RICS draft guidance note - Valuation of Intellectual Property Rights, Guidance Note, 2nd ed

RICS draft guidance note - Valuation of IP Rights, 2nd edition

The income approach

Paragraph 60.1 of IVS 210 states:

'Under the income approach, the value of an intangible asset is determined by reference to the present value of income, cash flows or cost savings attributable to the intangible asset over its economic life'.

The impact of legal, market, functional and economic characteristics of the subject IP on all prospective financial information or forecasts should be considered.

Economic life

Paragraph 100.1 of IVS 210 states:

'An important consideration in the valuation of an intangible asset, particularly under the income approach, is the economic life of the asset. This may be a finite period limited by legal, technological, functional or economic factors; other assets may have an indefinite life. The economic life of an intangible asset is a different concept than the remaining useful life for accounting or tax purposes.'

The relative characteristics of IP relating to brands, technology, artistic works and are identified in sections 6.1.1-6.1.4.

Brand-IP

Different periods of legal protection are provided by different rights supporting a brand:

Registered trademarks can be renewed on an ongoing basis so long as the necessary fees are paid and the mark remains in use.

Common law trademark protection varies by jurisdiction and generally depends on the extent of use and the distinctiveness of the mark.

Copyright has a finite period of protection, which can be long.

The term of a registered design varies by jurisdiction.

The useful economic life of a brand can exceed the life cycle of branded products and there are many examples of successful brands that are more than 100 years old. This should be balanced against high rates of attrition for start-up brands and the decline of some brands that previously achieved a strong market position.

An assessment of the useful economic life of brand-IP should include consideration of:

the extent of the legal rights that enable the brand owner to protect its brand equity

the market position and historic performance of the branded products and services

the brand equity, or other measure of consumer attitudes towards the brand, and trends therein if the brand-IP is closely associated with a single product,

the life cycle of the underlying product category and

the extent and trend of related advertising and marketing expenditure.

For well-established brand-IP with no sign of impairment and no foreseeable limit to the period over which economic returns can be generated, an indefinite useful life may be appropriate.

Tech-IP

The remaining legal life of a patent indicates the limit of its economic life. An assessment as to whether the economic life of the patent is shorter than the legal life should include consideration of:

the quality of the patent claims as reflected by the prosecution history and any legal challenges

the ease of designing around the patent claims

the market position and performance trends of any products or processes using the invention that is the subject of the patent

the technology life cycle and barriers to entry within the industry that the patent is used and

measures of commercial interest in the patent such as recent licences and the extent of forward citations.

An assessment of the useful life of trade secrets should include factors such as:

the legal framework within the relevant jurisdiction(s)

time restrictions to any supporting non-disclosure or non-compete contracts

the strength of procedures used to maintain confidentiality

the degree of difficulty for competitors to reverse-engineer the confidential information or create equivalent know-how

the technology life cycle within the related industry and

if the trade secrets result in a customer-facing benefit, the extent of the resulting product differentiation, the extent of consumer appeal and the product life cycle.

The economic life of a tech asset consisting of a bundle of complementary patents and trade secrets can extend beyond the legal life of certain constituent patents. However, the extent of protection afforded to the tech-IP, and its earnings potential, may diminish as a result of the expiry of a constituent patent.

Artistic-IP

Copyright has a finite period of protection. An assessment of the economic life of artistic-IP should include consideration of:

the performance trends of the artistic work

the useful life and sales curve of other works by the author, or of comparable works

trends within the related sector or genre and

the ability to control unauthorised use of the copyright.

Data-IP

Unlike copyright, there are no legal restrictions to the life of trade secrets. An assessment of the economic life of data-IP should include consideration of:

the time it would take to collect and organise data with similar utility

the extent to which the commercial relevance of the data is influenced by how recent it is

the extent to which commercially useful insights can be gained from trend data and

the uniqueness and durability of any algorithms within the data.

Inadequate protection of data confidentiality can reduce its expected economic life.

IP earnings and growth

Brand-IP

Brand-IP that is valued using the income approach will typically have an existing earnings stream, so a key assumption is the growth rate. Whether expressed as an explicit growth assumption or through a multiple, the assessment should include consideration of:

economic trends and growth trends of the market segments in which the brand-IP operates

maturity of the brand-IP and its historic performance relative to the market

brand equity, or other quantitative measures of consumer attitudes, and the trends therein

level of historic advertising relative to competitors and budgeted future advertising expenditure and

anticipated legislative changes concerning the markets in which the brand is used.

Where the brand-IP's earnings are embedded in those of a business unit, methods such as relief from royalty, premium profit, excess earnings and the Greenfield method should be used to estimate the brand's earnings contribution.

When the relief from royalty method is used, the comparability factors should be considered in the analysis. For example, any royalty information obtained should be adjusted to reflect the differences between the comparable royalty arrangement and the subject asset.

Factors to be included in the comparison should include terms of the licence agreement and differentiating characteristics such as market position, geographical coverage, functionality, whether they are used in connection with business-to-business or business-to-consumer products, etc.

Tech-IP

When the income approach is considered appropriate for tech-IP that is still under development, assumptions should be made regarding the expected date of commercialisation and future development costs. The assessment should consider:

R&D plans and milestones

technical complexity of the development project

progress through designated phases of testing and, if applicable, regulatory approval and

development cycles of similar R&D projects carried out by the IP owner, or of comparable IP or typical industry norms.

The probability of successfully concluding the R&D is considered under section 6.3.

Where the tech-IP's earnings are embedded in those of a business unit, methods such as relief from royalty, premium profit, excess earnings and the Greenfield method should be used to estimate the technology's earnings contribution. When the relief from royalty method is used, the comparability factors mentioned in section 6.2.1 should be considered in the analysis.

Future earnings and growth rates for tech-IP should take account of (if applicable):

if the IP is already in use, the historic performance of the tech-IP relative to the market and its maturity

the extent to which the functional performance of the subject IP is superior to alternative technology

the expected ramp-up period and sales curve following market entry

peak sales and sales curves of any comparable IP

economic trends and growth trends of the market segments in which the tech-IP operates

anticipated legislative changes concerning the relevant markets and

the technology life cycle within the related industry.

Artistic-IP

An assessment of the factors that influence the earnings and growth of artistic-IP should include consideration of:

sales targets identified in any arm's length contracts regarding the use of rights concerning the subject IP

the legal and market strength of the artistic-IP

historic earnings of the subject IP and the stage of its life cycle

peak sales and sales curves of other works by the author or of comparable works

trends within the related market and genre and

the ability to control unauthorised use of the copyright.

Data-IP

Where data-IP directly generates revenue, for instance through subscriptions, this represents the current IP revenue. The calculation of IP earnings should then consider the associated costs and, where applicable, charges for contributory assets.

In situations where IP assets contribute to earnings through product or service enhancements or cost efficiencies, the utility of the data and the resulting uplift in revenue and/or efficiencies should be considered. Assumptions regarding data utility and earnings growth are informed by a review of the items identified in section 4.4.

Risk assessment

The weighted average cost of capital (WACC) may not be appropriate if the subject intangible asset has a distinct risk profile from the rest of the assets and liabilities utilised in the business or if there is other evidence that indicates an alternative discount rate.

The risk profile of a stand-alone pool of complementary IP is unlikely to be the same as the systematic risk of a company that operates in the same industry as the subject IP.

Special consideration is required for IP that is still in development. Where there is a significant probability of failure, the valuer should consider using risk-weighted scenarios or the real options methods of valuation.

If the discount rate is used to reflect development risk, the probability of success should still be estimated and explicitly factored into the discount rate.

Brand-IP

For brand-IP, an assessment of the asset-specific risk should take into account:

strength and overlap of legal rights supporting the brand

security of historic brand-IP earnings and the trends therein

current brand equity and trends therein and

market position and trends therein.

Arm's length brand licences or securitisation agreements can provide evidence of commercial recognition of the brand-IP's market strength and risk profile.

Tech-IP

For tech-IP, an assessment of the asset-specific risk should take into account:

strength and overlap of legal rights supporting the technology, including the IP validity risk and IP infringement risk

enforcement risk; even once granted, the validity and scope of a patent can be challenged, thus an enforcement risk remains after grant

phase of development of the technology underpinning the tech-IP

inadvertent disclosure risk of trade secrets

security of historic tech-IP earnings and the trends therein and

commercial utility of the technology underpinning the tech-IP, including design-around risk and technical obsolescence risk.

Arm's length technology licences or securitisation agreements can provide evidence of commercial recognition of the tech-IP's market strength and risk profile.

Artistic-IP

For artistic-IP, an assessment of the asset-specific risk should take into account:

strength of the legal rights supporting the artistic work, including the ability to control unauthorised use and

market strength of the artistic work, including the risk of obsolescence.

Advances on publishing contracts and arm's length copyright licences can provide evidence of commercial recognition of the artistic-IP's market strength and risk profile.

Data-IP

For data-IP, an assessment of the asset-specific risk should take into account:

uncertainty regarding the utility and earnings potential of the data-IP

uncertainty regarding the ability to protect the data and

uncertainty regarding the regulatory environment.