IP Valuation and its role in the value of a start-up

Introduction

When one is starting a business, the most essential element to think of is intellectual property (IP). Your IP is what makes your business eccentric and gives you a sense of gamesmanship. As technology continues to drive changes in the global economy, many companies, especially those that are technology-based, are finding that IP increasingly comprises the lion’s share of their value.

IP-intensive industries contribute for over a one-third i.e around 38.2% of the total US Gross Domestic Products as per 2022 data. Different IP valuations may lead to wildly different results. That’s why it is important for companies involved in intercompany transfers of intellectual property to go for the most appropriate method.

The most reliable method is not necessarily the one with the most optimal financial outcome for the business, but rather the method that is fair to both parties in the intellectual property transaction and defensible should tax authorities raise questions. Per se, reliable valuation is important for multinational corporations engaging in IP transactions.

What is IP valuation and why do we need it?

Intellectual property (IP) valuation is the process used to determine the fair market value of IP assets such as copyrights, patents, trademarks, and trade secrets. IP valuation not only assists in determining the value of IP but the accurate worth of the business as a whole.

You really need to have a clear picture of your IP portfolio before getting a valuation for your start-up. Without information about your IP portfolio, it will be difficult to truly evaluate the value of your business. If you plan to purchase, sell, or licence IP, you need to do an IP valuation to know the value of the IP assets in question.

The shift to a global service economy over the past four decades has toppled traditional beliefs about value. In the new service and technology-oriented economy, physical assets no longer represent the bulk of business worth. Today, the value of Tesla is not primarily in the cars it produces, but in the company’s underlying technology and IP.

Some of the core purposes for which organisations perform IP valuation are establishing the value of IP licencing deals; franchising; for mergers & acquisition transactions; joint ventures; selling a business; tax planning and compliance; or transfer pricing.

The correlation between IP and start-up valuation

IP is often measured as one of the most vital assets of a start-up company. It can guide the IP strategy of a start-up, as well as influence investment decisions and valuation considerations. IP can take many forms, including patents, copyrights, trademarks, and trade secrets.

Each type of IP can bid different benefits and protection for a start-up. For instance, a patent can provide exclusive rights to an invention or document, which may be highly valued. Trademarks, conversely, can help to distinguish a company’s products or services from those of its competitors. A copyright protects original creative works, such as website content or software code.

From a valuation perspective, an IP portfolio will have value only if it is well-aligned with the assets that bring the most value to the business. In companies where technology is the most valuable asset, patents will have more value compared with companies where brands are the main asset.

Similarly, in companies where data is deemed to be the most valuable asset, copyrights, or trade secrets, will be the preferred mode of protection. Simply, every other IP can correlate with the value of a start-up in different ways, contingent on the nature of the business and the kind of intangible assets it holds, the stage of development, the potential market, and more.

By protecting key assets, IP can benefit by creating and sustaining value for a start-up.

IP valuation resources

When it comes to IP, the question of value is the most complex one. However, there are a number of resources that can be effectively helpful in this process. Primarily, the World Intellectual Property Organization (WIPO) proposes information and resources to help you evaluate the value of your IP. According to their website, there are three key methods for valuing IP:

• The income method – values IP based on the amount of economic income it is expected to generate. This method is best used when the IP creates a positive cash flow (for equity or debt funding purposes) that can be estimated with some degree of reliability. However, the method does not consider independent risks associated with an IP asset and lumps all the risks together to be adjusted for the discount rate.
• The market method – the most commonly used method for valuation; compares the actual price paid for the transfer of rights to a similar IP asset under comparable circumstances.
• The cost method – establishes the value of an IP asset by calculating the cost of a similar IP asset.

Does high-value IP guarantee a high start-up valuation?

In the world of start-ups, IP is frequently viewed as a valuable commodity. After all, it’s the foundation on which many companies are set up. But does high-value IP guarantee to high start-up valuations? That’s not necessarily the situation.

As a matter of fact, there are various factors that can influence a start-up’s valuation, including the stage of the company, the size of the market, and the overall financial health of the business. That’s not to say that IP isn’t important, but it’s one piece of the puzzle when it comes to start-up valuations.

Valuing IP assets can be difficult as there are many different factors and aspects that can affect the value of each IP asset. The value of intellectual property can change over period—for example, as its standing in the market strengthens or decreases, as the uniqueness of the IP changes, or as the strength of the IP protection grows or diminishes.

As such, when you are looking at the value assigned to similar assets in licencing agreements between unrelated parties, you need to make sure that the data is sufficiently comparable to the IP assets you’re analysing.

Conclusion

Today, conducting an accurate IP calculation is more challenging but more important than ever before. The most reliable method is not necessarily the one with the most optimal financial outcome for the business, but rather the method that is fair to both parties in the intellectual property transaction and defensible should tax authorities raise questions.

To achieve reliable IP management and valuation results, you must evaluate the potential outcomes, be pragmatic and rational, expect the valuation to be disputed, and last but not least, seek expert guidance.

Regardless of the method you use to calculate the value of your IP, it’s wise to calculate the value of your IP before valuing your start-up to ensure your business is valued truthfully and take all intangible assets into account.

References:

https://www.royaltyrange.com/home/blog/what-is-ip-valuation

https://www.valentiam.com/newsandinsights/ip-valuation

https://www.ipeg.com/the-correlation-between-ip-and-startup-valuations/

https://michelsonip.com/what-is-ip-valuation-the-role-of-ip-in-the-value-of-a-startup/

This article has been authored by Mahi Jaiswal, a student at Bharati Vidyapeeth Deemed University, New Law College, Pune.