.14.1.3 Depreciation And Obsolescence

Depreciation should be applied to the cost methods to allow for deterioration
to the asset over time. Forms of depreciation include physical deterioration
(which would not usually apply to the IP itself although it may apply to the
technology in which the IP subsists), technological obsolescence (where the
original function associated with the IP is not in demand), functional

obsolescence (where the IP cannot fully fulfil the original function and
which may result from the inherent nature of the IP or be due to external
influences) or economic obsolescence. Each of these forms of obsolescence
should result in the value of the IP being reduced.

5.14.1.4 International Issues

Application of the cost approach across international boundaries presents its
own considerations. The appraiser will need to consider separate taxation
regimes, transportation costs, costs of supporting the IP and the associated
technology and different obsolescence effects across countries.

5.14.1.5 Data Required For Cost Approach

The appraiser will seek the following types of information in order to apply
the cost approach:

Material costs:

Those costs that relate to the cost of tangibles used in the development of
the IP and associated technology, such as computer lease costs, diskettes,
books, and licence fees for software used.

Labour costs

Those costs arising from human endeavour in developing the IP and
associated technology such as wages, salaries, fees to contractors, workers
compensation insurance costs, superannuation contributions and other
employee related taxes payable by the enterprise.

Overhead costs

These need to be apportioned and the enterprise will usually be in the best
position to provide the relevant figure, which can be verified by the
appraiser.

Redevelopment information

The information required to enable the appraiser to calculate the cost of
recreating the IP or technology including time and resources.

Profit/incentive

A component should be included to reflect an incentive for the developer of
the IP (which mayor .may not De the enterprise) to have undertaken the
development and the enterprise for endeavouring to make a commercial
profit from the IP. This is largely a matter of judgment for the appraiser
although the enterprise may have certain policies on the extent of return it
would be expected to achieve in order to undertake the development of the
IP.

5.14.2 Market-Based Approach

The test applied by this approach is: what is a comparable price or royalty
that could be achieved by similar technologies or IP? If relevant market
information is available this approach can represent the most reliable and
accurate form of valuation. That is a big ‘if’ when trying to value IP, for the
reasons discussed below.

Unfortunately this test requires the enterprise to identify a comparable
product, the sale terms under which the comparable product is exploited and
the existence of independent parties dealing with the exploitation of the
technology. Allowances need to be made for the passage of time between
the valuation date and the date of the comparable transaction. Evidence of a
transaction for comparable IP may not represent the indicative value of the
IP that is the subject of the valuation because that transaction may have
encompassed a range of influences and assumptions that are not applicable
to the target IP.

Applying the market-based approach requires significant time and effort to
research market information relevant to the target IP. This has cost
implications for the enterprise when engaging the appraiser. Depending
upon the extent and reliability of information available it may be possible
for the enterprise to determine royalties on the basis of 'norms' for the
applicable industries.

5.14.2.1 Auctions

The cleanest form of determining market value of an asset is by auction.

Difficulties of auctioning IP include:

• Insufficient number of bidders. IP is usually specific to a particular
application;

• publicity costs, time required to adequately notify potential bidders
and time needed to assess the technology or IP;

• further ongoing involvement of the enterprise is often required to
assist the purchaser to make full use of the IP or technology;

• Proving that the technology in which the IP subsists is well developed.

• International issues

Application of the market approach to IP across countries will depend upon
the countries that need to be considered. For example, information about
relevant markets in the United States may be readily available but that
information may not be as robust for markets in developing countries. The
law of the country may have a strong influence on market dynamics.

5.14.2.2 Data Required For Market Approach

Valuation by the market approach depends upon access to public
information. This type of information includes data obtained from the
applicable market and assessment of the market conditions that apply at the
valuation date. Examples may include:

• Stock market variations that can be confined to changes to intangible
assets and IP in particular. This may involve business decisions
affecting a specific brand of the business. For example, Philip Morris
on one day ('Marlboro Friday') decided to reduce the retail price of
one of its best known branded products by 20 per cent to slow down
the advancing market of generic products. There was significant
slump in the share price by 23 per cent in one day;

• Where the share price of a company includes a premium that is based
upon the grant of IP registration. For example, a failure to renew
patent may result in the share price falling once that information is
announced.

The appraiser will need to acquire evidence of comparable transaction (such
as licensing terms, sales of assets and business that have involved the
transfer of IP). Assuming this can be done, the appraiser should consider
whether the market is truly comparable and if not, whether some allowance
can be made for the differentiating factors. The client will often have a great
deal of information about applicable markets. This will greatly assist the
appraiser. The appraiser can assist this stage of the process by determining
which information is relevant. For example, can software used for one
industry be applied for another industry? Are the transactions sufficiently
recent?

Even if information is publicly available concerning the transfer of IP, it is
unlikely that the circumstances applying to one technology will be
comparable to the technology that an enterprise wishes to value. For
example:

• Industry: the industry in which the technology is applicable affects
the valuation. The cycles experienced by the industry and the
competitiveness of the industry will influence the valuation;'

• Emerging technology: the valuation must account for the likelihood
of a new product superseding the enterprise's technology. This will
affect the future earning capacity of the IP;

• barriers to entry: for example, legislative requirements for therapeutic
goods or chemical approval present barriers to entry because they
impose a delay upon new technology being available to the market;

• Growth in income: are the products receiving or likely to receive the
same level of growth?

• Lifespan: will similar periods or similar robust legal foundations
protect the comparable products?

The information required for a market-based valuation makes it almost
impossible for a small technology-based enterprise to understand the value
of its IP. One methodology is to identify a publicly listed company that has
a comparable business. By doing so the appraiser can understand industry
cycles, competitive pressures, barriers to entry and emerging technologies
and reasonably extrapolate those elements to the enterprise. The comparable
company should be a company in which institutional investors have a
shareholding, there is active trading in its stock and the company has
released publicly available information. These factors will give comfort to
the appraiser that the share price of the comparable company reflects a
valuation given by risk adverse but profit seeking investors. The task of
identifying such analogous public companies will not be easy.

Once the data for the market approach has been collected and analysed the
appraiser will seek to verify that:

• The data is factually accurate: this involves checking the source of
the data (which is difficult because transaction documents are usually
kept confidential) or by some other cross check such as access to
multiple sources of information. Alternatively, the appraiser can
contact participants to a comparable transaction seeking confirmation
of the details that have been reported to the appraiser.

• The transactions considered were at arm's length: were the parties
to the transaction related? Was a party to the transaction close to
insolvency or otherwise has a significantly inferior bargaining
position? Was the transaction part of a litigious settlement?

• The data and transactions relate only to IP or associated technology:
this can be difficult because often the transfer of the IP will be part of
a broader transaction such as the sale of a business. Nevertheless, an
appraiser may be able to determine the value of the IP contained in
that sale by working backwards from the known sale price of the
business enterprise provided of course that the appraiser has access to
other information concerning the comparative business. This may
involve applying the subtraction method where the value of net
working capital (current assets less current liabilities), tangible assets
and non-IP intangible assets (including software, workforce,
contracts, distribution networks) are subtracted from the known value
of the overall business.

The appraiser will often seek guidance from the enterprise that assumptions
made about the comparative transactions are reasonable to the extent that

the enterprise is in a position to offer an opinion. It is prudent for both the
appraiser and the enterprise to keep sound written records of such
discussions to ensure that risk is appropriately borne, notwithstanding the
terms of any contract between the appraiser and the enterprise.

The enterprise can assist the appraiser by providing the following types of
information relevant to applying the market approach:

• giving information about other transactions known to the enterprise
that may be comparable to the target IP or technology;

• identifying the premium paid on a product where the IP is the
distinguishing feature between the product being valued and its
competitors;

• providing contacts in the relevant industries from whom the appraiser
may make further investigations;

• describing the potential uses and demand for the IP and technology;

• explaining the importance of the IP to the business operation
including frequency of use and whether it could be equally important
for other businesses;

• Supplying reasons why potential comparable transaction may not
satisfy comparability criteria, which would be verified by the
appraiser.

5.14.3 Income Approach

The objective of the income approach is to determine future income,
measured in present value that can be expected from the IP or the associated
technology. It is important for the enterprise to recognise that the appraiser
is seeking to determine the expected income that can be earned by the target
IP or technology. Income earned by other or related intangible assets is not
relevant. It is important to note that 'income' in the context of valuation of
IP or a business is a reference to cash flow rather than accounting profit.

There are three essential elements to the income approach:

• identifying the potential income that can be generated from the asset;

• assessment of the duration of that income stream; and

• assessment of the risk associated with the forecasted income.

5.14.3.1 Determining Potential Income

The task of determining the income stream will be influenced by:

• whether the income stream could be expected to be constant or not;

• whether the measure of income relates to revenues to be earned or
savings to be achieved {either from decreases in expenses or
investments};

• whether the projected income will be generated by use of the IP {such
as use of a trademark} ownership of the IP, licensing of the IP (to or
by the enterprise) or a decision not to use the IP {which may protect
the competitive position of the enterprise}.

Past income generated by the IP may be an indicator of projected income
although the appraiser will need to carefully consider factors that may
influence changes to historical income streams. The measure to be applied
in the valuation of IP will also influence the information required by the
appraiser. There may be a range of measures of income such as gross or net
revenues, net operating profit, profit before interest and taxes, cash flow
after tax or net cash flow after tax. If the appraiser is applying a measure
that is other than gross revenue, allowance must be made for expenses
incurred in generating the income such as cost of goods sold and overheads.

There are various forms of the income approach, which have been
categorised as49:

• methods that measure the incremental increase in income that would
be derived from the use of the IP or new technology. A common form
is comparing the price payable of a new patented pharmaceutical that
addresses the same illness as a drug that does not use that patent but
is still applied for the same illness or the price payable for a branded
shirt compared to a generic shirt;

49 see Robert F Reilly and Robert P Schweihs, Valuing Intangible Assets, McGraw-Hill, 1999, p 114

• methods that measure the decremental decrease in costs that would be
derived from the use of the IP or new technology such as use of a
patented machine that lowers the cost of producing a shirt;

• methods that estimate the costs saved by not having to pay a royalty
for the use of the IP or technology (known as the 'relief from royalty
method'). This applies the concept that the enterprise owns the IP and
therefore it does not have to pay a licence fee to acquire that IP. This
approach can also be categorised as a market approach to valuation
because it relies upon information from the market;

• methods that quantify the difference in the value of the overall
business of the enterprise due to owning the IP or technology;

• methods that estimate the value of the IP or technology as a residual
from the overall value of the value of the enterprise or as a residual
from the value of an overall estimation of the value of the intangible
assets of the enterprise. This approach involves applying a suitable
rate of return to all the assets of the enterprise and then subtracting
from those known values to determine the value of the target IP.

5.14.3.2 Determining The Projection Period

Not only must the appraiser consider the period over which the IP will
generate income for the enterprise but also the periods within that 'life of the
asset' that may generate different levels of income. This will affect the
method of calculation used by the appraiser in determining the income
stream

5.14.3.3 Assessing The Risk - Discount Rates

Income expected to be received in the future must be recalculated to a figure
that reflects value in present day terms. The rate that converts projected
future income to present value of that income is referred to as the 'discount
rate'. The discount rate is a combination of a 'risk free' assessment rate (such
as the rate obtained with government bonds) and a rate that reflects the
degree of risk associated with obtaining the expected returns from the
particular investment.

Knowledge of the present value can be important in negotiations for
licensing of IP. The payment income streams determined for licensing fees
may be lump sum, periodic or continuous. By applying an appropriate
discount rate the licensor can assess whether the proposed licence fees
reflect an appropriate rate of return.

The discount rate is influenced by:

• inflation: which reduces the purchasing power of the income stream.
A real discount rate must be applied to equivalent real income
streams, not income that is adjusted for inflation;

• liquidity: cash has the greatest utility. The easier it is for the enterprise
to convert the asset into cash the greater economic security it will
have. IP assets tend to be difficult to readily convert into cash;

• Risk Fee interest rate: if the enterprise could have used the funds to
invest in a secure income producing asset it would be paid a specified

interest rate. That rate reflects the opportunity lost by the enterprise
by it investing in the development of the IP. A common measure of
such rates are the rates of return paid on government bonds;

• Risk premium: an allowance made to account for possible loss of the
projected income streams and the potential for those income streams
to vary over time. The degree of risk will be influenced by the nature
of the IP, the stage of technological development and the nature of the
market (degree of demand, number of suppliers, level of competition,
barriers to entry).

It has been suggested that investments in emerging technology carry higher
risks with considerable potential for complete loss of the initial investment.
In these circumstances the rates of return expected by the venture capitalists
(who assist enterprises to commercialise such high risk technology) are an
appropriate guide to the applicable rate of return50. Typically discount rates
used for valuing IP are greater than 30 per cent.

5.14.3.4 International Issues

The principles of the income approach are well understood internationally.
However, the accounting standards between countries may vary and the
currency to be applied to the projected income may be an important factor.
The legal regime concerning the protection of the IP and the transfer of
income between countries may need to be considered. The political

50 see Gordon V Smith and Russell L Parr, Valuation of Intellectual Property and Intangible Assets, 3rd ed, pp 555-
6

circumstances of a country may influence the risk to be applied for
determining the discount rate.

5.14.3.5 Data Required For Income Approach

The following types of information will often be used by the appraiser to
apply the income approach (depending on the methodology that is adopted):

• the projections made by the enterprise concerning future selling
prices, market share and volume of product that will be sold, cost of
goods sold, future capital expenditures, the rate at which the market
takes up the product (penetration rate), marketing and selling
expenses (all of which would be verified by the appraiser);

• length of time required to obtain regulatory approval for use of the IP
and/or its associated technology;

• the length of time it would take competitors to re-engineer the IP
and/or its associated technology;

• the risk of technical failure associated with introducing the associated
new technology into the market;

• historical information regarding retail prices, sales, costs profits of the
targeted IP and technology and that of related competitor IP or
technology;

• manufacturing information: what equipment and labour are needed
and the associated costs;

• the extent of further development and R&D expenditure required to
bring the technology to a useful commercial stage;

• marketing: competition issues, selling prices, market opportunities,
market cycles;

• Legal: regulatory requirements to enable the technology to be
exploited and IP issues.

5.15 VALUATION APPROACH AND FORMS OF
INTELLECTUAL PROPERTY

Knowing the various valuation methods places us in a better position to
know what the appraiser is talking about. If we know how these methods
apply to various forms of IP the enterprise can focus on factors that will
assist the appraiser, hopefully derive a robust valuation and be well placed
in contract negotiations with other parties to the commercial transaction.

In some cases, such as computer software, more than one form of IP will
subsist in the technology. The purpose for which that technology is applied
will have a bearing on the appropriate valuation method to be applied and
the information to be gathered.

5.15.1 Copyright

5.15.1.1 Cost Approach

The cost approach is based upon the assumption that an investor wishing to
acquire copyright will not pay more than the cost to purchase or construct a

substitute property. Since the Copyright Act 1957 vests in the owner of the
copyright monopoly rights in the copyright work it is not legally possible to
create a substitute version or 'copy' of the copyright work unless the creation
is done independently of the copyright work. The cost approach therefore
can only provide the enterprise with an indication of the lowest possible
value of the copyright work, being the cost incurred in creating that
copyright work.

The application of the replacement cost method may result in a lower
valuation than the application of the reproduction method (the cost of
constructing an exact replica of the copyright work) due to technological
advances, particularly in relation to computer software copyright works.

The appraiser will need to account for any obsolescence relevant to the IP
or technology. This will include considering whether the technology is
maintained and enhanced. Technological obsolescence may occur in
relation to software if the software is not written in up-to-date language or
is reliant upon an outdated platform.

5.15.1.2 Market Approach

Obviously much depends upon the nature of the copyright work. Software,
for example, may have a ready market from which appropriate market
information can be obtained to enable the market approach to be applied.
However, firm evidence of market transactions can be difficult to obtain
because the parties seek to keep the transactions confidential.

Licensing of copyright works presents the most reliable form of market
information that can be used to value the copyright.

5.15.1.3 Income Approach

Any or all forms of the income approach methodologies (incremental
analysis, profit split or royalty income) may be applied depending on the
nature of information available to the appraiser. The appraiser must form a
view as to the useful life of: copyright work for the purposes of determining
the income stream and this will often be less than the legal life of the
copyright work, particularly for computer software.

Information that is relevant to a copyright work includes the remaining legal
and economic life of the work, which of the copyrights are being used and
any known impediments to the use of the copyrights.

The appraiser may also refer to:

• information provided by Copyright Agency Limited;

• decisions by the Copyright Tribunal and courts in which there may be
a market for the copyright work;

• professional societies such as LES or International Licensing Industry
and Merchandisers Association.

5.15.2 Trademarks, brands and domain names

The greatest difficulties in valuing trademarks and brands is separating other
factors that contribute to the success of the product or business that is
designated by the trademark or brand. An enterprise may use more than one
brand to generate its income. Often the enterprise will leverage off a core or
primary brand. Valuation of contributory factors and secondary brands need
to account for the influence of the primary brand upon the estimated value
of the secondary brand.

Valuation of domain names faces similar issues as trademarks and brands.
The context of web pages and the internet in general presents a special
flavour for the appraiser. Any laws that prevent the use of the domain name
by a regulatory entity will restrict the value of the domain name. Current
registration requirements for the dot.com registry prevent registration unless
the domain name is linked with the name of the applicant. The value of the
domain name may be inseparable from the website and its popularity will
be due to the content.

5.15.2.1 Cost Approach

The cost of reproduction approach is possible if historical data is available
concerning the creation of the brand. The cost of replacement approach
would not usually be applicable because the brand will be unique and so
theoretically the brand cannot be re-created in some other form.

The cost approach would usually be expected to indicate a low valuation
which would not truly represent the market value of the brand. The brand

may be the result of the use of a name, an informal brainstorming session or
have involved the engagement of experts, designers and market analysts.
The recognition of the brand may result from the lapse of time or a concerted
marketing strategy. The costs incurred in the development of the brand may
be small or significant.

5.15.2.2 Market Approach

The market approach may be useful if the appraiser has data of assignments
of brands that are comparable to the brand that is being assessed.
Unfortunately, it is rare for such data to be publicly available. It is possible
to resort to the subtraction method although many businesses will have more
than one brand and unless discrete figures are known for each brand it may
be difficult to reliably deduce the valuation applicable to the comparable
brand.

The brand can be valued on the basis of the royalty income that it could
generate by licensing to others on an arm's length basis. An important factor
is the assessment of the remaining useful life of the brand. A registered
trademark may be registered forever by maintaining appropriate renewals
of registration. The market value of the brand, however, may be less if the
goodwill associated with the brand is diminished due to poor performance
of the enterprise or the industry in which the enterprise carries on business.

If the market information is available a brand may be valued by reference
to the premium price payable for the branded article compared to generic
goods of the same type.

5.15.2.3 Income Approach

The difficulty with the income approach is establishing the link between
income projected and the brand because the brand is one mechanism to
attract clients whereas enterprises will apply a range of strategies to attract
clients. The projected life of a brand depends upon a broad range of factors
such as the support given by the enterprise to the maintenance of the brand,
the performance of the enterprise itself and the trends experienced in the
market.

5.15.2.4 Data Required For Valuation Of Trademarks And Brands

The appraiser may refer to:

• the influence of primary trademarks upon the target secondary
trademarks;

• the attention and support provided by management of the enterprise
to the maintenance, marketing and development of the brands;

• advertising and promotional expenses as reported by the enterprise in
its financial statements and accounts;

• historical revenue received that relates to the trademark or brands;

• brands of competitors to the enterprise;

• the market share enjoyed by the products or services that are marked
by the brand and the ability of that brand to influence the market;

• the level of demand for the branded products and the trend for that
demand over time;

• the retail price of the branded products or services and the retail price
of generic forms of the same types of the goods or services;

• evidence of transfers of brands of other companies in the same or
similar industries to the enterprise;

• development and maintenance costs concerning the brands.

• information relating the strengths and weaknesses of the brands of the
enterprise;

• whether the brand is registered as a trademark, the jurisdictions in
which it is registered, the degree of infringement activity and the
response of the enterprise;

• decisions by the courts in which there may be a market for the brand
or similar brands;

• specialist texts or external data resources concerning trademark
licensing.

5.15.3 Patents and confidential information

All three standard valuation approaches can be applied to the valuation of
patents. However, the usefulness of the approaches varies according to the
integrity of the information available. The legal life of a patent will often

outlast its economic value as new innovations cause the target patent to be
superseded. Whether this is so will depend upon the scope of the claims
within the patent and the breadth of the potential applications.

The significant costs associated with developing patent related technology
and applying for and maintaining patents are an incentive for an enterprise
to understand the value of the patent and related technology as early as
possible. In this context 'rules of thumb' may be of assistance where a
qualitative methodology has greater influence than a quantitative analysis
that may be associated with the three standard approaches51.

Similar issues apply to confidential information except that the potential
legal life of this form of IP is limitless. Confidential information is often
linked with people who have the know-how and the secrets. The scope for
those people to leave the enterprise will need to be considered by the
appraiser. The appraiser will also consider the procedures applied by the
enterprise to prevent unauthorised disclosure of the confidential
information.

5.15.3.1 Cost Approach

Application of the replacement cost method will result in a valuation of
technology that has the same utility as the target patent and related
technology. The appraiser will need to account (or discount) for the fact that
greater utility may have been achieved because contemporary creation

51 see, for example, Robert S Bramson, 'Rules of Thumb: Valuing Patents and Technologies', Les Nouvelles, Vol
XXXIV, No 4 December 1999, p 149

methods are assumed to be used in the development of the technology.
Allowance must also be made for obsolescence.

The appraiser will need to tread carefully to distinguish between R&D
expenses that led to the patented technology and those expenses that were
indirect to it or led to a separate form of technology. The lapse of time
between the incurring of costs of early research and the time of valuation
may prevent identification of the relevant costs.

5.15.3.2 Market Approach

The market approach is often used for patents because there will usually be
an existing market for a comparable product. Of course, there will be
occasions when the 'next big thing' arrives where the innovation has no
obvious market demand. In these circumstances the market approach may
be inappropriate.

5.15.3.3 Income Approach

Projection of income derived from patents can be estimated by having
regard to the premium in pricing of the patented article that would be lost if
the patent expires and generic articles are able to be legitimately produced.
This can be witnessed in relation to pharmaceutical products when the
patent of the drug expires. In some instances a pharmacy company may
develop its own generic drug to develop a brand allegiance before the expiry
of the patent. In those circumstances the price differential between the two
drugs will be a reasonable basis for valuing the patent. The appraiser will
need to consider the factors that may prevent direct comparison between the

goods such as increased branding and marketing costs for the generic
product.

The IP rights associated with patents are inter-linked with the product or
process that is to be sold. This means that the market approach will be a
useful check against projected income. The income approach can be used to
assess savings from greater efficiencies in a manufacturing process that is
the subject of a patent.

The expense associated with developing innovation (particularly in the
biotechnology fields), participating in clinical trials and prosecuting multi-
jurisdictional patents is well known. However, R&D costs will not be
relevant to determining valuation on the basis of the income approach.

The portfolio of products or technology that the enterprise has in the pipeline
will influence the risk factor that the appraiser applies. In relation to the
development of drugs, only one in five thousand compounds that enter into
the preclinical-trial testing graduate to human testing and after that, only one
in five are approved52. Even fewer are actually marketed. So the enterprise
that relies on one patented product will bear a greater degree of risk.

Other factors that will affect the risk discount applied to determine the value
of patent include:

• the likelihood of the patent being granted;

52 : see Bratic V W, Tilton P and Balakrishnan M, 'Navigating Through a Biotech Valuation' at
<www.pwcglobal.com>