How does intellectual property impact a startup’s valuation?
In this article, we will dive into the impact of IPs on startup valuations and IP valuation methods, and conclude with an IP valuation example.
Investors are always on the lookout for disruptive startups with economic moats. Intellectual property (IP) rights help startups meet the latter requirement. A study suggests that a startup with IP rights is 10.2 times more likely to secure funding in the seed or early growth stages.
Powerful IPs can allow a startup to operate almost as a monopoly. This allows the startups to freely set prices, enjoy stable demand, and enjoy protection against competition. Thus, IP rights can have a direct impact on a startup’s valuation as well as its ability to secure funds in the first place.
How do different types of intellectual properties affect startup valuation?
Typically, intellectual property rights result in brand loyalty and premium pricing, which directly impacts a startup’s revenue. Let us explore how different types of intellectual property rights lead to such benefits.
Patents
Patents give inventors exclusive rights to reap the commercial benefits of their inventions for a specific period. You can use your patents to enjoy monopolistic powers that allow you to charge a premium and enjoy stable demand. You could also earn licensing revenue by allowing other organizations to use your patents.
Thus, patents allow a startup to charge a premium, enjoy stable demand, or earn licensing income, directly impacting its valuation. The value generated by a patent depends on the breadth of its coverage. A patent’s value rises with the duration of its validity and the extent of its geographical coverage.
Trademarks
Trademarks are meant to prevent competitors from misappropriating your brand identifiers, such as logos, phrases, product names, sounds, mascots, and packaging styles. This form of intellectual property rights helps you monopolize the brand power you have generated through marketing, advertising, and meeting customer expectations.
For instance, when you buy a sedan or a sport utility vehicle (SUV), you will make a certain down payment and pay equated monthly instalments (EMIs) for about 5 years. Since this is a sizable long-term financial commitment, you would prefer buying a trusted brand’s car. Thus, you may prefer buying a Toyota over a Genesis. Apart from the features and services offered, Toyota’s brand would play a key role in such a purchasing decision.
Brands can also allow companies to charge a premium. A premier example of this would be Apple’s iPhones or Macs commanding a significant premium due to the brand’s innovative identity.
Copyrights
Copyrights give authors exclusive rights for original works such as songs, photographs, books, and computer software. While these rights do not prevent others from publishing similar works, they allow the authors to exclusively reproduce and distribute their works.
Copyrighting their software allows tech startups to enjoy a certain level of economic moat. It ensures that other startups cannot simply replicate the software and circumvent the research and development expenses.
Trade secrets
Trade secrets are IP rights that protect confidential information about a business’s practices, production techniques, or key raw materials. Famous examples of trade secrets include McDonald’s Big Mac sauce, Google’s search algorithm, Coca-Cola’s secret formula, and KFC’s signature blend of 11 spices and herbs.
When a product has proved extremely useful or meets customer preferences brilliantly, trade secrets can help the producer carve out a niche for themselves. Trade secrets can also result in higher perceived value.
How should you value intellectual properties?
According to WIPO, you can only value intellectual properties (IPs) that have the following qualities:
- Separate identity
- Tangible evidence of existence
- Date of creation
- Legal enforceability
- Transferability
- Separate income stream
- Salability independent of other assets
- Destructibility
Suppose you own an electric bike company. You believe that you are able to charge a premium because of your brand name. However, research suggests that electric bikes with similar specifications and safety features have similar price tags and demand. In this case, your brand is not enabling you to charge a premium or sell more. So, your brand does not have a separate identity from the features of your electric bike, and hence it cannot be valued.
However, if your intellectual properties have the abovementioned qualities, you can value them using the following methods:
Intellectual property Valuation
The three main approaches to IP valuation are:
Income approach
In the income approach, we calculate an IP’s valuation as the income it is expected to generate over its lifetime. This is a commonly used valuation method since it captures the economic value of an IP asset. To account for inflation and risk, the income approach involves applying a reasonable discount rate to expected future cash flows.
Cost approach
Cost approaches are used when an asset is easily replaceable. This involves calculating the IP valuation as the cost of developing a similar IP. In addition to the research costs, you must also consider expenses such as legal fees, registration fees, and testing expenses. You must also adjust the valuation for depreciation, as such IPs may lose effectiveness over time. Certain IPs that could be valued with the cost approach are simple software, website templates, and other IPs that are often swapped out once they lose their functionality.
Market approach
The market approach involves establishing an IP’s value by understanding how the market is valuing other assets of similar functionality. Since the selling price of similar IPs is a key input in this approach, its application is limited to IPs that are frequently transferred.
IP valuation example
In this example, we will value the different intellectual property rights held by ARKwork, a productivity tool developer. Their list of IPs is as follows:
- Licensing fee generating real-time communication (RTC) engine patents – IP expiring in 4 years
- Web assets (Other than domain name) – IP expiring in 2 years
- Brand assets (Including domain name) – IP expiring in 8 years
We will use the income approach to value the RTC engine patents since they allow ARKwork to access a new revenue stream.
In 2024, the RTC engine patents generated licensing fees of $4 million. The company expects the licensing fees to grow 20% annually. Assuming a discount rate of 6%, we can make the following projections:
| Year | 2024 (Base) | 2025 | 2026 | 2027 | 2028 |
|---|---|---|---|---|---|
| Licensing fee | $4,000,000 | $4,800,000 | $5,760,000 | $6,912,000 | $8,294,400 |
| Discounting factor | N.A. | 1.06 | 1.1236 | 1.191016 | 1.26247696 |
| Present value | N.A. | $4,528,302 | $5,126,379 | $5,803,448 | $6,569,942 |
The value of the RTC engine patents, i.e., the present value of the total licensing fee generated, is $22,028,072.
ARKwork’s web assets include various elements such as page templates, animations, and images. It is expected that these assets will become outdated in 2 years and must be replaced. So, we will use the cost approach to value these assets.
According to their internal estimates, recreating these assets would involve the following costs.
| Web asset | Cost |
|---|---|
| Web page templates | $100,000 |
| Photos | $200,000 |
| Images | $150,000 |
| Animations | $500,000 |
| Audio files | $300,000 |
| Videos | $800,000 |
| Documents | $120,000 |
| Website content | $400,000 |
| Total | $2,570,000 |
Thus, the value of the web assets is $2,570,000.
Since there is a market for ARKwork’s brand assets, it makes sense to value them using the market approach. The brand assets of ARKwork’s competitors had the following valuations.
| Company | Brand asset valuations |
|---|---|
| Taskloom | $50,000,000 |
| Focusly | $45,000,000 |
| ZapTrack | $70,000,000 |
| Efficio | $30,000,000 |
| ClarityHub | $20,000,000 |
| Prompto | $90,000,000 |
| WorkNest | $40,000,000 |
| TimeSplice | $50,000,000 |
| Nexdone | $90,000,000 |
| Flowmint | $60,000,000 |
Under the market approach, ARKwork’s brand assets can be valued as the average valuation of brand assets of similar companies, which is $54,500,000.
Thus, the value of all of ARKwork’s IP rights is $79,098,072 or approximately $79 million.
Eqvista – Decisive accuracy!
Securing IP rights is a great way to not only improve your startup’s valuation but also its competitiveness. Before heading into funding rounds, you must learn the value of your IP rights to make informed decisions.
To help you lead negotiations with confidence, Eqvista’s seasoned valuation analysts can provide an accurate and unbiased perspective through detailed reports. Contact us to learn more about our services!
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