The cost-based method of valuing patents is based on the idea that a patent’s value may be determined by comparing it to other patents that are conceptually comparable to it. The first thing you need to do in order to assess how much a patent is worth is to find out how much a comparable patent would cost. Finding patents that are similar to the subject matter of your invention as defined by the patent claims and then researching the prices at which those patents were sold are the steps required to accomplish this goal. The subsequent step is to figure out by what margin the value of your own patent exceeds that of the patents that are comparable to it. This can be accomplished by analyzing the degree to which your innovation adds new features or functionality in comparison to the patents that are already in existence.
The primary concept of the cost approach is to demonstrate the value of a patent asset by estimating the cost incurred in creating a similar IP asset. The picture behind this is to clinch the value of the patent asset based on today’s market value by adjusting the inflation and current cost incurred in its development which is further adjusted for obsolescence to arrive at the final opinion of the value of the patent by using cost-based approach.
While determining the value of an IP asset at a particular point, take the cost of developing the actual asset based on historical cost. Once the total cost of obtaining patent protection is achieved, adjust the cost as per inflation and other market changes. In this context, it is essential to deduct obsolescence in the Ip asset valuation. Obsolescence in IP valuation and Patent Valuation would include functional, technological, and economic obsolescence. Obsolescence is typically deducted as its functionality is replicated in the updated version.
Functional obsolescence ensues when the operational costs incurred to employ the IP are more than the existing alternatives, which may be state-of-the-art. Technological obsolescence, on the other hand, occurs when the latest development of technology reduces the value of IP assets. Lastly, economic obsolescence occurs when the use of the IP in its highest and best form cannot provide an adequate return on investment. Cost considerations include but are not limited to research and development costs, testing and regulatory approval cost, patent protection cost, fees for contract outside services, equipment and other capital investments, and opportunity costs of diverted resources, among others.
There are essentially two variants of the cost approach, namely, Reproduction and Replacement cost methods. Reproduction estimates the cost of reproducing the exact same patent asset, and the latter the cost to replace the asset by developing the asset with the same utility but not the exact replica. An important requirement for both these methods is that the costs be determined as of the valuation date and not the historical expenditures that place.
The cost approach can be summed up as:
Replacement cost – Economic obsolescence – Incurable functional and technological obsolescence = asset value.
The cost method is generally negligibly used now and then and is deemed appropriate only as a complement to the income method (if the valuation is not for bookkeeping purposes). The method is normally used when the subject IP is not generating any income.
The cost method for patent valuation figures out how much a patent asset is worth by figuring out how much a similar (or exact) IP asset would cost. The cost method is especially useful when the intellectual property asset is easy to copy and when the economic benefits of the asset can’t be measured accurately. This method does not costs that were not used, nor does it anything special or unique about the asset.
If you want to use patents as collateral to get financing, you have a better chance of success if your assets can be valued separately from your business. In this case, it’s important to show that the IP assets will still work, at least for as long as it takes to pay back the financing. They should also be easy to sell if the owner goes bankrupt or goes into foreclosure.
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Our team of advanced patent attorneys assists clients with patent searches, drafting patent applications, and patent (intellectual property) agreements, including licensing and non-disclosure agreements.
Advocate Rahul Dev is a Patent Attorney & International Business Lawyer practicing Technology, Intellectual Property & Corporate Laws. He is reachable at rd (at) patentbusinesslawyer (dot) com & @rdpatentlawyer on Twitter.
Quoted in and contributed to 50+ national & international publications (Bloomberg, FirstPost, SwissInfo, Outlook Money, Yahoo News, Times of India, Economic Times, Business Standard, Quartz, Global Legal Post, International Bar Association, LawAsia, BioSpectrum Asia, Digital News Asia, e27, Leaders Speak, Entrepreneur India, VCCircle, AutoTech).
Regularly invited to speak at international & national platforms (conferences, TV channels, seminars, corporate trainings, government workshops) on technology, patents, business strategy, legal developments, leadership & management.
Working closely with patent attorneys along with international law firms with significant experience with lawyers in Asia Pacific providing services to clients in US and Europe. Flagship services include international patent and trademark filings, patent services in India and global patent consulting services.
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