Patent valuation can be defined as a method to determine the real market value of patents. It is important as it plays a crucial role during many transactions such as negotiating deals, procuring investments, identifying strengths and weaknesses of the enterprise, technology transfers etc.
Important elements used to determine the value of a patent are –
- NPV (Net Present Value);
- Forecast of future value (growth options);
- Financial model to estimate cash flows from the patent.
The market today provides for three main approaches to value patents as provided in the table above. However, it has been acknowledged that factors such as the nature of the transaction (whether by assignment or licensing), desired result, realistic growth opportunities and the expenditure on research and development of the patent must be kept in mind while selecting which approach is most suitable.
The two broad classifications of valuing patents are through the quantitative and qualitative approach where one uses numeric and economic data. The other analyses the opportunities and the risks associated with the patent. A mixture of the two, or popularly known as the hybrid model of patent valuation, is in much demand. It provides for a holistic approach to understand all the aspects of income generation from a patent. The same will be discussed towards the end of this article.
The popular methods to assess value of the patent are as below:
- Market Approach Method
As the name suggests, this approach takes into consideration the amount of money that a buyer is willing to pay for a similar patent in an already existing market. This method is also known as the comparable transaction approach. The assumption that this approach is based upon which the value of the patent is equal to the amount that a buyer is willing pay to a seller of a similar patented product. The shortcomings of this approach are finding a comparable patent in the market and the ability of such a comparable patent in income generation would not be the same as the patent being valued.
The following components are required to use this approach of patent valuation –
- An active marketplace with available price information;
- An identical or a group of identical patents in the market;
- A method to control the variables or differences.
2. Income Approach Method
The income approach is also known as the Discounted Cash Flow (DCF) approach. It estimates the overall profit that a patent can generate. Most commonly, the value of the patent is based on company-specific profit projections and the use of a risk premium. The projected revenue inflow of the patented technology is discounted by variables such as the risk premium to ascertain the present value of the patent. The value attainted is considered to be the market value of the patent. The drawback of this approach is that the values used in the first place to derive at final market value can be clouded by subjective bias and manipulation.
The following components are essential to this approach:
- An estimate of the revenue inflows generated by the patent during its useful life;
- Measuring direct costs relating to the patent which are to be deducted against the revenue inflows;
- The amount of risk associated with the patent must be discounted or deducted from the present-day value of the patent.
3. Cost Approach Method
In this approach a patent is valued based on the amount of cost incurred to develop a similar patent either internally or externally. The historical rates trending in the market or the estimate of the cost of creation (based on current market conditions) serve as a basis to come up with the required cost estimate. It seeks to determine the value of a patent at a particular point in time by summing up the direct expenditures and opportunity costs involved in the development of the patent and considering its obsolescence. The most obvious shortcoming of this approach is that it does not consider the income-generating nature of a patent, which can and in most cases, is the primary reason to create a patent.
The following are the components required to carry out this approach:
- An estimate valuation of the cost of development of a patent;
- Value of expenditures, opportunity costs, inflation etc. at a particular point of time;
- Costs related to obsolescence of patent over a period of time.
4. Hybrid Model
A hybrid model would consist of factors envisaged in all of the above approaches. It included features of both qualitative and quantitative nature. This model aims to customize the patent valuation to the exact nature of the transaction that it aims to participate in. This approach has also been known to have the most practical use and has become an upcoming in the current market.
The following elements are essential to this model:
- The size of the market and the share of the technology concerned;
- The annual turnover that is generated by the patented technology;
- The profit derived after applying tax and other duties;
- The risk value that should be discounted;
- If the patent is a part of a product, then the value of how essential it is to the product.
Conclusion
No method of valuation can predict the value of a patent with 100% accuracy but valuing patents have become crucial to companies due to their ability to generate capital, attract profitable partners, enabling licensing and franchising business models and their relevance in solving disputes. Thus whichever mode of valuation that a company uses should have a nexus with the ultimate objective that the company has for the patent. Many companies often use two approaches together such as the income approach and the cost approach to obtain a more holistic view; further customization is possible and should be incorporated for such valuations in the future.
By: Aryashree Kunhambu, Shri Dharmasthala Manjunatheshwara Law College, Mangalore.
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