Why cal­cu­lat­ing cost is all in the mind

There are many fac­tors in de­ter­min­ing the cor­rect value of in­tel­lec­tual prop­erty

Business Day - Business Law and Tax Review - - BUSINESS LAW & TAX REVIEW - DINA BI­A­GIO

GEN­ER­ALLY, the rea­son for an in­tel­lec­tual prop­erty (IP) val­u­a­tion gives some idea of the con­text in which the IP is to be val­ued and this is the most im­por­tant de­ter­mi­nant of value.

For ex­am­ple, in some in­dus­tries an IP port­fo­lio is likely to be worth more to a large man­u­fac­turer than to a small busi­ness en­tre­pre­neur due to the ex­is­tence of com­ple­men­tary com­pe­ten­cies such as a skilled sales force, ef­fec­tive mar­ket­ing pro­gramme and es­tab­lished dis­tri­bu­tion chan­nels.

Be­cause these fac­tors vary from one sit­u­a­tion to the next, the same IP may have a dif­fer­ent value when con­sid­ered in the con­text of two or more dif­fer­ent en­ter­prises. So, the value of IP must be con­ducted with a view to the “hands” in which the IP is to be ex­ploited, the pre­vail­ing mar­ket con­di­tions and other cir­cum­stances which may have an ef­fect on the abil­ity of the IP to gen­er­ate rev­enues or in­crease prof­its.

A for­mal val­u­a­tion of IP will re­fer to a stan­dard of fair mar­ket value. In the­ory, this is the price at which the IP as­set ex­changes be­tween a will­ing buyer and a will­ing seller, both hav­ing rea­son­able knowl­edge of all rel­e­vant facts and nei­ther be­ing un­der com­pul­sion to act. With this stan­dard, it is as­sumed that a hy­po­thet­i­cal trans­ac­tion takes place. How­ever, there may be a marked dif­fer­ence be­tween the price at which the seller is pre­pared to sell the IP and the price at which a par­tic­u­lar pur­chaser is pre­pared to buy it. There may also be a marked dif­fer­ence be­tween what two dif­fer­ent pur­chasers would be pre­pared to pay for it. So with no real in­for­ma­tion on the no­tional pur­chaser, can a re­al­is­tic value be de­ter­mined?

The ef­fect of con­text on the de­ter­mi­na­tion of a pur­chase price isn’t all that sur­pris­ing since the same prin­ci­ple ap­plies to tan­gi­ble as­sets — there may be a mar­ket dif­fer­ence be­tween what a com­mer­cial of­fice space de­vel­oper and a bou­tique ho­tel chain may be pre­pared to pay for the same build­ing — and these prices will be de­ter­mined by the abil­ity of that build­ing to gen­er­ate fu­ture rev­enue and profit for the re­spec­tive pur­chasers.

In some cir­cum­stances, a com­pany or tax au­thor­ity may wish to es­tab­lish the value of IP where no par­tic­u­lar trans­ac­tion is en­vis­aged, that is a value of the IP in the con­text of the owner’s on­go­ing busi­ness. In these cir­cum­stances, the IP is typ­i­cally val­ued in the hands of the ex­ist­ing owner, us­ing a re­lief-from-roy­alty method. This method com­putes a value for the IP based on the present value of the amount that the owner would pay in roy­al­ties over the use­ful life span of the IP to li­cence in its use from a third party, if it did not own the IP. In this con­text, the IP is val­ued hav­ing re­gard to the fac­tors (such as mar­ket share, fore­cast rev­enue, ad­ver­tise­ment spend, competition, com­pe­ten­cies, in­fra­struc­ture and dis­tri­bu­tion chan­nels) which are rel­e­vant to the owner it­self.

So clearly a dis­tinc­tion must be drawn be­tween the “value of an IP port­fo­lio” and the an­swer to a spe­cific ques­tion, such as: “What would Com­pany X be pre­pared to pay to Com­pany Y to pur­chase the IP port­fo­lio?” These may be dif­fer­ent amounts. It is crit­i­cal to un­der­stand what is be­ing val­ued.

Con­sider a sit­u­a­tion where a pro­pri­etor of a trade­mark port­fo­lio has granted a wide, fully paid-up per­pet­ual li­cence to an­other party to use the trade­marks in its busi­ness. The trade­mark pro­pri­etor, al­though it owns the trade­marks, has di­vested it­self of most of the rights associated with the trade­mark — it can­not even use the trade­marks in the course of trade and re­tains own­er­ship only of the “bare do­mini- um” of the marks.

In the im­me­di­ate term, the trade­mark owner has no abil­ity to de­rive any rev­enue from the mark, un­less the terms of the li­cence agree­ment en­ti­tle it to sell the mark or the li­cence ter­mi­nates at some later time (due to breach, for ex­am­ple) and the marks have not yet out­lived their use­ful­ness.

The li­censee of the marks would prob­a­bly not be pre­pared to pay very much to take as­sign­ment of them from the pro­pri­etor, since it al­ready en­joys al­most all of the ben­e­fits associated with own­er­ship of the marks. Does that mean that the li­cence un­der the marks is not valu­able? Not nec­es­sar­ily — the marks may be well known, dis­tinc­tive and have es­tab­lished a high de­gree of trust among con­sumers, mak­ing it im­por­tant for the li­censee to have on­go­ing use rights un­der the marks.

In some cases, the abil­ity of the IP to gen­er­ate fu­ture rev­enue and in­crease prof­its is de­pen­dent on the oc­cur­rence of other fac­tors.

Since we don’t have a crys­tal ball, an in­tel­lec­tual prop­erty val­u­a­tion method that takes fu­ture con­tin­gent events into ac­count, must be adopted. Sev­eral val­u­a­tion tech­niques, such as bi­no­mial mod­els and Monte Carlo sim­u­la­tions, are based on a de­ci­sion tree anal­y­sis where con­di­tional events re­quired for the in­tel­lec­tual prop­erty to gen­er­ate rev­enue or in­crease prof­its (and the con­tri­bu­tion which the IP makes to these) is mod­elled ex­plic­itly.

Mod­el­ling the ef­fect of fu­ture events on the value of IP re­quires a two-step ap­proach: es­tab­lish­ing the prob­a­bil­ity of a cer­tain event oc­cur­ring that will make the IP valu­able and, sec­ond, com­put­ing the value of the IP if this event takes place.

If you lose sight of what you are valu­ing and why you are valu­ing it, you might be cal­cu­lat­ing the an­swer to a dif­fer­ent ques­tion.

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