The MARKET APPROACH is based on the economic principle that in a free market system the supply and demand factors will drive the price of any good to point of equilibrium. Intangible assets are valued by reference to transactions involving similar assets that have occurred recently in similar markets. The market-based valuation method assumes the intellectual property value is equal to the arm’s-length price paid in comparable transactions. The theory behind this method is that the licensee is not willing to pay more than others have paid for similar intellectual property. The best resource for valuation by this method are the books, articles and databases by Russell Parr.
This approach is best explained in terms of how purchasers of real estate and used cars operate. In these markets buyers can readily ascertain what other parties have agreed to for similar houses in the same area, or for the same make and year of car. The same approach is beneficial in valuing intellectual property, though perhaps not as useful because there will seldom be identical technology and intellectual property packages.
Six elements to consider when determining what constitutes a comparable transaction are: 1. Nature of technology and IP protection, 2. Market size characteristics (e.g., number of applications), 3. Scope and status of patent protection, 4. Terms of the agreement (e.g., field of use restrictions), 5. Growth outlook for relevant products, and 6. Barriers to entry. In addition, the commercial details of an agreement will not be ascertainable when they are considered by the parties involved to be competitor sensitive. To get around this issue it is useful to look at existing royalty rate ranges and other factors published by a variety of for-profit companies and professional society entities. Factors to consider when using this approach are: (1) royalty rate, (2) exclusivity, (3) geography, (4) duration, and (5) minimum/maximum caps.
Variation between royalty rates is also dependent upon which business area a company is working in. The “Variation of Royalty Rates Within Industries” figure shows this variation. Although the variation even within an industry seem to have a lot of variability, studies, particularly in the pharmaceutical area, show that 80-90% of licenses have royalty rates close to the average, versus being evenly distributed between the minimum and maximum.
VALUE GRID APPROACH This approach is based on the fact that royalty rates that can be charged by an owner of a technology are usually based on the economic benefits that can be derived from its use. The exact royalty rates for technology are difficult to get because patented technologies are unique. However there are comparable royalty rates that are available from professional societies and private sources that can be used to build a Value Grid. From this grid the most likely royalty rate can be ascertained.
The manner in which a value grid works is to set up a grid that captures a whole range of royalty rates that are being used in a specific industry. An example is shown for the chemical industry in the “Example Value Grid for Chemical Industry Product” figure. Such a grid is constructed for by utilizing overall values from commercial or professional society sources. Where individual grid elements are missing their values can be extrapolated from those that are present and available. For the product under evaluation the appropriate grid box is selected. This allows a user to identify the range of royalties for the technology under analysis.