How to Make Money From Your Invention (Chapter 6, Parts 2-3) - How to Proceed
2. Getting Background Information
We described the sources of market, technology and patent information when we emphasized the importance of doing your homework and doing a thorough job in searching for prior art. In the next section we will discuss valuing your invention.
It is important that you have good information about the markets for your technology, their forecasts and growth rates, pricing, who is in the business and where your invention fits in, as these will be important in the valuation.
The sources of information include many of the ones previously mentioned. In addition, a great deal of market and technology information on public companies is available from securities firms and from the web sites of the key companies in the markets of interest.
3. Valuing Your Technology
You made a discovery, applied for the appropriate protection and decided to try to license the invention. Among the critical questions is, how much is it worth? The inventor will almost always think it’s worth far more than does the potential licensee.
How do you establish a value that will strengthen your position in a negotiation session? There are acceptable methodologies for doing this and we will outline them in following paragraphs.
The approaches can get complex and require market and revenue forecasting for businesses that will utilize the product of your invention. Professional assistance can be invaluable.
3a. Methods of Calculating Value
There are three basic methods and a hybrid method used in valuing intellectual assets, that is, the patents or trade secrets that resulted from your invention. These approaches are:
• Relief from Royalty
In the Cost method, the assumption is that the value of the property is related to the cost of producing it. It is a simple method that adds together the costs of R&D, promotion, depreciation and other expenses that went into establishing the technology. However, value and cost are usually very different.
For example, a novel fuel additive that has gone through many phases of evaluation in the lab and in vehicles was later found to have some unforeseen environmental problems. Obviously, this product has low value but the cost of developing it was very high.
However, there are some situations where the cost method is valuable. For example, knowing the cost of development of a patented product can provide important information for the company that is considering licensing that patent versus inventing around it. The resultant calculation could help the company make the appropriate decision.
The Market approach, determines the value of the patent or technology by comparing it to the prices paid for comparable properties. In valuing patents, this usually involves the comparison of existing, comparable license agreements. This would appear to be an attractive method as the data represents real transactions between presumable willing and knowledgeable buyers and sellers.
The problem is that there are few cases where you can get directly comparable examples. Clearly, patents and other intellectual property are the result of unique, non-obvious discoveries, so direct comparisons should not be available. Also, finding any comparisons is difficult, as license details are not usually published unless they are of significant size where a public company must include them in certain SEC filings.
The Income Method is the method of choice in valuing or appraising an intellectual property. It represents the future profits that the property is expected to generate. The property can be viewed as an investment or a savings account which will generate income.
The net present value of the property, or the NPV, is determined by estimating the profit expected each year for the remaining life of the last limiting patent. These income streams are discounted to account for the time value of money and the risk involved in the business. The resulting NPV is considered to be the value of the intellectual property derived from the invention.
There is another approach to valuing your intellectual property involving a combination of the Market and Income methods. This hybrid is referred to as the Relief from Royalty method. The method involves calculating the NPV based on the royalty savings from future income that would have been charged by an outside licensor (income approach).
The key here is to determine a reasonable royalty rate for the business area you are considering based on comparable licenses (market approach). Since the royalties are usually based on some percentage of the sales, the profitability determination is not required.
The key requirements for the Relief from Royalty calculation are:
• Revenue at start, $
• Revenue growth rate, %
• Patent life remaining
• Royalty Rate, %
• Discount Factor
• Technology Factor
One additional factor is required in the calculation of the value of an intellectual property. It is the technology factor, which takes into account, the relative contribution the invention will make to the total business. Determining an accurate value for the technology factor will usually involve the input of various parts of a company. However, in general terms, the technology factor ranges are as follows:
Low – 0 — 30%
Medium – 30 — 50%
High – 50 — 75%
The final NPV is the product of the technology factor and the sum of the calculated discounted cash flows. For more details on the Technology Factor, see the Inavisis web site, www.inavisis.com.
The difficulty in determining the value for an untested application resulting from a new invention lies partly in the revenue and profit estimates and partly in the assumptions on the commercializability of the discovery. How can one predict the future with any accuracy? This is difficult and requires a good understanding of the technology application and the business where your invention will be utilized. This is another instance where the help of an experienced IP professional will be invaluable.
To offset the uncertainties of the market estimates and the commercial success of the technology, a discount factor is used in the calculation of the NPV. The profit in any year is discounted by a risk factor representing the commercial and market uncertainties. For an early stage invention, the discount factor will be much greater than that of a proven technology. For reference, the following discount factor guidelines were presented at a recent New Jersey Small Business Development Center conference by Russell Parr and David Weiler (June 5, 2003).
Relative Risk and Return
• Risk-Free Rate 3%
• Mature Product 10%
• Pre-National Launch 15%
• Technology Only is Sure 25%
• Embryonic R&D 50%
The value determination can be complex and difficult, depending on the nature of the invention and the business it will generate. Contact the Licensing Executives Society for references.
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This information is presented for the general education of independent inventors by the Invention Patenting Group. The Invention Patenting Group makes no warranty, express or implied, or assumes any legal liability or responsibility for the accuracy, completeness, or usefulness of any information, apparatus, product, or process disclosed herein, or represents that its use would not infringe privately owned rights. Reference herein to any specific commercial product, process or service by trade name, trademark, manufacturer or otherwise, does not necessarily constitute or imply its endorsement, recommendation, or favoring by the Invention Patenting Group.