Intellectual Property (IP) and intangible assets represent about 80% of the corporate valuations nationwide. Wow! IP includes a service, process, technology, or other work resulting from creativity or invention. This includes music, video, software, artwork, chemical processes, architectural designs, and the like to which a person or organization has rights. IP can be protected through a patent, copyright, trademark, or trade secret. Clearly, in today’s world, the generation of protectable technology is accelerating at an unbelievable pace. In fact, the commercialization of IP drives the startup and tech communities worldwide. Everyone wants to be disruptive or revolutionary or simply the most awesome new “thing” on the market.
Once IP is created, those owning the rights to the IP look to make money by licensing IP licensing to others. Such licensing or sales produces trillions of dollars in revenue annually. That’s right – TRILLIONS. Not only is licensing intellectual property a core strategy for many companies, it is the basis for company valuations from startups to the biggest tech companies in the world.
So, how do we value IP? Four significant valuation approaches exist, namely:
– Cost approach
– Market approach
– Income approach
– Relief-from royalty approach (hybrid approach)
The cost approach focuses on the cost expended to date to build the IP or, more typically, the replacement cost to build new IP. Building new IP presents an interesting risk-reward challenge. If a new replacement IP infringes the existing IP owner’s copyright or patent rights, the builder of the replacement IP will have simply provided yet another revenue opportunity for the owner of the original IP. Alternatively, if a new entity builds new and better IP and does not infringe, the owner of the original IP becomes relegated to “last year’s model” and can see revenue rapidly diminish. The sweet spot on IP valuation using the cost model then is IP that is well protected, costly to replicate in terms of time and money, and can then be continually upgraded to remain as “this year’s model” for some time to come. Such IP can have a high value which can drive investment, merger, or acquisition.
The market approach typically pitches IP value to a big company in a way that allows the big company to quickly enter a new market or add a new capability to keep up with competitors. In short, the market approach argues the value of the IP relates to the opening of the new market or keeps the acquirer abreast of the market. This type of IP valuation bases value of the IP on the potential income from new markets or the looming loss of market share if the IP functionality fails to be added to a big company’s portfolio or products or services.
The income approach takes a different approach to IP valuation. Really good products and services, based on IP, sometimes cannot build market penetration because the companies owning the products and services struggle to reach large numbers of clients. In other cases, the company with the valuable IP cannot gain entry into the market because the company is simply not known in the industry which makes clients reluctant to “take a flier” on a new product or service. Rebranding the IP driven product or service under a known name might make sales take off at jet speed. This type of IP valuation argues that the IP underlying the product or service produces a windfall when put in the hands of a well-known company with hundreds or even thousands of sales reps all across the company. This method of IP valuation can be very attractive but the acquirer may also know that a simple license accomplishes the same result and therefore resists outright IP purchase at almost any price.
Perhaps this drives the fourth method – the hybrid method – wherein the owner of valuable IP bases the value on a combination of replacement, market, and income, and then adds in the valuable aspect of an acquirer owning the IP. Many big companies have no interest in large revenue streams being tied to IP they do not completely control. This desire to control the IP, and the ability to bring resources to bear to generate new IP from or in conjunction with the acquired IP, can be very powerful.
Which method is best for which IP? It depends— on the target of the IP valuation. Investors like large growth curves followed by healthy exits. IP can be highly valued without the growth curve but without such a curve the income method can fail. In short, find more than one investor or acquirer, do your homework on how to make a case for IP value that makes the most powerful argument, and then keep pushing forward toward your goal. The most dangerous enemy of IP valuation may be time. After all, remember, the pace of innovation and IP creation hasn’t yet slowed down, and won’t for some time…