One method to determine the market value of Intellectual Property assets like patents, trademarks, and copyrights is to use the royalty avoidance approach (also known as Relief from royalty or Royalty Relief). This approach determines the value of Intellectual Property assets by estimating what it would cost the business if it had to purchase the Intellectual Property (IP) it uses from an outsider.
This approach requires the valuator to (1) project future sales of the products that use the technology, (2) determine an appropriate reasonable royalty rate, and (3) determine either a present value factor or an appropriate discount rate. The result is the present value of the Intellectual Property to the company. See the following example of the valuation of a patent:
The valuation of a patent is similar to other intangibles, in that computations principally focus on earnings ability. There are many issues that affect patent valuation:
- A new patent on a new product or process has no history of earnings.
- A patent may have a history of earnings although the history may or may not be indicative of the future.
- In valuing patents, the analyst may have the following questions:
- Are there comparable patents?
- What are the royalty rates paid for comparable patents?
- What is the nature and scope of the license?
- What is the current popularity of the patented property?
- What are the advantages of the patented property over the old models or devices?
- What is the demand for the patented property?
- Are there acceptable non-infringing substitutes?
- Do manufacturing and marketing capabilities exist to exploit total demand?
- Should projected income be attributed to other intangible or tangible assets?
- What is the remaining economic life?
- What is the company’s financial ability to defend the patent?
- Method of Valuation A common method of patent valuation is to estimate the earnings a patent could realize from future royalties if the owner granted an exclusive unlimited license during the use of the patent for its remaining useful life (assume 15 years in the following example):
Projected annual sales
Royalty rate Royalty Avoidance Approach
Projected annual royalties Royalty Avoidance Approach
Present value factor (€1.00 annual annuity for 15 years discounted at 12% per annum = )
Value of patent Royalty Avoidance Approach