Integrating IP portfolio and
company valuation
A thesis submitted to the Bucerius/WHU Master of Law and Business Program in partial fulfillment of the requirements for the award of the Master of Law and Business (“MLB”) Degree
Anna Konchenkova
Date: 4 August 2010
12 385 words (excluding footnotes)
Supervisor 1: Prof. Dr. Holger Ernst
Supervisor 2: Prof. Dr. Peter Witt
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Table of Contents
Table of Contents...............................................................................................................2
Table of Figures..................................................................................................................3
Table of Tables...................................................................................................................4
List of Abbreviations .........................................................................................................5
Chapter 1: Introduction
I. Background of the study …………………………………………...……6
II. Research problems and objectives……………………………...….……..8
III. Research design and methodology………………………………...…….10
IV. Conceptualization………………………………………...…………..….10
V. Overview of chapters……………………………………………….....…11
Chapter 2: IP importance in the overall value of the company
I. Importance of IP for the company…………………………………..…...13
II. Need to value IP…………………………………....................................16
III. Importance of IP for investors in their company valuation….……..……18
IV. Existing approaches for patent valuation………………………….……..23
1. Qualitative………………………………………………….………….25
2. Quantitative………………………………………………….………...30
2.1 Cost based method……………………………………….…....…30
2.2. Market based method………………………………………….…31
2.3. Income based method………………………………………....…32
2.4. Other methods………………………………………………........33
Chapter 3: Practical insight into IP and company valuation
I. Determinants influencing investor’s decision in valuing IP portfolio…...37
II. Tendencies in valuing IP portfolio from the investor point of view……..41
III. Conclusions from the interviews…………………………………………44
Chapter 4: Overall conclusion and recommendations……………………..45
Bibliography……………………………………………………………………...…..48
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Table of Figures:
Figure 1: Components of S&P 500 Market Value…………………………………….…6
Figure 2: Intangible Value as Percent of Market Value for Non-US Markets………..….7
Figure 3: Advantages of reporting IP …………………………………………………...18
Figure 4: How important is a company’s IP portfolio compared to other assets?............19
Figure 5: An importance of IP in assessment of an investment………………………….20
Figure 6: Rating and Valuations of Patents – Overview…………………………...……25
Figure 7: Valuation Techniques…………………………………………………...……..35
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Table of Tables:
Table 1: Reason for patenting product innovation………………………………………13
Table 2: Framework for using patent information in technology management…………15
Table 3: Established indicators of patent value…………………………………...……..27
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List of Abbreviations:
CEO Chief Executive Officer
CVCs Corporate Venture Capitalists
DCF Discounted Cash Flow
DIN Deutsche Institut fur Normung
ENPV Expected Net Present Value
EPO European Patent Office
FMV Fair Market Value
IAS International Accounting Standard
IP Intellectual Property
M&A Mergers and Acquisitions
NPV Net Present Value
PCT Patent Cooperation Treaty
R&D Research and Development
VC Venture Capital
VCs Venture Capitalists
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Chapter 1
I. Background of the study
In today’s knowledge based economies, securing intellectual property (IP) is of
increasing importance for a company’s competitive advantage. Mark Getty, the chairman of
Getty Images, one of the world’s largest Intellectual Proprietors said: “Intellectual Property is the
oil of the 21st century”1. There is recent statistical data which suggests reasons why intellectual
property is so important nowadays. Ocean Tomo LLC issued on June 15, 2010 findings from its
annual study of the composition of equity market value. In 2009, the implied intangible asset
value of the S&P 500 reached 81%, an all-time high for the years covered by the firm’s research,
which extends back to 1975.2
Figure 1:
1 The oil of 21st century, http://oil21.org/?about (last visited 01.07.2010)2 Ocean Tomo LLC, Press Release, http://www.oceantomo.com/media/newsreleases/Intangible-Asset-Market-
Value-Study (last visited 01.07.2010)
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Figure 2:
“Within the last quarter century, the market value of the S&P 500 companies has deviated
greatly from their book value. This ‘value gap’ indicates that physical and financial accountable
assets reflected on a company’s balance sheet comprise less than 20% of the true value of the
average firm,” explained James E. Malackowski, Ocean Tomo’s Chairman3. This statement
raises one significant question: How can one feasibly assess the value of the company when the
balance sheet reflects the value of tangible assets only, which constitute 20 % of the true value?
As stated in the Intellectual Assets and Value Creation report: “Current practices often focus on
backward-looking information, providing little systematic information about the capacity of the
company to generate future revenues with respect to intellectual assets”4.
There is an obvious need to assess intellectual assets and as a part of it intellectual
property of the company and communicate this information through a gathering strength specific
intellectual property reports. In 2004, some companies that have taken innovative approaches to
intellectual property began to publish intellectual property reports5. The expectations behind
3 Ibid4 Intellectual Assets and Value Creation; Synthesis report OECD 20085 See Fijitsu Intellectual Property Report 2009, available at:
http://img.jp.fujitsu.com/downloads/jp/jip/ipreport/ipreport2009e.pdf (last visited 12.06.2010)
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these moves are to promote investment by outlining the company’s R&D strategy to investors6.
These initiatives may allow investors to better assess future earnings and risks associated with
different investment opportunities. This should help to make financial markets more efficient by
reducing information asymmetry, biased or unfounded earnings estimates, unrealistic valuations
and unjustified share price volatility7.
James E. Malackowski also announced another very interesting finding. He said that
“further research shows that a significant portion of this intangible value is represented by
patented technology”8. Further Michael D. Friedman, Ocean Tomo’s Managing Director in
charge of investments noticed that “value of a corporation’s patents is a unique, forward-looking
indicator of corporate value. Patent value reflects itself in stock price and can be used to create
investment alpha that is uncorrelated with investments made using traditional ’34 Act data9”10.
All these statements suggest one thing: IP and patents in particular could capture not only
existing value of the company which could be as much as 100 %. “Our value is basically our IP
and its deployment,” says Rob van der Meij, chief executive of the Fluxxion medical company11.
And it is not the only example. But also potential value which could be extracted if a proper
strategic plan will be executed and those who will have the knowledge to see this potential by
evaluating the patent portfolios will be much better off compared to others.
II Research problem and objectives
The financial statements of publicly traded companies are increasingly misleading
investors because balance sheets do not explicitly recognize and value what is a company's
primary source of competitive advantage and value creation: its IP12. Mark Blaxill and Ralph
6 Miyake, Mune, Himeno, Strategic Intellectual Property Portfolio Management: Technology Appraisal by Using the
“Technology Heat Map”, in: NRI Papeprs No. 83, December 1, 20047 Ibid8 Ocean Tomo LLC, Press Release, http://www.oceantomo.com/media/newsreleases/Intangible-Asset-Market-
Value-Study (last visited 01.07.2010)9 The securities Exchange Act of 1934, also called ’34 Act10 Ibid11 Scott, Financial Times Report 03.06.2010, http://www.ft.com/cms/s/0/641dffcc-6ddb-11df-b5c9-
00144feabdc0.html (last visited 01.06.2010)12 Smart Recession Investing: Use Intellectual Property Metrics to Identify Sources of Return That Others Can't See,
http://www.voip-catalog.com/news_item27.html (last visited 03.07.2010)
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Eckardt, Intellectual Property strategists and former Boston Consulting Group partners, argue
that all investors - from venture capitalists to institutional and even individual stock investors -
need to assess the IP position of their investment targets in order to find sources of return.
Investors who understand and can apply the IP framework for analyzing investments will have a
significant wealth creation opportunity13. But the question is how to value IP and integrate it into
the overall value of the company. Academics and economists began struggling to come up with
some standardized measurement years before the technology boom brought the issue to the
forefront, Best Practices LLC CEO Christopher Bogan said.14 Those who are unable to identify
and assess the future potential of a new technology are doomed to failure. But few have
systematic processes in place to identify and track potentially disruptive technologies15.
A few years ago patents were regarded as only an expense to the company which
provided protection from the rivals but now it is commonly used as a business tool. The question
in front of investors is how to valuate and capture the overall value of the company which will
give the full picture and ease the investment decision. Due to lack of literature on how practically
investors valuate IP portfolio in order to identify the technological strength of the company and
its potential revenue creation this paper investigates this topic and answers the following
questions:
- What is the significance of patents to the company valuation;
- What are the reasons for valuation patents and patent portfolios by
management and investors;
- What are the existing techniques and methods of valuating patents; and
- How do investors currently valuate patent portfolio in order to capture the
full value of the company, if they do it at all, and how do they integrate it
into the overall company valuation.
13 Ibid14 Stock, Intangibles remain a hidden asset: non-financial metrics are key to IR's story in a recession, in: Investor
Relations Business 2003, Vol. 8, Issue 5, p. 215 Bower, Christensen, Clayton, in: Harvard Business Review 1995, Vol. 73, Issue 1, p. 49
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III Research design and methodology
A number of interviews were conducted in order to collect primary information on how
investors currently valuate companies comprising IP.
To foster cooperation and openness of discussion, it was agreed that none of the
companies, the persons interviewed, or the specific companies would be identified or generally
described in this study. Therefore, no specific company or its practices are identified in this
paper.
Due to a weak interviewees’ response, the study also uses some information taken from
researches conducted by some companies, institutions and practitioners.
Some data was derived also from documentary information. Documentary sources which
included text books and research papers, magazine articles, information available on the internet,
survey reports, business plans, and annual reports were collected, compared and integrated.
Another source of information will be comments solicited from the professionals in the field.
IV Conceptualisation
The notion of defining terms is to avoid misconceptions and ambiguity in the use of the
words. Even though in the paper a lot of terms are presented but the following are the most
abundant.
Intangible Asset: Is an asset that is not physical in nature16 (IAS 38)
Intellectual Property (IP): A broad categorical description for the set of intangibles
owned and legally protected by a company from outside use or implementation without consent.
Intellectual property can consist of patents, trade secrets, copyrights and trademarks17.
16 “IAS38 intangible assets”, StartRunGrow, 200717 Economic dictionary, available at http://www.investopedia.com/terms/i/intellectualproperty.asp (last visited
01.07.2010)
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Patent: Gives the right to its holder (patentee) to exclude others from making, using,
selling, offering to sell, or importing that which is claimed in the patent, for a fixed period of
time18.
Patent portfolio: Collection of related patents19.
In the frame of the Master Thesis Patents and Intellectual Property used interchangeably
and consequently Patent Portfolio and IP Portfolio identified equally here, but as already was
stated patents are only one type of intellectual property where others include trade secrets,
copyrights and trademarks.
V Overview of Chapters
The study comprises of four chapters. Chapter one consists of the following:
An Introduction
Research Problem and Objectives
Research Design and Methodology
Conceptualisation
Overview of chapters
Chapter two will discuss IP importance in the overall value of the company. And in particular,
why IP need to be valuated, what are the advantages of IP valuation. The importance of IP from the
investor as long as from the management point of view in the overall value of the company will be
regarded. This chapter will give an overview of the existing approaches in quantitative and qualitative
valuation of patents and patent portfolios of the company. It will include the review of the relevant and
related literature on patent portfolio valuation. Advantages and disadvantages of current approaches for
patent valuation will be assessed which will give bases for further discussion in next chapters.
Chapter three deals with received information from the investors and analysts during conducted
interviews in the field. The main questions which were asked are the following:
- Do investors value IP during their overall company valuation?
18Patel, A patent portfolio development strategy for start-up companies, in: Fenwick & West LLP White Paper19 Parchomovsky, Wagner, Patent Portfolios, in: University of Pennsylvania Law Review, Vol. 154, Issue 1, pp. 1-77
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- If yes, then how they do it? What methods do they use?
- Do they do valuation by themselves or they ask for a professional advice?
- What are the obstacles in valuing IP?
During the interviews some tendencies in the investor’s behaviour concerning IP portfolio valuation as
a part of the overall company valuation were uncovered and presented. The gap between what is in
theory exists and how it currently applicable by the investors and analyst will be discussed.
Chapter four concludes and provides a summary of the research as well as further
recommendations.
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Chapter 2
I Importance of IP for the company
“As firms shift to open models of innovation based on collaboration and external
sourcing of knowledge, they are exploiting their intellectual property, notably patents, not only
by incorporating protected inventions into new products, processes and services, but also by
licensing them to other firms or public research organizations, using them as bargaining chips in
negotiations with other firms, and as means of attracting external financing from banks, venture
capitalists and other sources”20. By means of exploiting patents there is an enormous possibility
to create extra revenue for the company and that is exactly what investors are looking for while
investing in a new project or company. Extra revenue creation is just one of the advantages that
patents can bring into the company. Cohen et al. conducted a survey where they found out the
reasons for patenting product innovation and what companies are expecting from patents (Table
1)21.
Table 1: Reason for patenting product innovation (% of respondents and ordinal rank)
US Japan
Prevent copying 98.9 (1) 95.5 (1)
Patent blocking 80.3 (2) 92.6 (2)
Prevent Lawsuits 72.3 (3) 90.0 (3)
Use for negotiations 55.2 (4) 85.8 (4)
Enhance reputation 38.8 (5) 57.9 (7)
Licensing revenue 29.5 (6) 66.7 (5)
Measure performance 7.8 (7) 60.1 (6)
20 Kamiyama, Sheehan, Martinez, Valuation and exploitation of intellectual property, in: STI Working Paper
2006/5, p.3 21 Cohen, Goto, Nagata, Nelson, Walsh, R&D Spillovers, Patents and the Incentives to Innovate in Japan and the
United States, in: Research Policy 2002, Vol. 31, Issue 8/9, p. 1359
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One of the most important features of patent information is that it can be used for a
strategic technology management22. Richard Thoman, CEO of the $20 billion sales Xerox
Corporation said: “I’m convinced the management of intellectual property is how value added is
going to be created at Xerox. And not just here, either. Increasingly, companies that are good at
managing IP will win. The ones that aren’t will lose”23. While talking about IP it is relevant to
focus on patents as they have the “greatest effect on the commercial success and market value of
companies today” and also “patent databases are a virtual Alexandrian library of information”24.
All the necessary data could be extracted from the publicly available sources. Especially
when combined with new automated data-mining and visualization software, these databases can
be powerful sources of rich competitive intelligence25. But before figuring out how to obtain
competitive intelligence and thereby advantage compared to others, one should understand first
the value of patents and what they can bring into the company: how they can be used not only as
a legal tool but also as a valuable business tool for revenue creation. Recent case can
demonstrate the hidden value of patent portfolio and how the right exploitation of it could
maintain the livelihood of the company.
Telecommunication Corporation Nortel which has Nortel’s Long Term Evolution or LTE
a high-speed wireless technology known as “4G” could have earlier exploited their patent
portfolio, identifying licensing opportunities as a source of revenue generation. Only after filing
for insolvency Nortel found out that their technology including patents might be worth as much
as $1.1 Billion. Peter Conley a managing director of MDB Capital Group LLC, who estimated
their value, stated that they would be a “natural fit” for BlackBerry maker RIM26. This kind of
natural fit could have saved Nortel’s company.
In order to avoid such mistakes patent portfolio should be properly managed in order to
discover the prospects for exploitation.
22 Ernst, Patent information for strategic technology management, in: World Patent Information 2003, Vol. 25,
Issue 3, pp. 233-24223 Rivette, Kline, Discovering New value in Intellectual Property, in: Harvard Business Review 2000, Vol. 78, Issue
1, pp. 54-6624 Ibid25 Ibid26 Miller, Nortel may raise as much as $1.1 Billion from patents, http://www.businessweek.com/news/2010-05-
26/nortel-may-raise-as-much-as-1-1-billion-from-patents-update2-.html (last visited 05.07.2010)
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Patents can support technology management in five areas of the conceptual framework
(Table 2)27.
Table 2: Framework for using patent information in technology management
Technology Creation Technology Storage Technology Use
Patent
Functions
Information Information Protection
Internal Support of R&D Investment
Decisions (Competitor
Monitoring and Technology
Assessment)
Human Resource
Management in R&D
and Knowledge
Management
Effective Protection
of Products, Processes
and Services from
Imitation
External Identification and
Assessment of Sources for
External Technology
Creation (e.g. M&A;
Alliances)
- Strategic (e.g. Cross-
Licensing) and
Operational (e.g.
Patent Sale) Value
Maximization of the
Patent Portfolio
Source: Ernst, 2003
First of all patents can be used as an internal tool of the company for supporting R&D
investment decisions. Management of the company should decide how the R&D resources
should be allocated and patents evaluation could support them in their decision making. Pr.
Holger Ernst and Jan Henrik Soll developed a very useful approach on how to align marketing
and R&D strategies using integrated portfolio28. Further patents protect core technologies from
imitation. Patents provide the exclusive legal control over the company’s technology meaning
that company is the only owner of it and could establish higher prices for the future product
which will result in higher revenue. It will last until the patent expiration. That is the only way
for pharmaceutical companies to pay off the R&D expenditures.
27 Ibid28 Ernst, Soll, An integrated portfolio approach to support market-oriented R&D planning, in: International Journal
of Technology Management 2003, Vol. 26, Issue 5/6, pp. 540-560
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Moreover patents are very helpful in exploiting external company strategy. Companies
may assess competitor’s position and think of R&D alliances or M&A in order to gain external
technological knowledge. These kinds of activities are extremely beneficial for the companies
from the efficiency gains point of view through reduced development time and costs, access to
superior knowledge and the reduction of technological risks29. They also can use patents as a
strategic tool for cross-licensing, as a bargaining chip in the litigation procedure, as long as in
operational strategy like patent sale.
All this information confirms that intellectual property and patents in particular are
important as value drivers for companies operating in highly competitive environments30. Patents
are an extremely valuable source of information which management of the company should
know how to extract by using the valuation techniques. Patents provide an important signal to
competitors, suppliers, customers and investors about the validity of the company’s business31.
II Need to value IP.
The primary reason for valuing IP is to maximize its value and therefore the value of the
owner organization through optimum management decisions32. Otsuyama developed a scheme
when there is a demand for valuation of IP at each stage of IP exploitation33. Need for IP
valuation is low when IP is exploited for defense purposes, that is, preventing other firms from
intervening and helping to fend off attacks from them. The value of IP gradually becomes
important as soon as IP is exploited to secure superiority when there is an expansion of
alternative product designs and need for enforcement against infringers. As soon as IP
considered is a business tool, its value is recognized independently. In this case IP is used as a
source of profits for the company. The next stage is when IP is exploited as management strategy
and its valuation becomes necessary for management decision making. The last stage where IP
valuation becomes essential is when IP is exploited as a financial asset. In this case IP becomes
a proxy of the financing method for IP holding firms and is regarded as an investment asset for 29 Ibid30 Levitas, Mcfadyen, Managing liquidity in research-intensive firms: Signaling and cash flow effects of patents and
alliance activities, in: Strategic Management Journal 2009, Vol. 30, Issue 6, pp. 659-67831 Kamiski, Metrics and Measurement for Patent Departments, in: Foley & Lardner LLP White Paper 200532 Valuation of intellectual property, in: IP for Innovation Handbook (ip4inno), p. 533 Otsuyama, “Patent valuation and intellectual assets management”, Chapter 5, Patent Strategy Handbook, Tokyo,
2003
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financial institutions34. Valuing IP is essential for investors so that they can see the future
potential of the company and make correct investment decisions.
There is an obvious necessity to value IP – inevitable part of the overall value of the
technology based company. But lack of a universal approach on how to value IP makes it
difficult to extract a potential value from IP hidden in it.
Traditional financial and accounting indicators are of very limited help to correctly assess
the presence and quality of internally generated assets.35 Internally generated IP is treated as an
immediate expense. “The same applies to Research and Development related to the creation of
IP. The costs incurred for the creation of IP are reported at one single point in time, while the IP
is accounted for only in the context of a commercial transaction”36.
It is crucially important to integrate IP into the overall value of the company in order to
support management and to ease the decision making for investors. As companies have more
information on the value of IP which could be integrated into the true value of the company, they
could report it to outside interested parties like investors and enjoy better market value of the
company afterwards. Figure 3 illustrates how IP accounting can ease the task for managers and
investors37. Particularly, reporting IP despite informing the investors about the true value of the
company, explains how the IP relates to business segments. On the other side, investors receive
valuable information about the drivers of company performance. By receiving this kind of
information investors can better estimate risks and revenues of an investment. It reduces
information asymmetries between the management and investors which will increase
predictability and lowers volatility.
34 Ibid35 Hand, Lev, Intangible assets: Values, measures, and risks, 2. edition, Oxford University Press, New York 2003 36Ghafele, Getting a grip on accounting and intellectual property, World Intellectual Property Organization Articles,
http://www.wipo.int/sme/en/documents/ip_accounting.html (last visited 10.07.2010)37 Ibid
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Figure 3:
As there are visible advantages from reporting IP, some changes in legislation were
introduced in the United States. In 2002 Senator Paul Sarbanes and Representative Michael
Oxley drafted the Sarbanes-Oxley Act, which created new standards for corporate accountability
and enhanced intellectual property reporting system38. Still the reporting system is not in
common use among companies: there is a big informational asymmetry between the
management of the company and investors concerning IP value.
From all said above one could make a conclusion that there is a need to value IP from
management point of view not only as a compulsory duty for the compliance with current
legislation, which is also one of the reasons for the valuation but also in order to capture the full
value of the company and as pointed out by Otsuyama in each stage of development IP. Investors
have their own reasons to value IP which will be discussed in the next chapter.
III Importance of IP for investors in their company valuation
In order to identify high value patents and determine a strategy to their exploitation, a
rating and a valuation of patents are necessary in the frame of all company valuation.
38 Valoir, Sarbanes-Oxley Compliance and Intellectual Property Portfolios, in: Intellectual Property and Technology
Law Journal 2010, Vol. 22, Issue 4, pp. 1-5
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Institutional investors such as venture capitalists need to appraise patents for their decision
making. In the research work the focus will be made mostly on institutional investors, though a
venture capitalist approach for patent evaluation also will be considered.
Research made by a Mergermarket in association with CRA International and K&L Gates
about the importance of IP assets in M&A transactions reveals that 84% of corporate
respondents and 72% of private equity respondents view IP portfolio as equally important or
even more important than other assets39. This suggests that investors are aware of IP asset
importance.
Interesting observation can be made from Figure 4. Corporate respondents place a
noticeably stronger emphasis on the IP portfolio which constitutes 40% compared to private
equity practitioners who submit only 12% of their votes toward IP portfolio.
Figure 4:
These findings shed more light on the institutional and VC investor’s attitude while
valuing the IP portfolio of the targeted company. VC’s do not pay as much attention to the IP
39 Brodowski, M&A Insights: Spotlight on Intellectual Property Rights, in: Mergermarket study in association with
CRA International and K&L Gates, December 2008, p. 4
0%10%20%30%40%50%60%70%80%90%
100%
Corporates Private equity practitioners
40%
12%
24%
36%
20%
24%
8% 28%6%
0%
Perc
enta
ge o
f re
spon
dent
s
How important is a company’s IP portfolio compared to other assets?
Not Important
Less Important
As Important
More Important
Crucial
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portfolio compared to corporate investors. “The decrease in importance to private equity maybe
the result that private equity tends to have startup and early stage companies whose IP maybe
primarily applications. Because those applications may never issue as a patent, the value to the
equity investors may be lower.”40
On this basis one could conclude that investors and in particular corporate investors give
a lot of weight to IP when making their investment decisions.
Another interesting observation could be made from the survey pursued by the London
office of US Law firm Howrey Simon Arnold & White which gathered the views of 100 fund
managers, analysts, private equity firms and venture capitalists. They found that whilst having
significant IP assets is of value in itself, 95% of survey participants agreed with the view that “it
is not just having the IP, it is protecting and exploiting it that makes the difference”. Taking it
one stage further, over half say that it is not sufficient for a company simply to protect its IP, but
that IP protection should be used as part of a significant competitive strategy (Figure 5)41.
Figure 5:
It means that patents are valuable when they are incorporated into the overall company’s
strategy. Patents are regarded by investors as a necessary tool for protection but if they are not
managed by the company properly they are not much in focus for investors while valuing the
company. Management should be aware of the future potential of the patents and explore them 40 Ibid41 Howrey, A survey on Investor attitudes on IP protection 2001, pp. 1-16
56% 19% 22% 6%
0% 20% 40% 60% 80% 100% 120%
An importance of IP in assessmentof an investment
As part of Competitive Strategy
Ptotection Sufficient
It Varies
Don't Know
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Only then could investors integrate such information into their business value model as they
know that management aware of company’s value driver.
“Despite the high value placed on IP strategy by survey participants, only one in three say
that they “always” or “usually” formally analyze and assess the value of a company’s IP when
they are looking to invest. This is more likely to be the case for those following Pharmaceuticals
or IT companies and infrequently those specializing in Consumer brands, Telecoms or Media,
where formal measurement may depend on the company involved”42.
It is very much dependent on which industry the company is operating in so that IP and
especially patents play a significant role for the value of the company itself and can be viewed as
a value added. But as already been said patents themselves do not have any value. Interviews
conducted by Munari and Oriani reveal the following significant information about how venture
capitalists approach patents and what they are looking for in the start-up companies in order to
make an investment decision43.
All the investors said that presence or absence of IP is the starting point and essential for
the value of start-ups. “Patents analyzed to determine its technical and legal validity, the value
added to the product in the end market by its utilization and its country coverage. Indeed, the IP
portfolio is fundamental to the competitive positioning and life cycle of a product in the
marketplace and, thus, the breadth and strength of the patent protection of the product itself and
the fence around it need to be analyzed” said one of the interviewees, a Partner in Sofinnova44.
Managing Director of Novartis Venture Fund attached big weight to patents as freedom
to operate. Recent Mergermarket survey confirms this statement: when valuing a target’s IP
assets, freedom to operate is the most important factor contributing to the value of IP (4,27
points out of 5)45.
Chief Technology Officer of TTVenture named IP as a “condition sine qua non” to invest
in a company “as it is the means to access the market and it offers barriers to entry, protection
and a tangible way of technological transfer”. But he mentions that patents per se have no value.
“We look at patents in conjunction with the company’s business model to verify the extent to
42 Ibid43 Munari, Oriani, The Economic Valuation of Patents. Methods and Applications, 1 edition, Edward Elgar
Publishing Limite, GBR, 2010, p. 28044 Interview with Partner in Safinnova conducted by Munari, Oriani.45 Brodowski, M&A Insights: Spotlight on Intellectual Property Rights, in: Mergermarket study in association with
CRA International and K&L Gates, December 2008, p. 9
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which patents protect the core technology of the company and not only a marginal component”
he said46.
Venture capitalists do not adopt monetary techniques to determine patent value, though
patents can indirectly enter in the valuation of the entire company as demonstrated by the
interviews with Saffinova and TTVenture: “We do not evaluate each patent through quantitative
techniques, but we assess the value of the company as a whole. The presence of patent is only
condition to invest, but it is not an asset per se. Patents come with business models and patents
without entrepreneurs have no value because they do not generate cash flows. We perform an
economic valuation of the company through qualitative techniques (i.e. benchmarking with
industrial competitors or past performance) and quantitative tools like the net present value. We
assess the expected revenues, costs, investments, time of development, risk of both technical
failure and market competition and cost of capital. However, the value of a company depends
also on the value of its patents, calculated in terms of the net present value of the commercial
applications which takes into account the technical development risk, rate of market penetration,
price of product, market size/peak sales and length of product life”47.
From the conducted interviews it is obvious that patents are extremely important in the
screening and due diligence phases for VC firms. They are a prerequisite for the company’s high
valuation but do not constitute a separate part of it.
A survey conducted by the Institute of Intellectual Property tried to find what matters
institutional investors consider most important in terms of information on technology-based
intangible assets and whether they introduce such matters in their corporate valuation models.
All institutional investors in Japan were asked to answer some questions regarding this topic. As
a result of the survey, it was found out that special importance was attached to qualitative
information that indicates relationships with strategy and organization among information on
technology-based intangible assets48.
There are the following matters to which investors attach importance and thereby regard
company as a more valuable entity:
- “Manager’s proper analysis of own company’s advantage and duration on
terms of technological development
46 Interview with Chief Technology Officer TTVenture, conducted by Munari, Oriani47 Ibid48 Ban, Group on disclosure of technology-based intangible assets, in: IIP Bulletin 2003
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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- Understanding potential customers and properly analyzing market size in
terms of development of new technology and products
- Ratio of the sale of a new product in the total sales
- Being able to understand the use of new technology and products and
analyzing the scale and growth potential of the customer market
- Establishing guidelines for preventing the outflow of technology and trade
secrets and those for obtaining and managing intellectual property, as internal rules
- Link between corporate strategy and research and development/
technological development
- Organization that manages and strengthens intellectual property in the core
business
- Consistently analyzing research and development, strategy and domain
- Outline of intellectual property portfolio
- Distinctiveness of the core technology
- Period of accumulation of unique technology in the field in which the
company has competitive advantage
- Strategic obtainment of patents, including peripheral patents
- Reflecting advanced know-how and technology on product price
- Appropriately managing technology for globalization
- Clearly demonstrating vision and strategy concerning research and
development as well as technology
- Income from patent rights and its change
- Degree of dependence of income on the development of new products”49.
All this information plays a crucial role in valuing the company. It is interesting to see
whether this kind of information is captured by existing approaches to valuation which will
be discussed in the next chapter.
IV Existing approaches for patent valuation
“One would be hard-pressed to find a major investment bank that employs even one
individual with experience in evaluating patent portfolio, as matters stand now, due diligence
49 Ban, Group on disclosure of technology-based intangible assets, in: IIP Bulletin 2003
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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regarding patent assets is usually more myth than reality”50. It is mostly due to inadequacies in
patent valuation methodology51. Lognormal distribution of patent value, which is spreading the
valuation of patents across a large range of values, add a certain degree of difficultness in patent
valuation and choosing the right method for the valuation52.
Scientific literature represents several approaches on how to execute valuation of patents
and patent portfolio, but all of them have pluses and drawbacks, some of them are quite difficult
to implement. There is no universal approach to value patents although a lot of attempts have
been made to come up with a useful and manageable method. Already in October 2008 Italian
Ministry of Economic Development, the Italian Banking Association, the Italian Confederation
of Industry and the Conference of Rectors of the Italian Universities signed a cooperation
protocol on the financial and economic valuation of patents. Italy is therefore the first country in
Europe to provide an instrument for valuating patents shared by both public and private sectors53.
Not only in Italy had these initiatives taken place. Germany’s standards body, the Deutsche
Institut fur Normung (DNI), adopted a valuation standard PAS 1070 “General Principles of
Proper Patent Valuation"54. The PAS defines general principles and requirements for a reliable
and appropriate valuation of patents. Its main intention is to serve as a guideline for users of
patent value information, to enable a quality assessment of valuation reports and expert
appraisals. In June 2010 DIN published General Principles for monetary patent valuation55.
Although they are tools for patent valuation, they are not commonly in use.
50 Rivette, Kline, Discovering new value in intellectual property, in: Harvard Business Review 2000, Vol. 78, Issue
1, p. 66 51 Carte, The maximum achievable profit method of patent valuation, in: International Journal of Innovation and
Technology Management 2005, Vol. 2, Issue 2, p. 13552 Ibid53 Modiano, New protocol on patent evaluation, in: Managing Intellectual Property 2008, Issue 185, p. 7954 Wurzer, General principles of proper patent valuation: the forthcoming European Standard, in: Presentation in
Hungarian Patent Office, November 2008, available at
http://www.mszh.hu/English/ipv/IP_Valuation_Budapest_2008_Wurzer.pdf (last visited 20.07.2010)55 Available at http://www.nadl.din.de/cmd?artid=129173643&bcrumblevel=2&level=tpl-art-
detailansicht&committeeid=117152656&languageid=en (last visited 10.07.2010)
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1. Qualitative methods to value patents
Dieter Reinhardt, a European patent attorney, who was responsible for patent licensing at
Siemens AG proposed the following structure which could be employed for patent valuation
(Figure 6)56.
Figure 6: Rating and Valuations of Patents – Overview
Source: Reinhardt, 2008
There are basically two approaches which are qualitative and quantitative methods.
Qualitative evaluation attempts rating and scoring patents depending on different
qualitative characteristics. These methods are usually used for the purpose of internal portfolio
management and transfer issues. “For managing the patent portfolio, the scores can be used to
make intelligent decisions in regards to filing as well as judging whether to maintain or abandon
the patents”57.
Some national patent offices, such as the Japan Patent Office and the Danish Patent and
Trademark Office propose qualitative valuation models within their countries. Some examples
of qualitative valuation methods developed in the private sector include the WISSPAT software
created by Prof. Ernst and Prof. Teichert. This tool gives a perfect visualization of the whole
patent portfolio of the company and its rivals. “This software has both an inward perspective, i.e.
56 Reinhardt, Rating and Valuation of IPRs, in: The Licensing Journal 2008, Vol. 28, Issue 4, p. 557 Reinhardt, Rating and Valuation of IPRs, in: The Licensing Journal 2008, Vol. 28, Issue 4, p. 6
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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the reassessment of the effectiveness and efficiency of companies’ current R&D policy, as well
as an outward perspective which focused mainly on the assessment of a potential target of
mergers & acquisition”58.
Another example of qualitative valuation includes the valuation tool called “PRISM”
developed by QED Intellectual Property. This tool classifies patents into four basic management
models, namely:
1. “Monopoly (patents for internal exploitation with high value)
2. Defensive (internal exploitation, low value)
3. License (external exploitation, high value)
4. Joint venture (external exploitation, low value)”59
For all these valuation models the patent value indicators need to be used.
Until today different patent value indicators were determined. Such as forward citations60
which show in which and how many younger patents, the patent in question was cited as peace
of prior art, backward citations61 which show the number and types of prior art documents cited
against the patent, family size62, which is the number of patents filed on the same invention in
other countries or regions. Reitzig identified these indicators as ”first generation” indicators of
patent value as they do not particularly involve in-depth knowledge of institutional details of the
patent system63. As a “second generation” he pointed out on patent-specific economic
considerations, such as referring to the filing strategy or the legal contents of backward citations.
Last and also a very valuable source of information are full-text documents themselves, which
58 Teichert, Text Mining for Technology Monitoring, in: IEEE IEMC 2002 White Paper, Institute for Innovation
Management59 Information-Technology Promotion Agency, Japan (IPA), Report of IPA Intellectual Property Study Group 2004,
IPA, Tokyo60 Trajtenberg, A penny for your quotes: patent citations and the value of innovations, in: Journal of Economics
1990, Vol. 21, Issue 1, pp. 172-187; Albert, Avery, Narin, McAllister, Direct validation of citation counts as
indicators of industrially important patents, in: Research Policy 1991, Vol. 20, Issue 3, pp. 251-259; Harhoff,
Scherer, Vopel, Citations, family size, opposition and the value of patent rights, in: Research Policy 2003, Vol. 32,
Issue 8, pp. 1343-136361 Narin, Hamilton, Olivastro, The increasing linkage between US technology and public science, in: Research
Policy 1997, Vol. 26, Issue 3, pp. 317-33062 Lanjouw, Schankerman, Characteristics of patent litigation: a window on competition, in: Journal of Economics
2001, Vol. 32, Issue 1, pp. 129-15163 Reitzig, Improving patent valuations for management purposes – validating new indicators by analyzing
application rationales, in: Research Policy 2004, Vol. 33, Issue 6/7, p. 942
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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are a “third generation” indicator for patent value64. Reitzig gives a good overview of the
established indicators of patent value and pointed out on the validity from the theoretical and
empirical point of view (Table 3)65.
Table 3: Established indicators of patent value
Variable Validity Availability in time(month after filing date)
Compilation costsTheoretical
foundationaEmpirical evidence as of todaya
Patent age ++ - 48+ EMarket value of corporation
++ ++ - M,partially E
Backward citation + +/- 18 EForward citation ++ ++ Ca. 42+ EFamily size ++ + 18+(preliminary)b,ca.42+(finally)c E“Scope” + - 18+(preliminary)b,ca.42+(finally)c EOwnershipd + ++ 18+(preliminary)b,ca.42+(finally)c ENumber of claims ++ +/- 18+(preliminary)b,ca.42+(finally)c EPatenting strategy ++ +/- 18respectively19+(preliminary)b,
ca.42+(finally)cE
Number of applications
+ +/- 18+(preliminary)b,ca.42+(finally)b E
Number of trans-boarder research co-opeations
+ +/- 18+(preliminary)b,ca.42+(finally)c E
Key inventors + + 18+(preliminary)b,ca.42+(finally)c ELegal disputes (opposition in particular)
++ +/- ca.42+(preliminary)b,ca.49+(finally)c
M,partially E
M: manual computation necessary; E: electronic computation possible.a(-) Weak; (+/-) Medium; (+) Strong; (++) Very strong.bInformation available after publication of application. Information can still change during the granting procedure.cLower bound.dDifferently computed indicators in different studies.Source: Reitzig 2004
While valuing patents there are different combinations of indicators which could be
employed. Different companies use different sets of indicators in order to find the value of
patents. For example, Zeebroeck use the following metrics for patent valuation: forward
citations, grant decisions, families, renewals and oppositions66. The reasons why those kinds of
value indicators were chosen are:
- “Have been found positively correlated with the value of patents in the
64 Ibid65 Ibid66 Zeebroeck, The puzzle of patent value indicators, in: CEB Working Paper No. 07/023, April 2009
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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literature
- Can be extracted from patent databases
- Could inform on the existence of a potential market for the invention”67.
Reinhardt in order to come up with a patent score group a number of indicators into the
bibliographic, procedural, content related, technological, and enterprise related factors68.
Bibliographic indicators could be identified from the data bases or the front page of the
patent. Into the bibliographical indicators he includes:
- patent age, which pointed out on the remaining lifetime of the patent
- forward citations
- backward citations
- key inventors.
Further, procedural indicators need to be identified such as:
- family size;
- legal status, which is status of the patents in the various patent countries;
- legal actions, patents that survived nullity actions or were successfully involve in
infringements suits
- patent procedure, patents were filed via European Patent Office (EPO), in accordance
with Patent Cooperation Treaty (PCT) or as national applications
The content related indicators include:
- number of patent claims
- number of categories in patent claims
- text elements
- number of words describing the object of the invention
- number of words describing the advantage of the invention
Then technological indicators add up to the overall value of the patent:
- technology
- number of patens in same IPC classes
- trend of patent filings in same IPC classes
- status of technology
And the last but not least group of indicators is enterprise related, which used to appraise
the enterprise that owns the patent:
67 Ibid68 Reinhardt, Rating and Valuation of IPRs, in: The Licensing Journal 2008, Vol. 28, Issue 4, p. 7
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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- ownership
- size and/or reputation of the company owning the paent
- market value of the enterprise
- Tobin’s Q, which is ratio of the market value of assets to the replacement costs of the
assets
- co-operations - number of R&D cooperations69.
After all the indicators were identified they were integrated into the key factors which
are legal position, difficulty of designing around, proof of infringement and technological
position of the patent. All key factors get weighted and receive a score from one to six where
six stands for the highest value. All these scores need to be compiled into the final score of
the patent and show the patent quality. As stated by Reinhardt, only a few patents have low
and high score, while the lion’s share of patents have a medium score around three70.
Prof. Ernst takes one step further and suggests to analyze the dynamic development of the
indicators over time integrating them into the patent portfolio71.
Even though this kind of information appears more valuable to the management of the
company in their decisions on investment of R&D resources, it could also be useful to the
investors who are interested in the companies with a potential where patent portfolio could
perfectly visualize company’s competitive position and possible future revenue generation.
Finn Valentin and Rasmus Lund Jensen, for example, emphasize the need to assess not
only patents alone but a patent portfolio as a whole in terms of the complementarities between
multiple patents. They examine effects of the configuration of patents, which are thickets
(consist of a large number of heterogeneous patents, brought together by the complementarity
roles for the same focal technology), fence (functionally similar patents) and scope related
configurations on firm value72.
Even though theoretically there are a lot of approaches that were developed in order to
value patents and patent portfolios from the qualitative side, there is an obvious gap between
theory and practice meaning that they are hardly implemented not only by management of the
companies but also by investors during their valuation of the companies.
69 Ibid70 Ibid71 Ernst, Patent information for strategic technology management, in: World Patent Information 2003, Vol. 25,
Issue 3, p. 23572 Finn, Rasmus Lund, Patenting strategies and valuation of science-based start-ups, in: Annual Conference of the
EPIP Association, Sept. 2009
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2. Quantitative approaches for patent valuation
The monetary or quantitative perspective of patent valuation represents three “classic”
approaches: income, cost and market-based approaches. They are most commonly used for
patent appraisal even though they have a lot of shortcomings when applied to patent valuation.
There are also more sophisticated methods: the relief from royalty, the technology factor, the real
options, and the Monte Carlo simulation methods. The following is a brief overview of these
approaches:
2.1 Cost based method
The cost-based method aims at determining a patent's value by defining the
necessary development costs for the product covered by the patent73. The costs include the cost
of developing the invention, as well as the cost of patenting the invention. This method can be
used to set a lower limit of patent value74. Within the cost approach one can look at the
reproduction costs, the replacement costs, the historic costs, and the avoided costs. “The
reproduction costs are the costs of an exact replica of the subject matter of the patent, whereas
the replacement costs are the costs of a subject matter having the functionalities claimed in the
patent. The historic costs of the patent include the development costs of the relevant portions of
the product or process covered by the patent and the related patent costs. Finally, the avoided
costs are the costs that a patent owner can save by owning the patent. This can be in the form of
future royalties that the owner otherwise would have to pay to a licensor”75.
One of the advantages of this method is that IP becomes visible in the company’s books
and IP awareness is increased. “The method is also a useful indicator of IP value in the case of IP
assets whose future benefit is not yet evident”76. Further cost based measures are objective and
consistency can be achieved and if a recent acquisition cost of a patent exists it is a reliable
indicator of value. There are several disadvantages which should be taken into account. There is
73 Sherry, Teece, Royalties, evolving patent rights, and the value of innovation, in: Research Policy 2004, Vol. 33,
Issue 2, pp. 179–191.74 Carte, The maximum achievable profit method of patent valuation, in: International Journal of Innovation and
Technology Management 2005, Vol. 2, Issue 2, p. 13675 Reinhardt, Rating and Valuation of IPRs, in: The Licensing Journal 2008, Vol. 28, Issue 4, p. 1576 Valuation of intellectual property, in: IP for Innovation Handbook (ip4inno), p. 6
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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no direct correlation between cost of development and the future revenue potential of assets77. In
addition, it can be problematic to properly assign accumulated costs to a single intangible asset78.
As a result the cost based approach is used only in limited circumstances. The cost
approach is most suitable for valuation for financial accounting and corporate tax purposes79.
Cost is, however, a relevant benchmark where a patent has recently been acquired80.
2.2 Market based method
The market-based approach tries to value a patent by referring to similar transactions that
have occurred recently, for example, the patent value is determined by comparing the patent to
similar patents that were sold in the past81. This approach comprises a plurality of methods,
namely, a transaction oriented, a price oriented, a profit oriented and a license based method.
These methods are very similar and only distinguishable with respect to the criteria used for the
comparison. “In the transaction oriented method one tries to identify the financial terms for
transactions of comparable patents and in the profit and price oriented methods one tries to find
the financial terms of transactions generating the same price, respectively. In applying the license
agreements based method one is looking for concluded license agreements in which either a
comparable patent was licensed, or in which royalties were paid that correspond to expected
royalties. In both cases the focus is on finding a royalty rate that is accepted in the market”82.
The advantage of this method is that it makes use of prices actually paid for comparable
assets and the variety of market based approaches gives flexibility in comparison. This approach
is easy to use if the market exists. But the main disadvantage is that the unique features of a
77 Pitkethly, The valuation of patents: A review of patent valuation methods with consideration of option based
methods and the potential for further research, in: Judge Institute Working Paper WP 21/97, Cambridge, The Said
Business School, University of Oxford78 Achleitner, Nathusius, Schraml, Quantitative valuation of Platform Technology Based Intangibles Companies, in:
Working Paper No. 2007-02, Center for Entrepreneurial and Financial Studies 79 Kamiyama, Sheehan, Martinez, Valuation and exploitation of intellectual property, in: STI working paper 2006/5,
p.27 (1-48)80 Zieger, Scheffer, Methods for Patent Valuation, Presentation at EPO-OECD-BMWA International Conference on
Intellectual Property as an Economic Asset: Key Issues in Valuation and Exploitation, 2005, available at
http://www.oecd.org/dataoecd/34/63/35428822.pdf (last visited 28.07.2010)81 Arora, Fosfuri, Gambardella, Markets for technology: the economics of innovation and corporate strategy, in:
MIT Press, Cambridge, 2001.82 Reinhardt, Rating and Valuation of IPRs, in: The Licensing Journal 2008, Vol. 28, Issue 4, p. 16
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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specific patent cannot be compared in the same way and consequently could be priced wrongly.
This could lead to an undervalue or contrary overvalue of the patent.
2.3 Income based method
The income-based approach considers a patent's possibility to provide an economic
benefit in the form of cash flows. With this approach, future cash flows are estimated and then
discounted83. Discounted Cash Flow (DCF) method is one variety of income-based approach.
With the DCF method, the patent value is calculated as the present value of future cash flows.
The present value of cash flows is calculated by applying a discount rate which adequately
reflects the cost of capital. Consequently, the DCF method requires three major components: the
forecast cash flow, the projected economic life of specific projects and IP, and the appropriate
cost of capital84.
Although DCF method does attempt to determine an economic value of a patent, it does it
in a very limited way because many of the factors that determine the ability of a patent to
generate profit are not explicitly considered85. But inspite of having these drawbacks it is one of
the most commonly used to value patents as it is widely understood.
After making an overview of most commonly used approaches it would be relevant to
point out on their shortcomings which arise when valuation of patents is needed. It seems that
these approaches are able to capture only half of the value of a patent. The cost approach, for
example, does not consider future cash flows generated from the patented technology. Even
though the income based approach covers this gap, it does not take into account the cost of
developing technology in the valuation technique. These methods do not account for all of the
known factors which affect the value of a patent such as patent breadth, novelty and the like,
which accounted in qualitative approaches for patent valuation but should also be considered in
the quantitative approaches too. It is worth mentioning that these methods do not value the patent
per se but patented technology, which sometimes could be misleading. The value of a patent is
83 Amram, The challenge of valuing patents and early-stage technologies, in: Journal of Applied Corporate Finance
2005, Vol. 17, Issue 2, pp. 68–81.84 Brealey, Myers, Principles of Corporate Finance, 5 edition, McGraw-Hill Companies, 199685 Carte, The maximum achievable profit method of patent valuation, in: International Journal of Innovation and
Technology Management 2005, Vol. 2, Issue 2, pp. 135–151
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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not always equal to the value of patented technology; usually value of patents is higher86. Only in
some industries, like in pharmaceuticals, where patents are a prerequisite for successful R&D,
the value of the patent could be equal to the value of the project87. That is why to employ these
approaches to evaluate patents could be not as sufficient as the ones examined further.
2.4 Other methods
More sophisticated and thus not commonly used approaches are the following.
The relief from royalty approach is similar to the income approach with the only
difference that the present value of cash flows is multiplied by an appropriate percentage royalty
rate. Thus, this method measures the royalty fees that a company does not have to pay to a third
company because it actually owns the patent88.
The technology factor approach is also based on the income approach, but it defines an
upper limit of maximum achievable income with the patented technology, which is then
shortened by competitive attributes in order to derive the expected income89.
“The income approach with its discounted cash flow method and the approaches based
around it have to be seen as “now or never” propositions, i.e., the firm has to decide in the
beginning whether it wants to perform the investment and if it does, it can no longer change its
strategy. If a firm does not invest, the investment opportunity is lost for future periods”90. There
are no other options and these neglects the value of flexibility in investments decisions91.
Comparably, the option based approach gives this “flexibility”. Patent evaluation based
on real options is similar to the income approach, but it is less static and firms can change their
86 Ernst, Legler, Lichtenthaler, Determinantsof patent value: Insights from a simulation analysis, in: Technological
Forecasting and Social Change 2010, Vol. 77, Issue 1, pp. 1-1987 Ibid88 Sherry, Teece, Royalties, evolving patent rights, and the value of innovation, in: Research Policy 2004, Vol. 33,
Issue 2, pp. 179–19189 Carte, The maximum achievable profit method of patent valuation, in: International Journal of Innovation and
Technology Management 2005, Vol. 2, Issue 2, pp. 135–15190 Ernst, Legler, Lichtenthaler, Determinantsof patent value: Insights from a simulation analysis, in: Technological
Forecasting and Social Change 2010, Vol. 77, Issue 1, pp. 1-1991 Bloom, Reenen, Patents, real options and firm performance, in: The Economic Journal 2002, Vol. 112, Issue 448,
pp. 97–116
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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behavior and strategy92. But still the option based approach remains static, even though it
employs more realistic assumptions93. In the contrary, the Monte Carlo approach allows for
explicitly considering the risk and uncertainty about predictions of the future94.
All of the valuation methods that have been presented above tend to have one of two limitations.
They are either overly simplistic by making unrealistic assumptions or too complex to be applied
in many managerial settings in reality95. By contrast, the real options and Monte Carlo
simulation models are more realistic because they capture costs and revenues as well as risk and
uncertainty96. However, these models often become very complex when applied to real world
settings97.
The Mergermarket survey confirmed that in practice the DCF approach is the most
frequently used approach. Second approach after the DCF is comparable transactions, which is
market based approach, where comparable transactions used in order to identify the value of IP.
On the third position is cost based approach, which is misleading as this approach one of the less
likely to capture the real value of IP, but has a good rating. The fourth place reserved by
probability or decision tree approach, which is more suitable for the IP valuation as it take into
account various possibilities or probabilities which could be employed through the patent life.
But as one can see this approach not frequently used and it ranked as a less important from the
point of view of valuators. Most difficult in terms of implementation, but most appropriate for
the IP valuation is option based approach and Monte Carlo simulations which received the last
two positions in the Figure 7. Thus the valuation experts and the IP experts must work together
92 Adner, Levinthal, What is not a real option: considering boundaries for the application of real options to business
strategy, in: Academy of Management Review 2004, Vol. 29, Issue 1, pp. 74–8593 Kogut, Kulatilaka, Real options pricing and organizations: the contingent risks of extended theoretical domains,
in: Academy Management Review 2004, Vol. 29, Issue 1, pp. 102–11094 Ernst, Legler, Lichtenthaler, Determinantsof patent value: Insights from a simulation analysis, in: Technological
Forecasting and Social Change 2010, Vol. 77, Issue 1, pp. 1-1995 Carte, The maximum achievable profit method of patent valuation, in: International Journal of Innovation and
Technology Management 2005, Vol. 2, Issue 2, pp. 135–15196 Vassolo, Anand, Folta, Non-additivity in portfolios of exploration activities: a real options-based analysis of
equity alliances in biotechnology, in: Strategic Management Journal 2004, Vol. 25, Issue 11, pp. 1045–106197 Carte, The maximum achievable profit method of patent valuation, in: International Journal of Innovation and
Technology Management 2005, Vol. 2, Issue 2, pp. 135–151
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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to ensure that both groups note all the risks facing the company and the effect that those risks
will have on the valuation98.
Figure 7: When you explicitly value IP assets, how often do you use the following
valuation techniques?
Source: A Mergermarket study in association with CRA International and K&L Gates, 2008
In order to capture the advantages of two approaches, the real options approach and
Monter Carlo simulations were combined to give a new approach for patent valuation99. The
real option approach in this case takes into account uncertainty about future value and Monte
Carlo simulations help to estimate the value. This new approach attempts to bridge the gap
between the closeness to reality and managerial applicability in patent valuation. Patent value is
identified as a surplus in profit that derives from comparing a specific R&D project with patent
98 Brodowski, M&A Insights: Spotlight on Intellectual Property Rights, in: Mergermarket study in association with
CRA International and K&L Gates, December 2008, p. 1099 Ernst, Legler, Lichtenthaler, Determinantsof patent value: Insights from a simulation analysis, in: Technological
Forecasting and Social Change 2010, Vol. 77, Issue 1, pp. 1-19
3,92 3,512,67 2,28 2,00
1,49
00,5
11,5
22,5
33,5
44,5
Nev
er
A
lway
s
Frequency of valuation technique
Frequency of valuation technique
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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protection and the same project without patent protection100. Consequently this approach
evaluates a patent per se.
After over viewing all the approaches for patent and patent portfolio valuation the attempt
to find out how practically investors proceed with patent portfolio valuation while conducting
assessment and valuation of the company was undertaken. The next chapter strives to answer the
following questions:
- What are the determinants that influence on the decision of investors whether to include
information about patent’s value into the overall value of the company?
- Whether the type of investor makes difference while valuing company which comprises
IP?
- What are the main trends in valuing patents? Do they get valuated by the investors at all?
- What are the approaches used by investors while valuing patents?
100 Ibid
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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Chapter 3
I Determinants influencing investor’s decision in valuing IP portfolio
A number of interviews were conducted with analysts and investors on the question how
investors integrate IP portfolio into the company valuation. The following findings were
revealed:
1. It is very much dependant on the industry in which the company operates
whether IP will be integrated by the investors into the overall valuation of the company.
It was documented by scholars that patent strength varies between industries in such that
in most industries patents are less featured that other means of protecting innovation101. Meaning
that they do not have a lot of weight in the company valuation and investors do not integrate this
information in their value model. Results of the 2008 Berkeley Patent Survey confirm that the
importance of patents to investors depends on the industry. Among biotechnology firms, for
instance, respondents were much more likely to reveal that commercial banks considered
patenting by the target firm important (43%) than software firm respondents (13%), investment
banks consider patenting in biotechnology more important (62%) compare to software (36%)102.
It is obvious that when a patent is essential for protecting patented technology it gets
accounted by the investor. In order to confirm this statement an interview with a pharma analyst
was conducted.
Interview with pharma analyst:
Pharma analyst from the investment bank pointed out that patents play a crucial role in
the pharmaceutical industry as they are the proxy for the future generation of cash flow and they
protect a new drug from the intervention of generics before the patent expiration. The analyst
stated that they do not value patents separately but they give them a rating as strong or a weak
patent which will be reflected in the overall value of the company. They divided patents in to
composition of matter patents and formulation patents. The United States Supreme Court has
defined "composition of matter" to mean "all compositions of two or more substances and all 101 Levin, Klevorik, Nelson, Winter, Appropriating the returns from industrial research and development, in:
Brookings Papers on Economic Activity 1987, Issue 3, p. 793 102 Graham, Merges, Samuelson, Sichelman, High technology entrepreneurs and the patent system: results of the
2008 Berkeley patent survey, available at http://ssrn.com/abstract=1429049 (last visited 01.06.2010)
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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composite articles, whether they be the results of chemical union, or of mechanical mixture, or
whether they be gases, fluids, powders or solids”103. From the words of the analyst formulation
patents are the patents which are granted after the expiration of the composition of matter patents
and aim to prolong patent protection in the markets for their pharmaceutical products.
Composition of matter patents is regarded as a strong protection from the generic drugs and they
receive a high ranking compare to the formulation patents, which will appear in the higher value
of the company. If a company has a composition of matter patent it will have a strong bargaining
power in terms of higher pricing of the company.
That is the only qualitative approach to value patents which was employed by the analyst.
To measure the value of the company analysts need to estimate future revenues and margins of
all the products in order to calculate future cash flows. For this, they have to model the impact of
patent protection on the overall value of the company. What is taken into account is that
composition of matter patents are stronger and hence difficult to challenge what lead to higher
protection from the rivals, higher future cash flows, which consequently makes the value of the
company higher. On the other side, reformulation patents can be more easily challenged which is
taken into account accordingly.
Early stage companies, for example biotechnology companies, which do not generate
revenues are very often evaluated in accordance with a real option approach. Pharma analyst said
that by using this approach it is possible to capture some uncertainties concerning patents, this
approach more flexible compare to others. But as was pointed out by the analyst there is no one
right approach to value the company and approaches vary from analyst to analyst. Some analysts
use net present value (NPV) of future cash flows with using probability adjustments for the
particular stage of development. As was explained, there are several stages in drug development
with a different level of probability whether the product will be launched on the market. For
example, if a drug is in phase one of development the probability that this particular product will
get to the market is only 10-20%, versus 70-90% if the drug is in phase three. These probabilities
vary according to indications and results available. The NPV in each stage is determined and the
expected net present value (ENPV) is calculated by taking the sum of the product of different
NPVs and the likelihood of their occurrence. But as plain NPV method is too static for the patent
valuation the probability adjustments need to be implemented.
103 Diamond v. Chakrabarty, 447 U.S. at 308 (1980)
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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From the point of view of the interviewed analyst modeling scenarios using both NPV
without probability adjustments and real option valuations are more useful as it is a yes or no
game.
From the interview it can be seen that not only one approach could be implemented in
order to value IP, but a combination of approaches depending on the stage of the project valued.
As was observed, when the project is not generating cash yet, the real option approach is
applicable. As soon as the constant revenue stream established, modeling scenarios using NPV
come into play. One should point out that the patent per se is not valued, the whole accent is on
the future cash flow of the patented technology, which is understandable as it is something
certain but one should also admit that patents are the essential value added and in the case with
pharma analyst not taken fully into account.
Interview with a venture capitalist:
As was discussed with the venture capitalist, the industry in which the company is
operating has a definite influence whether IP portfolio will be integrated into the overall value of
the company. In some industries it is very important to have a protection, patents for example, in
order to keep competitors on an arm length distance and have exclusive rights for the generation
of the future cash flow. The example of pharmaceutical companies was made. For these types of
companies patents are an inevitable part of the business and their existence gives a higher value
to the company. They most probably will be valued separately as they started to be regarded as
an asset of the company if they generate revenue through the products which have patented
technology or if they simply licensed to other companies.
This shows that investors already start to see patents not only as a legal tool for protecting
technology, but a business asset which could be employed in different company strategies like
licensing, cross-licensing, can be used as a bargaining chip and the like.
On the question how venture capitalists would include the value of patents into the
overall value of the company, the answer was that they usually do not integrate the value of the
patents per se but they look on their presence in the firm and their quality whether they can keep
rivals on the distance, whether the company having them has freedom to operate. Venture
capitalists said that they do not put a price tag on patents but they keep them in mind while
valuing the company. If the company has a sophisticated and well developed patent portfolio
which is managed on a constant basis, meaning that it would be hard for the investor to assess all
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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of it, he would probably ask for professional advice in order to value it. But it is very rare that
start-ups have a sophisticated patent portfolio in the early stage of development.
From this interview it is obvious that patents are the soft factor in company valuation,
meaning that they just one of the factor which add value to the company during its due diligence
and viewed by the investor as necessary part of the company, but they do not valued separately.
And as was discussed in this section industry in which company is operating add certain degree
of importance whether patents will be valued or not.
2. It is very much dependant on the type of investor whether information about IP
will be integrated into the company valuation.
Another observation which became uncovered during the conducted interviews is that is
not only industry which has influence whether patents will be valued or not and in which extent,
but also the type of investor plays a cruscial role in this process.
The study of Munari and Toschi revealed that Venture Capitalists (VCs), professional
intermediaries, and Corporate Venture Capitalists (CVCs), non-financial entity, differ in their
valuation ability. As CVCs possess more internal expertise and knowledge that can be leveraged
in the course of the due diligence process, they therefore develop more expertise in the valuation
of specific technological capabilities of the company and consequently while making their
investment decisions they measure technological content and quality of patents104. It shows the
general tendency that it is dependent on the ability of the investor and his qualification to value
patents and patent portfolios of the company and therefore include this information into their
valuation model of the whole company. A high degree of investor specialization plays an
important role in this process. It helps to reduce information asymmetry and uncertainty in the
valuation process. This held true not only among VCs and CVCs but institutional investors also.
The observation from the own held interviews obviously shows that venture capitalists do
not evaluate IP portfolios separately from the overall value of the company. His observation
mostly cover VCs. They rarely employ qualitative approaches as they leave it to the management
of the company. Quantitative approaches could take place if the patents are exploited and
generate revenue for the company. Investors look at the technology which a company owns and
104 Munari, Toschi, The relationship between patent portfolios and VC investments: the case of nanotechnology, in:
4th Annual Conference of the EPIP Association “Measuring the value of IPRs: theory, business practice and public
policy”, September 2009
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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whether patents can be helpful to maintain this technology and create free environment to
operate.
From the institutional investor point of view as they do investments in more mature
companies with a large patent portfolio they try to implement sophisticated approaches to value
it in order to reduce all the risks associated with it. As was found from the interview with the
pharma analyst the companies comprised patents get valuated with an option based approach,
which is considered to be comparably difficult to implement in contrast to the income based
approach for example. This shows that IP receives a growing importance in the company and
already more appropriate approaches are employed for their valuation. As was previously
discussed the option based approach dominates over other approaches as it allows to consider
different sources of uncertainty that characterize both patents and investment opportunities
linked to them.
As a result one could make a conclusion that it depends on the type of investor whether
IP valuation will be integrated into the overall value of the company and how it will take place.
Some investors have a specific expertise and can implement it into their valuation model, but as
long as they are not fluent in the valuation of technology-based company it could be a risky
endeavor to employ an uncertain information concerning patents. It worth to mention that if the
valuation monetary technique get employed then it would be likely an option based approach,
which getting strength over time and implemented more frequently in practice.
II Tendencies in valuing IP portfolio
1. It is difficult to capture value from the IP
All the interviewees pointed out that IP valuation of technology-based companies is
extremely difficult to execute. Very often investors look at the profits of the company and if the
company receives excess profits, they try to find the generator of the profits and how long they
will continue to exist. But it is very hard to say what exactly produces this excess profit. One of
the causes of it could be strong technology-based intangible assets. But again it is quite difficult
to integrate this information into the investment valuation model as it should answer on the
following questions:
- “Which technology produces excess profits
- How long the profits continue to exist
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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- How the profitability of the technology will change when a new technology is created in
the future
- How much influence the technology will have”105.
In this case it is crucial to consider when the term of patent expires and when a company
already without patent protection but still with a valid technology will be attacked by the rivals
and consequently the revenue stream will go down and patent is not count anymore for the future
cash generation. From this statement it becomes obvious that the continuity of the parameter of
profit rate is important, and when and at what stage the profit rate should be returned to an
ordinary rate is also important in terms of valuation.106 It means that companies get valuated
from the future cash flow perspective and patents as a mean of extra revenue generation play a
specific role in this valuation. Patents regard as an asset of the company. Investors count only
revenue which generated from the patented technology or the cash flow stream which occurs
from the patent deployment. But it doesn’t necessarily mean that patents get evaluated
themselves. As was discussed before the value of patents and patented technology is not the
same. Investors integrate information about patents as a soft factor into the overall valuation
scheme. As one of the investors pointed out: “We look on their existence, but they are not valued
from the monetary perspective and it is definitely hard to do it anyways”.
2. Investors value only those value drivers of which the managers of the companies
are aware.
It was found out that investors focus only on those value drivers of which the mangers of
the company are aware. There is no point for investors to focus on matters which are not known
to managers as they cannot use them in the future value extraction from them. They can increase
profitability and corporate value only if they know about the existence of such opportunity and
that is not the task of an investor to point out on them. This means that if management do not
give much weight to IP portfolio and ways of exploiting it and generate future revenue it will not
make sense for investors to include it into the overall value of the company.
One of the investors said that if the company has a strong patent portfolio and
management knows how to manage it and extract value they possess a bargaining power and
valued higher compare to other companies. Management is interested in the higher value of the
105 Ban, Group on disclosure of technology-based intangible assets, in: IIP Bulletin 2003, p. 2106 Ibid
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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company and they do all the valuation in order to present the company in a better light for the
investor. The price of the company is dependent on the information presented and the results of
due diligence of the company’s assets.
3. Investors tend to use only one metric in valuing patents and patent portfolios.
From the conducted interviews it became obvious that investors focus only on one metric
while valuing patents in particular how much revenue has been generated by the patent activities.
This mean that they do not look at other values which could be extracted from patents, like risk
avoidance, using patent as a bargaining chip if the litigation concerning the patent infringement
might occur. They look only at the revenue generation from the licensing or selling the product
which is covered by the patent. It was mentioned that in pharmaceutical industry it is pretty easy
to capture the value of the patent as it is the value of the patented technology, while in other
industries it could not be the case where the value of patent does not equals to the value of
patented technology.
From this one could make a conclusion that investors should be aware of different kinds of
metrics associated with patents and how they can be assessed and valued in order to be included
in to the overall value of the company. It is obvious that investors make focus on something
tangible, something that is certain like cash flow and other metrics considered to be provided by
the management of the companies.
Due to this factor, right now there is a tendency among Patent Departments of the
companies to come up with a variety of IP metrics in order to measure the success of the
company which afterwards can be communicated to the outsiders. As stated in the Foley &
Lardner LLP “Metrics and Measurement for Patent Departments” White Paper, investors are
demanding more and more information about a company’s inner workings related to IP and
patents.107 This information is needed for investors, such as institutional investors analysts in
order to better value the company or to weight the decision of whether to invest in to the
company.
107 Kamiski, Metrics and Measurement for Patent Departments, in: Foley & Lardner LLP White Paper 2005, p. 2
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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III Conclusion from the interviews
The overall perception from the conducted interviews is that IP portfolio is not very often
included into the valuation of the company even though investors and analysts stress the
importance of its presence in the company for their decision making. One of the reasons for this
result is that it is hard to integrate IP portfolio into the value of the company without well known
and highly developed approaches to do so. The nature of IP does not allow easily to capture their
value, there are a lot of uncertainties attached to them. Patents due to their lognormal distribution
of their value does not allow to capture their worth simply using traditional methods of
valuation. As was found investors use the option based approach and discounted cash flow
approach with certain adjustments for patent valuation more frequently compare to other
approaches. Qualitative valuations of patents they leave to management of the company.
Again not all investors integrate IP portfolio, but only those who had practical
experience in these kinds of valuation. It must be mentioned that investors focus on the monetary
perspective of patents, meaning that they do not see value in patents per se but they look at their
possibility to create revenue for the company through patented technology or the deployment
patents as an asset of the company through licensing for example.
There is a gap between the theorists who developed a number of approaches on how to
value IP portfolio and add it to the overall value of the company and investors who implement
the valuation of companies in practice and practically do not use those techniques or use them
very rarely.
There is a need to increase awareness of patents as significant value added for the overall
value of the company and need to value it through the more appropriate approaches which could
fully capture the value of it.
Some determinants from the conducted interviews were revealed which give a good
practical insight on the factors which influence the valuation of patents in the overall company
valuation by investors and which should be taken into account while discussing the topic how
investors integrate IP portfolio into the overall company valuation.
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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Chapter 4
Overall conclusions and recommendations
There is a need to value IP and integrate it into the overall value of the company as
otherwise the company value is not correct due to a large intangible asset component in it.
Investors need to value IP in order to capture the future potential of the company as IP is a proxy
for the future cash generation. It would be very beneficial for the investors to be able to identify
and measure company’s competitive advantage, which is IP. In order to do so investors should
implement existing approaches to value IP.
This paper considered an overview of existing approaches to value patents and patent
portfolios as most tangible part of IP. The following approaches were identified: qualitative and
quantitative methods. Qualitative methods are usually used by the management of the company
in order to develop an IP strategy. Qualitative evaluation of patents and patent portfolios allows
to align business and R&D strategy of the company. Patent portfolio valuation supports
management in their decisions concerning R&D resources, they should decide how they will be
allocated. That is not the only one function of patent portfolio valuation which is beneficial for
the management, but one of the most important ones.
In this thesis the view of management on patents was introduced, but the main focus was
on investors and their attitudes towards patents when they value the company. The question was
how practically investors value IP and whether they use existing approaches, which ones.
Interesting findings were revealed concerning the inclusion of patent information into the
valuation models.
It would be reasonable if qualitative methods to evaluate patents will be not solely only
business of management but investors will be able to perform such kind of evaluation too. As it
will support them in their right choice of the target to invest and as a consequence obtain an extra
revenue. This will help to identify the true value of the company. And the correct valuation of
the company could also decrease risks concerning the new investment as qualitative evaluation
could reveal the hidden dangers like possible future litigation from the patent infringement. But
the problem is that there is no one right approach to do so. A lot of metrics of patent value are
determined but the way they used and the combination is a totally subjective matter.
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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In order to find out a firsthand information about whether investors do qualitative
evaluation of patents and patent portfolios and whether they integrate this information into the
overall value of the company and how they do it, a number of investors and analysts from the
investment banks who invest in technology-based companies and pharmaceutical companies
were interviewed. The overall conclusion is that even though investors understand the
significance of IP for the company value and they look at it while making an investment decision
but very rare they integrate it into their valuation models. This paper assumes that some investors
do integrate such kind of information into their valuation models but interviewed investors did
not do it. It is mostly in regard to qualitative approaches for patent evaluation. It is so because
first of all investors rely on the management of the companies that they will do such kind of
evaluation and afterwards communicate it to outside interested parties. But not all the companies
conduct this evaluation. As was discussed with one of the investor as long as management
themselves do not evaluate IP internally meaning that they do not exploit the full potential of it,
there is no reason for investor to evaluate it and include into the overall value of the company
while management do not see the proper use of it.
But IP strategy inside the big companies with large patent portfolios becomes more and
more important nowadays and the situation with communicating the IP value improve rapidly. In
Japan and USA IP reports becoming commonly used during the last years. But again it is worth
to mention that even though there is an attitude which prevail amongst investors that qualitative
evaluation should be made by management, investors could better understand the company and
its actual value and potential if they will do it too. That is why as one of the conclusions and
recommendations would be to increase awareness of investors about the benefits of patents and
in particularly their valuation need.
The second reason why investors do not use qualitative approach is that it is hard to value
IP due to lack of commonly used approach. There is an option for the investor to ask advise and
proceed qualitative evaluation through the professional firm which is specializing in this kind of
services. A lot of companies now could support investor in this endeavor. One of the investors
said that if the company would have a big patent portfolio he will follow this line of action as
one should be knowledgeable in order to conduct qualitative evaluation.
From all said above one could see the gap between the theory and practice as it is hard to
blame academics for the lack of information as they provide a lot of research on how to evaluate
IP and which kind of metrics should be used in order to capture the full value of it but it is not
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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yet transformed into practice where all these techniques will be commonly used. That is why one
of the following suggestions for the investors would be to focus especially on the qualitative
evaluation of patents while valuing the whole company as very often they more concentrated on
monetary perspective, how much revenue has been generated by the patent activities, which
leads to the one-dimensional view of patents and does not appreciate the non-revenue benefits of
having a patent portfolio.
Monetary or quantitative methods of valuing IP were also discussed. Due to unique
features of patents some methods are less suitable for their valuation. Moreover there is general
difficulty in valuating IP. A Mergermarket survey shows that private equity practitioners and
corporate executives believe that IP value is not fully reflected in traditional valuation methods
like cash flow projections. “Respondents rated exposure to patent litigation, freedom to operate
and strength in key markets highest in terms of importance, and yet all of these factors are
overlooked or not readily incorporated by traditional valuation models”108. It is also worth saying
that some valuation models are more appropriate for IP valuation such as option based approach,
Monte Carlo simulation which considers the risk and uncertainty about predictions of the future.
It was discussed that when these two approaches are combined into a new method to
value patents per se but not the patented technology it is a reliable and good option for capturing
the patent value in the overall valuation of the company. As was shown all three standard
approaches which are cost, market and income based methods tend to have a heavy shortcoming
meaning that they value only half of the value of patent. They are static and can’t properly
measure patent value.
From the conducted interviews it was found that monetary valuation most frequently used
through option based approach but still there is a room for improvement in the valuation
techniques which used in practice by the investors and those who tries to capture the real value
of patents.
It is very important for the investors and management of the companies to integrate IP
portfolio into the overall value of the company taking into account all the approaches and
techniques discussed in the master thesis and consequently observe a real company’s value.
108 Brodowski, M&A Insights: Spotlight on Intellectual Property Rights, in: Mergermarket study in association with
CRA International and K&L Gates, December 2008, p. 2
Integrating IP Portfolio and Company valuation – MLB Master Thesis
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