When talking about patent valuation, each may have a certain understanding of valuation and value of a patent. This article should clean up with the most often experienced mistakes when inventors or patent owners perform their own patent valuation. This article shows the most frequent mistakes that were done with respect to the general understanding of a value, the scope of valuation and why a value is not necessarily also a price in the end.
1. Mixing up value and price
A value of a certain good is something that can be determined by applying different methods, like the market analogy, the cost approach or the income approach. But the price is depending on what a buyer is finally willing to pay. This price may be way higher when the buyer wants to make sure that he will own the patent afterwards, e.g. within an auction. Does a certain technology has a strategic meaning e.g. by locking out competitors for an alternative solution, this strategic price may be for this certain buyer higher than e.g. an income value or a market value may have calculated before. Also a way lower price is possible, when e.g. the expected income with a patent by a potential buyer is calculated lower due to a limited market access or an existing alternative product family that is already in the market.
2. Valuation scope not considered
In general the valuation scope has influence on the calculated value as well as the methodology that is used (see later). Unfortunately methodologies like income approach or cost approach do not consider the valuation scope within their calculation. The income approach allows at least the application of different scenarios like a worst case or a best case. But of cause it has for example a strong impact if you are just willing to have a rough overview of your portfolio value, you intend to sell it or it must be utilized in a short period of time within an insolvency proceeding.
3. Using not appropriate methodology
Income value is not cost value is not market value. Depending on the general methodology that is used, the values that are calculated will be different. Many brilliant inventions are random inventions like e.g. the Post-it glue. There for the cost approach would deliver a very small value because there are no big costs to assign, the income approach would deliver an enormous high value. The market value would calculate a value that corresponds to similar patents (in terms of its characteristics/indicators) that were traded in the past and would deliver a third value that is close to a potential trading value for the patent. All approaches mentioned above may deliver completely different values but all are approved methods for valuating a patent.
4. Income value not applied properly
When talking about patent valuation, many people´s understanding is an income value. As shown before there are different valuation approaches approved. When e.g. talking about trading a patent or activating a patent in the balance sheet a market (=fair value) is more appropriate. Nevertheless the income approach is also approved but it requires a lot of research and the grade of uncertainty is extremely high. Also there are often many mistakes done when calculating an income value:
Not all cost considered
The income approach does consider the total profit that is possible, e.g. by applying a discounted cash flow method. Therefor the potential income (direct income, e.g. by a certain product that is covered with the IP, or indirect income by e.g. saving cost within a certain optimised process) as well as all cost need to be considered. Cost include e.g. engineering cost, approval & quality management cost, manufacturing cost, all kind of marketing and sales cost, salaries as well as overhead cost. It is useful to calculate cost as if all needed services, infrastructure need to be purchased. The cost side is in most cases underestimated.
Relevant market and market share (according to family)
Determining the market shares is the result of detailed market segmentation. Often the total relevant market is considered here and then some shares are taken there from, e.g. 10% of the relevant. In reality the total relevant shares, where a market access is available to are way smaller. Especially for a new technology that is considered to replace an existing, market entry will be difficult, especially in the first years where additional investments on customer side are demanded. The very high cost to overcome market barriers e.g. by certain settles products, their established processes and established maintenance are often not seen. Here a realistic sales cycle especially radical innovations often require many years and will lead to no or small market shares in the beginning. For the market share determination also the patent family has to be considered: Only those countries that are covered with the patent (patent family) can be taken into account.
The meaning of market access
Often there is not considered that there must be a market access already. This is one of the major problems of the income approach, because the market access of a vendor (who calculated the income value) does in most cases not correspond to the market access to a potential buyer. Even when a market access is given, the sales people must be able and willing to sell, the product must be actively promoted.
5. Underestimate the importance of family size
As already mentioned before, the regional coverage of protection must be conform with the most relevant markets. Nowadays most companies who are interested in patents or applying patents are working globally. If a patent is only valid in e.g. Germany the patent is hard to utilize within products because in most cases a product sales does not limit to Germany only and a potential buyer or licencee will not waive to its exclusivity in all other countries, when he invests in a new product.
6. Not making difference between applied and granted patents
No, a patent does not necessarily need to be granted in order to get it utilized in products, licensed or sold but of cause it is a big value determinant, because it finally reflects the legal stability. For an application the calculated value is vaguer and normally leads to a deduction. This is due to the uncertainty – does it cover completely or in parts any prior art? In both cases the patent may lose its character in parts or will be worthless in total. An invention with a big amount of granted patents in its family will be easier to get utilized in terms of licensing or selling it and normally leads to a higher price.
7. Not considering “not invented here” problem
Many reasons for patent valuations are driven by the idea to get it sold. And in many cases the valuation is done internally without external help. Often a potential seller is wondering then why an invention is much more difficult to sell than expected. Even companies that are supposed to earn or save millions with an invention finally have no interest. Why? Apart from a too small patent family (not enough legislations covered with the IP), companies do not believe in a value that was calculated by the owner or even the inventor himself. Of cause there must be a reason why it is sold and when a potential value is high - why is it sold then? And when the invention is revolutionary, why didn’t the own specialists who are working on that field for years didn’t invent it then? This scepticism is summarized as “not invented here syndrome” that makes is extremely difficult to enter the door of a potential buyer with an invention, especially when a value was determined by the seller himself.
8. Being too optimistic as an inventor
Many inventors have this very stringent thinking: Well I may be too small and by some reason unable to utilize my own invention, but a company of a certain size and market presence should make millions with it. The thinking is that these large corporation were waiting for exact this invention to get it utilized. Reality is different. Most potential buyers don’t have processes to evaluate by themselves the acquisition of foreign patents as long as they don’t precisely address the technical problem they currently have. In case of disruptive inventions they even may fear cannibalisation effects, finally they look for reasons not to buy a certain patent and spending money instead of maybe seeking chances.
9. Not understanding the difference between qualitative and monetary value
A qualitative value does not reflect monetary values. It is used in order to e.g. compare patents or patent portfolios with each other. Typically a qualitative patent value is broken down to a certain set of Indicators or Key figures describing a patent’s quality. A qualitative value does not have to be proportional to a monetary value. For monetary values there are many factors to consider, e.g. how certain indicators affect each other. So e.g. a patent that has a focus on cost savings will have a higher value when the target group of the product the patent is covering is taking price driven decisions compared to a target group that is more technical/innovation-driven in their decisions. Also patents that increase the productivity will have their highest impact in markets with short innovation cycles and small margins. Oppositions may indicate that a patent is close to the state of the art (bad for a patent) but also that here is a big usability potential (good for the patent).
10. Ignoring the difference between single patents and portfolios
For many potential buyers of patents, especially when talking about bigger sized corporations, single patents are not interesting. The intention is that a complete technical portfolio must be covered in order to lock out the competitor. That means that e.g. the different components of a system (sender, receiver, protocol and encryption) or a product, all their alternative constructive alternatives as well as the manufacturing process are protected in a set of patents, described as patent or technology portfolio. A complete portfolio has higher chances to get sold and may result is a way higher price compared to its single patent values.