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Tudor
Valuation Methods
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TABLE OF CONTENTS
I.1
Practice in General................................................................................................................... 4
I.1.1 What? ..................................................................................................................................... 4
I.1.1.1
From price to value ....................................................................................................... 4
I.1.1.2
Valuation as a practice .................................................................................................. 4
II
II.1
What? ........................................................................................................................................ 6
II.1.1 Step 1 Definition of objective and standard of value.......................................................... 6
II.1.2 Step 2 Description of the appraised asset............................................................................ 6
II.1.3 Step 3 Determination of the valuation time period ............................................................. 7
III
Outcomes................................................................................................................................. 10
MARKET-BASED VALUATION ............................................................................................ 12
Outcomes................................................................................................................................. 13
INCOME-BASED VALUATION ............................................................................................. 14
V.1
What? ...................................................................................................................................... 14
V.1.1
Definition......................................................................................................................... 14
V.1.2
Practice parts in Practice.................................................................................................. 14
V.1.3
Pro's & Cons .................................................................................................................... 14
V.2
Why?........................................................................................................................................ 15
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V.2.1
V.3
Rationale.......................................................................................................................... 15
Outcomes................................................................................................................................. 15
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VALUATION PRACTICE
What?
Valuing an intangible asset is not correlated to giving it a true market price. Valuation exercises are
done to estimate the potential value of an item based on reasonable market assumptions and generally
accepted business principals, at a given date and within a specific environment. The goal of the
valuation effort is to give a starting point by which rational decisions, like royalty amounts, can then
be made.
As an end result, the actual market value for a specific intellectual property can only be determined
once a buyer and seller have come to an agreement on the commercial worth of the intangible asset.
Valuation for intangible assets is unique in that it demands that the estimation of economic (or market)
value for an object that does not fall into the traditional physical, brick and mortar category of asset
valuation. So the theoretical model used will have to differ from the classic methodologies that grew
out of real estate valuation models.
Determining value for ideas that are represented only by their manifestation on paper or in a specific
digital medium can represent a difficult task. Intellectual property management should focus on total
value creation and not solely left to the generation of barriers and transaction costs management for
dedicated markets. Furthermore, IP valuation analysts are often asked to evaluate an intangible
concept prior to its practical application in the marketplace, an often abstract and complicated task.
Valuation exercises are performed by TTO experts relying on their broad experience in their technical
domains and can count on experience in skills such as scientific knowledge, legal expertise and
management related experience on accounting, business administration and even possibly taxation.
I.1.1.1
As stated above, valuation is the practice of estimating a potential monetary value for intangible assets
on a given market using reasonable assumptions. Performed either for transactional or notational
purposes, valuation allows the determination of a subjective value for the considered asset.
Value is to be apprehended as a subjective financial indicator, because although it depends upon many
endogenous parameters, most are actually exogenous due to limited information. As such, value is
opposed to price, in the sense that the environment impacts value whereas it does not impact a price,
which is a fixed indicator (at least for short term).
I.1.1.2
Valuation as a practice
Most of the economic methods and procedures to evaluate intellectual property (IP) can be categorized
under qualitative or quantitative methods. The most used ones in this field belong to this second
category - quantitative - and are regrouped under three commonly used approaches. These three
fundamental quantitative ways of assessing the economic value of IP assets are the cost, market and
income approach.
Although based on different principles, the aims of these approaches are similar. They are all designed
to achieve a reasonable assessment of the value of the IP subject to valuation at a certain date and for a
given situation. The differences among those approaches make them complementary.
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However, since all of these approaches are different, it is only through the assessment of the specific
type of intellectual property asset under valuation, the purpose and scope of the latter, and the
inventory of the data available for analysis that a rational choice can be done upon them.
This document will detail the various quantitative valuation methods available, and more generally
will follow a classical structure for describing a practice to valuate intangible assets. The valuation
practice exposed hereafter will broadly follow the schematic representation of a valuation practice as
illustrated hereafter:
Objective definition
and standard of
Value selection
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Appraised
asset
description
Part 2 : Valuation
Valuation
date or
period
selection
Valuation Methods
Method
selection
and
calculation
Reporting
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II
II.1 WHAT?
All valuation procedures start by common preliminary phases, independently of the valuation method
chosen. The latter relates to the IP asset description, identification of informational sources, and data
selection. Each of these phases will be hereafter independently developed.
II.1.1 Step 1 Definition of objective and standard of value
This first step of the valuation practice relates to the definition and overview of the valuation
objectives. Such practice should bring answers to the following questions:
The value of an intangible asset is intrinsically related to its environment. Motives for valuation are
therefore important, and the means of valuing any given asset will differ depending on the objectives
related to the valorisation plan of the intangible asset. This will also impact the standard of value upon
which the valuation will be done. Standards of value can be purely monetary and financial, or can be
assimilated to relative indicators such as productivity impacts.
Amount of human resources (scientists, engineers, ...) who worked on the project and more
specifically on the IP research and development,
Salaries and benefits of those involved with the IP asset development,
Overhead costs for utilities and research space, for administrative and technical support,
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Finally, data specifically related to the patented invention have to be selected and extracted. This can
only be done with the help of the research team through discussions. The reading of the accounting
balance sheets is not given at this stage a sufficient level of accuracy. A validation of the expenditures
extracted and taken into consideration has to be done by the stakeholders of the research and
development of the IP subject to valuation.
II.1.3 Step 3 Determination of the valuation time period
In previous step, we have demonstrated how important it is to define which data should be taken into
account in order to use only the expenditures related to the IP asset as such. Following this idea, the
definition of the relevant period of time from which the data will be taken into consideration is a
crucial issue.
The definition of a time period would of course depend of the life stage reached by the valuated asset.
From a general perspective, a new product progresses through a sequence of phases including R&D,
introduction to growth and decline related phases. This practice, known as the product life cycle, is
illustrated in the graph below:
Each stage implies various hypotheses that impact the valuation practice:
R&D stage is the phase of research and development of a new invention which would end to a
new product. At this point there is no exploitation or commercialization nor revenues for the
right-holder. Uncertainty related to the transferability of the appraised asset is very high.
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Introduction stage point the phase of the entry of product into the market. The introduction
stage starts with the first sales and then sales begin to grow. As sales grow, uncertainty related
to the commercial opportunity decreases.
Growth stage is the period of rapid growth in product sales. It becomes more competitive
through modification, price adjustments, wider distribution and other initiatives. Uncertainty
is strongly reduced, as a market is found for the product.However, the length of the growth
stage can be strongly impacted by the apparition of substitution products.
Maturity stage shows a deceleration and stabilization of the sales growth. The sales volume
reaches its maximum at the end of the maturity stage. At maturity stage, uncertainty is by
hypothesis supposed to be marginal.
Decline stage describes the decrease of the sales decrease mainly because of market
saturation, obsolescence or other factors. This phase represents the period of declining sales.
Typically the initial years of development cannot be as costly as the later ones, mainly because the
research team firstly identifying potential research trajectories for R&D practicees. By definition, the
historical costs taken into account should be only those that were specifically associated to the asset
subject to valuation. This can be difficult for initial research expenses. Quantitative valuation methods
used in such phases are mostly market and income approaches.
Once all of those initial factors and information are gathered, the appropriate valuation method can be
chosen. The latter will be developed next.
Part 1 : Data collectionand analysis
Objective definition
and standard of
Value selection
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Appraised
asset
description
Part 2 :
Valuation
date or
period
selection
Valuation Methods
Part 2 : IP Valuation
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III
COST-BASED VALUATION
III.1 WHAT?
III.1.1 Definition
The cost-based approach relies on the principle that a link exists between the costs incurred during the
development of an intellectual property asset and the final value of this asset. This implies a
correlation in between costs and value. Parr (1998) stated that the cost approach measures the future
benefits of ownership by quantifying the financial amount of money that would be required to replace
(or develop) the future service capability of the subject IP. For Reilly and Schweihs (1999), the cost
approach is based upon the economic principles of substitution and price equilibrium. An investor will
pay no more for an investment than the cost to obtain an investment of equal utility.
Different cost-based methods, which can be applied to value intellectual property (IP), are derived
from this principle. They are exposed hereafter.
III.1.1.1
This method is generally considered as a starting point in any cost approach procedure. It measures the
actual costs incurred during the creation and development of the IP subject to valuation. An account of
all the costs associated to the IP subject to valuation is made (material, overhead, human resources...).
These costs are then trended to the valuation date by an appropriate inflation-based index factor.
III.1.1.2
This method makes an estimation of the costs to obtain an equivalent IP asset with similar use or
function as the original IP asset under valuation. This similar IP asset could be developed in a different
way of and with different components as soon as it recreates the utility of the subject IP. The main
factor related to replacement cost approach therefore links the economic notion of utility.
III.1.1.3
The calculation of a reproduction is based on a compilation of all costs related to the purchase or
creation of an exact replica of the IP asset subject to valuation. The method makes the estimation by
following an identical practice of development and by using the same components as the original IP.
Finally, other methods also exist as the prospective cost method or the avoidance cost method
(quantification of some measures of either historical or prospective costs that are avoided, not
incurred).
III.1.2 Practice parts in Practice
Compare to the other approaches, the application of a cost approach appears to be a good starting point
for the valuation of a patented invention for example, especially when the patented technology is
relatively young and its exploitation and commercialisation has not yet been launched. In this
situation, it makes the application of a revenue approach difficult and uncertain. Indeed, this approach,
based on expected revenue, generally uses business plan data, which are directly connected to the
business strategy. In addition, this type of approach requires a strong knowledge of the targeted
market. At this stage of development, the strategy regarding the exploitation and valorisation of the
patented invention is not clear enough to use this source of information. In addition, a market approach
could be a solution. However, it requires some transactions references with comparable and reliable
data, which is not always available.
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In conclusion, the trended historical cost method appears in this type of situation the best choice to
start with. In the literature, this method is often described as one of the simplest methods in term of IP
valuation. Most of the data required for the valuation practice are considered to be easy to collect
mainly because they are contained into the accounting balance sheets of the entity. In addition, as
previously stated, this decision in favour of a cost approach was done because of the recent nature of
the patented invention. Indeed, a cost approach is generally the sole useful approaches in such
situations where there is a lack of market revenue data and/or when the IP subject under valuation has
not yet been released to a marketplace. Another reason in favour of such a choice is that this method
provides the chance to make thoughtful historical lecture of the IP research and development project.
Through the historical information collection, the understanding of the patented invention history by
the evaluator should be improved, a list the different steps of the project would be made.
III.1.3 Pro's & Cons
Pros
o
o
Cons
o Value is rarely correlated with costs
o According the context, finding enough relevant information on costs can be difficult
for old IP asset
o Differencing costs that should be taken into account versus those that should not can
be difficult
III.2 WHY?
III.2.1 Rationale
The context
The cost method attempts to answer the question of the economic value of an intangible asset by
creating a link between the costs that were incurred during the development of the intellectual
property, and the price that the market will pay to have an identical IP asset of similar use or function.
This linking is generally accomplished by first tabulating all of the costs associated with the creation,
R&D or any associated tasks or overhead - like project management - that went into the overall
realization of the IP.
Why this was a problem?
The economic value estimation is assigned based on a theoretical amount that an entity would pay in
order to have a similar asset. A general accounting of all costs incurred during the development of the
IP does not automatically equate to the value that the market would assign for a similar or substitute
asset.
III.3 OUTCOMES
Cost-based valuation, based either on historical, replacement or reproduction costs, is an interesting
approach when performing a valuation. The main issue is that such an approach usually creates what
can be called an intra project value, which may differ from a global market value.
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As such, cost-based valuation information should be coupled with other approaches in order to
estimate such a market value.
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IV
MARKET-BASED VALUATION
IV.1 WHAT?
IV.1.1 Definition
The market approach to valuation focuses on how the market perceives the economic value of the
asset in question. Instead of looking at the costs related to the IP, market valuation focuses on the
identification and manipulation of market data to arrive to an approximate value for the valued IP.
IV.1.2 Practice parts in Practice
The market valuation approach can be roughly broken down into three components. The first steps
include the collection, cataloguing and validation of transactional market data for IP that would be as
similar as possible to the IP asset under review. Next, the data is then practiceed that similar units or
common denominators can be identified and then analyzed (as for the valuation method, the assets
under review and their related metrics need to be homogeneous).
Finally, this data needs to take into account all relevant dynamics, such as changes in market
conditions, differences between geographical regions, etc
The market valuation approach requires that any abnormal market forces need to be identified and
taken into consideration when making the comparison between the market for similar IP assets and the
one under analysis. Abnormal market forces relate to the context and dynamics behind the data that is
used for comparison. If, for example, the final market price for a similar type of IP was influenced by
bankruptcy or unfair market conditions, then this needs to be factored into the analysis. It therefore
stands to reason that this method works best when there is a large amount of market data with which to
work with. Another drawback is that IP from R&D is almost never completely the same. In the
pharmaceutical field, where there is a large, competitive market for new biocatalysts or proteins, it
may be easier to use a market approach to see what complementary IPs are valued at. However, if the
IP is truly unique and developed as part of an open source software development program, then it may
be very difficult to find enough data in which to make a fair and complete analysis. Clearly, the most
limiting and impacting factor against Market valuation consists of a lack of information in a given
context.
IV.1.3 Pro's & Cons
Pros
o Simple theoretical applicability
o Based on a market reality
Cons
o IP assets are rarely substitutable (e.g. a patent is supposed to be unique)
o Information asymmetry issues, where for example financial information related to
other deals is unavailable or partial
IV.2 WHY?
IV.2.1 Rationale
The context
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Value based on a market approach consists in the price of a comparable asset in a similar market
transaction. This creates major issues related to the comparability of the evaluated assets, and in a
similar manner the availability of the pricing information.
Lack of active and transparent market for IP transactions and potential market dynamics where value
of a given technology can be strongly impacted (in a positive or negative manner) have to be taken
into account in the practice.
IV.3 OUTCOMES
Based on good available information, and if used correctly, market approaches can grant the most
exact value for any given asset under valuation. However, this is rarely the case. Nevertheless, a
market approach to valuation can grant fundamental information which need to be taken into account
in a valuation practice. As a cost-based method, a market-based approach can be used in combination
with another approach.
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INCOME-BASED VALUATION
V.1 WHAT?
V.1.1
Definition
As the name implies, the income valuation approach focuses on the ability of IP assets to generate
future revenues for an entity that wishes to use it to create a product or service. This implies that
neither the development cost of the IP nor a comparison of similar IP value available on the market
need to be taken into account.
V.1.2
The income approach is only concerned with determining what amount of the future revenue of a
product or service would be achieved based only on the use of the IP asset. It needs to focus only on
the value added effects of the IP and remove any exogenous components from the analysis of the
proposed products or services.
At the heart of this approach is the idea that some estimated future revenue derived for the use of the
IP can be converted into a specific amount (i.e. estimated economic value or actualized) that could
be realized today.
Because the income approach creates a framework for estimating future revenues, it is important to
focus on two key areas; the business environment in which the product or service in being offered
(market size, market growth, competition, etc.) and the length of time concerning the specific business
proposition. By relevant, we mean to incorporate factors such as technical obsolescence or time
limitations for IP protection such as the time that a patent has until expiration of validity. Within this
analysis is the discovery and quantification of various market related risk elements that may influence
future income revenues. As with the market approach, the definition of a valuation date will be used to
anchor the calculations.
Income valuation relies on various sub-methods such as Direct Capitalization analysis or Yield
Capitalization analysis to determine the present value of potential future revenue generated by the IP.
Independently of the sub-method used, relevant market, industry, manufacturing and market risk
components are used to calculate the potential income for one or more periods after the valuation date.
These are encapsulated within royalty increasing and decreasing ratings that will impact each stage of
the model.
V.1.3
As a projection of estimated future sales, the income approach can be seen as always
right (at the time of the valuation present time)
Cons
o As a projection of estimated future sales, the income approach can be seen as mostly
wrong (the crystal ball is always right, as long as it is not carried forward in time)
o Difficulty to extract the data from the business plan only related to the IP asset subject
o
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to valuation
Difficulties in the estimation of an appropriate discount rate or in the definition of the
level of uncertainty, risk in the forecast of the future incomes
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V.2 WHY?
V.2.1
Rationale
The context
The benefit of the income approach is that it can be used for a wide variety of IP assets. Facing the
difficult issue of information asymmetry, the income approach only incorporates future potentials. The
cost approach as well as the market approach to valuation depend on information not necessarily
available to the evaluator.
In the case of valuation, all approaches have their own difficulties. However, as it does not rely on the
quality of prior available data, the income approach has the unique benefit of virtuality: predicted
revenues or impacting risk factors might not occur, but at the time of valuation they are the only
reliable estimation. In a sense, the crystal ball is always right, as long as it is not carried forward in
time.
V.3 OUTCOMES
The income approach is the most widely used valuation approach for appraising value of intangible
assets. However, good valuation based on the income approach depends on the quality of the business
plan, and the predictability and the clarity of the economic environment. A miss evaluation of an IP
asset is therefore not due (using the income approach) to the evaluation practice as such, but relates
directly to a poor business plan.
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