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Valuation Methods



                              FITT
– Fostering Interregional Exchange in ICT Technology Transfer –



                                 www.FITT-for-Innovation.eu
Except where otherwise noted, this work is licensed under a Creative Commons Attribution 3.0 License.
Valuation Practice


Valuation is the practice of estimating a defined monetary value for a single
  or pooled intangible asset

 Valuation processes are performed either for transactional (such as
  commercial activities) or notational (such as accounting activities)
  purposes.

 Three main approaches to valuation exist (cost, market & income
  approaches), each of which have specific strengths & weaknesses, and
  therefore answer different needs




2 | April 2011                   Valuation Methods
Valuation in practice
                          General

 A valuation process is structured in similar manners (tasks), whichever
  approach (cost, market and/or income) is chosen

 The different tasks include for such process
     • Objective definition
                                                     Data
     • Standard of value selection                   collection
                                                     & analysis
     •    Appraised asset description
     •    Valuation date or period selection
     •    Valuation approach(es) selection and related calculations
     •    Results reporting


 Always remember that a value is subjective, whereas a price is objective

3 | April 2011                          Valuation Methods
Valuation in practice
                       Cost approach

 Cost approach : Measure the value of an intangible asset by taking into
  account all relevant occurring costs and investments related to the
  appraised asset

       Historic costs : accounting all costs (effective and sunk) directly
        related to the appraised asset (such as securing, research,
        development, and licensing-in costs)

       Replacement costs : valuing the costs for buying an asset bringing
        the same utility than the appraised one

       Reproduction costs : valuing the costs induced in creating, at the
        time of the appraisal, a similar asset based on actual knowledge

 Cost approach is generally used in situations of high uncertainty and
  limited information exist
4 | April 2011                      Valuation Methods
Valuation in practice
                    Market approach

 Market approach : Value consists in the price of a comparable asset in a
  similar market transaction

 Market approach relates to the quantification and adjustment of pricing
  multiples in order to create theoretical comparable conditions

 Lack of active and transparent market for IP transactions and market
  dynamics have to be taken into account in the process




5 | April 2011                   Valuation Methods
Valuation in practice
                      Income approach

 Income approach : Measure the value of an intangible asset by reference
  to the expected and actualized benefits, incomes or saved costs over the
  remaining life of the asset

 Such prospective-based quantification of financial flows needs to take
  into account various risk-related factors such as

       Endogenous : Extend of IP protection, nature of competition, …

       Exogenous : Substitute product development risks, maturity of
        market, …




6 | April 2011                    Valuation Methods
Valuation process
                        Part 1 : Objective and standard of value definition


 Clear definition and overview of the valuation objective is fundamental

 This part of the process should answer the following questions
       What is the intangible asset under valuation?

       Why and for which use is the valuation done?

       For whom is the valuation appraised, in which context?

 Such definition helps clarifying the motives for valuation, which are not
  neutral. Such motives could be related to :
       Business and management (Mergers and acquisitions - M&A, Risk analysis,
        Joint Venture funding, …)

       Technology (Licensing in/out, Transfer pricing, …)

       Accounting and financial (Liquidation, Fiscal benefits, …)
7 | April 2011                        Valuation Methods
Valuation process
                        Part 2 : Appraised asset description and valuation date


 Intangible assets can be described based on various criterias such as
       Physical (example: what is the asset under valuation - single or bundled?)

       Functionnal (example: what does this asset do?)

       Technical (example: is the technology incremental or disruptive?)

       Economical (example: what is the economic utility of the asset?)

       Business (example: what is the market of this asset?)

       Juridical (example: is there a title of ownership?)

 Clear asset description is needed in order to select appropriate valuation
  approach

 Valuation date and/or time periods are used for appropriate actualization

8 | April 2011                         Valuation Methods
Valuation process
                        Part 3 : Valuation approach selection and calculation


 Valuation approach selection is based on the information gathered
  related to previous tasks in the valuation process (see previous slides)
       Cost approaches relate to past (certain) or present (reduced uncertainty)
        information. However, value is usually not correlated to costs.

       Market approach relates to the financial adjustment of similar market
        transactions to the valued asset. Uncertainty can be high, as market,
        technological, and more generally techno-economic environmental
        conditions can strongly differ.

       Income approach, based on a prospective analysis of future economic
        incomes, relies entirely on the validity of business and future economic
        benefits analysis. Uncertainty, although adjustable, is therefore high. Income
        approach is however the most used approach for valuation.


9 | April 2011                        Valuation Methods
Valuation process
                      Part 4 : Results reporting


 Valuation results reporting depends on the reasons underneath the
  valuation process

 Particular attention should be given on

       Confidentiality issues

       Level of engagement related to the validity of the results




10 | April 2011                     Valuation Methods
When is valuation needed?


 Valuation of intangible assets can either be a regular process or a
  specific, on demand practice (to avoid confusion with FITT processes
  and activities)

       As a regular practice, valuation activities could be conducted among
        organizations at various key moments within a R&D project lifecycle.

       As an on-demand practice, reasons for valuation needs are varied,
        such as :
              Active IP management & TT strategies (license pricing, …)

              M&A

              Litigation management

             …

11 | April 2011                         Valuation Methods
Who is implied in a valuation process?


 Key stakeholders in a valuation process are
     • Valuator
     • Client
             • Individual project members
             • Management
             • Employees implied in support-related activities
     • Third party experts


 Experience shows that valuation processes benefit from implying as many
   players related to the appraised asset as possible, in order to manage in the
   information gathering process the natural routine-related myopia developed in
   conducting day-to-day work.


12 | April 2011                          Valuation Methods
Pro’s & Cons


 Pro’s
     • Valuation is a mean to answer fundamental needs in terms of financial
          economic appraisal

 Cons
     • Valuation will always remain a mix between an art and a science

 Approach               Cost                      Market               Income


 Pro’s                  Reduced                   Simple theoretical   Always right (at
                        uncertainty issues        applicability        moment of
                                                                       valuation)
 Cons                   Future value is not       Information          Mostly wrong (due
                        correlated to costs       asymmetry            to uncertainty)

13 | April 2011                         Valuation Methods
Practical example : software valuation
                          Why was valuation done?


 Rationale for valuation
     • Context relates to the need for information in order to (1) decide on an IP
          management strategy for the results of a R&D project and (2) gather
          information for a technology license pricing negotiation
     • This valuation was done on a free software licensed development, bundled
          with a restricted trademark with strong goodwill and a key role in a
          community of creative users
     • The fact that the license for the software was free (Open Source) meant that
          no monopoly for the software from a technical standpoint could be
          transferred (therefore valued)
     • The software as such was protected only by copyright (no patents were
          involved)
     • Business model for asset exploitation by licensee relied on a software as a
          service (SAAS) strategy

14 | April 2011                         Valuation Methods
Practical example : software valuation
                             Why was valuation done?


 Impact of valuation practice
     • Valuation methods used where based on cost and income approaches
        • Precise historical financial data was available, hence historical costs
                  were valued (Human resources, investments, …)
             • Clear overview of technology was available (complete technology and IP
                  assessment was done), allowing us to value replacement costs
             • A “light” business plan was created, in order to gather all necessary
                  data for income approach valuation
     • This multiple approach gave us a useful “range of value”
     • This process was successful because it gave us information for license
          pricing negotiations, therefore reducing uncertainty
     • The business plan done for the income approach also gave us strong
          arguments in the course of this technology transfer operation

15 | April 2011                           Valuation Methods
Practical example : software valuation
                          Outcome of the valuation process


 Outcomes of this process are positive
     • However, technical difficulties and time-to-market issues were
          underestimated by project team
     • As exposed previously in this document, the valuation date is an important
          factor, therefore our valuation results needed updates (raised costs, evolving
          market, …)
     • Fortunately, the technology transfer operation can now be considered as a
          success (and valuation played a key role in this)




16 | April 2011                         Valuation Methods
Valuation Methods: tested by ICBS


The valuation methods were tested by ICBS (Imperial College Business
  School)
 Context of Test:
       IE&D program
       The excelsheet was used during the workshops to offer the students
        guidance in assessing the value of their IPR
 Difference in context:
       IE&D: pedagogical context
 Objective: value the IPR of the IE&D projects
 Modification of practice needed before testing: no




17 | April 2011                     Valuation Methods
Valuation Methods: lessons learned by ICBS


 Remarks after testing:
         The students that tested the tool all acknowledged the usefulness of the tool
         Quick overview and fast & reasonable evaluation
         The tool is applicable for many different projects
         Quality of the valuation still depends on the quality of the input data available to
          make the calculation
 Suggested Changes:
         For some of the indicators it might be useful to include some more explanation,
          for instance:
                     Tax rate: indicate tax rate for various countries
                     Risk free rate: explain what type of bond is usually used
                     Annual inflation rate: f. ex. Expected economic growth
                     Or the sheet could provide some links where this information can be obtained



18 | April 2011                                           Valuation Methods
Outcome of this process


 Plans for the future?
     • This process, based on several best practices, will be upgraded
        • A tool is actually under creation (excel sheet), which will facilitate the
                  various calculation and parameterisation needed for each approaches
             • A separate useful document (under creation) relates to the choice-
                  impacting factors for valuation methods based on information
                  availability (list of criteria related to technology, legal, organizational and
                  market and how their characteristics could favour the choice of a given
                  method)
             • Finally, our income approach model is based on endogenous royalty (or
                  income) increasing or decreasing factors. Such factors (i.e. parameters)
                  need to be developed further in order to be more representative of free
                  and open source software licensing issues



19 | April 2011                               Valuation Methods
Suggested Readings


 Codebook links

Valuation – Tudor – IP Management

 Other readings

      ISO/DIS 10668 - Brand valuation - Basic requirements for methods of
        monetary brand valuation

      http://www.iso.org/iso/catalogue_detail.htm?csnumber=46032




20 | April 2011                   Valuation Methods

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FITT Toolbox: Valuation Methods

  • 1. Valuation Methods FITT – Fostering Interregional Exchange in ICT Technology Transfer – www.FITT-for-Innovation.eu Except where otherwise noted, this work is licensed under a Creative Commons Attribution 3.0 License.
  • 2. Valuation Practice Valuation is the practice of estimating a defined monetary value for a single or pooled intangible asset  Valuation processes are performed either for transactional (such as commercial activities) or notational (such as accounting activities) purposes.  Three main approaches to valuation exist (cost, market & income approaches), each of which have specific strengths & weaknesses, and therefore answer different needs 2 | April 2011 Valuation Methods
  • 3. Valuation in practice General  A valuation process is structured in similar manners (tasks), whichever approach (cost, market and/or income) is chosen  The different tasks include for such process • Objective definition Data • Standard of value selection collection & analysis • Appraised asset description • Valuation date or period selection • Valuation approach(es) selection and related calculations • Results reporting  Always remember that a value is subjective, whereas a price is objective 3 | April 2011 Valuation Methods
  • 4. Valuation in practice Cost approach  Cost approach : Measure the value of an intangible asset by taking into account all relevant occurring costs and investments related to the appraised asset  Historic costs : accounting all costs (effective and sunk) directly related to the appraised asset (such as securing, research, development, and licensing-in costs)  Replacement costs : valuing the costs for buying an asset bringing the same utility than the appraised one  Reproduction costs : valuing the costs induced in creating, at the time of the appraisal, a similar asset based on actual knowledge  Cost approach is generally used in situations of high uncertainty and limited information exist 4 | April 2011 Valuation Methods
  • 5. Valuation in practice Market approach  Market approach : Value consists in the price of a comparable asset in a similar market transaction  Market approach relates to the quantification and adjustment of pricing multiples in order to create theoretical comparable conditions  Lack of active and transparent market for IP transactions and market dynamics have to be taken into account in the process 5 | April 2011 Valuation Methods
  • 6. Valuation in practice Income approach  Income approach : Measure the value of an intangible asset by reference to the expected and actualized benefits, incomes or saved costs over the remaining life of the asset  Such prospective-based quantification of financial flows needs to take into account various risk-related factors such as  Endogenous : Extend of IP protection, nature of competition, …  Exogenous : Substitute product development risks, maturity of market, … 6 | April 2011 Valuation Methods
  • 7. Valuation process Part 1 : Objective and standard of value definition  Clear definition and overview of the valuation objective is fundamental  This part of the process should answer the following questions  What is the intangible asset under valuation?  Why and for which use is the valuation done?  For whom is the valuation appraised, in which context?  Such definition helps clarifying the motives for valuation, which are not neutral. Such motives could be related to :  Business and management (Mergers and acquisitions - M&A, Risk analysis, Joint Venture funding, …)  Technology (Licensing in/out, Transfer pricing, …)  Accounting and financial (Liquidation, Fiscal benefits, …) 7 | April 2011 Valuation Methods
  • 8. Valuation process Part 2 : Appraised asset description and valuation date  Intangible assets can be described based on various criterias such as  Physical (example: what is the asset under valuation - single or bundled?)  Functionnal (example: what does this asset do?)  Technical (example: is the technology incremental or disruptive?)  Economical (example: what is the economic utility of the asset?)  Business (example: what is the market of this asset?)  Juridical (example: is there a title of ownership?)  Clear asset description is needed in order to select appropriate valuation approach  Valuation date and/or time periods are used for appropriate actualization 8 | April 2011 Valuation Methods
  • 9. Valuation process Part 3 : Valuation approach selection and calculation  Valuation approach selection is based on the information gathered related to previous tasks in the valuation process (see previous slides)  Cost approaches relate to past (certain) or present (reduced uncertainty) information. However, value is usually not correlated to costs.  Market approach relates to the financial adjustment of similar market transactions to the valued asset. Uncertainty can be high, as market, technological, and more generally techno-economic environmental conditions can strongly differ.  Income approach, based on a prospective analysis of future economic incomes, relies entirely on the validity of business and future economic benefits analysis. Uncertainty, although adjustable, is therefore high. Income approach is however the most used approach for valuation. 9 | April 2011 Valuation Methods
  • 10. Valuation process Part 4 : Results reporting  Valuation results reporting depends on the reasons underneath the valuation process  Particular attention should be given on  Confidentiality issues  Level of engagement related to the validity of the results 10 | April 2011 Valuation Methods
  • 11. When is valuation needed?  Valuation of intangible assets can either be a regular process or a specific, on demand practice (to avoid confusion with FITT processes and activities)  As a regular practice, valuation activities could be conducted among organizations at various key moments within a R&D project lifecycle.  As an on-demand practice, reasons for valuation needs are varied, such as :  Active IP management & TT strategies (license pricing, …)  M&A  Litigation management … 11 | April 2011 Valuation Methods
  • 12. Who is implied in a valuation process?  Key stakeholders in a valuation process are • Valuator • Client • Individual project members • Management • Employees implied in support-related activities • Third party experts  Experience shows that valuation processes benefit from implying as many players related to the appraised asset as possible, in order to manage in the information gathering process the natural routine-related myopia developed in conducting day-to-day work. 12 | April 2011 Valuation Methods
  • 13. Pro’s & Cons  Pro’s • Valuation is a mean to answer fundamental needs in terms of financial economic appraisal  Cons • Valuation will always remain a mix between an art and a science Approach Cost Market Income Pro’s Reduced Simple theoretical Always right (at uncertainty issues applicability moment of valuation) Cons Future value is not Information Mostly wrong (due correlated to costs asymmetry to uncertainty) 13 | April 2011 Valuation Methods
  • 14. Practical example : software valuation Why was valuation done?  Rationale for valuation • Context relates to the need for information in order to (1) decide on an IP management strategy for the results of a R&D project and (2) gather information for a technology license pricing negotiation • This valuation was done on a free software licensed development, bundled with a restricted trademark with strong goodwill and a key role in a community of creative users • The fact that the license for the software was free (Open Source) meant that no monopoly for the software from a technical standpoint could be transferred (therefore valued) • The software as such was protected only by copyright (no patents were involved) • Business model for asset exploitation by licensee relied on a software as a service (SAAS) strategy 14 | April 2011 Valuation Methods
  • 15. Practical example : software valuation Why was valuation done?  Impact of valuation practice • Valuation methods used where based on cost and income approaches • Precise historical financial data was available, hence historical costs were valued (Human resources, investments, …) • Clear overview of technology was available (complete technology and IP assessment was done), allowing us to value replacement costs • A “light” business plan was created, in order to gather all necessary data for income approach valuation • This multiple approach gave us a useful “range of value” • This process was successful because it gave us information for license pricing negotiations, therefore reducing uncertainty • The business plan done for the income approach also gave us strong arguments in the course of this technology transfer operation 15 | April 2011 Valuation Methods
  • 16. Practical example : software valuation Outcome of the valuation process  Outcomes of this process are positive • However, technical difficulties and time-to-market issues were underestimated by project team • As exposed previously in this document, the valuation date is an important factor, therefore our valuation results needed updates (raised costs, evolving market, …) • Fortunately, the technology transfer operation can now be considered as a success (and valuation played a key role in this) 16 | April 2011 Valuation Methods
  • 17. Valuation Methods: tested by ICBS The valuation methods were tested by ICBS (Imperial College Business School)  Context of Test:  IE&D program  The excelsheet was used during the workshops to offer the students guidance in assessing the value of their IPR  Difference in context:  IE&D: pedagogical context  Objective: value the IPR of the IE&D projects  Modification of practice needed before testing: no 17 | April 2011 Valuation Methods
  • 18. Valuation Methods: lessons learned by ICBS Remarks after testing:  The students that tested the tool all acknowledged the usefulness of the tool  Quick overview and fast & reasonable evaluation  The tool is applicable for many different projects  Quality of the valuation still depends on the quality of the input data available to make the calculation Suggested Changes:  For some of the indicators it might be useful to include some more explanation, for instance:  Tax rate: indicate tax rate for various countries  Risk free rate: explain what type of bond is usually used  Annual inflation rate: f. ex. Expected economic growth  Or the sheet could provide some links where this information can be obtained 18 | April 2011 Valuation Methods
  • 19. Outcome of this process  Plans for the future? • This process, based on several best practices, will be upgraded • A tool is actually under creation (excel sheet), which will facilitate the various calculation and parameterisation needed for each approaches • A separate useful document (under creation) relates to the choice- impacting factors for valuation methods based on information availability (list of criteria related to technology, legal, organizational and market and how their characteristics could favour the choice of a given method) • Finally, our income approach model is based on endogenous royalty (or income) increasing or decreasing factors. Such factors (i.e. parameters) need to be developed further in order to be more representative of free and open source software licensing issues 19 | April 2011 Valuation Methods
  • 20. Suggested Readings  Codebook links Valuation – Tudor – IP Management  Other readings ISO/DIS 10668 - Brand valuation - Basic requirements for methods of monetary brand valuation http://www.iso.org/iso/catalogue_detail.htm?csnumber=46032 20 | April 2011 Valuation Methods