Ten intangible/IP valuation myths revealed 20 Apr 09
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One of the articles we have in IAM 35 focuses on 10 valuation myths. Written by Patrick Sullivan and Alexander Wurzer, it identifies claims that many people make about IP/intangible valuation and then explains why these are completely wrong. At a time when transparency is the watchword, this is important stuff. It is also highly readable. So, as a little tickler, here are the myths and heavily edited explanations as to what makes them wideof the mark:
• Myth #1 – value is a well-defined and well-understood term. There isn’t one well-understood and agreed definition of value. In fact, there are at least five relating to inangibles: worth - the value of an item to a specific individual or entity; price - the monetary amount a seller asks a buyer to pay for an item or object; transacted price - the amount actually exchanged in a completed sale; estimate of price - the expected transaction price for a future sale; and estimate of worth - a valuation of the current worth of an item to an individual or entity.
• Myth #2 –the value of an intangible is equal to the price someone is willing to pay. For intangible items, value is rarely equal to price. Price is the amount in currency that a seller asks a purchaser to pay. If the worth of an object to a potential purchaser is greater than the price asked, the purchaser will consider the transaction. If the price asked is greater than the worth of the object to the potential purchaser, it is unlikely that a transaction will occur.
• Myth #3 – value is equal to the cost of creating an item. IP practitioners have observed that their most valuable patents are those that can be exploited in multiple ways in the marketplace, not those with the highest R&D and patenting costs. Because development costs are uncorrelated with the future economic benefit of a patent to its owner, practitioners rarely use it as a measure of either price or worth.
• Myth #4 – each intangible should have only one official value. A single intangible may have several very different values at the same time; all of them valid, depending on who owns it and for what purpose it will be exploited.
• Myth #5 – the balance sheet provides good information about the value of intangibles. There are three significant problems with using balance sheet information as the basis for valuing intangibles: not all intangibles are included on the balance sheet; when included, their value is based on the transaction price for which they were acquired, not their worth to the company; and different countries have different rules about whether a firm should include internally generated intangibles on its balance sheet and inconsistent requirements for how that value is to be estimated.
• Myth #6 – fair market value is a good construct for use with intangibles valuation. For items that are wholly differentiated and unique (such as intangibles), there are usually only a small number of potential purchasers and, for each, the worth of the item will differ, often substantially, from the others. As a result, it is difficult to determine a credible average, or fair market value, for a piece of IP.
• Myth #7 – there should be only one accepted method for valuing intangibles. Reaching agreement on one and only one method for valuing intangibles would mean coming to an *a priori* agreement on the dimensions for all valuations. At the present time it is unlikely that the business community will be able to agree on one set of dimensions for estimating either price or worth.
• Myth #8 – a current estimate of future price must equal the eventual transaction price in order to be considered accurate. When can an estimate be considered best? Whenever there is no better or more credible alternative estimate. This is true both for intangibles and for tangible business assets, but getting the best estimate is more difficult for intangibles because of their more complex characteristics.
• Myth #9 – patents cannot be valued credibly because each one is unique. People who believe intangibles cannot be valued credibly confuse credibility with certainty. They seek the comfort of established markets and market prices, such as one finds for automobiles, tables, chairs and other kinds of tangible objects. But the lack of established markets and prices does not mean that the value (either price or worth) cannot be credibly estimated.
• Myth #10 – The value of a company’s intangibles is the difference between its market value and the value of its tangible assets. We have been here before.
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