Intellectual Property valuation and transaction in India

Payal Goyal | 17th December 2019

Intellectual property (IP) refers to creation of the mind. Copyright, patents, trademark, design etc. are some instances. IP is an intangible asset/property that has legal protection in terms of legal, economic and moral rights. IP assets are those resources of the business that creates Brand Value. Like tangible property, IP is also traded and transacted. IP valuation helps you know the true value of your business and capitalize the assets which you might not know.  However, very few companies know methods for proper valuation of IP assets practically. It is therefore becomes important to make proper valuation of Intellectual property. The value of IP asset is measured by its ability to confer economic benefits to its owner/user. This benefit further depends on its ability to exclude competitors from a particular market.

Factors that influence IP valuation

• Situation in which valuation has been done i.e. what is the financial status and future course of plan of the owner of IP asset.
• Demand of that IP asset in the market at that date and time
• Market value of the IP asset
• Reason behind the valuation
• Strength, efficiency and good will of that asset
• Type of valuation method which has been applied
• Type of ownership
• Legal implications on such IP asset
• Restrictions in use of that IP asset

Difference between Price of IP asset and Value of IP asset

 The price of an IP asset is determined as the amount of money for which ownership of IP asset is transferred between a buyer and a seller. Whereas the value of IP asset is its ability to make economic benefits in future. IP valuation represents the overall economic value of IP asset.

IP valuation methods

1. Cost Method
2. Market Method
3. Income Method

1. Cost Method

This method is generally used for computing the value of IP asset.  The cost is determined by calculating the development cost of a similar IP asset either internally or externally in present. That is, the determining factors are total expenditures incurred on that IP asset, extent of obsolescent and opportunity costs in creation of similar IP asset at that time. The amount so arrived is the value of that IP asset. Obsolescence affects IP valuation. It refers to outdated or deteriorated part of the asset. There may be economic obsolescence, functional Obsolescence and technological obsolescence of IP asset.  The cost method is useful when the IP asset (whose valuation is to be done) can easily be reproduced or replaced.

There are two options for cost method of IP valuation:

 Reproduction cost method:  It is the total cost to develop an exact duplicate or replica of similar IP asset in present. This duplicate asset has same properties. It is created by using the similar materials having same quality standards, layouts and design, layout that of the original IP asset. It is used in litigation purposes, calculating return on investment (ROI), tax purposes etc.

Replacement cost method: It is the total cost to create an asset having equal functionality or equal utility of the IP asset in present. The replaced IP asset may have more qualities and efficiency that of the previous IP asset. This method is used in situations like estimating a target price prior to negotiations for purchasing an IP asset, computing transfer price, calculating the basis for suitable royalty rates etc.

2. Market Method

Under market method, valuation of IP asset is done by way of comparison with the actual price paid for a similar IP asset in those circumstances. The valuation will be precise when the person valuing the IP asset has accurate information of all determining factors.

Factors that must be taken into consideration while making IP valuation through market method:

• Date of valuation
• Nature of IP asset (for example- patents, designs, trademark etc.)
• Market inflation rate
• Nature of rights to be transferred (License, sale etc)
• Scope of legal protection
• Time period of such transfer
• Geographical aspects
• Market position of IP asset
• Profitability of IP asset
• Substitutes, if any
• Risks involved
• Management Structure
• Market size and penetration
• Channels of distribution

It is generally not possible to get exact information about all influencing factors. Therefore, it is difficult to determine exact valuation of IP asset through this method. 

3. Income Method

This method is very common in making IP valuation. Under this method, the IP asset is valued on the basis of economic income that it is expected to generate if adjusted to present day value. The economic income is determined by taking into consideration various factors like potential revenue to be generated by the IP asset in future, expenses incurred on such asset and net present value of such income. This economic income may be measured by way of:

• Net revenue
• Net Profit
• Net cash flow
• Income when not taxed
• Income when taxed
• Additional/Incremental income
• Cost savings

It is important to ensure that the capitalization rate or discount rate is used. Further the consistent with the economic income parameter is required. It may be done using either discounted cash flow or direct capitalization.

IP Transactions in India

The IP assets have monetary as well as economic worth. Therefore, an owner of the IP asset and an interested buyer may enter into transactions of IP assets by any of the following ways:

• Through sale or purchase of IP assets

Sale or purchase of IP assets is done once it is valued. The valuation may be done by way of cost method or market method or income method. This is the most common form of IP transactions.          This transfers the entire rights of IP asset generally.

• Through Licensing of IP assets

Licensing is similar to ‘permission to access’. It transfers the right of enjoyment or right to take benefits arising out of IP asset. IP valuation in such case is not so easy. It is therefore important to negotiate while licensing the IP asset in respect of terms and conditions of usage.  

• Through Merger & Acquisition

In the process of merger & acquisition, IP assets are also transacted. It is important to make proper IP valuation as to determine the future benefits of such asset.

• Through Joint Venture or Strategic Alliance

While entering into a joint venture or any strategic alliances, it is very pertinent to make valuation of IP assets. Further a comparative analysis of those values in various options like licensing, sale etc is made. The proper valuation will help to evade future loss and preserve the purpose of such combination.

• Through donation of IP Assets

Sometimes an IP asset is transferred by way of donation or similar to gift. That is generally made for social or charitable purposes, without any consideration.