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Up to date on: 29.1.2008
Provided by: Hungarian Patent Office
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Why value Intellectual Property?

In the last 15 years there has been a marked increase in the amount of companies which have become leaders through the effective creation, extraction and leveraging of their IP through efficient IP management.  Nevertheless, in most cases the fact remains that the role of IP in business is insufficiently understood.  Small and medium enterprises, the building blocks of many developed economies have been slow to realise the potential of IP management in increasing their competitiveness. Understandably, many governments have taken a stand in the promotion of such IP management business practises.

The primary reason for valuing IP is to maximise its value and therefore the value of the owner organisation through optimum management decisions.  There are various scenarios where valuation is required and needed, some examples are:

·        Company valuation (transactions, joint ventures, mergers and acquisitions, bankruptcy):

IP is a fundamental component of company value. An accurate IP valuation is required for buying or selling a company, establishing joint ventures, and executing mergers and acquisitions.  In such transactions, each party will need to know the value of IP assets being bought or sold as part of the company.  If company bankruptcy or reorganisation occurs, assessment of the company’s value is required, and this must include the value of IP assets and the assessment of the impact of proposed reorganisation plans.

·        Sale and license transactions:

Before a company buys or sells IP it must be aware of its worth.  Likewise, when negotiating a license contract, both parties must be clear about the values involved.  Often, a due diligence report is required outlining the details of the IP being purchased, sold or licensed.

·        Raising finance (bank loans, venture capital, investment):

To finance their development plans, many knowledge intensive companies can only offer their own IP as collateral.  More recently, there has been increasing debate about the collateralisation of IP in both cash flow based financing and asset based financing.  Due to insufficient knowledge about IP and valuation, banks are as yet reluctant to accept such assets.  In the future this type of collateralisation will be more accepted in the industry and IP valuation will become a key process.  Financing through venture capital is also important for many (especially knowledge based) companies.  When making decisions about possible investment and associated risks, these organisations must be clear about the value and commercial viability of the IP belonging to the benefactor and often the reason for investment.

·        Taxation planning and compliance:

For legal entities, knowing the value of their IP is important for possible tax deductions and tax compliance.

·        External reporting and accounting:

Accounting standards are generally not helpful in representing IP in company accounts and as a result these are often under-valued and mismanaged.  Accurate IP value is needed for many aspects of reporting and accounting, including the reporting of fair value estimates in annual reports.

·        Litigation support and dispute resolution:

Accurate IP appraisal is required in the event of IP rights infringement or breach of contract.

·        Internal management:

The successful exploitation of IP (for example in the ways outlined above) can lead to a company’s success or failure.  IP exploitation and creation of business strategies requires effective management internally within the company. Research, development, legal, industrial protection application and commercialisation decisions involve high but measurable levels of risk.  IP valuation facilitates cost effective decision-making and helps to understand and deal with the risks involved.

How do companies value IP?

Depending on the reason for the IP valuation, a specific valuation approach or a combination of approaches must be chosen, depending on what kind of value is required.  For example, IP valuation for the purpose of internal management will require an internal value, while sale or licensing will require a market value.  These may not be equal.  A number of approaches have been proposed and each has their own set of unique strengths and weaknesses. To get optimum results, it is important to choose the appropriate method or toolbox of methods for each individual case.  In practices each valuation toolbox is likely to include more than one of the methods listed below. 

The most important factors to consider when valuing IP and selecting the appropriate toolbox are the following:

1.      What is the IP being valued?
The valuation of IP is only possible if it can be exactly identified and differentiated from other material and immaterial assets.  In theory, each IP should be valued individually, but in practise this is far from an easy task.  For example, if separate appraisal is required, it can be difficult to separate two interdependent patents which complement each other, or a technological breakthrough with a trademark name. 

2.      What is the purpose of the valuation?
The type of value (internal, market etc.) and the type of value result (qualitative, quantitative) required is determined by the purpose of the valuation. 

For whom is the valuation being done?
Different valuation approaches are required if the target audience are prospective investors, internal management etc. 

3.      Who is doing the valuation?
The appraiser may have expertise in a particular field of valuation, and this can influence the choice of methods.  However, this may also introduce bias into the valuation. 

4.      Date of the valuation
The date of the valuation will influence the methods used and, in the case of income based methods, the discounting process. 

Methods used for business purposes can be generally divided into two groups, quantitative and qualitative methods.  Quantitative methods attempt to calculate the monetary value of the IP and include cost, market, income and option pricing approaches.  Qualitative methods provide a value guide through the rating and scoring of IP based on factors which can influence its value.

Which methods are employed in which situations? Is there a general rule or best practise tool for valuation? Below are a few commonly used general methods. Many more exist which are not covered here.

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