IP valuation is complicated by a host of factors, such as accessing market comparables, determining IP risk, handicapping potential licensees, and calculating the uncertain economic benefits to be generated by IP assets. While many sources enumerate methods of IP valuation for licensing, few provide real-life applications or guidelines. Furthermore, complex methodologies and spectacular settlement headlines can add to the confusion over the IP value. As a result, hopeful licensors often develop unrealistic value expectations that impair decision-making. This case study describes a recent project to illustrate how a cross-check of valuation methods can ground expectations in reality.
Recently, a publicly-traded manufacturing company aimed to out-license a portion of its IP. The licensing package consisted of a few dozen issued patents, pending applications, and trade secrets. Since out-licensing was a new initiative for the company, its executives solicited an independent assessment from outside consultants.
To understand varied perspectives of a target licensee, the consultants used three different valuation approaches: comparable royalties, real options pricing, and expected incremental profits. They discounted the projected economic benefits with a market-based cost of capital. They also included a specific risk factor, which is calculated based on the inventive strength1 of the company's IP.
All three approaches converged upon a range of $15-20M. After sharing these results, the executives told the consulting partner that their internal estimates were more than 10x the consultant-modeled results. Understandably, the executives were skeptical of the underlying models. To resolve the apparent discrepancy, both parties worked through additional "back-of-the-envelope" calculations of an adjusted market-to-book premium.
Despite the drawbacks of market-to-book data2, calculations using these data can sometimes help to ground estimates3. In this case, the company had a market capitalization of $700M and net tangible assets booked at $550M. The executives then made two determinations. First, they believed that investors knew about the IP under consideration. Second, they believed their books provided reasonable, current values for the company's straightforward manufacturing assets and liabilities.
The resulting $150M market value premium4 represented investors' expected present value of all intangible assets: IP, brand, people and experience, barriers to competition, and other off-balance sheet competitive advantages. While further work is required to break out the IP contribution, everyone agreed that non-IP intangibles, such as brand and experience, contributed significantly to the company's premium.
Thus, the quick adjusted market-to-book calculation of $150M for all intangible assets demonstrated that the executives' $200M estimate was not realistic for a portion of the company's total IP portfolio. The supporting calculation also lent credibility to the estimates from the consultants' three more detailed valuation methods.
IP valuation is both an art and a science: it requires experienced judgment, risk assessment, and facility with multiple valuation approaches. In addition, a cross-check of complex and simple approaches to IP valuation can provide a more realistic answer to the fundamental question "what's it worth?"
1. ipCG's proprietary IP risk assessment is the subject of a forthcoming article.
2. Several problems exist with using the market-to-book premium of publicly traded companies to estimate IP value. First, assets are carried on the balance sheet in accounting dollars; most assets are not marked to market. Second, investors may not be pricing competitive advantages from hidden IP, such as trade secrets and unassigned patent applications. For further reading on communicating IP value, see ipCG's Fall 2006 article on "Does Wall Street understand the value of your IP?"
3. Other types of data, such as a competitor's IP purchase or a formal IP agreement within the industry, can also help to ground estimates.
4. Figure: Back-of-the-envelope reality check using an adjusted market-to-book