Still A Long Way To Value-Based The Patent Valuation Practices Of Europe’s Top 500

By Martin A. Bader and Frauke Rüether

nnovations and make important contri- sized the importance of innovations and patents for butions towards corporate success. A survey on corporate success. Innovative products account for I the top 500 patent applicants of the European 66 percent of the interviewees’ turnover and for Patent Office on behalf of PricewaterhouseCoopers 60 percent of their profits. Patents, which are one conducted by the Institute of Technology Manage- segment of the overall field of innovation, are also ment at the University of St.Gallen, Switzerland and held in high esteem as drivers of success. Fifty-eight its innovation and intellectual property management percent of the interviewees confirmed the impor- advisory spin off BGW reveals the status quo of valua- tance of patents. Correspondingly, 57 percent of the tion procedures and methods. companies interviewed indicated that value-oriented Success Factors for Companies innovation management is firmly entrenched in their Since innovations are of immense significance in organization; only 12 percent answered this ques- the attainment of a competitive edge today, their tion in the negative. protection may create durable corporate success. To determine the contributions of patents to Innovations and patents are therefore considered to corporate success patents should be managed and be success factors for companies of all sizes and in- valued. This could happen through monetary and dustries. In view of companies’ increasing capital re- non-monetary valuation methods. While the costs quirements, and growing exploitation opportunities for the issuance of a patent can be determined with on inter-national financial markets, patents are also of relative ease, the actual valuation of a patent requires considerable interest for stakeholders and investors. an appropriate set of tools. Monetary valuation can Accordingly, the management of immaterial assets is be carried out with the help of capital value, market an important element of strategic management that price and cost oriented methods (a more detailed is constantly increasing in significance. description is given in the last sections of this article). As a consequence of the introduction of the In- This high number of methods, combined with the ternational Financial Reporting Standards (IFRS) and non-standardized specific procedures they involve, the palpably increasing interest of the capital market result in a great deal of uncertainty in the valuation in immaterial assets, a Europe-wide study was con- of patents. ducted seeking to investigate the status quo of patent valu- Figure 1. Monetary Valuation Methods By Needs ation in corporate practice. The questionnaire was sent to the top 500 Europe-based 36.4% Disputes 43.2% patent applicants before the 20.5% European Patent Office. In 34.0% particular, the investigation Transfers 31.9% focused on the current gen- 34.0% eral importance of technolo- 35.7% Taxation 28.6% gies and patents, valuation 35.7% motives and valuation meth- 42.9% ods in companies, and the Accounting 21.4% position of the value-oriented 35.7% management of technologies 24.4% Management 31.1% and patents. 44.4%

Status Quo of Valuation 0% 10% 20% 30% 40% 50% in Europe Number of mentions (%) More than 90 percent of the interviewees empha- Income-based approach Market approach Cost-based approach

121 les Nouvelles Patent Valuation

The results with regard to monetary valuation potential values in patents. methods came as a surprise. For one thing, the in- The path from a currently dominating risk and terviewees indicated that monetary valuations are cost approach in patent portfolio management and conducted relatively rarely. For another, 44 percent patent valuation to an at least application dependent of the companies stated that they use a cost oriented opportunity and market or income based approach valuation process, sometimes even for management still seems to be steep and breathtaking for Europe’s events (see Figure 1). top enterprises. Cresting this task aids to manage This result is surprising since particularly the man- patents and patent portfolios suitable and also fosters agement who frequently asks to be informed about the utilization of patents. the potential value contribution of their patents will Appendix: Valuation find it difficult to infer it from this method. It is also Approaches ■ Martin A. Bader, BGW AG surprising in the light of the importance of value- As a final comple- Management Advisory Group, oriented innovation management. tion to the interested St. Gallen-Vienna, Even if all the monetary valuation processes are ap- reader, some general Managing Partner, plied more frequently or more rarely depending on information is given in the various occasions, there appears to be a wide the following about the Rorschach am Bodensee, dispersion of their application (see Figure 2). On the state-of-art in valuation Switzerland strength of this wide spread it can be deduced, how- approaches. E-mail: martin.bader@ ever, that cost and market-price-oriented processes In order to valuate in- bgw-sg.com tend to be used as specialized instruments, whereas tangible assets, in prin- ■ Frauke Rüether, Institute of capital-value-oriented procedures tend to fulfill more ciple, three valuation of a broadband function. approaches can be used Technology Management, Still a Long Way To Go (source: IDW ES 5): University of St. Gallen The results of the study thus confirm that patents a) market approach, Research Associate no longer are solely used for protection but started to b) income approach, St. Gallen, Switzerland be seen as a corporate success factor and as an asset. c) cost approach. E-mail: [email protected] Even though companies are more aware of patents and their value proposition, the study’s results identi- Within these ap- fied still many problems and uncertainties regarding proaches, several valuation methods can be applied the valuation of patents. The uncertainty in valua- (see Figure 3). tion methods leads not only to a loose management a) Market Approach of patents but also to insufficient utilization of In case a reason for valuation calls for a valuation which draws on market prices, this is generally only possible Figure 2. Occasions for Valuation of Patents and Technologies if and to the extent the market prices concern sufficiently comparable assets. In addition, 1 (never) 2 3 4 5 (often) the market concerned must Maintenance of patent PF be active. Compensation of employee Control of R&D A market is active if all Distribution of budgets the following conditions are Cross-licensing fulfilled: Strategic alliances a) the goods in the market are Purchase/sales of company homogenous; External reporting Compensation for damages b) purchasers and sellers will- Loan collateral ing to enter into agreement Voluntary information can generally be found at any Debt/Equity financing time; and Liquidation, insolvency c) prices are publicly known. Transfer pricing Transfer of functions Since intangible assets are 40.0% 20.0% 0.0% generally not traded in active % of mentions unknown markets, it must be deter- mined whether comparable

June 2009 122 Patent Valuation

Figure 3. Valuation Approaches and Valuation Methods such an asset. In exceptional According to the IDW ES 5 Standard cases, revenues in perpetuity may be considered in case the useful life of the asset is suffi- Approaches Market Approach Income Approach Cost Approach ciently long so that it becomes irrelevant whether the present Market Prices in Direct Cash Reproduction value of a limited series of cash Active Market Flow Prognosis Cost Method flows is considered or whether the present value of cash flows Methods Analagous Relief-from-Royalty Replacement in perpetuity is considered. method Method Cost Method The income approach al-

Multi-Period lows valuations from different Excess Earning perspectives. Aside from stan- Method dardized concepts of value, Incremental e.g. the fair value, which are Cash Flow relevant for company external Method objectives, it is possible to in- clude individual and subjective transactions can be drawn upon for the valuation of components and thereby reach strategically relevant an . By means of analogies a compari- decision values. This is relevant in cases in which son between the observable price for a comparable the valuation is carried out not only for tax or ac- object and the value sought for the (to be valuated) counting purposes, but for example shall be used intangible asset can be made. Since adequate data for a purchase price finding or shall facilitate other from comparable transactions are very rarely acces- decision making processes. sible, it is necessary to provide a detailed background There are basically four different methods to evalu- and reasoning for the choice of comparable transac- ate intangible assets based on an income approach tions and the key indicators deducted therefrom. each of which allows for a different way of isolating b) Income Approach the specific cash flow for the relevant intangible asset. The income approach is based on the assumption These methods are generally equivalent. In individual cases, one method or the other may be better suited that the value of an intangible asset results from the than another due to the importance of the specific future success which will be generated by the asset intangible asset for a company or the fact that the in the form of cash flows. information required for the application of one spe- The value of an asset is considered to be the sum of cific method may be difficult to come by. the present value of the future cash flows that can be Within the income approach, the following methods generated as of the day of valuation (Discounted Cash are applicable: Flow) from the use of the intangible asset within the expected economic useful life and possibly its divest- • Direct Cash Flow Prognosis Method, ure/disposal. The central tasks within a valuation are • Relief-from-Royalty Method, therefore the prognosis of the cash flows relevant for • Incremental Cash Flow Method and the valuation and the determination of the capitaliza- • Multi-Period Excess Earnings Method. tion interest rate/capitalization cost rate depicting c) Cost Approach the risk of the concerned intangible asset. The third approach for the evaluation of intangible A major task in connection with the valuation of assets consists of the Reproduction Cost Method single assets is isolating the specific cash flows that and the Replacement Cost Method. However, this can be credited to the asset to be evaluated. These approach has a major conceptual weakness since it is cash flows are a type of added value to the cash flows not use driven and since the data used always refers that could be generated without the specific asset. to the past. For these reasons, the cost approach The planning period for the cash flows is to be for the valuation of intangible assets can generally based on the economical useful life of the intangible only be used to verify plausibility or to determine asset or its remaining useful life. The useful life of minimum price thresholds, e.g. in purchase price intangible assets is usually limited wherefore a valu- negotiations. ation may not consider revenues in perpetuity from In applying the cost approach, either the costs

123 les Nouvelles Patent Valuation required to create an exact duplicate of the asset T; Lohwasser, E.; Menninger, J. (2008): One Valuation in question (Reproduction Cost Method) or the Fits All?—How Europe’s Most Innovative Companies costs for the manufacture or acquisition of a use- Valuate Technologies and Patents. Munich. equivalent asset (Replacement Cost Method) can BGW (2007): Glossary Practice of Valuation of be used. It has to be verified whether discounts Technologies and Patents. St. Gallen, Vienna. are to be applied to properly consider economical, Gassmann, O.; Bader M.A. (2007): Patentmanage- technical or functional obsolescence. ment. Innovationen erfolgreich nutzen und schützen. The depreciation must be oriented towards the ex- 2nd edition, Springer: Berlin. ■ pected useful life defined by economical criteria. IDW ES 5 (2006): Entwurf IDW Standard: Grund- References sätze zur Bewertung immaterieller Vermögenswerte Bader, M.A.; Beckenbauer, A; Gassmann, O.; König, (IDW ES 5). http://www.idw.de/

June 2009 124