In recent years, smart companies have effectively started using Intellectual Property system to create, identify, and manage the value of most of their intangible assets by developing and executing intellectual property asset management strategy. But till now this is limited to few companies worldwide only. IP Valuation is done on the basis of Cost Approach, Market Approach, Income Approach. It helps the organization in confronting the opportunities in mergers, acquisitions, divestitures, corporate reorganizations, public and private equity financings, securitization with IP assets. Cost Approach Method is a complex method of determining the value of IP by aggregating the costs involved in its development. This method is not only about addition of all the receipts for expenditure associated with the development. In this method of valuation it is important to determine the context in which asset is being analyzed, date as of which valuation to be done and purpose of valuation. Two types of approaches can be used for cost valuation depending on the requirements.
Reproduction cost: In litigation involving the specific intangibles or when an attempt is made to measure return on investment. Basically reproduction cost is the cost necessary to reproduce exact same asset.
Replacement Cost: This method measure the cost to develop an asset with similar utility. This method is useful in predicting the price prior to negotiations or when calculating a basis for a fair rate of return from which suitable royalty rates or transfer pricing can be determined.
Market Approach Method (i.e. the sales of comparable intellectual property, where a somewhat similar deal is used for the purposes of comparison) is an approach which is basically used in the absence of a buyer-seller or a licensor-licensee relationship. This approach reproduces the context in which a transaction would normally take place in an open market. In this technique a survey of the information available on transactions made by publicly traded companies in similar industry to the valued IP is generally performed.
Income Approach Method: Intellectual property has the ability to generate cash flow and this ability is utilized in the income approach.. This approach is based on discounted cash flow theory and defines the value of the subject property as the present value of the anticipated net economic benefits to be achieved over the duration of the property’s useful life. While using the Income Approach to value intellectual property, future income or cash flow related to the business, business segment or product line under consideration is estimated. The forecasted cash flow is then discounted via present value calculations to determine the current value of the operation.
It is always advisable to follow the methodology depending upon the conditions. Also a comparison should always be done between the methodologies to verify the findings.