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How are Patents Valued?

Innovation is one of the most important means of staying competitive in the business, and the only way to keep that advantage is to protect innovative ideas and prevent other companies from making use of them. Patents offer a way for businesses to keep their ideas safe from other users for a while. Patents are assets to companies, and both businesses and investors must know how to calculate and account for the amount of the patent.

The value of a patent is essential to business transactions involving mergers and acquisitions, bankruptcy, business dissolution, and infringement analysis. The vital part of valuing a patent is obtaining the value of the invention in question. It doesn’t make a good business sense to get a patent on an invention that doesn’t result in return for the inventor. Since the patent is an intellectual property that’s an intangible asset, it’s often difficult to set a monetary value to it.

Basics of Patent Valuation

Setting a monetary value for a patent is an integral part of the intellectual property portfolio. But before picking out the right patent monetization strategy, it’s important to have a general sense of the value of the portfolio. Overall, patent valuation is a complex undertaking, and it requires a great deal of expertise, experience, and judgment for the IP attorney. A patent valuation expert may employ many approaches.

Deriving the value of a patent can be done through several valuation techniques. The most common method is the economic analysis valuation, which is commonly grouped into three basic approaches: the market approach, cost approach, and the income approach. Each approach is based on well-established principles of economics and finance but looks at a different perspective. In a given patent situation, some specific information may not be present – so for any given valuation, one or more approaches may be more appropriate than the other.

Approaches to Patent Valuation through Economic Analysis

1. Market approach

The market approach determines the value of a patent based on the price a willing buyer would pay for a similar property. It means that the value of a patent is approximately equal to the value of similar patents or other patented products that have been sold and purchased before. The market approach asks the question, “What would be the value of the asset on the open market, considering the information from similar market transactions?”

For this approach to be used for patent valuation, two things must be considered:

  • Existence of an active market for the asset, or a similar one
  • Past transactions of a comparable property

Pros:

  • No prognosis risk in terms of future income
  • Offers fair value
  • The market value is a potential trade value
  • Blocking patents can also be evaluated using this method

Cons:

  • The price of the alternative patent should be found out
  • Finding corresponding patents can be difficult
  • Expensive and time-consuming method
  • Alternatives may lead to a completely different value when a standard is involved

2. Cost approach

The cost approach states that an investor will pay no more for an asset than the replacement cost or the amount necessary to replace the protection right on the invention. The replacement cost of an item refers to the amount of money – at present – that would be paid to replace the item. The cost approach asks, “what would it cost to recreate an asset equal to (or of equal utility to) the patent?” This approach considers the costs of the invention itself, as well as risks, lost sales, and other adverse economic effects connected with alternative technology. Here are all the direct associable costs considered for this approach:

  • Development expenses for the invention
  • Prototype development
  • External expenses
  • Patent search
  • Patent application expenses (attorney, translation, other fees)
  • Maintenance expenses (fees, attorneys, trials, and more)

The sum total of all these costs is the value of the patent. Applying this approach to patent valuation needs an investigation of the cost of achieving a market-acceptable substitute in a way that will not violate the patent. If there are one or more market-acceptable substitute technologies that can offer a similar result more cheaply, the patent may have less value than a patent for which no readily available substitute exists.

Pros:

  • When the cost accounting is settled, costs can be easily added together

Cons:

  • Cost is not proportional to inventive success
  • Not always precisely possible, for example when there are multiple inventions created within the same project
  • The value rises with age and external cost

3. Income approach

The income approach values future cash flows. It states that a patent’s value is the present value of future cash flows the asset is expected to generate. When a company or an individual develops a product that has patent potential, the underlying hope is that the product will cause an increase in sales and generate income, or at least save costs for the company. This approach asks, “How much would someone pay in exchange for the future cash flows generated by the asset?” It has been used for valuing corporate projects, financial instruments, and whole or subsidiary businesses since these generate returns that can be predicted.

There are two types of income taken into consideration:

  • Direct income – licenses or revenues associated with products protected by the patent
  • Indirect income – the cost savings or additional revenues by locking out competitors with alternative solutions

Pros:

  • Transparent process
  • Easier approach when a patent is already utilized
  • Different scenarios can be applied

Cons:

  • Indirect income is difficult to value
  • Shares of a patent on a certain product must be known
  • Difficult to use if a product contains multiple patents
  • Difficult when blocking patents are valued
  • The future can be uncertain, even with the most probable predictions
  • Assumptions done are always vague
  • Time-consuming

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