How To Value Intellectual Property Rights

As with everything, Intellectual Property Rights are only worth what someone is willing to pay for them. With no fixed set of rules, around how to set an accurate valuation, it’s important to step into the buyer or investors shoes once again.

An investor will typically want to see a return on their investment, in relation to the level of risk.  Will the investor get their money back within 5 years or less, in other words will they get guaranteed income of more than 20% every year?


Different investors have varying levels of appetite for risk.  For the risk averse they will want to see their money returned in a much shorter period of time.  Valuation will also vary on the market in general, and how the economy is performing at the moment.  If an investor can get a much higher return elsewhere, they’ll put their money into those avenues instead.

 

Consider any commercial agreements, such as product market share, barriers to market entry, patents, legal protection, profitability, economic useful life, and growth forecasts along with any industrial and economic factors.

 

The typical model for sellers and licensors, is usually to receive an upfront fee, followed by ongoing royalty payments.  The payments should always consider what the economic useful lifetime of the product, will return in terms of revenue to the licensee.


The three more common methods of valuing Intellectual Property Rights are:-

  1. The Cost Approach Method

This method involves taking into consideration, all of the costs in creating the intellectual property, together with an assessment of what the likely costs would be, for recreating the intellectual property.


These costs might include:

  • Labour hours
  • Material Costs
  • Equipment costs
  • External Supplier Costs
  • Overheads
  • Any Research and Development cost
  • Development of a prototype
  • Trials, testing & Perfecting
  • Regulatory approval, certification & patent
  • Registering the IPR

 

The basis of the Cost Approach Model, is that an investor would not pay any more, than the cost of creating the Intellectual property from scratch.  This means it can be based on the cost to build the current product, or the cost of creating the same product in the future.  


Generally from a buyers perspective, the cost of developing a product, probably will have little bearing on the future revenue it might create.


2.  The Market Approach Method.

The Market Approach Method of valuing Intellectual Property, is based on the principle of competition.  In general this means that the laws of supply and demand will drive the market value.  The valuation is thus based on comparing the price of any similar property in the most recent past.  The problem with this approach, is that it can be difficult to discover such information due to confidentiality agreements.  The Market Approach Method is generally impractical in establishing a fair price for Intellectual Property.  


3.  Income Approach Method

The Income Approach Method takes into consideration the income that the intellectual property will generate, taking into consideration any capital cost incurred in realising that income.  The result is then discounted to accommodate risk factors, and the cost of capital.  This generates the Net Present Value (NPV).  The only problem with using this method, is it can be difficult to estimate the economic life of the intellectual property.  This means it’s difficult to value any future income.  Generally using this method, the valuation wouldn’t consider any more than 5 years into the future.  

 

How to Calculate Royalty Payments.

Royalty payments are generally paid as a percentage of sales or gross profits.  The royalty rate, will normally be adjusted according to any upfront fee that’s paid, thus paying a lower upfront fee, but paying a higher royalty fee.

 

We hope you’ve received some value from this article, and some information that you can use to move forward toward your vision.

 

If you’re confident that selling your business is the way to go, or perhaps you’re undecided, it’s important to consider the significant amount of effort and resource you’ll need to make it happen.  It’s a full time job. - The time investment alone is enough to put anyone off.  So imagine for just a minute, that you didn’t need to do all of this work.  What if this could be done over the next 3 - 5 years (by someone else).  Everything we’ve listed in this article, is what you’d need to do, if you were selling through a business broker, or direct to a buyer.

 

Unlike other private equity firms, our focus is on growing businesses at the smaller end of the market.  We’ve worked in, and grown our own businesses in the exact same fields you work today.  We’ve spent years coaching and supporting small businesses just like yours, developing their teams, and helping them to grow, but now, we’d like to help you.  

 

We have a solution for business owners that need to sell their business immediately, or for those who want to stick around for a few years.

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