Table of Contents:
Introduction to Patent Valuation
Patent valuation is the process of determining the actual market value of a patent or patent portfolio. Patent valuation is required when companies or inventors negotiate deals such as mergers, acquisitions, sales, or licensing of patents.
A Patent valuation can be performed using one of three approaches: the market approach, the income approach, or the cost approach. Although each approach differs depending on the type of patent transaction, the Market Approach is one of the most widely utilized to estimate a base cash value or damage appraisal in the event of an infringement.
Cost Approach to Patent Valuation
According to this approach, the value of a patent is the replacement cost, or the amount required to replace the protection right on the invention. The replacement cost of an item is the amount of money that would be paid today to replace the item. If an inventor has patented an item, the patent's value is the amount of money required to replace that invention. A prospective client would not be willing to pay more for a patent than the cost of obtaining an equivalent protection right.
Income Approach to Patent Valuation
This method relies on future cash flows in determining the valuation. It states that the value of a patent is the present value of the additional cash flows or cost savings that it will help provide. When a company or individual develops a product with the potential to be patented, the underlying hope is that the patented product will increase sales or, at the very least, be a cost-saving measure in the company. According to this approach, the patent's value is the current cash value of these future benefits.
Based on an income approach, there are basically four different methods for evaluating intangible assets, each of which allows for a different way of isolating the specific cash flow for the relevant intangible asset. In general, these methods are equivalent. In some cases, one method may be better suited than another due to the importance of the specific intangible asset to a company or the fact that the information required for the application of one method may be difficult to obtain. The following methods are applicable within the income approach:
Direct Cash Flow Prognosis Method
Incremental Cash Flow Method
Multi-Period Excess Earnings Method.
Market Approach to Patent Valuation
This method entails determining what a willing buyer would pay for comparable property. In other words, the patent's value is roughly equal to the value of previously sold and purchased similar patents or patented products.
For this approach to be used for patent valuation, two conditions must be met:
Existence of an active patent market, or one similar to it
Comparable property transactions in the past
When looking for comparable patents, look for similar values for the following items:
Features of the industry
Market share or potential market share
Prospects for growth
Fig: Valuation Approaches and Valuation Methods According to the IDW ES 5 Standard
Patent value is calculated using a number of different factors similar to tangible products such as cars, phones, and houses whose market price is meticulously calculated using a variety of different factors such as labor cost, overhead cost, market dynamics, product originality, and competitor's position. The number of different questions when evaluating patent includes but is not limited to-
What does it mean in terms of importance and criticality for a certain technology domain?
What is the estimated level of reliance on the patent for currently accessible products?
Is the patent for a brand-new invention?
Is patent safeguarding an important feature of a well-developed technology?
Is the patent becoming obsolete and being replaced by newer technology?
Is the patent application restricted to a certain field of application?
Is there any lateral technology that can solve the same issue of placement ease?
What is the size of the relevant industry?
Within the relevant technology domain, how crowded is the IP?
The answer to any of the above questions can change over the course of a patent's life, increasing or decreasing the patent's value at any one time. As a result, portfolio managers must proactively monitor the patent portfolio for relevant patents that may be monetized at the appropriate time. Let us discuss several factors that play a part in assessing the profit-making capacity of a patent or a portfolio.
Nature and Scope of the Patent
Some patents' practical exclusive effect is limited to specific industries, markets, or products. Patents limited to incremental improvements within a market subsection may have fewer resulting income streams and thus a correspondingly limited value in some circumstances. Others may be broader in scope and applicability, providing practical and commercial value in a variety of industries, markets, and products. These may be especially advantageous because they have the potential to generate multiple income streams. In this case, for example, the patent owner may retain its rights under the patent in one field while simultaneously licensing it to another company in another field, thereby maintaining its own revenue stream without interruption while gaining additional revenue from sales by another company in an unrelated, non-competing market.
Size of the Market for the Product
Patents that provide a highly specialized improvement to existing technology or that support a niche product may have a relatively limited value in some cases. Patents that contribute to products with a broad market appeal or that represent a significant improvement to an existing product in an established market, on the other hand, are likely to generate significant economic returns. As a result, the commercial value of a patent may be determined in part by the size and nature of the market for the product to which the patent relates.
The “Pioneering Patent” and the Proximity of Competitors
Many patents are for minor or incremental upgrades to existing products or technologies. These enhancements may be quite valuable on their own, but they may be relatively less valuable in comparison to existing, alternative, market-acceptable means of accomplishing the same thing.
Patents that are considered pioneering patents, i.e., those that create entirely new industries, markets, or product lines, are rarer but often more valuable. Aside from pioneering new fields of endeavour, pioneering inventions may enjoy broad scope, both literally and under the doctrine of equivalents, due to the scarcity of prior art. Furthermore, the pioneer patent holder may benefit from a first-mover advantage that competitors cannot easily or quickly replicate. If properly prepared and prosecuted, those patents may provide a relatively broader scope of protection as well as the potential for a long-term competitive advantage. They can be especially useful for these reasons.
Another factor that can affect a patent's profitability is the profitability of the industry in which the patented technology is used. A thorough analysis of patent value might begin with defining the market in which the patent operates and developing an understanding of the market's dynamics. Some industries are more profitable than others due to inherent factors. The "five forces'' analysis is a useful framework for assessing an industry's profitability. The five forces are as follows:
The possibility of new entrants - Industries with high entry barriers are more profitable than those where startups can compete with established companies quickly.
The availability of substitute goods or services - If the industry's technology is the only established and market-accepted solution to the consumer's need, that industry will be more profitable than industries that provide one of many competing products or services that a consumer can easily switch between.
Customers' relative power - Many factors can influence buyer power in relation to provider power. Price sensitivity, bargaining power, customer knowledge, customer loyalty, switching costs, and the degree to which buyer decisions are independent or aggregated are examples of these. All else being equal, markets in which customers have more power tend to be less profitable than markets in which customers have less power.
Suppliers' relative power - Each company in an industry, is not only a provider of goods and services but also a buyer of inputs such as specialized labour, raw materials, technologies, and distribution bandwidth. As a result, the power relationship with suppliers, like the power relationship with customers, may have an impact on profitability.
The Intensity of competition - In some industries, competition between competing firms is fierce, whereas, in others, competition is less intense or, in the case of monopolies, non existent. Some industries even see some cooperation between ostensible competitors. In general, the more intense the competition among firms, the less profitable the industry.
There are several individual reasons or motivations to conduct an IP valuation. The reason or purpose of the valuation is referred to as the valuation triggers. The table below includes some of these valuation triggers:
The Patent Evaluation Process Using Artificial Intelligence
A number of companies have lately updated their evaluation tools to include the ability to evaluate the value of a patent. Academic research implies that a patent's forward citation count – and other patent-related features – can be a measure of a patent's level of technological importance and an acknowledgment of the patent's value by others.
Thomson Innovation, Innography, Patent Ratings International, and Randolph Square IP are among the companies that have introduced software to automate the evaluation process. Some of these firms promote their services by claiming that their algorithms can predict "patent value and relevance" or "make certain predictive assessments about the quality and likely value of other patents." These algorithms commonly rely on citation velocity, forward and backward citation counts, and claim length.
The evaluation process is divided into phases, similar to the standard appraisal procedure; however, the diligence and analytical phases are shortened. The analysis step appears to be based solely on the notion that an analyst may determine value by comparing a patent's features to those of other patents of known value. As a result, the due diligence process may be confined to gathering only the data contributing to this narrow analysis scope.
Reports generated from automated evaluations provide other information that may be relevant to a patent owner, such as a list of companies that cited the patent-at-issue, the number of forward citations received, and landscape analysis of comparable patents, in addition to the results of financial analysis.
In general, artificial intelligence algorithms work by first locating patents with known royalty rates and/or dollar values through public sources. Simply put, the software uses a valuation multiple to link observed market prices to the patent's qualities (e.g., the number of forward citations per dollar of value). The algorithm then multiplies the properties of the patent-at-issue. The algorithm might value the patent-at-issue at $2 million if a set of related patents has five forward citations per million dollar of value and the patent-at-issue has ten forward citations.
The Benefits of Using Artificial Intelligence
When implemented correctly, artificial intelligence has a number of advantages. Software programs can be a more cost-effective, faster, and convenient way to evaluate some parts of a patent than hiring an expert to do a human examination.
The software solutions can give patent owners information they can utilize to quickly discover prospective licensing leads and provide a rough, quantitative result. Patent owners can use the applications to compare their portfolios to those of other companies. For instance, the software may be used to compile a ranked list of a competitor's most important patents. Furthermore, a software tool may enable patent owners to discover trends in innovation (e.g., white space analysis) that can be used by firm management to drive R&D activities.
The above-mentioned uses for patent evaluations are typically based on bibliographic data directly pulled from patent office databases (such as the United States Patent and Trademark Office), such as the names of companies that cited the patent-at-issue, the number of forward citations received, and a list of comparable patents. A software package based on algorithms could be an excellent beginning point for patent holders who don't need a complete appraisal of a patent's monetary worth but instead prefer to start with a high-level, qualitative examination.
The Limitation of an Automated Approach
The software-based evaluation process implements only a form of the market approach when estimating value. While versions of the market technique might be valuable and are frequently used by appraisers, they can have some drawbacks. For one thing, patents are one-of-a-kind, making it difficult to identify and rely solely on comparable asset pricing. Second, because the vast majority of transactions are conducted privately, transactional data is limited. In view of these possible flaws, using market approach results in conjunction with an income approach and/or cost approach is an industry-recognized best practice (to the extent that such approaches provide reliable indications of value).