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Intellectual property valuation

Valuation is considered as one of the most critical areas in finance; it plays a key role in many areas of finance such as buy/sell, solvency, merger and acquisition. Furthermore, intellectual property (IP) valuation is considered as one of the most important management strategic issues.[who?]


[edit] Background

The intellectual property is an intangible asset, that is, it is intangible as well as it cannot be defined or specified by its physical parameters. It is created by human intellectual or inspirational activity. Therefore, the intellectual property must be defined in some discernible method to be protected by the laws.

As a subset of intangible assets, the intellectual properties are classified into particular categories in which they have some similarities in terms of nature, feature, method of creation, and legal protection. The most widely accepted classification among the academics as well as the valuation analysts[who?] is:

[edit] Rationale

There are numerous individual reasons or motivations for conducting an intellectual property valuation or economic appraisal analysis. It is prepared, for example, for transactions, pricing and strategic purposes, financing securitization and collateralization, tax planning and compliance, and litigations support.

[edit] Factors driving the intellectual property

Intellectual property derives its value from a wide range of significant parameters such as market share, barriers to entry, legal protection, IP's profitability, industrial and economic factors, growth projections, remaining economic life, and new technologies.

[edit] Approaches

The valuation process necessitates gathering much more information as well as in-depth understanding of economy, industry, and specific business that directly affect the value of the intellectual property. Therefore, such information may be gathered from external and / or internal sources. Finally, the information is devoted to be turned into financial models to estimate the fundamental value of a particular type of intellectual property based on such adapted International Valuation Standards.

The valuation analysts use numerous approaches in order to reach a reasonable indication of a defined value for the subject intangible assets on a certain date which is referred to as the valuation date. The most common approaches to estimate the fundamental or fair value of the intellectual property are defined as the following:

1. Cost Approach: The cost approach is based on the economic principle of substitution. This principle states that an investor will pay no more for an asset than the cost to obtain, by purchasing or constructing, a substitute asset of equal utility. There are several cost approach valuation methods, the most common being the historical cost, replacement cost, and replication cost.

2. Market Approach: The market approach is based on the economic principle of competition and equilibrium. These principles conclude that, in a free and unrestricted market, supply and demand factors will drive the price of an asset at equilibrium point. Furthermore, it provides an indication of the value by comparing the price at which similar property has exchanged between willing buyers and sellers.

3. Income Approach: This approach estimates the fair value of intellectual property by discounting the future economic benefits of ownership at an appropriate discount rate.

4. Direct Approach: The direct approach is based on the current value of shares of intellectual property in an Intellectual Property (IP) Share Market. [1]

5. Competitive Advantage Valuation[2]

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