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How can you use the royalty rate method to value IP assets?

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If you have developed a product or service that relies on intellectual property (IP) assets, such as patents, trademarks, copyrights, or trade secrets, you might wonder how much they are worth. Valuing IP assets can help you make strategic decisions, such as licensing, selling, or investing in them. One of the most common methods to value IP assets is the royalty rate method. In this article, you will learn what the royalty rate method is, how it works, and what are its advantages and limitations.

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1 What is the royalty rate method?

The royalty rate method is a way of estimating the value of an IP asset based on the expected future income it can generate. The idea is to compare the IP asset to similar ones that are licensed or sold in the market and use their royalty rates as a benchmark. A royalty rate is the percentage of revenue or profit that a licensee pays to a licensor for using their IP asset. For example, if you license a patent for a new technology to a company and agree on a 5% royalty rate, you will receive 5% of the sales or profits that the company makes from using your patent.

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2 How does the royalty rate method work?

To use the royalty rate method, you need to identify comparable IP assets that have been licensed or sold in the market, and collect their royalty rates. You can use databases, industry reports, or expert opinions to find relevant data. It's important to adjust the royalty rates to account for any differences between the comparable IP assets and yours, such as the level of risk, exclusivity, stage of development, or expected life span. Factors like risk premium, market share, or growth rate can be used to make the adjustments. After calculating the average or median adjusted royalty rate and applying it to your IP asset's projected revenue or profit, you will get the estimated value of your IP asset. For instance, if the average adjusted royalty rate is 6% and your IP asset's projected revenue is $10 million, then the value of your IP asset is $600,000.

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Azfar Kamal, Ph.D., PMP, LSBB

Global Director R&D, Product and PMO
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Royalty rate method is a first good estimate to value an IP but often not the only factor in deciding to pursue the IP. When an inventor approaches for an invention that might be turned into a product with their own royalty needs, besides the cost to buy out the inventor outright or over a specific period, we must do our own analysis of its market value, global protection, and risk of infringement. We also assess if the time and effort spend to bring this IP in form of a product and create a market is really worth our efforts. But, I am in industrial manufactured product industry and can’t speak of SW/ IT industry, where startups IPs are far readily sold.

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3 What are the advantages of the royalty rate method?

The royalty rate method of IP valuation has several advantages over other methods. It is based on actual market data, making it more reliable than methods that rely on assumptions or hypothetical scenarios. Furthermore, it is relatively simple to apply as it requires only basic financial calculations and data analysis. Additionally, it can capture the value of IP assets with multiple applications or markets by using different royalty rates for different segments or scenarios.

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4 What are the limitations of the royalty rate method?

The royalty rate method can be limited by the availability and quality of comparable IP assets and their royalty rates, as well as data confidentiality or reliability. Additionally, it assumes that the royalty rates are constant and do not change with market conditions. However, this may not be true as royalty rates can vary depending on supply and demand, competition, innovation, or regulation. Furthermore, this method does not consider the synergies or interactions between an IP asset and other assets or factors that could affect its value. Therefore, other methods or approaches may need to be used to capture these effects.

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Cedar Boschan ?? GDC

Forensic Accountant & Expert Witness ?? Damages, Royalties, Audits & Valuation
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Besides a dearth of information about royalty earnings for comparable IP, one thing that is not comparable between IP that is earning royalties and IP that has yet to be exploited is that the latter has no guarantee that it will generate even $1. If IP is already generating income, an intrinsic valuation (discounted cash flow) method is usually preferable, though the comparable method (the so-called "royalty rate method" is but an example of the comparable method) is one way to check an intrinsic valuation for reasonability, but it is a mistake to rely solely on the comparable method given other options.

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5 How can you use the royalty rate method effectively?

The royalty rate method can be a useful tool for valuing your IP assets, but you need to use it with care. To use the royalty rate method effectively, you must do your research and gather as much information as possible about the comparable IP assets and their royalty rates. Be selective and critical about the data you use, making reasonable and consistent adjustments to account for the differences between the comparable IP assets and yours. Additionally, compare your results with other IP valuation methods or indicators, such as cost, income, or market methods. Lastly, use a range or a sensitivity analysis to show the uncertainty or variability of your results. By following these tips, you can ensure that you are using the royalty rate method correctly and effectively.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How can you use the royalty rate method to value IP assets?

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1 What is the royalty rate method?

2 How does the royalty rate method work?

3 What are the advantages of the royalty rate method?

4 What are the limitations of the royalty rate method?

5 How can you use the royalty rate method effectively?

6 Here’s what else to consider

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How can you use the royalty rate method to value IP assets?

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6

1 What is the royalty rate method?

2 How does the royalty rate method work?

3 What are the advantages of the royalty rate method?

4 What are the limitations of the royalty rate method?

5 How can you use the royalty rate method effectively?

6 Here’s what else to consider

Product Innovation

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