As a business appraiser and intermediary in the sale, merger and acquisition of privately held companies, I’m often asked about how to value intellectual property.
Intellectual property is something originally created in the mind. Among other things, it can be an invention, a written manuscript, a piece of art or a company logo including words, phrases and images used in business.
Some experts in intellectual property break it down into four categories: copyrights, trademarks, patents and trade secrets.
A copyright is a person’s or company’s exclusive right to reproduce, publish, or sell his or her original work of authorship (as a literary, musical, dramatic, artistic, or architectural work). The ownership right is protected by law.
A trademark is a distinctive design, graphics, logo, symbols, words, or any combination of these that uniquely identifies a company and gives the owner the legal rights to prevent its unauthorized use.
A patent is a right granted to an inventor by the federal government that permits the inventor to exclude others from making, selling or using the invention for a period of time.
In general, a trade secret is any confidential business information that gives a company a competitive edge. Legal protection for owners of trade secrets is available but murkier than for the other categories.
How do you place a value on intellectual property?
It’s not easy but I’ll tell you how I do it to get fairly close. When I’m appraising an on-going business entity, I’ll determine the total market value of the business by using industry-specific valuation formulas, sold comparables and other methods. Then I’ll subtract from that total market value the (1) inventory at cost, (2) the furniture, fixtures and equipment at used replacement value, and (3) the value of any other tangible assets.
The remaining balance is the company’s goodwill value which may include intellectual property. However, be aware that goodwill can include other items in addition to the intellectual property. Such things as company reputation, trained employees and a loyal customer base are also part of the goodwill of the business. For an article explaining goodwill in more detail, please see “What is Business Goodwill.”
For further reading, here are additional articles that may be of interest:
- How to Use Valuation Guidelines to Estimate the Value of a Business
- How to Analyze a Business You’re Considering Buying
- How to Make a Written Offer to Buy a Business
- Seven Negotiating Rules When Buying or Selling a Business
- How to Conduct the Due Diligence When Buying a Business
# # #
William: Is my understanding correct, that you are saying the value of Business Intellectual Property {BIP] is not something that is added to the market price of a business – using the normal valuation metrics [i.e. “industry-specific valuation formulas, sold comparables and other methods”]. As I understand your article [and I agree with this approach], the value of BIP is the difference between the Market Value of the Business and the value of the net assets of the business.
Tom, yes, you are correct. The valuation formulas assume that the intellectual property is already contributing to the revenue and discretionary earnings of the business, hence the valuation formulas for percentages of revenue and/or the multiple of discretionary earnings are inclusive of the IP.