Appraising a Patent

by Christopher Faille
One approach focuses on the costs of inventing the patented asset.

One approach focuses on the costs of inventing the patented asset.

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The question of the appraisal or valuation of patents has excited a good deal of discussion in the business and financial worlds, for obvious practical reasons. Patent owners have to make a number of decisions and these decisions often turn on the value of the assets involved.

Cost-Based Approaches

There are two distinct cost-based approaches to valuing a patent, one focusing on the costs of the technology and the other on the costs of the patent as a legal instrument. The technological-cost approach values the patent by looking to the hours expended by engineers in its development, laboratory space and resources they consumed at the time, and so forth. A legal-costs approach looks at the money expended in filing fees and attorney costs to assert and defend patent rights. Neither method is very satisfactory in the assessment of market realities and they have fallen out of favor.

Market and Income Approaches

A market-based approach, as explained by Meir Pugatch of the University of Haifa, equates the patent to be appraised with "recent transactions that involve patented technologies of a similar nature and function." In this sense, the market method looks backward. This can be very effective when there are comparable transactions available, but since patents are not fungible, this is seldom straightforward. An income approach looks forward to the expected stream of revenues, from exploitation of the protected technology, and discounts that to its present value. (Some discounting is necessary simply because $1 today is worth more than $1 next year, for reasons of inflation, uncertainty, and simple impatience.) Thus, the stream-of-revenue approach is also known as the discounted cash flow (DCF) approach.

Option-Based Approach

Another approach, one that combines elements of the market and income methods, is the consideration of an underlying research-and-development project as an exchangeable option. This allows for an explicit adjustment for the most pertinent risks in such an assessment: the risks that a certain research project will never result in a viable invention or, even if it does, the invention will quickly be superseded by another devised by a competitor. Also, the options-based method does not implicitly assume that a brand new asset leaps into existence the moment a patent is issued; it sees that issuance as only one event on a timeline. The R&D; project may have had option-based value well before that moment. This is sometimes known as the "real options" approach to valuation.

Conclusion

Though research continues, the real options approach is the best fit yet devised for appraising the value of many patents, even pre-patent projects. It can guide a patent owner's decisions about, for example, whether it is appropriate to pay the necessary fees to patent in the first place and renew the patent, whether to license an existing patent rather than develop it internally, and so forth.