Intellectual Property

Approaches to value intangible assets and intellectual property

The three key valuation approaches described in the International Valuation Standardscan all be applied to the valuation of intangible assets and intellectual property.

Market approach

The market approach can only be applied to value intangible assets and intellectual property if both of the following criteria are met:

information is available on arm’s length transactions involving identical or similar intellectual property on or near the valuation date, and
sufficient information is available to allow the valuer to adjust for all significant differences between the subject intellectual property and those involved in the transactions

The heterogeneous nature of intellectual property and the fact that intellectual property seldom transacts separately from other assets means that it is rarely possible to find market evidence of transactions involving identical assets.

Income approach

The income approach is the most common method applied to value intangible assets and intellectual property and is frequently used to value technology, customer-related intangibles (e.g., relationships), trade names and brands and operating licenses.

The methods referred to in the standard include the excess earnings method, relief-from-royalty method and the with-and-without method.

Cost approach

Under the cost approach, the intellectual property valuation is determined based on the replacement cost of a similar asset or an asset providing similar service potential or utility.

The cost approach is commonly used for intellectual property such as internally developed and internally used, non-marketable software.

The replacement cost method assumes that a participant would pay no more for the asset than the cost that would be incurred to replace the asset with a substitute of comparable utility or functionality.

Valuation methods

Excess earnings method

The excess earnings method estimates the intellectual property valuation as the present value of the cash flows attributable to the subject intangible asset after excluding the proportion of the cash flows that are attributable to other assets required to generate the cash flows (“contributory assets”). Contributory assets are assets that are used in conjunction with the subject intangible asset in the realisation of prospective cash flows associated with the subject intangible asset.

Relief-from-royalty method

Under the relief-from-royalty method, the intellectual property valuation is determined by reference to the value of the hypothetical royalty payments that would be saved through owning the asset, as compared with licensing the intangible asset from a third party.

Conceptually, the method may also be viewed as a discounted cash flow method applied to the cash flow that the owner of the intellectual property could receive through licensing the intangible asset to third parties.

With-and-Without Method

The with-and-without method indicates the intellectual property valuation by comparing two scenarios: one in which the business uses the subject intellectual property and one in which the business does not use the subject intellectual property (but all other factors are kept constant).

Discount rates

According to the International Valuation Standards selecting discount rates for intellectual property valuation can be challenging as observable market evidence of discount rates for intellectual property are rare.

When assessing the risks associated with an intellectual property, a valuer should consider the following:

intellectual property often has higher risk than tangible assets
if the intellectual property highly specialised to its current use, it may have higher risk than assets with multiple potential uses
intellectual property used in risky (sometimes referred to as non-routine) functions may have higher risk than intangible assets used in more low-risk or routine activities

intellectual property with a longer life is often considered to have higher risk, all else being equal.