A great deal has been written on the valuation of intellectual property. The best resources are available from the World Intellectual Property Organization (WIPO) and the Licensing Executives Society International. The focus is on three primary means to determine how much intellectual property is worth. These are cost approach, and income approach, and the market approach. Within each of these generalized approaches there are variety of tools and techniques that address the specific unique characteristics of the asset to be evaluated.
The value of intellectual property, intellectual assets, and human capital is always dependent upon the context of the evaluation. The three overall environments or contexts for valuation are: 1. Is the evaluation being done as a final stage of a legal action or lawsuit; 2. Is the reason for the evaluation to determine the fair value for an arm’s length friendly licensing negotiation; or 3. Is the evaluation being done to satisfy the requirements of tax authorities or business regulators? Each of these requires slightly different valuation methods.
When it comes to innovation management, it is the second environment relating to friendly licensing negotiations that is of most importance. For this situation three issues or questions become relevant. 1. How much can the company afford to pay for the right to use the licensed technology? 2. In what way should the licensee pay the licensor? 3. How much should the licensee pay the licensor?
The first of these issues is important because of prudent licensee cannot base decisions on the theoretical value of technology but rather on whether or not it will enhance his ability to gain revenues. If the price of the new technology, when added to the cost of the product, results in a cost of goods that is higher than what the market will bear, the licensee will lose money and the licensed negotiation will of been a wasted exercise. In win-win negotiations both licensee and licensor discuss and share the data related to this issue so that the ceiling for the value of the technology is established. Then below the ceiling, the value according to the cost approach, income approach, and market approach is established by a variety of methods. Again these methods are reviewed in great detail in the WIPO literature and will not be repeated here. What will be shared now are some of the nuances that are important.
One special case is when technology is being acquired or sold to entities in emerging economies. In this situation the laws and regulations must be carefully understood. There are five of them. They are: 1. compulsory registration; 2. limitations on confidentiality; 3. limitations on royalty; 4. export restrictions; and 5. requirements relative to use of local technology. These laws and regulations can greatly affect the value of the technology in emerging economies and must be fully accounted for when conducting such valuation exercises.
Other common factors that affect the value of intellectual property fall into six general categories. These are: 1. the type of license i.e., exclusive or nonexclusive; 2. whether or not sublicensing is allowed; 3. if the royalties are paid in advance or in arrears; 4. whether running royalties are to be paid; 5. any minimum amount of royalties; and 6. Length of the period for which the royalties are payable.
Another special case of note is the 25% of profits valuation rule. This rule is fallen into disfavor over the past decade but nonetheless is often found useful as a starting point for negotiations.