One method to determine the market value of Intellectual Property assets like patents, trademarks, and copyrights is to use IFRS 13 Relief from royalty method (also known as Royalty avoidance approach or Royalty Relief approach). This approach determines the value of Intellectual Property assets by estimating what it would cost the business if it had to purchase the Intellectual Property (IP) it uses from an outsider. Other valuation methods are provide here.
This approach requires the valuator to
- project future sales of the products that use the technology,
- determine an appropriate reasonable royalty rate, and
- determine either a present value factor or an appropriate discount rate.
The result is the present value of the Intellectual Property to the company. See the following example of the valuation of a patent: Relief from royalty method.
The valuation of a patent is similar to other intangibles, in that computations principally focus on earnings ability. There are many issues that affect patent valuation:
- A new patent on a new product or process has no history of earnings.
- A patent may have a history of earnings although the history may or may not be indicative of the future.
- In valuing patents, the analyst may have the following questions:
- Are there comparable patents?
- What are the royalty rates paid for comparable patents?
- What is the nature and scope of the license?
- What is the current popularity of the patented property?
- What are the advantages of the patented property over the old models or devices?
- What is the demand for the patented property?
- Are there acceptable non-infringing substitutes?
- Do manufacturing and marketing capabilities exist to exploit total demand?
- Should projected income be attributed to other intangible or tangible assets?
- What is the remaining economic life?
- What is the company’s financial ability to defend the patent?
- Method of Valuation A common method of patent valuation is to estimate the earnings a patent could realize from future royalties if the owner granted an exclusive unlimited license during the use of the patent for its remaining useful life (assume 15 years in the following example):
Example: IFRS 13 Relief from royalty method
Projected annual sales
Royalty rate Royalty Avoidance Approach
Projected annual royalties Royalty Avoidance Approach
Present value factor (€1.00 annual annuity for 15 years discounted at 12% per annum = )
Value of patent Royalty Avoidance Approach
Because trademarks are associated with particular products and businesses, sales of trademarks are less common than licenses for their use. As such, there exists a fair amount of publicly available information on trademark licensing, often derived from financial reports filed with the SEC. This information allows a specialist to develop units of comparison for trademarks, most notably a royalty rate.
IFRS 13 Relief from royalty method makes use of the royalty rates involved in comparable uncontrolled transactions (CUT)—essentially, comparable arm’s-length trademark license transactions between willing buyers and willing sellers—to derive the value of the subject trademark.
The theory behind IFRS 13 Relief from royalty method is one of cost avoidance—that is, the value of the trademark is reflected in the trademark license royalty payments the trademark owner avoided having to pay by owning the trademark.
In this method, the analyst assumes the actual owner does not own the trademark and, therefore, must pay a hypothetical third party for a license to use it. The hypothetical trademark royalty payment is calculated as a market-derived running royalty rate multiplied by the actual owner’s projected revenue over the remaining useful life of the trademark. IFRS 13 Relief from royalty method
Because IFRS 13 Relief from royalty method depends on applying the royalty rate to the projected revenue, it overlaps with the income approach, and some analysts will characterize this method as an income approach method. IFRS 13 Relief from royalty method
The selected trademark royalty rate is determined from an analysis of the CUT trademark license royalty rates. No “true comparable” exists because trademarks are, by their nature, unique.
So, in practice, the analyst typically identifies CUT licenses based on a degree of similarity.
The degree of similarity may include an assessment of the following: IFRS 13 Relief from royalty method
- Product similarity (the trademark in controlled and uncontrolled transactions should be used in association with similar products or processes within the same general industry or market)
- Profit potential (taking into consideration growth expectations)
- Form of the royalty payment (e.g., lump-sum amount or running royalty)
- Duration of the trademark license IFRS 13 Relief from royalty method
- Restrictions (e.g., exclusivity, geographical area or territorial limitations, and market limitations)
- Stage of development
- Collateral transactions or ongoing business relationships between the transferor and transferee (e.g., joint venture arrangements, cross-licensing arrangements, or the exchange of other intangible property or services as part of the transaction)
Generally, comparable trademark license transactions are those involving a similar product or business to that of the subject trademark with similar license terms, particularly with regard to the structure of the royalty (e.g., a lump-sum amount versus annual royalty payments) and restrictions of use (e.g., exclusivity).
Even after identifying reasonably comparable trademark licenses, some dissimilarity can remain. So the selected royalty rate may be adjusted to fit the particular facts and circumstances surrounding the subject trademark. Some factors that analysts often consider in the adjustment of the royalty rate are:
Factors Considered in the Adjustment of the Royalty Rate
Long established or newly created trademark
Older or newer than competing trademarks
Used consistently on related products or inconsistently on unrelated products
Used on a broad range of products and services vs. narrow range
Has wide appeal (e.g., can be used internationally) vs. narrow or local appeal
Potential for expansion
Unrestricted vs. restricted ability for use on new and different products
Potential for exploitation
Unrestricted vs. restricted ability for licensing in new industries and uses
Trademark associated with positive vs. negative person, event, or location
Name has positive vs. negative connotations and reputation among consumers
Trademark is perceived as modern vs. old-fashioned
Trademark is perceived as respectable vs. less respectable
Profit margins on associated products is higher vs. lower than industry average
Profit margins on associated products is higher vs. lower than competitor(s)
Expense of promoting
Low vs. high cost of advertising and marketing of trademark
Means of promoting
Numerous vs. few means to promote the trademark
Market share, absolute
Associated product has high vs. low market share
Market share, relative
Associated product has higher vs. lower market share than competitor(s)
Market potential, absolute
Products are in an expanding vs. contracting market
Market potential, relative
Market for products expanding faster vs. slower than competitor(s)
Trademark has high vs. low recognition among consumers
See also: The IFRS Foundation