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Intellectual property valuation is both qualitative and quantitative in nature. Generation of numbers with no basis in rigorous, qualitative analysis will not bear up to the close scrutiny of third parties – often with conflicting interests – for whom an IP valuation is often commissioned.

Qualitative Analysis

Qualitative analysis examines, at a microscopic level, the intangible assets themselves, the business within which they operate and their position and importance, relative to other business drivers, the broader industry within which the business operates, including a review of the business’s competitors and potential competitors, and finally, at the highest level, the macro-economic outlook, over the useful life of the intangibles, for the economy in which the business operates.

Quantitative Modelling

The qualitative study is used to formulate (and justify) assumptions on which the financial models, used to ascribe a numerical value to the IP under consideration, will be based.

Quantitative models are constituted in three principal categories:

Cost Approach

Cost-based models approximate IP value by determining the replacement cost of equivalent IP.

The approach, while appealing in theory, presents one insurmountable problem: it wholly disregards the innovation and uniqueness that are at the very heart of intellectual property. The notion of “equivalent” or “identical” IP negates the novelty and inventiveness that define intangible assets.

While appropriate for tangible assets whose cost is usually a perfect reflection of their value, particularly in the case of fungible assets (i.e. capable of mutual substitution, one bag of cement being as good as the next), the cost approach is generally inappropriate to valuation of intangible assets, inasmuch as:

• intangible assets tend to grow organically, and their full value is not apparent at inception; and
• over time, any correlation between their cost and value, which may arguably have been present at the pre-commercialisation outset of the IP, definitively falls away.

A cost-based valuation may, therefore, be appropriate in instances where IP is at an embryonic, uncommercialised stage (having no trading results whence to extrapolate future potential); thereafter, it is best used as one methodology among a collage of approaches, perhaps to temper the over-exuberance that may creep into more forward-looking approaches premised on future potential.

Market Approach

The market approach postulates intellectual property value as the amount for which equivalent IP was either sold or offered for sale on the open market.

While ideologically appealing owing to its incorporation of an objective, market-based figure, the approach falls down for much the same reasons as the cost approach, in its assumption of the existence of intangible assets that are sufficiently equivalent to those being valued.

At a practical level, the approach also suffers from the scarcity of available information; sales that are strictly IP-based tend not to relate to public companies (with their public records), and where a sale price is made public, more often than not, the amount allocated to IP from the total purchase price is not reported.

These constraints notwithstanding, the market approach is also useful for tempering future-income-based forecasts, and is moreover favoured by emerging ISO standards on brand valuation.

Income Approach

The income approach has emerged as best practice within the realm of IP valuation. The approach posits intangible value based on a royalty savings hypothesis, essentially asking (and hopefully, answering) the following question:

“Over the useful life of the intellectual property, what would a person or business save by owning, rather than licensing, the intellectual property under consideration?”

The approach uses these savings as a proxy for intellectual property value; arrival at a savings figure requires a number of assumptions, notably as to a reasonable royalty rate, the reasonable remaining useful life of the IP, and an appropriate discount rate (or weighted average cost of capital, taking risk into account) by which to obtain the present value of these future, hypothetical royalty savings. In certain instances, favourable taxation consequences for acquirers of IP are also in play, and are fed into the owner-rather-than-licensee hypothesis, having a bearing on the ultimate figure.

All assumptions are derived from and justified based on the bespoke, rigorous analysis of the IP, its business context and importance (versus other business drivers), as well as broader industry and competitor related constraints, and economic outlook.

Mathematical Rigour

IP valuation, for whatever reason undertaken, must bear up to scrutiny by a diversity of third parties (whether investors, potential purchaser, a judge, trustees, or even company shareholders), and such parties often have conflicting interests interests (e.g. a venture capitalist wishes to invest at low value for a high shareholding, while the startup favours the opposite).

For this reason, not only is it essential that the valuation be carried out by an independent third party having no financial interest in the transaction(s) for which the valuation has been prepared, its legitimacy must be apparent at a quantitative level.

To this end, all ip21 Valuation reports meticulously test financial assumptions through through sensitivity and scenario analysis, and temper any exuberance or unjustifiable subjectivity that may, inadvertently, corrupt such assumptions through use of a collage of the approaches alluded to above.