Valuation of Patent: A Classification of Methodologies

Valuation of Patent: A Classification of Methodologies Arundhati Banerjeea Dr. Rajdeep Bakshib Dr. Manas Kumar Sanyalc Abstract In the modern days business is centred on technological development, with patents recognised as valuable assets. These are transferable in nature; hence it is necessary to determine their fair market price, thus valuation. Worldwide several methods exist for determination of financial worth of patents. After a review of relevant literature like serious books, journals, newspaper articles, whitepapers, and websites, it has been found that there are plenty of methods of patent valuation. These methods are either outcome of academic research or they are proprietary assets of specialist firms involved in patent valuation. Some of these models are adopted for valuation, while others remain stand-alone. The existence of such large number of methods is like a jungle, where the practitioners and academic researchers find themselves lost. In this paper an attempt has been made to map this jungle, through presenting a classification of the existing methods. The review of a large number of relevant documents given confidence, that the main approaches have been captured. The existing methods are classified into two broad groups’ viz. praxis models and academic models, indicating their advantages and disadvantages. Key Words: Intellectual Property, Patents, Patent Valuation 1 a. Arundhati Banerjee; Research Scholar, Department of Human Resource Management, IIEST Shibpur, Howrah, West Bengal, India b. DR Rajdeep Bakshi; Director, Scintillance Education Consulting (Pvt.) Ltd. Kolkata, India , Former Dean and Principal, BBIT Kolkata, India c. DR Manas Kumar Sanyal, Professor and Head, Department of Human Resource Management, IIEST Shibpur, Howrah, West Bengal, India Introduction: A patent is a set of exclusive right granted by a sovereign state to an inventor or assignee for a limited period of time in exchange of detailed public disclosure of an invention (WIPO,2008) and grants right to restrict others. The first patent was granted in 1641 by Massachusetts General Court. Restricting power of patents keeps others away for imitating, thereby defending business. A firm having more employees with registered patents, has the propensity to command business (Cortada, 1998). Patents are now recognised as transferable assets, possessing significant financial value. Patents being recognised as asset require determination of fair worth for transfer (purchase and sale), as collateral for securing finance, generating income for the firm in the form of royalty or for disclosure in the financial statements (International Accounting Standards-38 (1998) on Intangible Assets). Thus there arose a need of a model to determine fair market price for patents (Bodie, 2009). The driving force for the development of the patent valuations methods is a sound patent management system, protection for infringement, measuring corporate performance, taxation and making proper justification for stock prices. The challenges and opportunities for patent valuation attracted attention of academic researchers and practitioners, opening a new domain of research directed towards developing a methodology for patent valuation. To meet the need of the above, various researchers and valuation firms got themselves involved in patent valuation. A search on Google revealed names of twenty two (22) such valuation experts firms and institutes, and worldwide there may be more which are beyond access. Patents are unique assets having differing impacts in different hands, and calls for valuation only by specialists (Kelly, 2011), as patent valuation is a tough and challenging task. Patent possess certain special characteristics that creates problem to its valuers. These are in the form of its intangible nature, each one in unique. Moreover, there are risk of infringement, risk of obsolescence and risk of invalidity. Therefore, the valuation experts and researchers 2 need to keep in mind the probable ways to tackle the above obstacles while developing an objective valuation model. There are many methods of patent valuation, each has its own uniqueness and limitations, these methods co-exist in a clutter which is like a jungle. This makes the reader / practitioner / users wonder which method to select under an existing situation to get the best result. Objective: Through this article an attempted has been made to map this jungle through presenting a classification of these methods and highlighting their advantages and disadvantages. Methodology: In this article the technique of literature review has been adopted to explore and collect relevant document relating to patent and their valuations. Sources like serious books publishing research outcomes, research journals, newspapers, electronic databases and websites has been explored. Exploration through abstract and keyword search of e-database like Emerald provided twelve (12), ScienceDirect (ELSEVIER Scopus Database) provided twenty nine (29), Jstor database identified five (5), Springer Journal Archives provided three (03) relevant documents and research papers relating to patents and their valuations along with many other irrelevant ones. Moreover search on Amazon, exploration of National Library of India, American Library, British Council Library identified relevant books on patent valuation methodologies. Kolkata Patent office and their website have been visited and references of whitepapers and promotional material of valuation providers are taken. Beyond these, we used our experience and personal sources to locate additional techniques. The collection and exploration of a large number of relevant documents has given confidence about capturing the main approaches. Through an initial review of these literatures the important ones were shortlisted for further detailed analysis; these are referred in their appropriate places. 3 Analysis: The depth study of the documents shortlisted was conducted to summarize the different methods and bring to light the working methodologies along with their salient features, benefits and disadvantages. The existing valuation methods are classified into two broad groups-viz. Praxis Methods and Academic Methods. Praxis Methods: These methods find their origin with practicing firms and patent attorneys. The members of the group are shown in the Figure 01 presented below Figure 01 Praxis Methods of Patent Valuation Praxis Models (Methods under Practice) Monitory (Market Approach) • Stock Market • Rating / Ranking • Rule of Thumb • Industry Standard • Auction Method • Analogous Method Monitory (Income Approach) • Direct Capitalization • Discounted Cash Flow • CAPM • Decision Tree • Royalty Relief • Technology Factor • Legal Risk Adjusted Framework • IP2 • Real Options Other Approach • • • Monitory (Cost Approach) • Reproduction Cost • Replacement Cost Indicator- Based (ClearViews IP) Renewal Data Methods Due Diligence Method Models adopted for practice Source: Developed by Authors 4 The deeper analysis and the associated classification show that the member methods can be further classified as. Monetary methods and Other methods. Monetary Methods: These methods can be further sub grouped on the basis of their operating approaches viz. Cost approach, Market approach and Income approach. The member methods are critically analysed below. a. Cost approach: In this approach patents are valued on the basis of reproduction cost (i.e. all cost associated with purchase or development of a replica of patent under consideration) and replacement cost (i.e. cost to be incurred to obtain an equivalent patent asset having similar use/or function). In both of these methods, the present prices are considered (Anson, 2015). Cost heads include, cost of .research and development, promotional expenses, management time, legal licensing and registration fees, and opportunity cost (if any). The method also takes into account obsolescence costs like, technological, economical and functional obsolescence. The Table 01 below shows a comparative analysis of the various approaches under this method indicating their advantages and disadvantages. Table 01 Comparison of Cost Approach (Praxis) Methods of Patent Valuation Variants Methodology Reproduction This method contemplates the Cost (Drews, construction of an exact replica of 2011) the asset (i.e. patent). Contemplates the cost incurrent to recreate the functionality or the utility of the patent, but in a different form in comparison to the subject patent. Source: Developed by Authors Replacement Cost (Drews, 2011) Advantages Estimates the future cost of producing a similar type of assets Disadvantages 1. Does not account for changes in technology or factors relevant for the assets 2. No allowance for the future benefits that might accrue from the patent 5 b. Market approach: In this subgroups, the member methods estimate patent value by taking reference of open market values, where there is evidence of prices, at which similar assets with similar uses have changed hands (Anson, 2015). If the asset is unique in nature, then comparison is done on the basis of utility, technological specificity and property. Data is collected from different sources like, companies annual reports, specialized database of royalty rates, stock price, legal decisions, pure patent deals (Bulakowski, 2014). The Table 02 below shows a comparative analysis of the various approaches under this method indicating their advantages and disadvantages. Table 02 Comparison of Market Approach (Praxis) Methods of Patent Valuation Variants Methodology Stock market Method (Cockburn, 1987) Estimates the patent value on the basis of movement of the stock market value. Rating/ Ranking Method (Razgaitis, et.al, 2007) Value estimated through 1.Identification of a. criteria relating to the patent right b. scoring system; c. weight factors. 2. Assigning scores or value to the criteria by experts and multiplying by weights. 3. Adding up of weighted score to determine the rated/ranked score Advantages 1. Supports estimating the volatility of the patent values 2. Useful in option based valuation method Useful in internal patent management decisions e.g. to file or not to file for certain inventions, extending patent rights abroad, renewing or abandoning patents. Disadvantages Reflect an extremely dispersed distribution of the values of patented ideas 1. Identification of the valuation criteria and determination of weights, factors are arbitrary and subjective. 2. Lack in strong empirical support. 6 Variants Methodology Advantages Licensee pay a royalty 1. Can be the basis rate equivalent to 25 per (principle) of Rule of cent of its expected early agreement Thumb profits for the product 2. Appropriately (Goldscheider, that incorporates the IP at tied to et.al, 2002) issue. profitability 3. Widely accepted Industry Standards Auction Method (Jarosz, et.al, 2010)) Analogous Method (American Institute of CPA)s Here the patent is valued first by referring to the industry it belong and selecting the royalty rate that is specified (Razgaitis, et.al, 2007) The patent is put to sale in a hypothetically perfect auction market with several well aware potential buyers, the price of the patent would be determined through bidding. Here a comparison between the observable price for a comparable object and value sought for the patent is done. 1. The values used as the basis are based on the market. 2. No calculations are required Disadvantages 1. Have the effect of rewarding licensee business inefficiency. 2. There can be significant year-toyear variability in available income statement numbers. Published information is inevitably dated, and such datedness could have a material effect on the present value of a similar deal. The fair value is expected to be determined by the willing seller and willing buyers The use of auctions is much more complicated than a simple cash payment. Logical method permits comparison between the observable price for a comparable object and value sought for the patent 1. Adequate data from comparable transactions can be rarely accessed, 2. Necessary to provide a detailed background and reasoning for the choice of comparable transaction. Source: Developed by Authors c. Income approach: Under this approach, the patent is valued on the basis of the future benefits that would accrue from the concerned patent and discounted by an appropriate discount rate (Ahya, 2005). 7 The following Table 03 explores the various methods under this category. Table 03 Comparison of Income Approach (Praxis) Methods of Patent Valuation Variants Direct capitalizati on (ICAI,2007 ) Discounted cash Flow (Collan, 2011) CAPM (Meng, 2008) Decision Tree Analysis (Chiu, 2007) Real Options (Bloom, 2002) Methodology Based on estimation of appropriate measure of economic income for a period, then dividing that measure by an appropriate investment rate of return known as the capitalization rate. Based on projection of appropriate measure of cash flows for several discrete periods into future and then converting into the present day applying discounting factor. Estimating the discounting factor and multiplying the risk premium with the asset specific beta and the result is added to the risk free rate. Based on consideration of the various possibilities i.e. at various stages of the life of the patent if it could be allowed to lapse or abandon. Subsequent to the initial application, there is also option to expand the patent family making corresponding foreign applications. Based on theories of market behaviour, designed to explicitly incorporate and analyze risk and uncertainty associated with real assets. Applies financial options theory to quantify the value of intellectual property. The two variants are Binomial Method and Black-Scholes Method Advantages Disadvantages Accounts for time and Uncertainty The discount rate does include the varying risk of patents over its life. Accounts for flexibility Discount rate problem. The rates used need to be appropriate to include the risk at each stage and for each type of decision, in practice a constant rate is used. Considers the changing risk of the patents during its life span Variance estimation is difficult. Under Black-Scholes method it is assumed that there are no interim payments while the cash flows are expected over the patents life. Difficult to forecast expected cash flows from the patent. 8 Variants Methodology Advantages Royalty Relief Method (Hagelin, 2002) Based on the licensing fee the company would have to pay if it did not own the patent. This method involves discounting of the cash flow i.e. estimated net sales multiplied by the estimated royalty rate minus fiscal charges ip2(www.ne ifeld.com) Developed by the German Patent Attorney. Association . Based on Uses the license analogy and the profit approach. Economic Value of the patent=Cumulated Discounted Estimated Net Sales (CDEN) over the expected Product Life Cycle (PLC) multiplied by the royalty factor (RF) Eliminates the intrinsic difficulty of estimating the profitability and risk differentials Discount factors reflecting legal risks associated with the validity of a patent and its freedom-tooperate. Technology Factor (Hagelin, 2002) An upper limit of possible income with patented technology is estimated. This estimation is adjusted by competitive attributes in order to arrive at the estimated income. A Legal RiskAdjusted Valuation Framework (Flammer, 2014) The patent value is estimated by the formula- Patent value = (risk-free patent value)*(1 – (discount)*(impact)) Simple, structured and easy process Considers Synergistic portfolio discounts, Information asymmetry factors. Disadvantages As patents are for unique features of the product the appropriate royalty rates are difficult to find (Lee, et.al. a 2016) Based on cash flow which is difficult to forecast. Does not provide a quantitive means for determining the incremental cash flow attributable to a technology. Discount rates become a secret formula for the valuation. Concealment, deceit, incomplete communication, or information too difficult or too costly to obtain are all hazards and this can shift the economic analysis. Source: Developed by Authors Other Methods: These are other relevant methods used for valuing patents but not included above. These methods are classified below in Table 04 below 9 Table 04 Comparison of Other (Praxis) Method of Patent Valuation Variants Details Estimates patent value from patentees’ point of Renewal view, from patent data renewal data as a way method of measuring patentees’ assessment worth. Identification of relevant facts affecting Due patent value and Diligence assessing it with Method technology that the patent protects. (Munari, et.al. 2011) Source: Developed by the Authors Advantages 1. Aims at the value of the patent alone 2. Better valuation of potential opportunities, example licensing opportunities Gives information relating to the maturity of the technology, existence of the competing products/technologies, barriers of penetration of the technology to market. Disadvantages Due to some of the organizational bias related reasons be an overestimate of the true value. Requirement of a thorough understanding and assessment of the patent claims which is sometimes difficult in critical cases. 10 Interrelationship between the Methods The interrelations between the approaches which are analyzed, these relationships are depicted by the following Figure 2. Figure – 05 Interrelationship between the Approaches Market Approach Cost Approach Future Cost Information required for estimation Information on Royalty Rate Required Information of indicators required to fix price Income Approach Information of indicators required to compute discount rate Indicator Based Approach Source: Developed by Authors Academic Models The various methods as recommended by the valuation experts are explored and their advantages and disadvantages are shown in the earlier discussion, these bring in major obstacle in determining the fair market price of patents. Therefore to suggest improvement the academic researchers developed certain models, these are called academic models. Information about these models are of patent valuation has been obtained from academic 11 literatures like books publishing research outcomes, research journals. These are reviewed and categorized according to their approaches four sub groups viz. Income approach, Indicator-based Approach, Mixed approach and Market approach according to their working methodology. A comparative analysis of their advantages and disadvantages has also been recorded. The members of the group are shown in the Figure 03 presented below Figure 3 Academic Methods Academic Models (Based on Theory of Intangibles) Income Approach • Russel, (2016) • Sohn, et. al, (2013) • Goldenber et. al, (2012) • Ernst. et. al, (2010) • Meeks, et. al (2010) • Reitzig.et.al (2000) • Sereno. (2010) • Leone, et. al, (2007) • Triest., et. al (2007) Mixed Approach Wartburg. et.al (2008) Indicator –Based Approach • Han et.al, (2015) • Jun et.al, (2015) • Frietsch, et.al., (2014) • Grimaldi, et.al., (2014) • Wang et.al, (2014) • Hall et.al, (2010) • Greenhalgh, et.al, (2006) • Park. et.al, (2006) • Cromley, (2004) Market Based Approach Chiu, et.al (2007) • Ideal models based on utopian ideas, these models are not always used in practice Income approach Under this classification the income approach there are nine approaches, these are described in the Table 05 presented below 12 Table 04 Comparison of Income Approach (Academic) Methods of Patent Valuation Source Methodology Advantages Reitzig.et.al Option based 2000 pricing Considers several factors which cover the risk effect. Leone, et.al, 2007 Option based pricing Taken into consideration the option characteristics of patents Triest, et.al 2007 Income Approach (DCF method) Gives the economic value of patents Ernst. et. Al, 2010 Real Option Approach, Simulation Analysis (Sebastian, 2010) Meeks, et. al 2010 DCF Method Sereno. 2010 Real option based DCF Approach Goldenber et. al, 2012 Real Option Approach (Two Step compound option pricing model) Sohn, et. al, 2013 Classification Tree Analysis Considers the risk over the time period of the project 1. It seeks to determine the true value of a patent, not a proxy for value; 2. It uses patent litigation as the backdrop for the claim analysis and damages calculation; 3. It is most appropriate in the technology context Taken into consideration the option characteristics of patents and the discounting effect of the income approach Allows for an enhanced ability to ensure that the patent system supports innovation Supports the development of patent policies that are more sophisticated than the current size fits all system 1. Valuing patents from two angles-willing to sell and willing to buy 2. Several factors have been taken into consideration which covers the risk of patents Disadvantages The volatility rate does not consider the changing risk of the asset over time The volatility rate does not consider the changing risk of the asset over time Shortcomings: Detailed inputs, detailed knowledge of market and technology 1. The model is based on certain assumptions. 2. The model may not be applicable in other cases The method is based on the comparable transactions. But where new patents are in question this method cannot be applied due to absence of data. The volatility rate does not consider the changing risk of the asset over time Volatitly rate does take into consideration the changing risk of patents over time This method requires further improvement for being applied in practice. 13 Source Russel, 2016. Methodology Advantages DCF Approach Discloses conditions to the & Value investors when the valuation of Relevance Test patents would be useful Disadvantages Patent valuation is dependent on cash flows, discount rate and patent expiry assumptions and estimations. Source: Developed by Authors Indicator –based approach Under this classification the income approach there are nine approaches, these are described in the Table 05 presented below Table 05 Comparison of Indicator –based Approach (Academic) Methods of Patent Valuation Source Grimaldi, et.al., 2014 Frietsch, et.al., 2014 Han et.al, 2015 Methodology Advantages Disadvantages Conceptual Framework for assessment of patent valuation 1. Assessment of the value of patent portfolios in companies' context both if a single portfolio and a single patent are considered 2. Aim at the maximum exploitation of that portfolio Application of the model in different areas of management has not been considered A new way of measuring patent value The study is mainly focused on developed nations. It may have varied effect in the emerging economies where no strong IPR system exists Econometrical Approach Quantitative Patent Analysis 1. Gives a list of factors/indicators that are significant for survival of patents, thus bringing in improvement in patent valuation. 2. Helpful in making business plans or obtain finance for innovation based on patents. 3. Also helpful in patent infringement lawsuits 1. Need to consider other industries. 2. To make the model more suited towards patent infringement cases certain other risk factors required to be considered. 14 Source Jun et.al, 2015 Hall et.al,2010 Methodology Quantitative Patent Analysis Regression Analysis Advantages 1. Efforts for an objective valuation 2. The model combines technology and market values. Lacks a practical approach Mathematical Model Considers several indicators Need to determine the most determining factors to perform analysis using several independent variables (Lee, et.al, 2016 b) 1. The value of patents can be effectively analyzed and measured for subsequent classification. 2. Patent value is measured from three perspective protection, strategic and commercialization 3. System proposed can help research institutions and high-tech companies to determine the value of patents and maximize commercial potential in future This method includes several factors which covers the risk of patents to certain extent Wang et.al, 2014 Fuzzy Multiple Criteria Decision Making Cromley, 2004 Conceptual Framework Greenhalghet. al, 2006 Regression analysis Considers several indicators Structural relationship Approach 1. This method is simple, easy 2. Covers some shortcomings of other methods. 3. The method has practical application Park. et.al, (2006) Disadvantages The model if based on monetary model would be best suited for industry May become too complicated Lack of practical usage 1. The parameters that are considered are subjective in nature. 2. The method lacks validation module Source: Developed by Authors Mixed approach Under this classification there exists one approach, described in the Table 06 below 15 Table 06 Comparison of Mixed Approach (Academic) Methods of Patent Valuation Source Wartburg. et.al 2008 Methodology Methodology Real Option, Game & Social Network Modeling, Scenario Value-chain Analysis, Diffusion Modeling Modeling, Technology Mapping Advantages 1. Multiple valuation methods are used. 2. Valuation done from two perspective-static and dynamic. 3. Enable in valuation of patents for outlicensing Disadvantages Calculation may be complex Source: Developed by Authors Market Based Approach Under this classification the market based approach there exist one approaches, these are described in the Table 07 presented below Table 07 Comparison of Market Approach (Academic) Methods of Patent Valuation Methodol Advantages ogy Rating/ Useful in licensing Chiu, et.al 2007 Ranking decision Approach Source: Developed by Authors Source Disadvantages Done from the view of licensor. Licensee perspective not considered. Limitations and Scope of Future Research For conducting a critical analysis of the patent valuation methods attempt has been made to collect information from various research papers. The research presented in this article is based on available literature, globally some more may exist which are beyond access. In order to refine the findings, a formal survey of practitioners can prove to be worthwhile. It would also be useful to conduct a survey on clients’ satisfaction with the methodologies used. 16 Conclusion This article has given the researcher / reader an idea on the existing patent valuation methods and reached the conclusion that no one method is suitable for all uses / users, it could not be made sure that which methods is suitable for some usage. The valuation should focus on three aspects, viz. purpose the valuation is being done, for whom the valuation is done and finally what is the time period for which the valuation would remain valid. The valuation methods should analyze the bundle of legal rights, and, finally, there should be easy of availability of sufficient data for such valuation. This article has also brought to light that there are few criteria’s that needs to be considered for valuing the patents. These are the unique features of the underlying asset protected by the patent, the breadth and scope of the patent, the existing technology that the new technology would replace. It is also needed to keep in mind factors like time required, processing cost to be incurred to fully commercialize a technology, the capability to protect the new technology, the market size for the new technology, future prospects for the industry to which the technology belongs and any strategic or economic influence that the technology would face. The article classified the existing methods in two groups (praxis and academic), the academic models, though sound in nature, requires data on ideal factors, which at times is difficult to achieve. On the other hand the praxis methods are not always academically robust, is some cases there is need to validate. In this paper thirty nine (39) approaches had been discussed and their advantages and disadvantages recorded. 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