Valuation of IPR
Presented by Deepika Maheshwari
Financial Advisory Services
Deloitte Haskins & Sells, Ahmedabad
Audit.Tax.Consulting.Financial Advisory
This document is confidential. No part of it may be be reproduced without express approval of Deloitte.
© Deloitte 2008.
9 th Feb 2008
1

Overview
•Basics of Intellectual property rights
•Importance of Intellectual property rights
•Management of IPR
•Valuation of IPR

Intellectual Property Rights- Basics
•Increasing investment in Intangibles.
• Shift in focus from Physical capital to
Intellectual capital
• “
Value of Intangible Assets
Value of future growth opportunities that are already in place
Value of future growth opportunities from new assets

Intellectual Property Rights- Importance
•Source Of unexpected revenue
•Increases Shareholders Value
•Establishes Proprietary Market advantage
•Enhances Competitiveness
•Exploits new market opportunities
•Reduces risk

Intellectual Property Rights- Management
Identify
Design
Process
Method
Software
Trade Secrets
Know-how
Trademarks
Brand names
Formulations
Literary work
Patents
Copyrights
Design
Trademarks
Publishing rights
Source: Deloitte Research
To be able to reap benefits out of IP, a sound IP management programme is required
Valuation Approaches:
Accounting
Residual Value
Cost
Market value
Income
Real option
IP Trading
M&A
IPO/Fund raising
Financial Reporting
Licensing-In
Licensing-Out
Contract/ Royalty rates
Transfer Pricing
Litigations
Technology transfer

“ The intangibility of a company’s most important assets makes it extremely hard to figure out what the company is really worth.”

Valuation Parameters
What
Whom
Why
How
What is the IP to be valued
For whom the valuation is being done
Why the firm has decided to value IP rights
(Purpose)
Patents, Copyrights, Designs, Trade secrets, Know how, Trade marks,
Brand name
Shareholders, Management,
Licensor/Licensee, Investor, Court of
Law, Acquiror , Investment banker
Corporate valuation for shareholders,
M&A, Management buy-out or buyin, IPO/Fund raising, Financial
Reporting, Acquisition/Licensing of
IP, Litigations,, and reorganization
How the valuation would be done in given circumstances
Different approaches to valuation may be used

While valuing IP…
•Understand the value chain of business and understand how profits are generated
Patent Manufacturing Distribution Sales Brand
•Understand Important features of IP and how it adds value to business
•Obtain Adequate knowledge of trends in the industry and technology
•Consider scope & Strength of IP asset
•Assess the availability of competing IP in the market
•Ascertain the unpredictability of future returns

Valuation- A Daunting task
•No active market for trading of intangible assets
•Difficult to identify the potential earnings and profits that can be generated
•Uniqueness of each IPR – Non Comparability
•Difficult to Segregate profits generated from tangibles and intangibles.
•Difficult to ascribe appropriate economic benefit to an individual IP Asset if there are more than one IP.
•Inadequate disclosure of Intangibles in financial reports
•Most valuation methods ignore managerial flexibility

Valuation Methods
Static valuation models
Accounting Approach
Cost Approach
Market Approach
Dynamic valuation models
Income
Approach/Discounted cash flow
Decision tree Analysis
Real Option Model
Monte carlo Simulation

Accounting Approach
•IPRs are subset of Intangible Assets
•As per AS-26 issued by ICAI, the recognition of an item as an intangible asset requires an enterprise to demonstrate that the item meets the:
• “ definition of an intangible asset and
• recognition criteria set out in the standard”
•As per definition Intangible asset should be
•
•
Identifiable
Controllable
• Able to generate economic benefits
•An intangible asset should be recognized if, and only if:
• it is probable that the future economic benefits that are attributable to the asset will flow to the enterprise; and
• the cost of the asset can be measured reliably.

Accounting Approach- Acquisition
Separate
Acquisition
Valuation
• Cost of intangible would be the purchase consideration paid either in form of cash or in Fair value of shares or assets exchanged
• Cost =Purchase consideration+ Import Duty+ Taxes+
Any direct attributable exp.
As a part of
Amalgamation
Valuation
• Allocation of purchase consideration to individual identifiable assets (including IPs) and liabilities based on their fair values at amalgamation date
• Valuation method must:
• Estimate Fair Value, and
• Reflect current transactions and practices in industry

Accounting Approach – Valuing Internally Generated IP
Research Phase
ECONOMIC BENEFITS
Commercial Phase
Expensed
Development Phase
EXPENSES
Direct + Indirect
Capitalized Expensed
1.
Technical feasibility
2.
Intention to complete and use/sell
3.
Ability to use/sell
4.
Probable future economic benefits
5.
Resource availability
Available for use
6.
Ability to measure
• Internally generated goodwill can not be recognized as an intangible asset

Cost Approach
Value
(Rs)
Historical cost trending
Method
Recreation
Cost Method
Assumptions :
 Cost to purchase or develop new property is commensurate with the economic value of service
 An investor would pay no more to purchase an asset than would be required to reproduce the asset
Replacement cost method
This method seeks to measure the future benefits of IP assets by calculating the amount of money that would be required to replace the future service capability of the subject intellectual property

Cost Approach- Examples
Historical Cost
•Example : Cost incurred on R&D to develop a new technology know-how:
INR 100 for Y1 and INR
200 for Y2
•Inflation index: Y1 = 100,
Y2=105, Current = 110
•Estimated Value of IP
100 x 110/100 + 200 x
110/105 = INR 320
Replacement Cost
•Example : Cost incurred on R&D to develop a new technology know-how:
INR 100 for Y1 and INR
200 for Y2
•Inflation index: Y1 = 100,
Y2=105, Current = 110
•Chances of Success : 60%
•Estimated value of IP would be (100 x 110/100
+ 200 x 110/105)/0.6 = Rs
533

Cost Approach- Pros & Cons
Pros
•Good for internally developed intangibles or in liquidation scenario
•When comparable market data is not available
•When intangible is not income producing
Cons
•Requires numerous adjustment to financial data
•Difficult to apply if historical records are not there
•No direct correlation between price and value
•Risk is not factored

Market value Approach – Comparable Market value
•Value of an IP = prices paid for comparable IP as part of arm’s length transactions
•The transaction price, as a ratio of an asset attribute such as sales, is used to derive a market multiple
•This market multiple is then applied to the attribute of the asset being valued
Requirements
•Active market involving comparable property
•Past transactions of comparable property
•Access to price information at which comparable property exchanged
•Arm’s length transactions between independent parties

Market value Approach – Comparable Market value
•Factors to be considered while comparing
– Industry
– Market Share
– Profits
– Impact of New Technologies
– Barriers to Entry
– Growth Prospects
– Strength of Legal Protection
– Remaining Economic Life

Market value Approach – Comparable Market value
Objective: To value a trademark ‘XYZ’ of a pharma co. ‘Pharma Co.’.
•Annual sale of products with ‘XYZ’ trademark = INR 100
•Comparable transaction: Purchase of 32 medical remedy trademarks by
M&J Labs for INR 5000. Annual sale of all 32 trademarked products just prior to purchase was INR 4000
Solution
•Value-to-sales multiple of comparable trademark = 5000/4000 = 1.25
•Value of ‘XYZ’ trademark = Annual sale from ‘XYZ’ trademarked products x Value-to-Sales multiple of comparable trademarked products
= INR 100 x 1.25
= INR 125

Market value Approach- Pros & Cons
Pros
•Relatively easy to apply
•Conceptually attractive
•Provides evidence of value
Cons
•Most of the information is not publicly available
•Low Frequency of comparable transactions
•Each intangible transaction is unique.

Residual Value Approach
Assumption : Markets are efficient. i.e, all future economic benefits from assets
(tangible and intangible) and IP of the firm are factored into the market price of firm’s equity and debt
•Starts with the company’s value of equity (as measured by its stock price) plus the value of its liabilities.
•From such amount, value of the company’s tangible assets, plus the value of any intangibles not transferred (Unidentifiable Intangible
Assets) is reduced. The result is the lump-sum value of the intangibles being valued.
•Value of IP = MC-(N+U)
– Where MC= Market Capitalization
N= Net Tangible Assets as shown in book (Total assets- total liabilities)
U= Unidentifiable Intangible Assets
Drawback: Valuation would fluctuate with market. IP assets would not be valued individually. Is the market really efficient to factor in all the benefits

Income Approach
Variations Method
Premium Pricing method
Excess Profit method
Royalty saving method
Premium over generic product/services
Excess earnings over the company that does not possess intangible
License fee/ Royalty saved by owning the intangible
Cost savings method Cost saved by owning the asset
Value of IP = Present Value of expected future economic benefits from ownership of IP

Approaches
Direct Capitalization
• Estimate an appropriate measure of economic benefit for one period future to the valuation date and multiply it by an appropriate capitalization rate (r) r = 1/discount Rate
•Where, r is a measure of economic benefit
• Does not consider future economic benefits
Discounted Future Economic Benefits
Value of IP
= Economic Benefit Period 1 Economic Benefit Period 2
(1 + k) 1 (1 + k) 2
Plus
The terminal value of the business at the terminal year
TV = Economic Benefit n
(K - growth)*(1+k)^n
..
Economic Benefit Period n
(1 + k) n

Illustration
• The book is expected to generate
$150,000 in after-tax cash flows for the first three years and $100,000 a year for the following two years. These are the cash flows after author royalties, promotional expenses and production costs.
About 40% of these cash flows are from large organizations that make bulk orders and are considered predictable and stable. The cost of capital applied to these cash flows is 7%. The remaining 60% of the cash flows are to the general public and this segment of the cash flows is considered much more volatile. The cost of capital applied to these cashflows is 10%.
1
2
3
4
5
Year Stable
Cash flows
Present value @
7%
60,000 56,075
60,000 52,406
60,000 48,978
40,000 30,516
40,000 28,519
Volatile
Cashflows
90,000
90,000
90,000
60,000
60,000
Present value @
10%
81,818
74,380
67,618
40,981
37,255
Total 216494 302053
Source: Damodaran online

DCF Approach- Pros & Cons
Pros
•Captures economic benefit flowing due to Intangibles
•Considers appropriate risk based rate of return at which to discount cash flows and estimates economic life
Cons
•Reliable financial projections
•Estimating income attributable to intangibles, its economic life, appropriate discount rate/ cost of capital
•Use of same discount rate in
R&D as well as Market phase
•Managerial flexibility is completely ignored
•No accommodation to option like nature of investments

Matrix- Accounting for Risk & flexibility
Source:Crystal ball confrence

Real option model
•Investment in intangibles does not generate immediate payoff
•Each intangible may have a bundle of options
Source:Crystal ball confrence

Decision Tree Analysis
Patent failed
P = 0.70
NPV5= (0.20 x NPV1 + 0.80 x NPV2)
Patent
Application
Cost
Product fails
P = 0.20
NPV10 = NPV9 x0.3 - Cost
Patent granted
P = 0.30
Low
Revenue
P = 0.40
NPV8= NPV7 x0.8
Product
Success
P = 0.80
NPV7= NPV5 x0.4 + NPV6 x 0.6
High
Revenue
P = 0.=60
Lapse
P = 0.20
Renew
P = 0.80
Status Quo
P = 0.60
NPV6 = (0.60 x NPV3 + 0.40 x NPV4)
File patent in UK
P = 0.40
Application to Grant
Grant to
Commercialization
PHASES
End of first year of commercialization
NPV1
NPV2
NPV3
NPV4

Real Option Technique
• Valuation under uncertainty
• Use Black-Scholes (1973) Option Pricing Model
• Option parameters
– Value of Underlying = Present Value of Economic Benefits
– Exercise Price = PV of investment in IP
– Time to Expiry = Remaining economic life of IP
– Standard Deviation = Standard Deviation of Economic Benefits
– Risk free Rate = Riskless interest rate that corresponds to the economic life of IP
– Dividend (Value Leakage) = 1/Economic Life of IP

Patent Payoff Diagram
PV of Cost of developing and commercializing the
Patent
Net payoff from Patent
Present Value of Economic
Benefits from Patent

Problems
•Estimation of future economic benefits
•Economic benefits may not follow a continuous process
•Variance may be unknown and may change over the economic life of IP
•Exercise may not be instantaneous
•Compound options

Independent and Cash flow generating intangibles
Not independent and cash flow generating to the firm
No cash flows now but potential for cashflows in future
Examples
Valuation approach
Copyrights, trademarks, licenses, franchises, professional practices
(medical, dental)
Brand names, Quality and
Morale of work force,
Technological expertise,
Corporate reputation
Undeveloped patents, operating or financial flexibility (to expand into new products/markets or abandon existing ones)
Estimate expected cash flows from the product or service and discount back at appropriate discount rate.

Compare DCF value of firm with intangible with firm without (if you can find one)

Assume that all excess returns of firm are due to intangible.

Compare multiples at which firm trades to sector averages.
Option valuation

Value the undeveloped patent as an option to develop the underlying product.

Value expansion options as call options

Value abandonment options as put options.
Challenges

Life is usually finite and terminal value may be small.

Cashflows and value may be person dependent (for professional practices )
With multiple intangibles (brand name and reputation for service), it becomes difficult to break down individual components.

Need exclusivity.

Difficult to replicate and arbitrage
(making option pricing models dicey)
Source: Damodaran website

•IP valuation calls for co-ordinated efforts from a CA, IP attorney, and a technology person
•Adopt as many appropriate valuation techniques as possible, understand the pros and cons of each valuation method, and make a best estimate

Deloitte Haskins & Sells
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Near Gujarat Vidhyapith
Off Ashram Road
Ahmedabad-380 014
Gujarat
Deepika Maheshwari
Assistant Manager
Email: dmaheshwari@deloitte.com