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WAYS TO VALUE & PROTECT YOUR INTELLECTUAL PROPERTY

By Ryan Kuhn. A Harvard MBA, Ryan founded M&A advisor Kuhn Capital 35 years ago. Since then, the firm’s principals have initiated hundreds of high-IP mid-market M&A transactions together worth more than $3 billion. This article was first published 10/17/23 under the title GOT IP? Ways to Protect & Value It and revised 4/15/24.

Introduction

Intellectual property (IP) is the invisible Iron Giant of the U.S. economy. In 2019, IP-intensive industries supported a third of all employees and generated a value of $8 trillion. With the advent of AI and other advanced digital technologies since then, growth in the value of intangible assets has far outstripped that of the overall GNP. That trend shows no signs of slowing down. IP Is an Economic Giant

For the entrepreneur — especially the small business owner running a digital start-up — the massive impact of IP begs a question: Could your business be sitting on a hidden IP goldmine? Could you — by finding and nurturing it – also benefit from its great value? Once you create it, how do you go about protecting intellectual property?

Understanding IP

IP has traditionally been defined as the “intangible creations of the human intellect” or as “creations of the mind.” (But now with the arrival of AI, maybe also non-human intellect?)

IP ranges from inventive technologies to iconic brand symbols. In the United States, IP creators go about protecting their intellectual property four ways – with patents, trademarks, copyrights and trade secret treatment.

Intellectual Property Protection Comes in Four Flavors

Patents

Patents provide intellectual property protection for innovations. They do so for 15 to 20 years and they’re subdivided into utility patents (covering inventions and processes); designExamples of Patents patents (protecting how a product looks); and plant patents (for new plant varieties).

The patent application process is intricate and time-consuming, with utility patents being the costliest due to their comprehensive coverage. In general, expect to spend $3,500 to $17,000 to file a patent depending on patent type and complexity. Then there’s annual maintenance fees ranging from $500 to $7,500.

Trademarks

Essential for brand names or other forms of identification, trademarks distinguish goods and services in the marketplace.Example Trademark Registration fees at the trademark office range from $250 to $1,000. Because trademarks are so ubiquitous, for more detail on registration costs see this Forbes piece. You must renew a trademark registration every 10 years or risk abandonment.

Copyrights

Copyright protection shields artistic works as well as literary and other creative works for 95 to 125 years. While you gainCopyright Symbol copyright protection as soon as you create a work, registering your copyright fortifies your claim to ownership rights.

Trade Secrets

Encompassing proprietary knowledge from formulas to business strategies, trade secrets deliver a competitive advantage. But for something to be considered a trade secret, you must vigorously protect it. Trade SecretWays of doing so include NDAs, physical security measures, and written agreements with contributors to the IP, if any, that clearly state your intellectual property rights to their deliverables.

IP’s Role in M&A

While you need to know the four types of IP in order to develop and protect yours, what dealmakers care about is whether or not those exclusive rights have material value. They also care about whether your IP is “organic” or “inorganic.”

Organic IP integrates with ongoing company operations. You can’t extract it from the processes and products that you sell without diminishing cashflow.

Said another way, organic IP is a key reason why a company’s operating margins are high (or not). Imagine the Coca Cola™ company’s value without its trade secret syrup formula. In contrast, we call products with very little IP “commodities.”

Inorganic IP, on the other hand, has independent value unrelated to company operations. You could sell it off without affecting operations. Acquirers are unlikely to pay you what your inorganic IP is worth. After all, they’re after your core operating assets. Therefore, you’re usually better served by selling inorganic IP separately to other buyers, ideally those who see an organic fit.

In their due diligence, acquirers of companies pay attention to organic IP (for instance by carefully examining the breadth and remaining life of a patent) because its presence increases confidence that the company will reach its projected growth and margins.

So-called “financial” buyers in particular place great weight on these IP-driven margins when valuing a target. For a description of why that’s so, see HOW TO VALUE A GOING BUSINESS and HOW TO VALUE A START-UP.

And for a definition of what a “financial” buyer is, see our WHICH ACQUIRER FITS YOUR COMPANY BEST?

How to Value IP

Valuing IP is complex, time-consuming and just plain hard. Better to leave it to experts like investment bankers and IP valuation specialists. That said, every entrepreneur should have at least some idea how IP is valued. Knowing that can help them maximize their IP’s value.

Below we cover only the six most commonly used techniques. Many more exist. To see a comprehensive, visit IPwatchdog.

Relief from Royalty

The most widely used approach, Relief from Royalties has you estimating what you’d have to pay someone to license or rent your IP from them. You then collapse those periodic payments into a single number (a present value or PV) by discounting each payment for risk and time, then adding them together.

Market Approach

Looks at comparable market transactions, like the sale or licensing of similar IP assets. Since by definition protected IP is unique, attempting to find comparables can be a Quixotic exercise. Market Approach to IP Valuation

Yet by reviewing a series of at least somewhat similar IP deals, you can often triangulate a reasonable range. The major advantage of using the Market Approach is that it’s based on actual recent transactions, not some theory.

Cost Approach

Calculates what the IP is worth based on the costs incurred to develop it — R&D, testing, prototyping, and the opportunity cost of time and resources. While the Cost Approach can be a useful way to price newly developed IP, it’s typically much less relevant when valuing IP already exposed to market demand (or lack thereof). Just because you spent money developing IP doesn’t necessarily mean it’s worth anything.

Option Pricing Models

Used for IP with high levels of uncertainty about practicality or market demand, as with patents on emerging technologies. Analysts apply the Black-Scholes or binomial Options Pricing Models to estimate value. Options are financial instruments that give their holders the right to buy or sell an asset (in this case IP) at a fixed price by a certain future date. Using OPMs requires technical proficiency and deep familiarity with the type of IP at hand.

Technology Factor Method

Developed especially for technology-related IP, the TFM approach begins with a traditional valuation of the IP’s future cashflows (NPV). Then applies a multiple to that figure based on scores for the specific technology’s maturity, market, legal status and other factors.AI IP

In sum, IP valuators attempt to apply at least two of the above five methods in hopes that their value ranges agree. To the degree that they do, your confidence in the valuation’s accuracy rises.

But Wait: The Market Testing Approach

Should the above techniques prove unsatisfactory, consider retaining an investment banker to explore actual bids for your IP (or company as the case may be) from a representative sample of parties. Your banker may be able to do so anonymously.

While this approach can generate the most accurate valuation, it may also be the most-time-consuming. Yet if your goal is to confirm a value and sell if you find it acceptable, a sellside engagement would be of course your most direct route.

Wrapping Up with IP Action Steps

IP is an economic powerhouse, vital to entrepreneurs. Properly understood and managed, it can be one of the best ways to enhance and maintain company value.

Here’s how to do that:

  • Understand Your IP
    Identify all potential IP assets within your business — inventions, brand names, designs, proprietary information, etc.
  • Grow It
    Broaden and deepen the IP assets you’ve identified; think of ways to create new IP that leverages your expertise and resources at hand.
  • Shields Up
    Seek to protect your intellectual property with:

    • Patents: File for patents to protect inventions, designs, and new plant varieties.
    • Trademarks: Register trademarks for your brand identity in the marketplace.
    • Copyrights: Register copyrights for literary and artistic works.Steps to Protect IP
    • Trade Secrets: Implement measures to keep business strategies, formulas, processes (like source code) and other confidential information protected. Use both confidentiality agreements (NDAs) and physical and digital security measures. Ensure that your employees understand the importance of IP and how to avoid breaches.
  • Monitor for Infringement
    And take legal action against unauthorized uses, e.g., copyright infringement.
  • Keep IP Documentation Current
    Like registrations.
  • Review and Update
    Conduct periodic “IP Audits” of your IP strategy, status and potential vulnerabilities. Revise accordingly.

Taking these steps increases the chances that when it comes time for potential acquirers to value your company, their due diligence will reveal that you’re sitting on an IP goldmine — one ringed with strong intellectual property protections.


© 2024 Kuhn Capital, Inc. All Rights Reserved

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04/16/24

Ryan Kuhn is the founder of Kuhn Capital (bio). This article is not the product of AI. AI is a product of this article.