Intangible Asset Valuation Approaches

1 Intangible Asset Valuation Insights Intangible Asset Valuation Approaches and Methods Brian P. Holloway and Robert F. Reilly, CPA. There are numerous reasons to apply the cost approach to the Valuation of an Intangible Asset . Before applying this Valuation approach, the Valuation analyst should be familiar with the generally accepted cost approach methods and procedures. In addition, the Valuation analyst should have sufficient data to measure (1) the Intangible Asset cost components and (2) the Intangible Asset obsolescence components. This discussion summarizes both (1). the data requirements and (2) the analytical procedures needed to apply the cost approach. Introduction 3. that best fit the characteristics ( , use, age, etc.) of the subject Intangible Asset ;. As mentioned in the previous discussion, there and are three generally accepted Intangible Asset valu- 4. that are most consistent with the practical ation Approaches : the cost approach, the market experience and the professional judgment approach, and the income approach.

2 The Valuation of the individual analyst. analyst will typically consider, and attempt to apply, all three Intangible Asset Valuation Approaches . This is because the application of multiple Valuation Within each Valuation approach, there are sev- Approaches provides the analyst with multiple value eral Valuation methods that the analyst can select indications. and apply. And, within each Valuation method, there are also numerous procedures that the analyst can These multiple value indications often reconcile perform. into a reasonable range of Intangible Asset values ( , with the analyst being able to consider mean, Therefore, to use the proper professional jargon, median, mode, interquartile measures, and other Valuation procedures are performed within a valu- central tendency measures). Ideally, the multiple ation method to conclude a value indication. And, value indications provide mutually supportive evi- Valuation methods are applied within a Valuation dence for the analyst's final Intangible Asset value approach to conclude a value indication.

3 Conclusion. The analyst may perform two or more Valuation Typically, due to data limitations, most intangi- methods within a single approach. For example, ble Asset valuations are primarily based on only one the analyst may perform three different income Valuation approach. For each Intangible Asset valu- approach Valuation methods and then reconcile the ation, the analyst will typically select the approach three value indications to conclude a single income (or Approaches ): approach value indication. 1. for which there are the greatest quantity At this point in the process, the Valuation analyst and quality of available data; typically reconciles the various Valuation approach indications (if more than one approach is used). 2. that best reflect the actual transactional This synthesis of the various value indications will negotiations of market participants in the result in the analyst's final Intangible Asset value owner/operator industry.

4 Conclusion. INSIGHTS AUTUMN 2012 13. The Economics of tual property. However, since the Valuation analyst .. all cost assumes a greenfield, the hypothetical intellectual Intangible Asset property does not infringe on actual intellectual approach methods Valuation property. apply a compre- All cost approach Valuation An FCC license may be an example of a fungible commercial Intangible Asset . A buyer may refuse hensive definition methods are based on the eco- to accept the seller's asking price for, say, an FCC. nomics principle of substitu- of cost, including tion. That is, the value of the broadcast license. Instead, the buyer can go to the marketplace (or to the FCC) and buy a perfectly consideration of subject Intangible Asset is influ- identical substitute license. In this case, the cost of enced by the cost to create a an opportunity new substitute Intangible Asset . the alternative license is relevant to the FCC license Valuation .

5 Cost during the As will be discussed, all A patent is typically not a fungible Intangible cost approach methods apply Intangible Asset a comprehensive definition of Asset . A patent (by definition) is a unique intellec- tual property. A buyer cannot go to the marketplace development cost, including consideration of and buy a perfectly identical substitute patent. an opportunity cost during the stage. Intangible Asset development There is only one subject patent, and it is registered with the Patent and Trademark Office (PTO). stage. In addition, the cost of the new substitute Intangible Let's assume a subject patent. The buyer may Asset should be reduced (or buy a functionally similar patent. Or, the buyer can depreciated) in order to make the hypothetical new develop a new noninfringing invention. Let's assume Intangible Asset comparable to the old subject a substitute patent. A perfectly identical substitute Intangible Asset .

6 Patent would, by definition, infringe on the subject patent. Not all commercial Intangible assets are fungible. Some Intangible assets are unique and, therefore, However, the cost approach application should cannot be replaced. For example, there may only be consider the cost to create a noninfringing substi- one hospital certificate of need (CON) granted by tute with the equivalent utility to the actual patent. the state for a particular town. In that case, either a Therefore, the cost approach may still be used in hospital holds the one unique CON or it does not. A an intellectual property Valuation , although it may substitute or replacement CON will not be available have certain application limitations. at any cost. In such an instance, the cost approach All market approach Valuation methods are may not be the best approach to use to value the based on these two economics principles: CON Intangible Asset . 1. Efficient markets The Intangible Asset may be unique because it 2.

7 Supply and demand is legally protected. This situation may occur in the case of an intellectual property, such as a pat- ent, copy, trademark, or trade secret. That is, the That is, the value of the Intangible Asset may be marketplace cannot actually replace an intellectual estimated by reference to prices paid in the market- property with a replacement intellectual property. place for the arm's-length sale or license of a compa- This is because the subject is a legally protected rable (or a guideline) Intangible Asset . intellectual property, and the replacement intellec- A comparable Intangible Asset is very similar tual property would infringe on the unique subject to the subject Intangible Asset . The comparable intellectual property. Intangible Asset is approximately the same age, is at In this situation, the analyst should note that the approximately the same place in its life cycle, and cost approach considers the cost to replace the util- serves a similar function as the subject Intangible ity of the subject intellectual property.

8 The applica- Asset . tion of the cost approach assumes that the subject The comparable Intangible Asset may be used in intellectual property does not already exist. the same industry, performing about the same func- Real estate appraisers call this assumption the tion, at about the same size as the subject Intangible greenfield premise. That is, the subject building is Asset . Sales or licenses of a comparable Intangible assumed not to exist, and the real estate appraiser Asset provide direct pricing evidence to the analyst faces an undeveloped greenfield ( , a vacant site). about the subject Intangible Asset . The Valuation analyst may be able to apply mean or median pric- In the Intangible Asset Valuation , the replace- ing metrics to the subject Intangible Asset . ment provides the same utility as the actual intellec- 14 INSIGHTS AUTUMN 2012 A guideline Intangible Asset is generally similar cost and development effort data may still be avail- (but not identical to) the subject Intangible Asset .

9 Able (or may be subject to an accurate estimation). The guideline Intangible Asset should be subject to In addition, cost approach methods are also the same general risk and expected return invest- applicable (1) to the Valuation of an in-process ment elements as the subject Intangible Asset . Intangible Asset and (2) to the Valuation of a Compared to the owner/operator Intangible noncommercialized (or defensive use) Intangible Asset , the guideline Asset may be operated in a dif- Asset . An example of a noncommercialized intan- ferent industry, at a different size company, with a gible Asset is a patent or a trademark that is held different function, and so forth. Sales or licenses of primarily for its strategic defensive use ( , so a guideline Intangible Asset still provide meaning- the owner's competitor cannot own or operate the ful (albeit indirect) pricing evidence to the analyst Intangible Asset ). about the subject Intangible Asset .

10 The Valuation analyst should realize that the In order to obtain pricing evidence from guide- Intangible Asset value is not derived from the cur- line Intangible Asset sale or license transactions, rent cost measure alone. The Intangible Asset value the Valuation analyst should compare the guideline is derived from the current cost measure (however Asset properties to the subject Asset . This com- defined) less appropriate allowances for all forms of parison is often based on such measures as relative depreciation and obsolescence. growth rates, relative profit margins, relative returns Market approach methods are particularly appli- on investment, etc. These comparative analyses will cable when there is a sufficient quantity of compa- allow the Valuation analyst to select subject-specific rable (almost identical) Intangible Asset transaction Valuation pricing metrics. data or guideline (similar from a risk and expected The Valuation analyst will consider comparable return perspective) Intangible Asset transaction uncontrolled transaction (CUT) pricing data related data.