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N. 32, March - April 2007
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 | IP & RTD: Articles
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Reasons for Patent Valuation
Theo Grünewald
Dr.rer.nat
Alexander Wurzer
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The topic of the first article of this series (see IPR-Helpdesk
Bulletin No. 30) was the term “value”. It has been proven that
the patent value is not an objective figure, but one which can vary widely,
depending on the valuation subject. Patent valuation must therefore always be
conducted from the perspective of a certain person or company. At the same
time, there are various valuation approaches that seem appropriate in different
situations and that lead to divergent results. Therefore the specific reasons
for valuating the patent are decisive for the results themselves, since they
will determine the questions to be asked of and answered by the valuation.
Only by taking into account the reasons for valuating a patent a
suitable basis and method for valuation can be selected for a particular case.
Sometimes the reasons for valuating themselves define the complete valuation
procedure. This is usually the case when valuation is a legal requirement. In
this case, the parties involved normally have different aims for seeking a
patent value. A clear valuation procedure, one which is subject to legal
regulation, is therefore in the interest of all parties concerned. In some
other situations, the patent valuation is being done voluntarily, e.g. for
management purposes. Here the addressee of the valuation is the one determining
the requirements for transparency and significance. In this case, the selection
of an appropriate basis and method of valuation is defined in terms of
expedience as regards valuation costs, reliability and other relevant factors.
If there is no specific procedure required in terms of the external
circumstances surrounding the valuation, a discounted cash flows approach
should be selected. In such a case, the patent value is calculated from the
economic benefits expected in the future. This corresponds exactly to the value
definition and therefore leads in most cases to adequate valuation results.
Table 1 shows a summary of different reasons for the valuation of patents.
Table 1: Summary of reasons for patent valuation
In the following paragraph, the impact of different reasons for
patent valuation on the procedure of valuating will be explained with the help
of some short examples. Within the scope of financial accounting as defined by
the International Financial Reporting Standards (IFRS), intangible assets,
including patents, have to be activated under certain prerequisites on the
balance sheet. The balance sheet needs to satisfy the very different
information interests of various parties, like investors, outside creditors,
employees or the State. The necessary valuation of the patents therefore needs
to be made in the most objectified form. The valuation approach in this
situation is determined by the concrete rating situation. For example, if the
patents have been generated within the company itself, their value has to be
estimated very prudently. Therefore the patent values are derived from
manufacturing costs incurred in the patents’ development. In this case,
the data necessary for the valuation originate from the company’s cost
accounting system. Another basis for the valuation has to be used when the
patents have been acquired from third parties. In this case, they are activated
in the IFRS balance sheet by their acquiring costs, and the costs of a given
transaction will be estimated as the amount stated. This means it is assumed,
that the patent’s value has already been objectified for the company
when it paid the purchase price. But if the protection rights are purchased
within the acquisition of a company as part of that company, their value is not
directly discernable in the purchase price. They need to be valuated
individually and thus separated from the goodwill paid for the company. The
regular rating scale for this is the fair value at moment of the
company’s acquisition. To determine the fair value, it is necessary to
use current market prices or experiences with similar transactions. For
intellectual property rights for which there is no active market because of
their uniqueness, the relief from royalty method is stated as suitable for the
determination of value. According to this method, the value of a patent is
calculated through the hypothetical licence fee, the owner of the intellectual
property right would have to pay, if a third person was the owner of the
patent.
In the scope of patent infringement procedures similar third party
comparisons are regularly used. The injured party can claim its lost profits,
the infringer’s profits or an appropriate licence payment as
compensation in damages. In practice, usually the third alternative is chosen,
i.e. the payment of a licence fee, because then the infringed party is not
being forced to disclose its business data. Furthermore, it is not vulnerable
to being manipulated by the infringer. The amount of the compensation in
damages is calculated based on the amount that a fictitious, reasonable
licensor would have claimed at the beginning of licence negotiations if he had
known the circumstances that exist at the date of the court’s decision.
As a deterrent, some countries place an extra charge on the calculated licence
fee. In France for example, an extra 50% is charged, in Austria the
compensation in damages is double the license fee.
Another area in which patent valuation is gaining more and more
importance is the determination of adequate transfer pricing. Transfer prices
are amounts of money that are paid in corporate groups for the internal
exchange of products and services between the associated companies and company
departments. They serve as an instrument for managing and optimising the
interaction of companies that are run as profit centres. In international
companies this is also a means for shifting profits to countries with lower tax
rates. This is the reason why tax authorities also have an intense interest in
the determination of transfer pricings. Taxation offices only accept transfer
pricings that are calculated according to the arm’s length principle.
This means, that the transfer pricing needs to be based on the amount of the
licence that would have sensibly been agreed on by two independent parties.
Therefore a third party comparison is needed for the determination of the
transfer pricing. This can be performed using a comparison of a licence
agreement between two external third parties (external arm's length principle).
Alternatively it is possible to compare licence agreements that the company
itself has concluded with external third parties to the current situation
(internal arm's length principle). The challenge of the valuation for transfer
pricings consists in finding comparable situations. As a benchmark, different
parameters come into consideration depending on the data situation, including
profit potential, products, markets etc. But since it is seldom possible to
find truly comparable transactions, there must be an adaptation between the
compared situation and the situation to be valuated.
The examples above show that there are many valuation approaches and
procedures that differ widely in their methods, calculation processes, data
origin, reliability, significance, etc. The individual approaches cannot be
called ‘correct’ or ‘wrong’ in general. Rather they
are ‘appropriate’ or ‘inappropriate’ in respect of
a certain valuation situation. This is also a fact that shows that there is no
objective patent value. Choosing the right valuation approach is the linchpin
for the quality of the valuation. Therefore it is necessary to take a great
deal of care to select the appropriate valuation approach before starting the
actual valuation activity. Only in this way high quality valuation results that
correspond to the concrete reasons of valuation and the related question asked
can be derived.
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