How can we say that IP has a value?There are various circumstantial evidences to prove the same.
- money and time is spent on registering an IP
- IP protection involves legal and other costs
- A lot of amount is spent on advertising brands- IP contributes to national economic accounts. What are the areas that require IP valuation?
- purchase and sale of assets
- corporate finance
- transfer pricing
- financial reporting
How can IP be valued?There are mainly three methods of valuation of IP.
- cost based method
- market based method
- economic based method
A brief of the valuation methodsCost based valuation: It can either be based on historic cost or on replacement cost. A historic cost is the actual cost of creating an IP. This method is not recommended as there is no correlation between expenditure and subsequent value of asset. E.g. a product promoted at huge cost does not appeal the customers. Replacement cost is the cost to replace the asset. It is determined as to what will be the cost of creating a new trademark or a patent. A major drawback of this method is that it is not possible to determine an exact future cost.
Market based valuation: This method can be based on the market price comparability or on comparable royal rate. Market price comparability- the value of an IP is determined on the basis of price of comparable IP products. Comparable royal rate: this requires construction of a business plan around an IP. The resulting return is then compared to the price of being owner of the asset. If the price is higher than the return, it is recommended not to buy the asset.
Economic based valuation: This is the most preferred method of valuation. This method requires identification, separation and quantification of cash flow or royalty fees to IP and then the capitalization of future cash flow. Quantifying the future revenue stream can be done in view of exploited or unexploited IP. In case of capitalization, longer the period of money receipt, higher will be the risk. Risk is described in terms of discount rate which in turn is based on inflation rate, cost of capital and premium. A cash flow projection is constructed and discounted to derive a net present value. This estimated present value is the worth of the IP asset.
Limitation of IP valuation: a major limitation is that it is based on estimates, assumptions and judgments than on facts. Thus it lacks accuracy. Since IP valuation is a new concept and is still at the stage of development, more experience in this field will help making accurate estimates. It adds to the value of the company and helps the company make sound economic strategies.
Thus IP valuation is an important concept that helps a company to get the price of which it is worth.
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