38

Methods for Intellectual Property Valuation

Dilip Sharma and Abhijeet Kumar

I. Introduction

With the rapid shift in the last couple of decades from an industry-​based tangible
market to an information-​based intangible market, companies have realized the
importance and necessity of amending their strategy of asset management, with a
specific focus on intellectual properties. The widely reported data from the United
States (US) in 2016, suggested that intellectual property (IP) intensive industries
were responsible for around 38.2 per cent of the national GDP of the year 2014,
which was an increase from 34.8 per cent in 2010;1 data published in 2019 by the
United Kingdom (UK) suggests that in the last decade, the annual growth for
all non-​financial assets2 have been at a rate of 4.8 per cent, and amongst that the
growth rate of intellectual property (IP) products has been at 4.4 per cent;3 and
the report of European Union (EU) published in 2019 suggests that 45 per cent
of the GDP of the EU is attributable to IPR-​intensive industries, which have also
provided for 38.9 per cent of employment, either directly or indirectly.4 The data
coming from all other regions of the globe also suggests similar findings, wherein
it is reported that the reliance of business on the intangible IP is increasing with the
changing dynamics of the economy.
The beginning of this shift is attributable to the expanding scope of the term
‘asset’ with the passage of time, which changed from primarily tangible to pri-
marily intangible in the course of the last thirty to forty years.5 The benefits
1 Joint Report by ESA and USPTO, Intellectual Property and the US Economy: Industries in Focus, US

Commerce Department (26 September 2016).

2 Non-​financial assets include dwellings, building and structures, machinery equipment and weapon

systems, cultivated biological resources, IP products, inventories, land and contracts, leases and licenses.
See generally UK National Balance Sheet Estimates, Office for National Statistics (2019), https://​
www.ons.gov.uk/​economy/​nationalaccounts/​uksectoraccounts/​bulletins/​nationalbalancesheet/​2019
(last visited 22 April 2020).
3 Id.
4 IPR-​ Intensive Industries and Economic Performance in the European Union, European Union
Intellectual Property Office (September 2019), https://​www.boip.int/​uploads/​inline/​WEB_​IPR_​
intensive_​Report_​2019.pdf (last visited 22 April 2020).
5 See generally John P. Ogier, Intellectual Property, Finance and Economic Development, WIPO

Magazine (February 2016), https://​www.wipo.int/​wipo_​magazine/​en/​2016/​01/​article_​0002.html

(last visited 22 April 2020). ‘Up to the 1980s, tangible assets accounted for 80 per cent of company value;
the rest was made up by intangibles, including IP. Thirty years later, the reverse is true with 80 per cent of
company value made up of intangibles.’

Dilip Sharma and Abhijeet Kumar, Methods for Intellectual Property Valuation In: Handbook on Intellectual Property
Research. Edited by: Irene Calboli, Maria Lillà Montagnani, Oxford University Press. © Dilip Sharma and Abhijeet Kumar
2021. DOI: 10.1093/​oso/​9780198826743.003.0039
598 Dilip Sharma and Abhijeet Kumar

reaped by companies by adopting this inclusive approach is multifaced, viz ap-

preciation of value of IP assets with time as against depreciation of the value of
tangible assets; it is convenient for businesses to pledge the IP assets for raising
capital, without hampering business, as opposed to the pledging of tangible
assets, and it also ensures the lender with regard to repayment, as businesses
cannot operate without essential intangible assets; and usage as additional se-
curity which is related to the borrowing company, i.e. juristic personality it-
self, rather than individual operating on its behalf. The understanding of the
aforesaid benefits leads the discussion to the core topic of this chapter, i.e.
illustrating under what scenarios the IP assets could become valuable for the
holder and what are the means to ascertain the most appropriate value of the
IP asset.

II. Intellectual Property Valuation—​Needs and Triggers

The answer to the questions ‘why to carry out the valuation of IP assets’ and ‘when
to carry out valuation of IP assets’ lies with the understanding of the instances or
events, commonly known as triggers, which arise the need for getting IP assets
valuated.
These triggers may vary depending upon the nature of the event, viz. commer-
cial transactions (including sale, merger and acquisition, joint venture, licensing,
etc.), banking (including borrowing, insurance, bankruptcy, etc.), events related to
individuals (including divorce, partition, will, etc.), court proceedings (including
claim of damages, loss of profit, etc.), and governmental requirements (including
asset worth declaration, direct and indirect taxations, etc.).
It is on the occurrence of—​or probability of occurrence, as the case may be—​any
of the aforesaid events, that the necessity to determine the value of the IP assets
gets triggered, on behest of all the parties involved, so that it can be ascertained
that the right value of the property in question, is being given and received. The
IP assets while being conveniently transactional, also bring the risk of them being
either over or undervalued, because of its inherent nature of operating in the state
of intangibleness. Thus, the triggers, as discussed above, do not only respond to
the question of ‘when’ but also respond to the query on ‘why’ there is a need for
valuation.
All the intangible assets in a company, or with any individual, may not be
related to IP, in these instances the occurrence of any of the aforesaid events
also triggers the need to carry out valuation of other intangible or tangible as-
sets thereof. However, for the purpose of this chapter, we will be restricting our
scope to intellectual properties only and will be discussing different methods
of valuation, traditional and modern, which may be adopted in a particular
scenario.
 Methods for Intellectual Property Valuation 599

III. Traditional Methods of Valuation

A. Cost Method

The cost method is a well-​known but least used method for the valuation of IP
assets.6 This method values the intellectual properties based on the cost of devel-
opment of an identical or similar asset at a given point of time. This method is gen-
erally used as an alternative approach to arrive at the minimum base cost in such
cases where IP assets are no longer generating income.
The cost method is used to valuate an IP asset by aggregating the expenditures
incurred (raw material, labour, etc.) and opportunity cost after considering dif-
ferent kinds of obsolescence factors such as physical (e.g. landline phones to mo-
bile phones), technical (e.g. CD and DVD Drives to HDD to SSD to cloud storage),
economical (e.g. dot matrix printers to LaserJet printers), and functional (e.g.
floppy disk, camera roll) obsolescence.7
There are two variants under this approach for determining the value of an
asset using the cost method: the ‘reproduction cost method’ and the ‘replace-
ment cost method’.8 The reproduction cost method (also known as historical
cost approach or historical cost trending) includes the cost of creating a replica
of the subject IP asset at current prices, using the same or similar raw mater-
ials, quality, and standards; whereas under the replacement cost method, it de-
termines the value of an asset on the basis of cost of creation of an equivalent
asset with similar or better utility or functionality.9 The historical cost trending
evaluates the cost of creation of IP asset in past. The cost for the purpose of
valuation will always be calculated on the basis of price on the date of valuation
rather than the historical cost. The cost incurred in recreating or replacing an IP
asset can vary from the actual cost incurred in past due to various factors such
as better technologies, variable cost of raw material, etc. Under the replacement
cost method, the cost incurred will be determined after considering obsoles-
cence factors. Hence:

Replacement cost = Reproduction cost - Obsolescence factorss

6 World International Property Organization (WIPO), Module 11: IP Valuation, WIPO

International, https://​www.wipo.int/​export/​sites/​www/​sme/​en/​documents/​pdf/​ip_​panorama_​11_​
learning_​points.pdf (last visited 22 April 2020).
7 Ronald L. Brown, Valuing Professional Practices & Licenses 17–​18 (4th ed. 2013).
8 APEC Intellectual Property Experts Group, Intellectual Property (IP) Valuation

Manual: A Preliminary Guide 17 (2018).

9 Mark L. Zyla, Fair Value Measurement: Practical Guidance and Implementation 163

(2020).
600 Dilip Sharma and Abhijeet Kumar

Example 1
Black & white televisions are functionally obsolete and are no more in demand
in the era of smart coloured LED televisions. In such a situation, when there is no
active market and income flow, the cost method is the most suitable approach for
the valuation of IP assets. In such a situation, the valuator accumulates what was
spent historically and accordingly estimates how much will be spent to replace that
particular asset. Considering the same example, if for some industrial purpose, the
same old Black & White technology can be used, then in such a situation, the re-
production cost method will come in handy for the procurer of such technology.
The cost method is most suitable when the subject IP asset can be easily repro-
duced or replaced with an equivalent or better asset of similar nature. But since the
cost method provides a minimum base value for the IP asset so it is the least used
approach under the IP regime. While, this method is generally used when the IP
asset is no more generating income and hence, other approaches are not suitable
for the purpose of valuation. However, the cost method also provides a minimum
threshold value, which is considered as the lowest value of the IP, for calculating its
worth or income-​generating capability (through licensing, assignment, etc.), at the
time of negotiation for any transaction related thereof.
The cost method also has some issues or disadvantages attached to it such as
it does not consider the cost of failure and risk associated with the IP asset. The
approach is also criticized for completely ignoring the marketability or non-​
marketability of assets, future cash flow, and the remaining tenure of protection.

B. Market Method

Market method is considered as the most practical and logical approach for the
valuation of an IP asset where a comparable asset is available in a similar active
market.10 It determines the value by comparing both the assets in similar trans-
actions under similar circumstances. This method for the purpose of valuation
takes into consideration various factors such as time, nature of asset, remaining
tenure of protection, purpose, geographical territory, profitability, exclusivity, etc.
For example, HDD and SSD are two comparable assets present in the same active
market. So, here the market approach can be utilized for the purpose of valuation.
Similarly, Cadbury and Nestle are two famous trademarked companies engaged in
the manufacturing of chocolates so, their IP assets of a similar nature can be valued
using market approach in an active market.
The valuation under market method involves a multistep process. The first step for
valuation under market method is to identify a comparable asset in an active market.

10 Martin Brassell & Jackie Maguire, Hidden Value: A Study of the UK IP Valuation

Market 14 (2017).
 Methods for Intellectual Property Valuation 601

After identifying the comparable asset, the second task is to obtain accurate data on
an arm’s length transaction.11 Then, identify the various factors which are to be con-
sidered for the purpose of valuation and accordingly compare the value of both the
assets based on per unit or geographical territory, etc. Thereafter, make adjustments
based on quantifiable changes and accordingly analyse the available data. Based on
this analysis, the market approach will provide the final value of the subject IP asset.
The biggest challenge for using this approach is to identify a comparable asset be-
cause every IP asset is unique in itself as novelty or originality are very important factors
for the purpose of IPR protection. To overcome these challenges, similar IP assets, or its
nearest substitute from the same market, is considered for the purpose of valuation.
Another important challenge for using this approach is non-​availability of ac-
curate data. Under the market approach, the accuracy of data is very important for
correct valuation of IP assets as inaccurate and old data often yield inaccurate re-
sults.12 Most IP transactions are carried out confidentially with disclosure of related
information to the public.13 In such a scenario, obtaining accurate data for the pur-
pose of valuation is really a tough job. Data on which valuation relies are not readily
available in the market and hence procuring the same requires sufficient expertise..
The reliable data for the purpose of valuation can be obtained through surveys, of-
ficial filings (e.g. for taxation etc), and proprietary databases on royalty, etc. This
method also does not take into account various hidden or strategic factors such as
negotiation, influence, etc. used to arrive at a particular value. As these factors cannot
be calculated numerically, the valuation of the asset so obtained may not be accurate.

C. Income Method

Often regarded as the most widely used method to determine the value of an IP
asset, the income method relies on the historical data of income earned using the
asset, along with the prevailing competitive environment and trends in the in-
dustry to calculate the future income which possibly can be generated, in order to
determine the present value of the asset in question.
The popularity of this method can directly be attributed to the fact that it is the
most scientific in its calculations. The economic income is determined using the
following parameters:

(1) Proposed earnings or savings done by the use of IP asset for remaining
useful life.

11 ‘Arm’s length transaction’ refers to the transactions involving two parties acting independently

possessing equal bargaining power. See generally WIPO, IP Panorama, Module 11: IP Valuation.
12 Brassell & Maguire, supra note 10, at 50.
13 Kelvin King, 7 The Value of Intellectual Property, Intangible Assets and Goodwill

245 (2002).
602 Dilip Sharma and Abhijeet Kumar

(2) Adjusting the earnings or savings against the investments made for the de-
velopment of the IP asset.
(3) Discounting the probable income to the value in the present day using a dis-
counted rate.14

Considering that there are multiple measures that come into play at different times,
therefore while the method is quite scientific, it becomes a task to actualize the
data for appropriate findings. For example, the remaining useful period, which re-
fers to the period of monopolistic commercial usage rights, is calculated from the
time when valuation is being done and the rate arrived at is discounted against the
future risks, such as inflation, liquidity, actual interest, premium against probable
risk, etc.

1. Discounted Cash Flow Method

This method is adopted by the companies in order to derive the present value of
its assets based on probable future cash flows, appropriated against the required
capital for discounting. The basis of the formula is that it relies on the fact that with
time, the value of the asset will change.

Example 2
An iPhone XI Pro will have higher value in 2020 than in 2023, because technology
would have advanced with newer models in the market and support for the present
model might not be available, all of which will affect its future value.

Example 3
Shares of a year-​old start-​up at initial public offering will have lower value in 2020
than in 2023 (presuming that the business was successful), because the brand
value, profit from business, and net worth has increased, all of which will affect its
future value.
For calculating the same it relies on the formula:

ECF
NPV =
(1 + R)t

NPV –​Net Present Value

ECF –​Estimated Cash Flow
R –​Rate of Discounting
t –​nth number of Year

14 Harald Wirtz, Valuation of Intellectual Property: A Review of Approaches and

Methods 40–​48 (2012).

 Methods for Intellectual Property Valuation 603

While ECF is an expected presumption that may be earned from the asset, the dis-
count rate is specific to the company. It depends upon the mode through which the
company obtains or manages its funds.15
Therefore, if an investor expects a return on equity instrument at 12 per cent,
then that may be the discount rate used for valuation of such instrument; or if a fi-
nancial institution charges an interest of 4 per cent on loan, then that may be used
for determining the discount rate used for valuation of such mortgaged asset.
In case of unavailability of the rate of discounting at the hands of the firm con-
ducting valuation, the most convenient and equilibrium model available is the Capital
Asset Pricing Model (CAPM), which takes into account the market trend for deter-
mining the rate of discounting. The formula relied upon by the CAPM represents:

R = R f + β[R m − R f ]

R –​Required rate (to be used for discounting)

Rf –​Rate in a risk-​free market
Rm –​Expected rate of return
β –​Beta Factor

The Beta Factor in the above example belongs to the condition of the market and
measures the risk accordingly. For a risk-​free market, β is Zero (0), while it is One
(1) in a market with standard risks. If the value of β > 1, then the risk involved is
more than that prevailing in the market, and if the value of β < 1, then the risk in-
volved is lesser than that prevailing in the market.

Example 4
A soft drink brand, Ole owned by Ole Inc., is willing to license its trademark in
a foreign jurisdiction to Moto LLP for expanding its business. Ole Inc. has been
using the mark for several years now and is regarded as a globally well-​known
mark, and the brand value has been increasing at a rate of 11 per cent annually,
which has been provided to Moto LLP as a matter of public record of accounts. Ole
Inc. has demanded an upfront premium of 100 million USD, for the license term
of three years. Moto LLP is expecting to earn a profit from licensing, of 20 million,
40 million, and 60 million in the next three years.

Query

Help Moto in negotiation by suggesting them with Net Present Value (NPV) of the
brand based on the expected cash flow and difference in profit as per NPV and pre-
mium demanded.

15 Amy Gallo, A Refresher on Net Present Value, Harv. Bus. Rev. (19 November 2014), https://​hbr.

org/​2014/​11/​a-​refresher-​on-​net-​present-​value (last visited on 22 April 2020).

604 Dilip Sharma and Abhijeet Kumar

Solution

As the return on brand value of Ole is 11 per cent, therefore the same could be used
for the rate of discounting.

ECF
NPV =
(1 + R)t

20 40 60
NPV = + +
(1 + 0.11) (1 + 0.11) (1 + 0.11)3
1 2

NPV = 18.01 + 32.46 + 43.87

NPV = 94.34

Profit for Moto LLP = ECF –​ NPV

= 120 –​ 94.34
= 25.66 (in million USD)

However, it is seen that the demand of Ole is more than the NPV calculated and
hence, the expected promise has been decreased by 5.66 million for Moto.

Example 5
A new processing chip has been invented (and patented) by Mr Rabbit which ex-
tends the boundaries of functionality for mobile phones. Oogle, one of the largest
tech company eyes on the invention for maximizing its profit. On approaching, Mr
Rabbit made an offer to sell the invention for 50 million. In order to have a favour-
able negotiation, Oogle realizes that it will require to determine the value of the
asset in the market at present time, based on the following information:

(1) Oogle expects a return of 50 million, 40 million, 30 million, because of the

usage of the chip in the next three years from the asset.
(2) Rate in the risk-​free market is 8 per cent.
(3) Oogle expects a rate of return at 14 per cent.
(4) Market has standard risk.
(5) Demand from Mr Rabbit is 50 million.

Query

Calculate the NPV of the new processing chip and suggest if the deal is beneficial
for Oogle or not.
 Methods for Intellectual Property Valuation 605

Solution

As Mr Rabbit, being an individual developer, doesn’t have a discounting rate avail-

able, therefore that has to be determined using the CAPM formula:

R = R f + β[Rm − R f ]

R = 8 + 1[14 − 8]

R = 14

Having the value of rate of discounting (R = 14 per cent or 0.14) in hand, along
with the estimated cash flow that the asset is expected to generate for the next three
years, the present value is calculated, using the formula provided by the discounted
cash flow (DCF) method.

ECF
NPV =
(1 + R)t

50 40 30
NPV = + +
(1 + 0.14) (1 + 0.14) (1 + 0.14)3
1 2

NPV = 43.85 + 30.77 + 20.27

NPV = 94.89

So, the NPV of the inventions is 94.89 million USD, and total expected earning
out of the same for Oogle is expected to be 120 million USD in the next three years,
as per the factual information provided at point (1).
Expected profit = ECF –​ NPV
= 120 –​ 94.89
= 25.11 (in million USD)
Therefore, upon this exercise, now Oogle knows that if Mr Rabbit demanded
a value equivalent to the NPV calculated, still Oogle would have made a profit
of 25 million in the next three years. However, as Mr Rabbit has demanded only
50 million (which is 44.89 million less than the calculated NPV, therefore the ex-
pected profit for Oogle out of this deal would be 70 million, during the course of
the next three years.
While the above example is illustrative of the fact that why Income Method is
most widely used for the purpose of valuation, it has to be noted that the outcome
606 Dilip Sharma and Abhijeet Kumar

so reached is not assured, but only expected, and depend highly upon the factors
which are taken into account for calculating the value.

2. Advantages and Limitations of Income Method

The income approach is desired as one of the best available method of valuation
for several reasons, such as its independence from reliance on any related market
for similar transaction; ability to forecast the probable revenue generation, or cost
saving, by the subject IP; provisions for discounting the risks systematically, while
calculating present value; and, its flexibility of utilizing the market portfolio for de-
termining the probable interplay between investment and expected return.
It is not all good with this method as well, and it has its own limitations. The
primary hurdle faced by valuers using this method is that the information re-
quired for carrying out the calculations is not readily available, and the valuer
has to rely upon the declarations made from the party involved. Another issue
generally pointed out by the IP holder, while using this method to determine
the value of their asset, is that application of the method, requires the holder
to allocate cash flow subjectively. It is also often stated that the whole process
of valuation using this method mostly relies on the valuer’s wisdom of making
assumptions for appropriate conversion of theoretical formula into practical ap-
plication thereof.
However, with the passage of time, certain new methods have been created
through case law or through the adoption of financial methods made for tangible
assets for valuating intangible assets.

IV. Modern Methods of Valuation

A. Monte Carlo Method

The limitations of the Income Approach is that it provides for a single NPV, which
is adjusted mostly by adopting the DCF method, with respect to the assessed risks.
While the approach does not fit the need when an early-​stage technology is required
to be valued, however, this method visualizes the NPV based on the best, worst, or
most likely outcome in the form of a frequency chart which is easy to understand.
The underlying problem is the presence of multiple probable scenarios, such as
rejection of application for protection, part protection of claims, impossible in-
dustrial application, undue hindrance caused by regulatory authorities, etc. The
occurrence of any of these scenarios changes the parameters by which NPV was
calculated and hence creates a demand for a variable NPV.
The solution to this issue is offered by the Monte Carlo Method. The appli-
cation of this method provides the valuer with simulations to run for different
possible scenarios in order to determine the possible NPV or to provide a range
 Methods for Intellectual Property Valuation 607

of NPV.16 It grants the valuer with the liberty to calculate a single value for the
assumptions or to make use of probability-​based distribution to create a range of
values, using different variables such as upper-​lower limit, calculating a standard
deviation or mean, etc.17
Upon identification of all the variables, the valuer applies the formula, mostly
through software which performs multiple calculations, wherein a specific value is
allocated to each variable depending upon the probability of outcome and range,
and unique NPV for each scenario is calculated using the DCF method.

B. Royalty Rate Method

The Royalty Rate Method is used to valuate an IP asset in case of licensing where
the royalty rates are negotiated between the licensor and licensee for the use of an
IP asset. Royalty under IPR regime is considered as a profit-​sharing mechanism for
the use of IP asset. It is also referred to as the fees paid to the owner for the use of
IP assets. The value of an asset can be determined based on the amount of royalty
received from it.18 Higher amount of royalty signifies a higher value of an asset. The
most important factors for ensuring high royalty rates are high profit margins, big
market size, and maximum market share of IP assets. However, it is inversely pro-
portional to capital expenditure incurred to commercialize the subject IP asset.19
The biggest challenge for using this approach is how to arrive at a reasonable roy-
alty rate? The analysis is generally based on the incremental profits derived from
the future commercialization of IP assets. Sometimes, it is also based on the estab-
lished royalty rates as per the industry specific standards if there is any, utilizing the
rule of thumb approach.

1. Rule of Thumb Approach

This classical 25 per cent rule of thumb was propounded by Robert Goldscheider.20
His approach is based on the assumption that in non-​litigious circumstances, par-
ties normally negotiate with each other to arrive at a suitable royalty rate which
approximately range between a quarter to one-​third of gross profits irrespective of
the nature of IP or industry. Many people consider this method as vague whereas
others use it to analyse and evaluate the results obtained from other methods.

16 See generally Peter Jackel, Monte Carlo Methods in Finance (2002).

17 It depends upon the valuer to adopt an existing distribution model (viz. uniform, exponential, tri-
angular, normal, etc.) or to create a custom distribution model.
18 A. Damodaran, IP and Finance: Accounting and Valuation of IP Assets and IP Based Financing,

WIPO INTERNATIONAL, https://​www.wipo.int/​edocs/​mdocs/​sme/​en/​wipo_​smes_​bwn_​13/​wipo_​

smes_​bwn_​13_​13_​damodaran.pdf (last visited 22 April 2020).
19 Akshat Pande, Valuation of Intellectual Property Assets (2010).
20 Robert Goldscheider, The Classic 25% Rule and the Art of Intellectual Property Licensing, 6 Duke

L. & Tech. 1 (2011).

608 Dilip Sharma and Abhijeet Kumar

While the Federal Circuit Court squarely rejected the ‘rule of thumb’ approach in
the case of Uniloc USA, Inc. v. Microsoft Corp.21 for being fundamentally flawed for
determining royalty rate, however, this method is often used as a starting point for
analysing the reasonable royalty.

2. Hypothetical Negotiation Method

This method is generally used by courts in cases of infringement to derive the
reasonable royalty rate for the unauthorized use of IP an asset based on a hypo-
thetical scenario. This approach is based on the hypothetical negotiation between
two frictional parties (infringer and proprietor of the IP asset) assuming that both
the parties are willingly entering into a licensing transaction under given circum-
stances. The negotiation is done considering the time and situation immediately
before the occurrence of the first infringement. In the case of Georgia Pacific Corp.
v. US Plywood Champion Papers Inc.,22 the court laid down fifteen factors for de-
termining royalty in an infringement case. Most of these factors can also be used in
determining the royalty rate in other circumstances such as licensing, assignment,
etc. A few of the most relevant factors laid down in this case are as follows:

(1) Nature of the invention.

(2) Expected derived profits from the use of IP asset by infringer.
(3) Loss caused to the proprietor of IP asset.
(4) Royalty rates in other licensing agreements of the subject asset.
(5) Time and duration of infringement.
(6) Remaining tenure of protection.

Under the hypothetical negotiation method, the total benefits will be divided
among the proprietor of the IP asset and the hypothetical licensee to arrive at the
royalty rate considering the scenario where they would have actually entered into
the licensing agreement before the occurrence of infringement.

C. Loss of Profit Calculation Method

This is another famous approach used by courts to evaluate the quantum of dam-
ages granted to the proprietor in case of infringement. This approach was developed
on the principle that it is not fair to award the same royalty in case of infringement
which would have been negotiated between parties under the hypothetical nego-
tiation method. According to courts, the damages in case of infringement should

21 Uniloc USA, Inc. v. Microsoft Corp., 632 F.3d 1292 (Fed. Cir. 2011).
22 Georgia-​Pacific Corp. v. United States Plywood, 446 F.2d 295 (2d Cir. 1971).
 Methods for Intellectual Property Valuation 609

ideally be higher than the royalty rate so this method was evolved to evaluate the
appropriate damages in case of infringement.23
This approach is based on ‘but for’ analysis where monopoly profits are calcu-
lated in a hypothetical market in absence of any competition or infringement.24
To calculate the loss of profits in any market, the courts consider three important
factors which include: elasticity of demand in relevant market; profitability; and
market share. This approach also factors in the market share of participating
entities while identifying the share of the infringer and proprietor to calculate the
monopoly profits. At last, the loss of profit will be calculated by deducting the cur-
rent profits from the monopoly profits. Loss of profit method is widely appreciated
for granting incremental damages in case of infringement.

D. Decision Tree Analysis Method

The decision tree analysis (DTA) method is used to valuate an IP asset at different
stages in its life such as from its creation to registration to commercialization to
expiry or infringement to dispute resolution. This method is generally considered
as an improvement or extension of the income method. The issue with the DCF
method is that it lacks flexibility in decision making as it considers the same risk
factor throughout the life of an asset.25 The risk associated with an IP asset keeps on
changing with time at different stages during its tenure. In the DTA method, dis-
count rates are relatively low as risk is dealt at various stages, rather than by heavy
discounting at once.26 For example, the risk factor post registration will be lesser
than at the time of filing of application for registration due to chances of rejection,
or opposition, etc. Hence, it is not fair to apply the same risk rate at every stage.
The DTA method considers the risk involved in every stage for valuation and
decision-​making. This method provides a highly effective step by step structure
by analysing the outcome at every stage. This helps the proprietor in taking appro-
priate decisions for commercialization and exploitation at different stages during
the life of an IP asset.
The DTA method is based on an underlying DCF analysis of each branch.27
This method works on the assumption that every decision has a significant effect
on the future value of an IP asset. The analysis starts with a graphical representa-
tion of the decisions or alternative outcomes that can affect the overall value of an

23 William J. Murphy et al., Patent Valuation: Improving Decision Making Through

Analysis 279 (2012).

24 Pande, supra note 19.
25 Id.
26 John F. Magee, Decision Trees for Decision Making, Harvard Business Review (July 1964),

https://​hbr.org/​1964/​07/​decision-​trees-​for-​decision-​making (last visited 22 April 2020).

27 D. Bosworth, The Management of Intellectual Property 276 (2006).
610 Dilip Sharma and Abhijeet Kumar

Litigation
Infringment 80%
Successful 60% Settlement
Successful Registration
Uninfringed 20%
Examination/ 70%
Acceptance 40%
of Opposition
Registration
Application 55%
Product X Rejection
(Patent) 80% Rejection 30%
Rejection 45%
20%

Figure 38.1 Decision Tree Model for Product X Representing Probability Percentage
at Various Stages

asset. It showcases the development over a period of time with expected outcome
by selecting discount rates appropriate to the risk associated at various stages in a
property’s life.
The above diagram showcases an example of a patent X with its complete de-
cision tree model. The model provides for all possible outcomes, along with risk
probability at different stages. After drawing this decision tree model, the next step
is to analyse the tree to find out when the subject IP is most worth for the propri-
etor at different stages in different scenarios. In Figure 38.1 (above), the probability
of each outcome is represented by percentage. The total percentage at every stage
must be equivalent to 100. Based on the assigned percentage, the value of the IP
can be calculated at each stage using the DCF method and accordingly decisions
can be made in the best interest of the proprietor. Considering the various options
and risks involved in the life of an IP asset, this approach is presently considered as
the best approach for the valuation of an IP asset. This method can also be used to
analyse the contingent claims based on the probability of occurrence of favourable
events, at any given point of time.

E. Contingent Claim Analysis

While the original valuation method is utilized by the financial market for
evaluating the probability of default by a firm by evaluating the prevailing price in
the market for its debt and equity, an offshoot of this theory has been discussed to
be applicable for the valuation of IP assets.
Two primary issues which a purchaser of such IP assets considers are:

(1) Considering the unpredictability with regard to unhindered enjoyment of

the asset, how much could be the variation in the future value of the asset?
 Methods for Intellectual Property Valuation 611

(2) On occurrence of certain circumstances affecting the value of the asset, what
would be the minimum return on investment required from the asset? 28

Absolute monetization of an IP asset is contingent on several happenings. Prior to

registration, an IP asset faces procedural and administrative contingencies, such as
amendments, modifications, pre-​grant oppositions, etc. Similarly, if such IP assets
are already registered then there are contingencies like infringement, left over pro-
tection period, technology becoming obsolete, etc. These contingencies may lead
to partial or complete non-​usage of the subject IP asset, and therefore depending
upon the stage when the transaction is happening, such contingencies are required
to be factored in while valuation.
One may get this confused with the DCF method, however, the difference lies
in the fact that the DCF method does not grant liberty to the valuer to drop such
contingencies (or events) which are not going to happen because of the passing
of their respective stage. For example, for an IP which is already registered, risk
of failure of registration will still be factored in the DCF method; however, in the
Contingent Claim Analysis method all risks prior to registration will cease to affect
the value. However, the formula to conduct the valuation using this method re-
mains the same as explained in DCF.

V. Conclusion

The most important aspect of valuation of IP is that the nature of assets and risks
involved, along with the aim with which the party is conducting valuation, deter-
mines which method of valuation will be adopted. It, however, is also considered
that because a lot of assumptions, based on the wisdom/​experience/​knowledge of
the valuer goes into determining the worth of asset, therefore it is advised that the
valuer should always consider valuation using more than one method for deter-
mining the best value.
The answer to the question that which methods are most suitable for valuation
of a particular type of IP asset, primarily depends upon its uniqueness, availability
of related information, purpose of valuation (if it is for sale, purchase, or licensing
and is being done on behest of the granting or procuring party) and last but not the
least, on the intelligence and good sense of the valuer.
However, the challenges for valuation of IP assets are as novel as the assets them-
selves. Meaning as the technology progresses, so does the complications for the

28 See generally 39 I. Karatzas & S.E. Shreve, Contingent Claim Valuation in a Complete

Market (1998).
612 Dilip Sharma and Abhijeet Kumar

valuer, as it leads to overlap of domain of IP under which the asset is being pro-
tected, or being considered for the same. An example to understand the same
could be protecting the smell of a cologne, which while in some jurisdiction being
provided protection as a trademark while in other is required to be represented in
its chemical composition for protection, which may or may not have any protec-
tion, leading to be kept as a trade secret. It is the complexities developed in such
scenarios which require the experience and wisdom of the valuer to play a decisive
role in providing the asset with the optimum value.