There are three methods widely accepted as best practice for quantifying the value of intellectual property or intangible assets:

  1. cost approach – intellectual property is valued at the historic cost of development;
  2. market approach – intangible asset value is extrapolated from similar or equivalent sale transactions that are a matter of public record (much as you would do when buying a house); and
  3. relief from royalties approach – the relief from royalties (or “royalty savings”) approach posits intangible value as the net present value of royalty savings – that is, the fees saved by owning rather than having to license intangible assets from a third party – over the useful life of the intangibles, taking into account other, incidental financial advantages of acquiring and owning those intangibles (such as tax write-offs) instead of licensing them.

Each methodology suffers from inherent flaws:

  •  the cost approach is, arguably, unduly conservative for purposes of valuing an asset class that is overwhelmingly premised on future potential. It is most appropriate to untested technologies on which large sums have been expended by way of research and development. Moreover, where up-and-running businesses are concerned, empirical data show that once an intangible asset is commercialised, and the overarching business profitable, costs spent on development of the asset bear no reliable relation to actual value. It is also widely accepted that businesses may expend inordinately high amounts on research and development that turns out, ultimately, to be worthless in commercial terms. These principles notwithstanding, costs of development may serve, for want of any better metric, as a good proxy for (if not an indicator of) value in instances of intangible assets that remain uncommercialised and untested in the market. In instances where there is a danger of over-exuberance in valuation (as was the case in Silicon Valley immediately preceding the bursting of the dot com bubble), a cost accounting of intangible assets can be instructive in tempering a revenue-based valuation that is overly optimistic and forward-looking;
  • the market approach, while ideologically appealing:
    • fails to take into accountthe novelty or originality that is at the core of any intangible asset, properly defined, rendering the comparisons of pure equivalence, on which the market approach is premised, unlikely if not impossible (in essence, intangible assets are not fungible, and as such, are unlike houses of similar size on the same street which are readily comparable for valuation purposes); and
    • is hindered by the dearth of public information regarding sale of intellectual property, which is often the subject of very early-stage transfer, or sold in private transactions.
  • the theoretical approach of the royalty savings method is the most defensible and rigorous, having been cited with approval by courts in a number of jurisdictions, but is also:
    • vulnerable to an over-exuberance bias, inasmuch as it is exclusively forward-looking;
    • heavily reliant on financial assumptions about an essentially unknowable future; and
    • premised on the assumption of revenue levels that have reached critical mass and can therefore reliably be modelled to predict future revenues (rendering the methodology inappropriate for valuing very early-stage or uncommercialised intellectual property).