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Published by Enhelion, 2019-11-24 05:14:25

IP_Module 10

IP_Module 10



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 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).

1 See W Lonergan, The Valuation of Businesses, Shares and other Equity, 3rd ed, Business and
Professional Publishing, 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
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


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 endeavours 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

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.



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.


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 someone
could not file a lawsuit on the ground that its patent had been infringed and the firm that got
its product patented saved itself from payment of damages.

5 Ibid



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

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 institutions 9

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


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

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


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 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 (FAS 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

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-

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


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 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

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. 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

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


22 Pro INNO EUROPE, INNO ACTIONS, Student Handbook Valuation of Intellectual Property, available
at (Last visited 19th May, 2012). Also see Paul Flignor & David
Orozco, Intangible Asset and Intellectual Property Valuation: A multidisciplinary perspective, available at (Last visited 19th May, 2012)
23 Pro INNO EUROPE, INNO ACTIONS, Student Handbook Valuation of Intellectual Property, available
at (Last visited 19th May, 2012)
24 Paul Flignor & David Orozco, Intangible Asset and Intellectual Property Valuation: A multidisciplinary
perspective, 2, available at (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
29 Ibid


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 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. 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. 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.

Ex 1: IP as Bank Collateral:

30 Flignor & Orozco, supra note 21 at 2
31 Ibid
32 Ibid
33 Ibid
34 Ibid
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 (Last visited 19th May, 2012)


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 Pharma in order to diversify its holdings and mitigate the risks
associated with diversification, securitized a set of 13 patents that it had.44

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.


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.

38 Kamiyama & Shechan & Martinez, supra note 1 at 20
39 For further information on this programme, see (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
44 Kamiyama & Shechan & Martinez, supra note 1 at 21
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.


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.


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

47 see <>.


clearly specifies the deliverable that is to flow from the performance of the valuation
services. This is usually 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.


• A statement of the 0bjective 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.


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.


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.


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

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



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.


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.


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.


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