“It depends!”

In Insights, Uncategorized

25 April, 2008

A week ago I got a telephone call from a potential client asking me to generally suggest the royalty rate or price for an intangible asset. My immediate attorney answer in this case (which, by the way, would be the same in any other similar case…), was not the one wished for, namely: “It depends.” And it does.

The price/royalty and the value of an intangible asset are interlinked. Usually, the value of an intangible asset is calculated by reference to a royalty under a license (which can be an actual or hypothetical license). A license is simply an agreement, whereby the proprietor (the licensor) grants the rights to use an asset to a licensee. The royalty rate is then the price or rent for this use, reflecting e.g. the rights and obligations of the parties (licensor/licensee), the risks assumed by each of the parties, the real or potential value of the rights and obligations transferred to the licensee.

However, the business context of the valuation and the royalty rate is not always understood. In considering acquiring or licensing an intangible asset, a company would weigh up certain options. Broadly speaking, the various technology acquisition strategies may be:

  • internal exploitation, i.e. create a similar asset itself. (what would it cost to create, recreate and/or design around the asset?)
  • acquiring the asset (what is the price of a similar asset?) 
  • licensing-in the asset (what is the royalty to licence in the same asset or a similar asset?)
  • do not acquire or license the asset at all (what profits would be given up if the company did not acquire or license the asset?)

Each of the above-listed approaches can, and should be, used either to determine the value of the intangible asset or to determine the royalty rate. As with any IPR valuation, the quality of the resulting outcome of the valuation depends on the level of exactitude and insight in the underlying analysis. By now, you might note that valuation of intangible assets is not a very easy task! A proper valuation not only requires knowledge about specific valuation methodologies, it also requires a deep understanding of the asset to be valued, and of the market, and not the least the context in which the valuation is to be performed, etc.

To make things even more complicated, note that while the statement “The price/royalty and the value of an intangible asset are interlinked” above is correct at a general level, this link also depends on a number of parameters, for example, whether one discusses the value for the owner of the intangible asset or the potential acquirer of the asset. For example, an intangible asset may be, in principle, worthless and a cost driver for an owner but constitute a real business opportunity for an acquirer. How should the price/royalty be determined in such a case ? Again, the answer is probably: “It depends”.

The Black & Scholes model for evaluating options has gained wide spread use in the valuation of patents. This model is a mathematical model of the market for an equity, in which the equity’s price is a stochastic process. The value of the equity, i.e. the patent, increases the more volatile the environment is, for example, the value of a patent within a technical field experiencing a fast development will probably increase. This model gives an approximate value, which is as inexact as the approximations made in the model, but at least it gives an objective value. The option market functions due to the fact that there exist a commonly accepted model for valuating the equity. The approximations used on the input side will though vary – otherwise no market would exist. In light of this, the market for valuation of IPR would probably benefit from accepting a model for the valuation process.

So, if you are still pondering about the price of an intangible asset my immediate answer would still remain the same: It depends. This answer would remain so at least until we meet and define the framework for the IPR valuation together…

Christian Arkelius, Patent Attorney

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