The advent of the digital age has brought along new business processes and technology that run organizations. Globalization has since taken root in concepts of products development and service delivery and thus companies are able to have operations in almost every corner of the world. Nations are now able to take advantage of such worldwide business opportunities in order to increase profits and revenue. However, this global nature of business has brought along its fair share of problems. There is new wave of competition in the market by companies consistently innovating new products to meet consumer needs. This cut-throat competition has led to commercialization, development and production of products based on ideas. Thus the corporate world is engaged in efforts to ensure that their ideas are not infringed by competitors. Cases have been lodged in courts and other instruments of retribution due to lost revenue from infringement of original ideas. This valuation and commercialization of ideas has taken center stage in today’s business forum. This research paper evaluates the current state of intellectual property as it would propose to Acme’s upper management. The paper will provide a succinct analysis of the increasing importance of intellectual property and the different methods that can be used to value such an intangible asset.
The rise of Intellectual property in America
The word intellectual property may not have caused much concern among CEOs in the 1980s. In fact any matter regarding common laws and infringement was a matter left to the company attorneys. At the time companies concentrated on matters such as trademarks, patents, copyrights and other legal aspect of tangible assets besides intellectual property. However, the introduction of the computer age introduced new products that were highly intangible. Such products included software, the internet and other things such as online advertisement. The idea of owning knowledge based property and the possibility of making revenue from the same introduced the concept of intellectual business.
This rise in knowledge economy meant intellectual property would soon provide the future direction of a company in diverse ways. This is so because innovation and creations means that businesses are able to produced differentiated products and this difference in products could be the definition of profits and increased market shares . The evolution of knowledge-based property has been defined by the twenty key innovations that have now defined current day business. Some of these innovations include the discovery of cell phones, the discovery of the Hepatitis-B vaccine and the discovery of MS-DOS . According to Barrett (2008) these innovations led to the seven types of intellectual property. These include trademarks, copyrights, designs, patents, know-how, trade secrets (confidential information about the production process) and databases (knowledge on distribution and marketing methods). Holland, Reed, & Lee (2007) assert that in a recent analysis of the fortune 500 companies, intellectual property now constitute nearly 75 percent of the worth of the companies. This figure was about 20% 20 years ago. This illustration simply underpins the nature of the importance of intellectual property.
With this realization, there is consistent clamor by big multinational corporations and other big businesses to buy out small and undervalued companies that have innovative ideas. In the new millennium, there is evidence increasing rates of buy outs and mergers . This allows big corporation to increase their marketing strategies on such new ideas and make revenue out of them. Companies are constantly reviewing the business prospect and opportunities that may accompany a new idea. Thus there are several matters that a company must consider before committing to buy an intellectual property.
A company must first evaluate the possibility of a merger or acquisition of a candidate organization. However, before such an analysis, the company must first be able to identify and prioritize the assets that would drive business and value. In this sense, the organization seeking to purchase the idea must be able to identify the potential of the intellectual property and how it would drive value. Thirdly, the company must be able to define the financial implication of the intellectual property in terms of maintenance, commercialization and donation . An analysis of the possibility of research and development is also essential in future valuation of the ideas under review. All these issues point to the fact there is need for a thorough analysis of the processes and methods of valuing intellectual property.
Methods of Valuation
There are several methods that have been developed by business experts that can be used to value an intellectual property. These methods vary from the future incomes to current state of the target market. There are several approaches used in these analyses as will be discussed next.
Income methodology
As the name suggests, this is a method of valuation based on futures income that would be derived from a particular piece of intellectual property. This implies that an analysis of the forecasts and prediction of future market behavior is vital. According to Bainbridge, (2009) some of the possible areas of analysis could include an estimation of the income stream from either sales of the product or licensing fees gained from the property. A second analysis could be an estimation of the duration of the patent economic usefulness. Additionally, a review of the threats or risk associated with the product should be included in the income valuation.
In this particular method of valuation, it is very vital to provide a succinct analysis of the risk that is inherent in the intellectual property concept. Barrett, (2008) argues that, the ideals and nature of intellectual property is subject to several risks that an organization must be conscious about. One of the key risks associated with intellectual property in the issuance of a patent on a new idea. The ideas behind in intellectual property are in most cases time bound. In general, the issuance of a new patent on a new concept simply renders the existing technology obsolete. Additionally, there is no knowing all the cases waiting for patent approval at the U.S. Patent and Trademark Office (USPTO). This implies that, while an organization may be acquiring a patent, there could another under review that would automatically make the intellectual property valueless.
The second risk associated with intellectual property is challenges to the patent or a declaration that it’s invalid. An issued patent is always accessible to the public and thus remain open to challenges from any person. Typically, challenges to a patent arise from persons other than the inventor and any grounds that could suggest infringement could render it invalid. This implies that the organization must thoroughly evaluate the concept presented by the intellectual property before committing any resources to it.
The third risk that is associated with intellectual property is patent infringement suits. The ideals and principles behind the concept of intellectual property is originality in concept. Thus suits from lack of originality are one of the common risks that accompany intellectual property and any findings of possible infringement render the patent invalid.
Discounted Cash Flow Method
The second method that may be employed in determining the value of an intellectual property is computing the cash flows by discounting present value methods. This method estimates the economic useful life of an asset and discounts the current earnings of the property to future cash flows. The rate used for discounting is usually based on increasing free cash flow from the patent. In this sense, the company is able to determine the amount and the rate of increase from the said patent.
The advantage of this method is that it is possible to evaluate the value of difference in patents based on the discounted incomes. Additionally, a company’s past a financial performance is a sure way of providing reliable estimates in determining the value of the patent. However, discounted rats method has a major drawback. This drawback emanates from the fact that the discounted rate used does not take into consideration individual risks associated with each patent. In essence, all risks are lumped together and are assumed to have equal effect on the discounted rate .
Relief from royalty method
The relief from royalty method is based on the deprived value theory. In this method, a company would evaluate the amount of income that it would be ‘deprived’ if it did not own the property. Thus to mitigate the lack of property; the company would look to somehow ‘rent’ the property. This rental charge, like it would apply on fixed assets, is considered the possible value of the intellectual property. In case of intellectual property, the rental value refers to the royalty that would be paid to the licensor if such a theoretical situation would the reference.
However, obtaining the royalty value is just but the first step in determining the value of the intellectual property. A reliable sales forecast is equally vital in determining the value to the intellectual property so as to find a viable value for the royalty payments.
Other costing methods
There are other methods that can be used in determining the value of an intellectual property. One of these methods is the market comparables of the property. This is perhaps one of the simplest methods that can be applied in theory. Here a company simply takes a market research of the value of similar intellectual properties and provides an estimate. However, this method has been found to be generally flawed due to the fact that no two intellectual properties have a similar value . Additionally, the requirement that each patent bears a unique component throws the market comparable method into disarray.
Historic costing method
In this method of valuation, the developing company costs the intellectual property by summing all the resources that have been directed to the development of the property. This allows the company to sum up all the cost used in research and development and possible incomes forgone apparent to the intellectual property.
Conclusion
The idea of knowledge based businesses has introduced the concept of patents that are worth huge amount of money. Acme’s upper management must undertake different valuation methods to arrive at a proper valuation for an intellectual property.
References
Bainbridge, D. (2009). Intellectual Property. Toronto: Pearson Longman.
Barrett, M. (2008). Intellectual Property. Chicago: Aspen Publishers Online,.
Financial Consulting Group. (2000, May 29). Intellectual Property Valuation. Retrieved May 5, 2012, from accounting.smartpros.com:
http://accounting.smartpros.com/x7594.xml
Holland, C. J., Reed, D. M., & Lee, S. H. (2007). Intellectual Property: Patents, Trademarks, Copyrights and Trade Secrets. Boston: Entrepreneur Press.
Parr, R. L., & Smith, G. V. (2005). Intellectual Property: Valuation, Exploitation, and Infringement Damages. New York: John Wiley & Sons.
