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Patent Valuation Made Easier

Placing a value on Intellectual Property like Patents and Trademarks is usually a more subjective under taking than for example, placing a value on Real Estate or a Classic Car.
 
In the world of Real Estate and Classic Cars there is usually an abundance of like or very similar property or vehicles that have recently been on the market and sold; from which one can extrapolate a fairly close comparable that would represent at the very least a starting point for a fair market value.
 
The reason for subjectivity as it relates to Patent and Trademark values is in most cases the lack or even absence of market comparables as it applies to a Patent(s) or Trademark(s) being offered for Assignment/Sale.
 
In fact, one of the standards used by the United States Patent and Trademark Office [USPTO] when examining a Patent application is the Novelty standard. If a submitted application seeking Patent protection is not novel or new based on the examiners investigation of world wide Prior Art references, then the application will be rejected by the USPTO.
 
So, strictly speaking, by their very nature of having to be novel or very different than any other invention anywhere on the planet, issued Patents should not actually have a market comparable. The question remains, how would a seller and or an acquirer arrive at some reasonable valuation for a Patent(s) or Trademark(s) being offered for Assignment/Sale.
 
Some research reveals a number of methods or formulas suggested by I.P. Valuation firms seeking compensation for their work. Most of the formulas are complicated and in some cases even convoluted, purposefully designed so that even an intelligent person is lead to conclude that he/she must use their services to get the answers they seek.
 
Using the adage that the value of anything including Intellectual Property is what a willing Seller and a willing Buyer finally agree to is ultimately true. However, before good faith negotiations can start both sides need to begin from a realistic starting place or risk derailing negotiations before they get started due to unrealistic expectations from one or both parties.
 
The following is a list of eight basic valuation fundamentals that most valuation experts agree on that form the basis of arriving at a fair I.P. valuation. While these fundamentals have an important bearing on the value of a Patent they each have a separate rating. Reason being, considered individually, each will have a greater or lesser rating impact on the overall value of a Patent. A perfect score would be 100.
 
  • Is the Patent a “Game Changer”? In the I.P. universe game changer translates into revolutionary technology or a product that a high percentage of the population will want and purchase even though at the time of introduction, they know nothing about it or why they need it. The late Steve Jobs built an empire on the ideology that his Apple products, once seen and used by the retail public would be must have products by millions, even though the users had no prior knowledge of them. He was a leading advocate of “Build It and They Will Come”. Score 20
  • Is the Patent “Transformative” or “Incremental”? An example of this would be the first Mobile Phone being transformative as compared to the multiple of incremental changes/improvements made to it over the years since being first introduced. Score 10
  • Is the Patent a “Money Maker”? For a Patented product or technology to score high in this category it must be a “Game Changer” and “Transformative”. If it possesses both of these characteristics it has a good chance of wide market acceptance and high demand, which usually equates into high sales revenues and subsequent profitability. Score 20
  • Is the Patented product or technology easily integrated into existing product offerings? Generally, the value of a Patented product to a manufacture/distributor is much higher if the product complements existing products and especially so if the Patented product helps to drive increased sales of existing products. Score 10.
  • Is the Patented product simple to manufacture? Historically, Patented products that do not require the manufacture to incur “Re-tooling” expense and can be produced from existing production machinery, will score a higher valuation. Additionally, if the Patented product can be manufactured with minimal human labor, it will
  • score a higher valuation. Score 5
  • Does the Patented product fill a need or solve a problem? This requirement is similar to “Transformative”. If a Patented product fills a need or solves a problem which are both transformative qualities, then it scores a higher valuation. Score 5
  • Patent Claim Strength and Term? Careful drafting of the Patent claims is very important. Patents with the broadest possible claims score a higher valuation, are more difficult or even impossible for an Infringer to design around and much easier for a Patent owner to prosecute and receive Court ordered damages should someone attempt infringing.
 
In the case of a “Design Patent” which claims the “Ornamental Aspects” of the invention rather that what it does, as in a Utility Patent, the drawings of the subject seeking Patent protection are very important. While Design Patents usually have only one claim, that one claim provides the broadest possible protection for the invention if properly drawn. A Design Patent can also embody utilitarian aspects of the invention if properly drawn while not needing or being required to itemize them as claims. To that end, recent Court decisions have significantly strengthened Design Patent validity and enforceability.
 
Term: The longer the term or time remaining on the Patent granting protection to the Patent owner, the higher the valuation. Score 20
 
  • Patenability vs Marketability? Many inventors are under the false assumption that if an Invention passes the USPTO's relevant laws of Novelty, Obviousness and Anticipation that an issued Patent must also be marketable. The truth is that most issued Patents are not marketable due to there not being a market demand or sufficient market demand for the Invention. Patents with Marketability that generate a high market demand score a higher valuation. Score 10
 
In summary, a Patent with a score of 95 to100, is a Patent with greater value, meriting a higher valuation than Patents with a lesser score.
 
Doing the Math: Earlier we discussed how many I.P. Valuation firms suggest the use of complicated formulas to arrive at a fair market valuation for Patents or Trademarks. The above list of valuation fundamentals certainly has a bearing on a Patent's value and provides a starting place, but this is where the math can get fuzzy, complicated or unless you have a Harvard forensic accounting degree , makes little sense to the lay person. I have always believed in the application of Occam's razor law where appropriate in solving complicated matters, “All Things Being Equal, The Best Solution Is Usually The Simplest”. Similar to: “The Shortest Distance Between Two Points Is a Straight Line”.
 
After all my research on the subject, the “Income” based approach seems to me to be the most straight forward and simplest method of determining a fair market value for I.P.
 
Using this method, a potential acquirer estimates sales revenue or total gross income derived from the acquisition of the I.P. Allowing for a one year ramp-up period, the potential acquirer then calculates the estimated total gross income over the remaining term of the Patent. The longer the term, the more income generated, thus adding more value to the Patent.
 
Lets use the example of a Design Patent that has a 12 year term left before expiration. The potential acquirer determines that over that 12 year period, sales of the acquired I.P. will result in 50 million dollars of new or additional sales/income.
 
Now, depending on the score of the above eight listed fundamental basics, a percentage of the 50 million dollars is factored to arrive at a fair market valuation. A range of percentages are used from 5% to a high of 12%.
 
We can further simplify the process of arriving at a fair market valuation by assigning a percentage multiple of 5 to12 to total points scored from the list of eight fundamental basics. A Patent with a score of less than 40 is arguably not marketable. We will start with a score of 40 points.  
 
Score... Percentage Multiple:
40 ... 5
45 ... 5
50 ... 6
55 ... 6
60 ... 7
65 ... 7
70 ... 8
75 ... 8
80 ... 9
85 ... 10
90 ... 11
95 ... 12
100 ... 12
 
A low score will likely mean no interest in an acquisition or a low percentage multiple used. On the other hand, a higher score merits a higher percentage multiple used. So, for the sake of this example, lets say the Patent in question scored a 70 out of 100 points. Simple math: 8% of 50 million dollars is 4 million dollars. In this case 4 million dollars is fair market value for the Patent.
 
So, at this point you must ask yourself, in a world [year 2015] where a CD [Certificate of Deposit] yields 1% or less, would a serious Buyer/Acquirer commit $4 million dollars to generate a $50 million dollar increase in Gross Sales over the 12 year period? I think reasonable persons would have to answer yes especially since any dollar figure used for gross sales/revenues [in this example 50 million over the remaining term of the Patent] is logically going to be a conservative number to start with and only a number the potential acquirer can provide.
 
Granted, the increase in Gross Sales of $50 million is spread over 12 years, but averaged out over that period equals $4.2 million per year, which arguably is still an attractive return. Also consider, in the absence of the acquired I.P. there would be zero increase in sales revenue relative to having acquired the I.P.
 
No doubt, some will object to what they will call my over simplified formula at arriving at a fair market value for I.P. and of course everyone is entitled to their opinion. Furthermore, they will argue that any mathematical equations used should be based on net profit not gross sales.
 
I assert that not many, if any acquisition deals would get to closing if net profits were the only yard stick used to arrive at a fair market value.
 
Reason being, that between the top line of the Income Statement [total gross sales] and the bottom line [net profit] there is a lot of creative accounting employed to minimize the Company's taxable profit. Secondly, it may be an accounting nightmare to separate out expenses related only to the acquired I.P. since most of the Company's fixed operating expenses and discretionary spending are already spread out and attributable to its other offerings.
 
Fixed and reoccurring operating expenses could be factored against the percentage of new sales that are attributed to the acquired I.P. then use that same percentage to determine what portion of expenses are related to it. Even this method can quickly get convoluted and potentially be out of compliance with GAAP [Generally Accepted Accounting Principles] standards.
 
Furthermore, the Seller of the Patent has no control or influence over the Buyers ability or accounting methods used to earn profits. Every for profit business must earn a profit to remain in business. No business person will dispute that fact. But, for the purposes of Patent valuations, why use metrics to arrive at conclusions that the Seller is so far removed from it renders them analytically invalid.
 
Please take notice that the title of this article is “Patent Valuation Made Easier” not easy. I do not contend that the process, method and guidelines used herein are easy and completely non-subjective. However I do claim that if the parties to the transaction are honest and fair minded and use the guidelines set forth in good faith, that in the final analysis, a willing Buyer and willing Seller will close the deal!
 
By: Robert S. Lowery, Inventor, Designer, Disruptor
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