Quantitative Valuation Of A Patent

Patents and other forms of intellectual property are intangible assets. The asset is merely a legal right conferred upon the patent holder. Yes, one can physically hold a registration certificate or other indicia of the asset, but one cannot physically feel, touch, smell, or hold, the underlying legal rights. Add to a patent's intangibility the fact that the legal right is by definition unique (because a patent must be something novel), and one has the very essence of a difficult-to-value asset.

On the other hand, patents are given valuations all the time. One possible valuation model focuses on the price that a willing buyer and a willing seller would agree upon for sale of the patent. Of course, if the willing buyer/seller model is to yield a result that is anything other than an estimate, there must be a ready market for the patent. In addition, for the result to be accurate the patent must have either been recently sold, or there must at least have been a recent arms-length negotiation. If there is no ready market, or the last transaction is a bit long in the tooth, the willing buyer/seller model is just an educated guess.

A second valuation model focuses on the market for the product (or products) covered by the patent. In the marginal profit model one makes assumptions about the market size, market penetration, cost of entry, cost of production, lifespan, and profitability of the patented product, and then runs a spreadsheet to estimate profit. The value of patent is then taken to be the discounted present value of the estimated marginal profit, i.e., the profit over and above profit that which one would expect to be generated without the patent. Unfortunately, the validity of the marginal-profit model depends entirely upon the validity of the underlying assumptions, and those assumptions can vary wildly among different analysts. At the end of the day, it all boils down to experience and judgment. My advice is to use a company that specializes in valuing patents, and preferably that has experience in valuations in the particular field of interest. Firms to which I have successfully recommended clients for IP valuation include This e-mail address is being protected from spam bots, you need JavaScript enabled to view it at Standard and Poors, and This e-mail address is being protected from spam bots, you need JavaScript enabled to view it at Globalview Advisors. Also recommended, especially for biotechnology assets, is William Snyder, director of Valuation Services at Financial Markets Analysis, LLC.

A third valuation model focuses on the costs incurred in developing the technology and securing the patent, and in some instances the replacement cost of re-creating the technology. The cost/replacement model is perhaps useful for bookkeeping purposes, and may be important to shareholders to understand where their funds have disappeared. But costs incurred in developing technology and securing patent protection have nothing whatever to do with the value of the patent. One can easily spend millions of dollars securing a patent that is worthless, and one can also spend less than ten thousand dollars to secure a patent worth many millions.

For the willfully blind or the just plain lazy, there is a fourth valuation model that focuses on simple metrics, such as the number of patents in a portfolio, the number of claims in a patent, or the number of times that a given patent is cited by later patents. From perusal of the rest of this book, it should be completely obvious that those numbers have little to do with value of a patent. The one exception is where the owner holds a very large patent portfolio. In those instances the simple metrics model has at least some validity because every additional patent has intrinsic value regardless of the independent value of the patent. The whole is greater than the sum of the parts. IBM, for example, has so many patents on desktop and portable computers that it is essentially impossible to build a commercially viable computer without stepping on one of their patents. Years ago IBM threatened one of my clients with patent infringement for building and selling desktop computers. The IBM licensing agent sent me five patents to review, and I diligently found either work-arounds or invalidating prior art for all five patents. When I presented that information to the licensing agent, he merely offered to send me another twenty patents for consideration. The point is that IBM has so many patents, and is so reasonable with their licensing rates, that it makes no sense whatsoever to fight them. Independently of any other analysis, the sheer size of IBM's patent portfolio means that the portfolio has inherent value.

A fifth valuation model focuses on the management team charged with exploiting the patent. That management team model is the darling of investment capital firms because startup companies rarely have a "B" management team, let alone an "A" team. Indeed, the venture capital firms regularly use that deficiency as a cudgel to beat the patentee over the head, declaring that the patent is worth very little without an adequate team to build and market the product. They have a point, of course, but the argument is illogical. The value of the patent is independent of the people who are exploiting it. With enough money and stock options one can always hire good people, and raise sufficient funds. Ironically, one of the assets that the venture capital firm is supposed to bring to the table is the very management team that they find lacking.

The valuation analysis is the same for both licenses and assignments, with the proviso that there is somewhat greater perceived value for the assignee to hold a patent than for the licensee to hold a license. That perception is not necessarily justified, however, because in many ways it may be better to hold a license than a patent. One factor is venue of litigation. It is not uncommon for an infringer to bring a declaratory judgment action against the patent holder to declare the patent invalid. But the owner of a patent is a necessary and indispensable party to the litigation, and an individual owner can only be sued where he resides. Thus, maintaining the patent ownership in the name of the inventor can often prevent the licensee from being dragged into court in the middle district of Georgia, or some other locality where the judge is the brother of the infringer. Another factor is cost of litigation and maintenance. Where a patent is assigned, the assignee becomes responsible for defending the patent (by suing infringers) and for paying maintenance fees. With licenses it is common for the licensee to cover those costs.