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PATENT COMPENDIUM
Patent Valuation and Financial Activation
In the past decades, several methods for patent valuation have been developed, such as:
Hoffman/Barney model
Hofinger portfolio model
Cost based model
Earnings-oriented approach or discounted cash flow method
Incremental cash flow method
License analogy method
Relief from Royalty method
real options approach
In addition, proprietary systems for evaluating patents have been developed that combine different methods. Only the cost-based, market-based and revenue-based approaches are considered in this section.
Cost based approach
According to the cost-based approach, the value of the patent is equal to the cost of research and development of the patent. This fundamental idea is at the heart of all cost-based approaches. There are different variations of the cost-based approach such as discounting the cost with the inflation rate or comparing it with the falling replacement cost.
The disadvantages: The cost-based approach is particularly useful for administration and controlling. It is not suitable for a financial transaction as often the costs are higher or lower than the patent value for the transaction and thus the patent value is over- or undervalued.
1. Replacement Cost
The replacement cost is the cost required to replace a good at the current time. These costs include the development costs but not the costs for failed prototypes.
2. Recovery Costs2
The recovery cost is the amount required to redevelop the exact same pre-existing patent currently using the same method. This includes the cost of all prototypes.
3. Acquisition costs
Acquisition cost is the real cost of developing the intellectual property at the time of development. For a precise analysis, inflation and the development of technology must be taken into account.
market approach
It is well known in our economic society that the market value of any asset is the most reliable and robust value. It simultaneously shows what the buyer is willing to pay and what the seller is asking for the asset. The rough idea is to find a similar patent that has already been priced and traded. Actual value/price is derived from past transactions. This approach involves two fundamental difficulties. Firstly, it is not always easy to collect and find data on already traded patents, secondly, all patents are unique and only a fraction of them are similar.
In order to solve the first problem, the IPB has collected numerous data from patents that have already been priced and traded, for example from expired licenses, remuneration of employees with their own inventions, patent auctions (e.g. from liquidations), etc.. With this amount of data the IPB specialists have localized value indicators that can be found in almost every patent report. With the help of a regression analysis, meaningful correlations between indicators and patent values could be identified. Today, these parameters are fed into a multivariate regression model, which assigns each parameter a 'personal' beta coefficient. The betas measure the influence of a parameter on the patent value.
IPB's evaluation result is not a simple price calculation, but a value distribution that shows the probability of recovery on the y-axis and the relevant value interval on the x-axis.
One of the advantages of this assessment is that the IPB can obtain 95% of the relevant data from public databases. This allows the IPB to value any patent portfolio without involving the owner. The advantage of this objective method is not only that it makes it easier to convince investors or lenders, but also to collect data.
Another advantage is the value distribution, which shows an investor an opportunity-risk distribution and puts banks in the position to calculate the value-at-risk, which is essential for the loan calculation. A disadvantage is that most patents are not purchased at their actual value, which is why there are no objective sales prices.
Yield based approach
With regard to the revenue-based approach, the patent value corresponds to the future revenue that the patentee can achieve with this patent. The present value can be determined by discounting the sales to the current date.
When using the revenue-based approach, there are two challenges to be overcome: firstly, a broad data basis is required with which one can reliably obtain an outlook on the turnover during the patent lifetime. The second fundamental problem is to determine which part of a product and its turnover is protected by the patent's monopoly right. While this is easy in the pharmaceutical industry, it can be more difficult in the automotive industry. Sometimes it is impossible to find a one-to-one relationship between a patent, a product and its value.
The required reliable data can make a yield-based patent evaluation very expensive due to the effort involved in collecting it and, depending on where the data comes from, can also be subjective. Therefore, the revenue-based approach is not fully usable for financial transactions, especially for the calculation of security deposits. On the other hand, for equity investors, the income-based approach could provide a good indication of their return on investment (ROI).
Activation of IPR in the balance sheet
Intangible assets in accounting terms are defined as: identifiable non-monetary assets without physical substance (IAS 38.8), computer software, patents, copyrights, customer data, licenses, brands and goodwill are among the intangible assets. Intangible assets that meet these criteria are initially valued at cost, then using the revaluation method and amortized systematically over their lifespan (unless the asset has an infinite lifespan, in which case it is not amortized).
Based on the IFRS standard (International Financial Reporting Standards), intangible assets can only be capitalized if a direct value can be determined. IAS 38 clearly regulates that, for example, research costs cannot be capitalized, but development costs can. The cost-based approach for intellectual property rights can be used for activation.
From a tax perspective, assets on the balance sheet are neutral to the company, and are classified as intangible assets, but they can be used by the company to obtain better credit terms or to increase goodwill in mergers and acquisitions.