Germany: Valuation of Patents

In recent times the valuation of patents becomes an increasingly crucial issue for technology driven companies, especially in the so-called new economy, when the company value is based essentially upon intangible assets and intellectual property rights such as patents. The more the economical value of a company is regarded in terms of share holder value, the more companies are trying to upgrade their standing by marketing their potential for technical innovation.

Although according to most European accounting standards the valuation and balancing of legal rights as intangible assets is still not required, most companies now publish their legal monopoly positions as a major competitive advantage. For example, the pharmaceutical company Aventis publishes not only in a simplified balance sheet the amount of intangible assets which amounts in the case of Aventis in 2000 to about 35% of the total company assets, but also publishes patent related details on all major products such as the patent expiration date etc.

A company will therefore seek the "real" value of its patent rights not only in case of licensing or merger and acquisition situations but out of a large number of different reasons, such as accounting, controlling or other strategic and patent-related decision processes as well as in case of ongoing or looming infringement proceedings between competitors.

Known methods of valuation are more or less focussed on economical or technical aspects. Important legal risks and/or factors which could heavily influence the value of a patent in a negative or positive way are commonly not enough taken into account.

Profit / cost principle for a monopoly right

With regard to business management, patents have their aspects of profit and cost which an applicant or assignee has to balance against each other in order to avoid a waste of resources. The cost side can be equaled with the expenditure and the investments for mainly the legal proceedings of attaining, maintaining and defending the patent. In a broader sense, the costs of a patent may become significant, yet the final amount is almost not predictable. At least as far as the cost-related side of patents is concerned, there are various investigations to be found in literature. On the whole, however, the cost side of a patent remains to be an abstract difficult to calculate.

The profit side of a patent results from the rights related to this patent. For the patent holder, these rights may lead to competitive advantages which again can be turned into corresponding profits. Thus, the real or potential growth factors can account for the definitive value of a patent. There are, however, other aspects relevant to the value of patents which cannot be mirrored directly in financial terms such as savings or profit gains. In particular because of the difficulty to quantify these qualitative value factors, it is not easy to estimate the value of a patent in the sense of a certain figure that can be substituted to a patent’s profit side. Additionally, in many cases, there is a lack of sufficient value-related information with regard to patents, or, adequate methods of valuation are not even known in practice.

The task of an evaluation of Intellectual Property is to assign to a patent - as an immaterial economic asset - a money value which is representing its property value as precisely as possible. It is next to impossible to make a general valuation of a patent independent of its respective situation and of the evaluating person or company.

A patent can be extraordinarily precious for a certain company, while for another it may be of little value or of no value whatsoever. This applies, for instance, if the subject of a patent can only be exploited in conjunction with certain other patents for reasons of legal dependencies, or if its realization presumes a special, not generally available know-how. Therefore, one cannot speak only of a single patent value. There exists a plurality of "patent values" of the same patent object which may vary according to weighting, to the (market) situation and to the time and purpose of such a valuation.

A wide variety of reasons can be found for validating patents or inventions that have been filed as a patent application. A merging of companies, a selling of intellectual property rights or a patent-related investment decision such as the expiry of the priority deadline or a due diligence for reorganization purposes can be concrete reasons for the economic and legal valuation of a patent. The purpose of the valuation is of decisive influence on the one hand for the costs to be expended and on the other hand for the choice of one or more adequate methods of valuation.

Difficulties that arise with the valuation of technical IP rights result primarily from the value related assignment, from the difficulty to objectify the valuable parts as well as from the risks inherent to such a valuation. The quantity of these value-related risks and uncertainties depends primarily on the time when the valuation is effected and also on the available information relevant to value. In an early stage of the life of a patent, the risks of a wrong validation are much higher than at a later stage, when the deadline for an opposition is passed or when the opposition procedure or even a subsequent nullity proceeding has been successfully survived, and thus at least the legal risks have been minimized accordingly.

The risks in evaluating patents are varied and should, as far as they are calculable, absolutely be included in the valuation. They should also be used as criteria of validity in order to arrive with the resulting value figures at a realistic estimate of the chances of a patent position. One can differentiate between the economic, technical and legal risks of a patent valuation.

From an economic point of view, for a concretely patented object there is the risk of uncertain success in sales on the market. This success can be diminished by market dynamics and by activities of competitors, but it can also crucially depend on non-patent factors such as the use of marketing instruments.

Among the technical risks of a valuation, the ability of technical realization of an invention must be named as well as its ability to integrate with other products or programs into existing production processes, as well as the technical effects of edging-out or other given problems of manufacturing.

The third group consists of the legal risks. They encompass primarily the chances of success of the granting of a patent as well as its legal validity before and to a minor degree also after the granting, which may be endangered, for example, by an unknown state of the art or a hidden right of prior use for a competitor. This may lead to an opposition or to a nullity action by competitors if they feel themselves to be illegally restrained by a patent or if the object is relevant for market success. But also a possible dependency of a patent from other patents as well as a possible circumvention of the scope of protection are further aspects of the legal risks of a patent valuation. Thus legal experts in patent law are necessary for a reliable IP valuation. The above-named risks are taken into account by deducing a corresponding risk percentage of the resulting value figure. The higher the risks, the lower the concrete value of the patent.

There is a positive correlation between the timing of a patent valuation and the meaningfulness of its statements. The later a valuation is administered, the more precise its statements will be. The value of an intellectual property right can be calculated most precisely after its termination. However, this special case is an exception since, as a rule, a valuation in the sense of a pre-calculation is necessary at an earlier point in time. With the granting of licenses or with the sale of a patent as well as when decisions regarding applications in foreign countries have to be made, a valuation will happen at an early stage when there may be very little information available with relevance to possible legal developments and market acceptance. This dilemma can be met by an early assembling of information regarding a patent’s costs and profits as well as value related legal information.

A central problem with the valuation of technical IP rights arises when the period of exploitation has to be estimated. No matter which method of patent valuation is finally chosen, the remaining time of exploitation has to be investigated first. Here, one has to distinguish between the economic and legal duration, i.e. the maximum possible life span of a patent. Patents are often "dropped" before the termination of this period by non-payment of the renewal fees. Furthermore, the economic period of exploitation can be shorter than the legal life span of a patent. On the other hand, the economically exploitable time of protection may be extended beyond the duration of a patent by a patenting of further technical developments, by advantages given through patent-related know-how of the owner, or by requesting subsequent protection by means of a supplementary protection certificate (SPC) (German: Schutzzertifikat) for a pharmaceutical product.

The real, economically sensible period of exploitation of a patent depends, however, on different factors: It depends on the situation of the patent within a chain of products, on patent-strategic reasoning such as defensive patents or license packages, on marketing success, on the degree of innovation, on the novelty of the object as well as on relations to clients and distribution.

The period of exploitation of a patent necessary for the valuation can be approximately determined by taking into account and weighting these factors. With regard to a business point of view, it makes sense to create two scenarios: one for the maximum possible period and another for the minimally predictable time of economic exploitation.

Of the traditional methods of patent valuation, the method of license analogy is primarily used in contemporary practice and is the best known among the market-oriented instruments of valuation. In an intellectual property context it is used, for example, for calculating damages in infringement suits, assessing compensation for inventions of employees and, not least, to determine the value of a license during license negotiations. With the help of a license analogy one determines the price (the license fee) which a licensee is willing to pay for the exploit of a subject matter of a patent. Such a licensee is saving on the costs of the technical development of the patent subject matter, on related uncertainties and on the expenses necessary to attain the legal protection before the national patent offices. The license analogy method requires the following steps: First, another comparable patent right has to be found, which must be approximately comparable on a factual as well as on a timely basis and for which a value has been determined at some point in the past. If necessary, the sum of the value of the comparative patent has to be adjusted to the relative strengths and weaknesses of the object which has to be validated. Then the expected time of exploitation has to be determined. Finally, growth rates have to be predetermined and value-diminishing risks have to be taken into account by way of a risk deduction.

Today, there are a number of new methods available. These various new methods for validating patents are partly based on scientific-economical investigations, and partly they originate from valuation practice in business administration. With the methods explained below, I would like to show how multifarious the possibilities for a valuation of technical IP rights are, and how a rather objective and realistic value of a patent can be calculated which in practice depends on value influences and on an interdisciplinary background. The following tools may be of use for a patent valuation: portfolio analysis, patent audit, life cycle analysis and profit value analysis.

Portfolio analysis has long been known to innovation management as a strategic-economical tool of planning for an alternative innovation of products. It facilitates long-term decisions by yielding a multi-dimensional presentation of the market situation of single products or of whole areas of business. In analogy to that, this method can also be used as an instrument for the strategic valuation of patents.

For a patent portfolio analysis, two prime factors of influence are chosen out of a quantity of patent - and company-related factors and out of a group of competition factors, respectively, in order to be condensed into a market dimension on the one hand and a company dimension on the other. The market dimension is to be understood as the economic attractiveness of a patent. The company dimension stands for the relative value which a patent holds for an individual company. Subsequently, the two value dimensions are entered into a two-dimensional system of coordinates, similarly to the famous BCG-"Cash Cow"-portfolio analysis. Thus the resulting patent value is located in a certain field within the coordinate system, while different business strategies are assigned to various fields: investment, de-investment, absorption of profit or even a pull-out of the patent business concerned. Supplementing the patent portfolio, a third dimension can be represented in the diagram, for instance, the scope of legal protection or exclusivity of the patent in question can be illustrated as the diameter of the respective circle.

When a portfolio analysis is put to use as a planning tool, the existing intellectual property rights of a company are assembled as a portfolio of the actual stock of patents at the present moment on the basis of which a target portfolio is being developed while the business targets of the company are taken into consideration. From the differences of these two portfolios, the operative measures of the patent policy are deduced. The goal is to close the gaps in the actual stock portfolio and to focus activities on potentially profit making patents. There is one variety of portfolio analysis in which the patent situation of the competition is juxtaposed in a portfolio diagram to ones own patent situation in order to identify patent related points of strength and weakness of the competitor as well as within the own company, for example, to create a patent strategy fencing around the alleged monopoly situation of a competitor.

A further, in business practice still little used method of patent valuation is the patent audit. The purpose of a patent audit is to register patents or technical IP rights existing in a company and to find for each IP right standardized information on technical, legal and value-relevant aspects in order to, firstly, arrive at a statement regarding the value the patents and secondly, to uncover possible unused potential such as possibilities for licensing. The background of the patent audit is the at times very small ratio of exploitation of patents. From the value information thus attained, patents can be, for example, classified into various categories of value, comparable to the marketing approach of A, B, and C-product differentiation, in order to secure sensible decisions in the patent business.

A life cycle analysis investigates the performance of products or markets over a certain period of time. It is based on the assumption that the success parameters of a given market segment or product is performing characteristic phases and is following a bell-shaped curve (- a value number as ordinate and time as abcissa). Accordingly, a product’s life evolves in the following cycles: (1) introduction, (2) growth (above average growth rates), (3) ripeness (diminishing growth rates), (4) stagnation (diminishing turnover), (5) decline (collapse of turnover).

Patents go through a similar development. With regard to time, however, they are subjected to other rules, i.e. legal parameters, and for this reason it makes sense to draw up a separate life cycle of a patent next to the life cycle of a product. The advantages to be derived from a patent or the related profit can serve as parameters for measuring the success of its value-related life phases. With the help of market data from a life cycle of a patent, statements concerning its value can be made. The life cycle of a patent starts on the day of its priority or application date and ends with its cancellation caused either by non-payment of the renewal fee or by elapse of the maximum legal period of validity. In case an object is patented too early, the value of the patent can be minimal, for instance, if the life cycle on the market starts only much later – in the worst case it would only start when the patent is cancelled.

As a further new method for valuation of patents, the utility value analysis can be advantageously put to use. This is a means for alternative valuation with the help of a multi-dimensional target system and target preferences. It is in the favor of this method that also criteria of quality (and not only quantitative value factors) are taken into account which cannot be expressed in monetary units. Thus also legal factors may be included in value determinations. Within a matrix, alternative patents are valued using a number of criteria, and they are attributed points while each criterion is weighted according to its significance. The weighted criteria are added corresponding to the alternatives and thus result in a ranking list of the number of points assigned to the (utility) value of the respective patent. This ranking patent value analysis is very helpful in operative managerial and strategic patent decisions. However, the disadvantage with this method is that it yields no patent value in terms of a certain sum, at least not directly, since only a comparison of alternative patents is effectuated.

The above explained methods and approaches for the valuation of patents are taking into account various factors of value influences according to the respective information available. However, in individual cases other factors and aspects may be decisive in approximating the value of a patent. With a cost-oriented valuation, for example, legal factors of value are totally disregarded. Such a purely economic approach would not be satisfactory, since the legal situations can differ widely and often are crucial issues. It is therefore advisable to not only to take one evaluation method as a basis, but to use a number of different approaches simultaneously and to ask for the help of expert evaluators or patent attorneys who have, according to their experience, the capability to objectively assess and eventually correct the values investigated with a certain method.