Some of these alternative methods are permutations of traditional methods while, on the other hand, others of these are completely new approaches to the questions and issues of valuing very complex assets. Each is treated briefly and is intended as a summary for the reader. More detailed discussion of these alternative methodologies would require a book in and of itself. 

Because this book is providing an overview of IP valuation and management, we will briefly cover as many alternative valuation methodologies as possible – but shall do so in a summary fashion. If additional details are needed on a given format the reader can look to other research and to professional valuation analysts for further explanation. Just as in footwear, diamond rings or clothing, one size does not fit all – and the three basic traditional methodologies, cost, income, and market, may need to be modified slightly depending on the IP being valued and the context in which it is being valued. With some of the alternatives listed below they are specific to a particular type of intellectual property or intangible. A good example of this is the technology factor approach. This approach is primarily used to analyze the strengths of early stage technology or patents, and occasionally trade secrets. Its methodology to some extent mirrors the relative strength analysis that goes into establishing royalties in a relief from royalty approach.

Because the analysis and valuation of IP is an evolving process and a relatively new field of discipline – not much more than two decades old – methodologies continue to be refined and expanded. Therefore, one can expect to see ongoing changes, modifications, refinements, and evolution of IP and intangible asset valuation techniques. 

Finally, some of the variations listed in this chapter are quite new while others are fairly well established and respected. In the following pages we will review approximately twenty of them. They are not arranged in order of priority or preference but rather alphabetically, so as not to predispose the reader to one particular alternative or another. A cautionary note, however: when faced with a valuation report based on a proprietary or non-standard methodology, the client should exercise caution. In that case (or in any valuation) a second, more traditional methodology should be employed if at all possible. As we have said here and in other books a dependence on a single methodology to value an IP asset, particularly a complex family of technologies or brand assets, should be viewed with uncertainty. As with any discipline that is relatively new and robust, change is constant and methodologies are constantly changing, but the following techniques should be considered from time to time as a valuation analysts’ needs may dictate:

This methodology is based on the premise that when valuing IP more than one asset may be involved, this proprietary technique recognizes the principle that a brand or a technology is composed of multiple intangible assets and intellectual property elements including trademarks, logo, corporate colors, trade dress, slogans, etc. In this methodology, a core value for the trademark is calculated, and then each of the individual other assets attached to the core asset have their values calculated. Therefore, the sum of the core brand value plus the incremental assets becomes a total brand value. Expressed in an equation it as follows:

This technique is best used when the subject company has a complex portfolio of intellectual property. The competitive advantage technique works on the supposition that the IP is giving its owner an advantage over its competitors because of proprietary patents, technology, trademarks, software or other intangibles. This method attempts to measure that advantage in a number of different ways. The competitive advantage can sometimes be quantified based on share of market, market growth, higher competitive pricing, or other benchmarks. While individual pieces of intellectual property within the overall portfolio of a company may be difficult to measure, this approach allows one to estimate the value of the entire portfolio as used in one or more business units of a corporation. 

Similar in philosophy to the brand value equation discussed briefly discussed above. This methodology works when one is trying to represent some percentage of value of an individual asset that is associated with a larger trademark or patent portfolio. For example, if an underlying trademark or brand has a value of $100 million, and the domain name associated with it is generating 10% of revenues (e.g.), then one can allocate a relative value of 10% of the total or, $10 million dollars for the domain name. This allocation methodology can also be used in some cases when establishing the value of a sub brand, such as the value of Diet Coke relative to the total value of the Coca Cola brand. 

This is the method that quantifies a decrease in the level of costs being experienced by the IP owner / operator. If, in fact, the IP owner can quantify lower levels of capital or operating costs connected directly with the ownership of the IP; then those lower costs can be a direct measurement of the value of the specific IP. For example, Company A may have a trade secret that consists of a superior blending process that enables it to reduce the number of people and the number of raw materials needed to produce a specific product. These lower costs that would be calculated in a net present value of the future savings, would express the value of the IP. 

This is related to the traditional income method approach to valuing IP. The valuation analyst establishes the value of the IP owner’s overall business enterprise value as a result of owning the IP – and then compares that to the business enterprise value if the owner did not, in fact, have or control the IP or was not able to use it in its business enterprise. The value of the IP then would be the difference between the total business enterprise value and the business enterprise as calculated without the IP. 

A subset of traditional income approach methods, this imputed income analysis can be used quite effectively in valuing a domain name or sub brand attached to a trademark; or in valuing flanker patents for a core patent portfolio. In the case of a domain name, value is established by looking at the activity generated by the domain name and associated website assets, relative to the overall value of the core trademark and brand bundle. Therefore, one is able to estimate through imputation the relative value of a domain name to its parent trademark.  

This is a method sometimes used to estimate the value for intellectual property that has no predetermined statutory expiration (like trademarks) and for which net income (royalties or profit) is not expected to vary greatly over time (due to contractually-defined license fees, for example). This involves taking an estimate of expected annual royalty stream (or profit) and multiplying this amount by a factor known as the capitalization rate.

The suitable capitalization rate will, in principle, reflect the interest rate environment and trends, the state of investor return expectations, prevailing attitudes and incentives to take on financial and management risk, how closely royalty payments track inflation. In practice, capitalization rates are typically derived from observations of comparable ratios of revenue to sales price in actual transactions.

One notable use of this method is found in the pharmaceutical industry, where a leading company is credited with applying a quick method when valuing marketed product lines for acquisitions. The direct capitalization formula in this case is, on average, equivalent to multiplying annual sales times a capitalization rate of 2.7; conceived as two plus two-thirds of the remaining economic life of the product line (or its patent).

This particular variation of the income method uses the phrase “income differential” literally: It simply means that a company manufacturing and selling a product with a particularly strong trademark or unique technology will receive more income than a competitive company producing the same product but without the addition of the specific IP, such as the trademark or patent. A simple example is the income differential between what Land O’Lakes receives for a pound of its butter versus the income received by a second-tier company, such as Knudsen – the income differential capitalized over a number of years then becomes the value of the IP (see also premium pricing). 

Found most often in bankruptcy situations, as the name implies liquidation value for any piece of IP is the lowest price that the asset is virtually guaranteed to be sold in a distressed situation. Used almost solely in bankruptcy, other distressed situations or time critical contexts, litigation value scenarios arise most often in a Chapter 7 bankruptcy. In its simplest form, it is that value below which, with some certainty, the valuation analyst can guarantee the price will not fall. Although it is important to note that with each passing month in the liquidation scenario, the value of the IP can decrease rapidly – sometimes by 5 or 10% per month, or more. 

Based on techniques that have long been used in engineering and aerospace applications to test various physical operating models. It is a method to evaluate how possible future outcomes can affect the decision of whether or not to use a new piece of IP based on possible value – remember that this methodology is most useful in valuing early stage, non-commercialized technology; and, in particular, where there are many unknowns and numerous scenarios about the future development of the technology. It is useful when a single discounted cash flow analysis is problematical at best, given the uncertainty. In using this approach, one runs simulated cash flow analyses for all the various scenarios, taking values from the probability of each scenario occurring, and then incorporating those probabilities into a large number of scenarios (often as many as 1,000 scenarios). The result of the analysis is a distribution of present values of the many possible future outcomes; and one can therefore predict first, second, third, and fourth quartile values based on the possible future outcomes. 

Patent licensing shares at least one attribute with all other relevant business decisions: it involves risk. Where decisions involving financial risk are concerned, sound management principles suggest considering ways and vehicles to hedge that risk. One of the central vehicles to hedge risk in modern finance is an “Option.” A financial option on a stock, for instance, is simply the right to buy the stock for a predetermined price before the option expires, but it does not entail any obligation to buy. Similarly, a patent can be seen as the right to invest in or to license (or enforce through litigation) an underlying technology or product line, during the term of the patent. Therefore, an un-commercialized patent can be valued from this “options” perspective using, for example, methods such as those derived from the famous “Black-Scholes” model. 

The application of option valuation analysis to patent valuation requires, nevertheless, careful consideration of similarities and differences to arrive at significant results.

Of all the variations to the income approach, this is perhaps the most easily understood – because the value of an asset is established by looking at the difference in the price that it can command in the market, typically at wholesale, compared to the average product in the market. The difference between these two prices is the price premium.  This, then, is projected out on an annual basis and a net present value established. A price premium approach can be used with consumer goods such as soft drinks, with internet search engine pricing, or with mobile telephone handsets where price premium can be directly attributable to software and features. However, it is important to note that the method may overstate the value of a particular technical asset because of market perceptions as opposed to actual utility.

A form of the income approach, it can be tricky to apply accurately: because the profit split method attributes a share or portion of a company’s profitability to a particular intangible asset. This method requires that the valuation analyst have the ability to understand the IP to such an extent that he or she can isolate and expressly separate the intangible asset’s profit generation potential from all the other business assets – and then allocate that portion of profit split to the company’s operations and capitalize that value over a number of years. 

The method is recognized by several authorities, most notably the IRS, and the process is often used in valuation environments driven by tax allocation over inter-company transfer pricing issues. This method is more technically complex at first glance because it is similar to an accounting calculation for purchase price allocation. Therefore, the value of the intangible assets is essentially determined by first calculating the value of all of the various tangible asset classes. Every company has several classes of assets ranging from real estate and equipment to inventory and intangible assets and each can expect a different return on investment. For example, a company’s real estate would expect an annual return of 5% on its value; and, therefore, that amount of income on the value of the real estate would be calculated and isolated from the remainder of the company’s total income. This process would then be repeated for each of the other tangible asset groups such as inventory, plant equipment, working capital, etc. 

After proper returns are calculated for these other assets and deducted from the income of the company what would therefore be left represents the return to be allocated to the intangible assets as a whole. This amount can then be capitalized and expressed in today’s dollars. Note, however, that while technically inspired, it is best to use when one is attempting to establish a single value for all of the intangible assets within a company’s portfolio as a group – and is far more difficult to employ if one is attempting to establish a value for a single piece of IP using this methodology.

As I am fond of telling audiences everywhere, the first and most important rule of thumb is that all rules of thumb are faulty. Therefore, one should be aware that there are rules of thumb used by some practitioners in intellectual property valuation that we simply cannot support. Primary amongst these are the so called “25% rule of thumb” that allocates one quarter of a company’s “profit” as imputed royalty for its intangible assets. (But 25% of what, one asks: Gross profit, operating profit, net profit, profit before tax, marginal profit, etc.) The second rule of thumb is the “5% of sales rule of thumb.” This fantasy says that 5% of sales should be an appropriate number to be used as imputed royalty for a piece of intellectual property. (Again, would one charge 5% for the use of the Coca Cola trademark, as well as 5% for use of an improved pump jet sprayer on a bottle of windshield washer fluid? Clearly not.) The bottom line is that the results from applying these so called rules of thumb is a royalty rate or attributable cash flow which practitioners then incorporate into a traditional, but clearly faulty, relief from royalty or income approach calculation. 

Earlier we discussed the business enterprise value approach. This is similar in nature in that the snapshots value is based on establishing two different values for a company: one, based on the assumption that the company has full access to the ownership of the intellectual property and intangibles, and the second snapshot of value based on the fact that the company does not have these assets. Measuring the difference between the two snapshots establishes the value of the IP or intangible asset portfolio.

Establishing the value of a company against another company by comparing them on a so-called benchmark basis is the premise of this method of value. In one instance, the benchmark value will be a company that owns a particular trademark or patent and the second value for a comparable company that does not have that same asset. One might value the cash flows associated with a producer of generic or house brand detergent, for example, against those of a branded manufacturer, like Proctor & Gamble. In that instance, if the value of the company without the branded product is $200 million, and the value of the company with the branded product is $300 million (on a comparable level of sales), then the subtraction value theory says that the value of that particular trademark is the difference between the two, or $100 million.

As the name implies, this method is applicable only to technology and has been gaining in acceptance over time. The technology factor methodology is designed to measure the portion of a business units overall market value that is based on the utilization of its underlying patents and technology. The willing buyer, willing seller aspect of a fair market value definition is incorporated by scoring a series of attributes for the technology as to whether they favor a buyer or a seller in a hypothetical negotiation. Accurate use of this technique depends on ascertaining the appropriate technology factor scale and components. The components within the technology factor scale help determine an upper limit for the contribution of value provided by the given technology used in a particular industry, and then performing a relative strength analysis of the various utility and competitive attributes in order to narrow the contribution of the subject technology to a specific percentage within the overall value. 

Industries using products featuring large contributions from technology, such as scientific instruments and pharmaceuticals will have relatively high upper limits on their technology factor analysis, while those companies with products using little contribution from technology, such as mining or other mineral extraction will have relatively low technology factor attributes. Examples of utility attributes for technology include the current stage of the technology, the level of capital required to commercialize, the size of the potential market, and the potential margins. Competitive attributes for the technology should include the existence of alternative technologies, the potential for obsolescence, and the likely response by competitors to the technology’s potential to displace their existing products. Once these attributes are selected, weighed, and scored, a higher or lower value will be assigned. The utility and competitive attributes averages may also be weighed according to the relative contribution to the overall determination of technology value. The mean of these two averages (utility and competitive) is then combined to arrive at the final technology factor – this is then multiplied by the net present value of the subject business unit to arrive at the value of the technology; thus, separating the technology value from that of other assets of the business enterprise. 

A proprietary approach employed by our firm, it is a variation on the return on assets employed approach (see above). ValCalc establishes the economic return that each intangible asset class should be earning. Calculations of adequate return are applied also to all classes of tangible assets within a company. Then the return for each intangible asset is calculated as a result.

This proprietary system was developed by our firm more than two decades ago and employs a matrix of the twenty most important predictors of value for a trademark, patent or piece of software. The predictors for each of these types of IP are, of course, unique. They are used in a common manner, however: To score a given IP asset against its peers on a numerical scale. Value is therefore established relative to similar trademarks or patents. For example, one would not compare the Levi’s trademark to the Toyota trademark, nor the Apple operating system to the Google operating system. The numerical score generated by assessing and weighing the twenty factors in the Valmatrix approach is used to establish a percentile ranking relative to all similar IP – similar trademarks, similar patents, and similar software. This relative value ranking is applied to the appropriate range of market comparables or streams of income. Over time, the Valmatrix technique has proven to be especially useful in ascertaining at which point in the spectrum of comparable IP values an asset is positioned. 

Having covered many of the alternative valuation approaches with intellectual property, there is one further area that should be addressed: How to define value (see Chapter 4) and how to establish the life span of an asset.