Valuation of IPR is a tricky business

1 month ago by in featured articles, Finance, Valuation Tagged: ,

“What’s the value of my IP” is a question that comes up in the mind of a lot of IP owners, enticed by news of lavishly priced IP rights, they would like to see if they can get their IP monetized in a similar lucrative way. For the companies that receive the question whether they can valuate the IP this is not always good news. “It depends”  is mostly not a reply that is welcomed by a hopeful IP owner, who expects immediate enthusiasm by the valuator and a strong confirmation of his own ideas about how valuable his IP is.

For those that are in the valuation business this may be a familiar sound-bite.

Let’s start by saying that there is nothing like a “fair” valuation. Owners of IPRs have – only experienced market players exempted – way overheated expectations of the value of their IPR. Economists have called this the “endowment effect”. We come to that in a minute. First, in the absence of a specific value that someone is willing to attach to a certain IPR due to specific circumstances, we concentrate on fair value of IPRs.

What is “fair value”? Under US GAAP accounting rules, fair value is the amount at which the asset could be bought or sold in a current transaction between willing parties, or transferred to an equivalent party, other than in a liquidation sale. However nice that sounds, in IPR this supposes a market in which both buyers and sellers are equally well informed, both have experience in buying or selling IPR, both operate in a fully transparent market (buyers and sellers are known or can easily be found) and conditions for sale are constant, identifiable, transparent and equally accessible to both purchaser and seller. Most importantly fair value supposes a fair market. That’s the problem in IP as there is no such a thing as a “fair market” for IP.

The endowment effect is particularly present in monetizing of IPR and will hence have a significant negative effect on valuation of IPR. The gap between what people are willing to accept (WTA) to sell their asset or property and what others are willing to pay (WTP) for those assets is commonly termed the “endowment effect” and has been detected for many forms of property. A survey of endowment effect experiments found that the discrepancy between WTP and WTA tends to be highest for public and nonmarket goods such as health and safety measures, lower for ordinary private goods such as mugs and candy bars, and lowest for objects associated with monetary payments, such as lottery tickets.

Buccafusco & Sprigman, in “Valuing Intellectual Property – An Experiment” (2010) performed a test of the endowment effect in a setting intended to mirror an IP market especially with the intent to see whether the endowment effect can be extended also to goods that an owner has created. In all previous experiments, the owners have either simply been given the goods that they are then asked to value or, occasionally, have done something to earn them. None of the previous experiments asked subjects to actually create an object and then value it.

The assumption would be that with IP rights (which are so called non-rivalrous goods, meaning goods that may can be possessed or consumed by more than just a single user) only a reduced endowment effect is likely as these forms of property involve only partial alienation, especially with copyrights. Rights in a creative work such as a poem, novel, screenplay, or even most photographs and other graphic arts does not deprive the original rights holder of possession of a copy of the work. So Buccafusco and Sprigman organized a series of experiments intended to simulate a market for buying and selling creative works to test whether there are any endowment effects in transactions in non-rivalrous creative works.

Their experiment demonstrated a large valuation asymmetry between creators of new works and potential buyers and hence a strong endowment effect (read Buccufusco & Sprigman’s article for the details of their experiments.

Although not measured in case of patents and trademarks, it leads us to believe that the endowment effect in IPRs is particularly prevalent and strong. Making valuations that satisfy both sellers and buyers an almost impossible task. Therefor a caveat is in order for those that seek “honest” or “fair” valuations: there is no such a thing. Don’t let yourself be fooled by valuation companies pretending to give the ultimate professional valuations providing glossy graphs, statistics and attractively designed brochures and opinions.

Be realistic and take any IPR valuation with ‘a grain of salt’, actually pounds of it.

IPEG Intellectual Property Expert Group is an IP consultancy based in Europe