How to Value Intellectual Property

The valuation of intellectual property involves assigning a dollar value to the non-tangible assets of an entity. This valuation is a major issue in the mergers and acquisitions field, since a potential acquiree typically claims to have accumulated a significant amount of intellectual property, and wants to be paid for it. This valuation can also be useful when deriving the value of collateral to be used in a lending situation. Examples of intellectual property are unique manufacturing processes, patents, copyrights, and brands.

It is not possible to assign an exact value to intellectual property, since the underlying notion is so vague. Instead, several valuation methods are used to develop a range of possible valuations. The acquirer then uses this information to develop an initial offer price, as well as a permissible range of increased prices that reasonably encompass the calculated value of the intellectual property. The more common methods used to value it are noted below:

Replication cost method. This is the cost that the acquirer would have to incur in order to replicate the intellectual property. There is also a time component to this calculation, in that the acquirer might require years of effort in order to create the intellectual property. If the acquirer wants access to the property immediately, it should be willing to pay a premium to buy it from the acquiree.
Market price method. This is the price that third parties would pay for the intellectual property if it were put up for bid in a fair market, with multiple bidders. An acquirer may want to pay more than this amount in order to avoid a bidding war with potential competitors.
Discounted cash flows method. This is the present value of the cash flows currently generated by the intellectual property, with certain assumptions included regarding possible changes in those cash flows over future years. The rate at which these cash flows are discounted to a present value is subject to interpretation and negotiation.
Relief from royalties method. The relief from royalties method is based on the cost that an acquirer would otherwise incur if it were required to pay a royalty for access to the intellectual property in question. The concept is most applicable when intellectual property has an identifiable revenue stream associated with it, and where there is valid market-based data available on the royalty rates being charged for similar assets. This approach may not work if access to the intellectual property cannot be obtained through a licensing arrangement.