IP Valuation Methods for Financing Purposes

Intellectual Property (IP) Valuation

As an increasing number of companies focus on innovation and the share of Intellectual Property assets increases in comparison to tangible assets, financing using IP assets as collateral has been gaining some popularity. But, for the IP assets to be used as collateral precise valuation is needed to ascertain the terms of the financing. This article aims to explore the diverse methodologies utilized to value IP assets, highlighting the importance and challenges faced in the process.

The market method, cost method, and income method are the most commonly used methods for the evaluation of intellectual property pledge financing (Lagrost et al., 2010; Svishchova, 2022).

Cost-Based Approach: This approach determines the value of IP assets based on the cost incurred to develop or acquire them. It includes expenses such as research and development costs, acquisition costs, and legal fees. This method is useful when the IP does not directly generate any cash flows. The fundamental issue with this approach, and why it is inappropriate for most intangibles is that it fails to capture the future expected cashflows that the IP asset will generate.

Market-Based Approach: The market-based approach assesses the value of IP assets by comparing them to similar assets that have been recently traded in the market. This method relies on market transactions and prices to determine the value of the IP. Although more applicable to IPs than the cost-based approach, it is still quite difficult to apply to intangibles, as sufficient transaction details of comparable assets and under comparable circumstances is mostly unavailable. Another use case for the market-based approach is to provide benchmarks and inputs for the income-based approach.

Income-Based Approach:  Lastly, the most widely used approach involves calculating the value of the IP asset based on its income-generating capabilities. The logic is the same as the Discounted Cash Flow analysis used to value companies. There are several sub-approaches in the income approach, which can be widely categorized based on cash flows or earnings generated or the costs saved by the IP assets. For this method to work, the cash flows or income generation through the IP asset should be measurable with a sufficient degree of accuracy for the upcoming periods. Finally, the selection of an adequate discount rate is a crucial component that can sway the valuation either way if not selected carefully.

(Read further on IP valuation here – WIPO, and read more about a modified income approach here – Valuation method of IP pledge financing based on income interval analysis)

As a lender might navigate the uncertainty of choosing the appropriate method for valuing the IP asset that is to be used as collateral, there are some further challenges that need to be kept in mind. Currently, there is no universally accepted single methodology to value an IP asset. Even after arriving at a valuation through one of the above-listed methods, one must be careful of avoiding a bias, check the accuracy of the comparable market data, check for market demand of the IP asset (which can be an extremely complicated exercise), and ensure external factors such as regulatory and technological changes that could make the IP asset obsolete are factored in the valuation.

Successfully overcoming these complexities requires proficiency in Intellectual property law, macroeconomics, market research, and industry expertise. Taking the aid of seasoned valuation experts can aid in addressing these obstacles and yield dependable valuation outcomes. Furthermore, proper documentation, transparency, and sensitivity analysis are all required components of reliable IP asset valuations.

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