Patent Valuation for Startups and Early-stage Ventures

Have you recently established a startup? If so, patenting your company is important. According to a report by Pitchbook, startups at all stages of growth can benefit from patenting their big idea. This allows them to raise funding and achieve greater valuations.

The ownership of European patents and trademarks is associated with startups being 6.1 times more likely to secure early-stage funding. Patents can also serve as collateral for loans,around 400,000 patents had a pledged security interest from 2016 -2019, double the amount from 2012-2015.

Lets see what’s there with patent Valuation and the challenges you can encounter while doing one.

Patent valuation for startups

Startups should get their patents valued because it helps with investment and market value determination. It motivates the entrepreneur to put in more time and effort to ensure the startup’s success and entices investors to boost investment by proving the value of the big idea.

Benefits of patenting startup idea

If you are double-thinking about valuing your patent, the following points can help you understand the benefits of patenting a startup idea.

• Competitive Advantage – Patent valuation for startups can be benifit by highlighting their unique features. By placing a monetary value on your patent, you can get an advantage over your competitors by allowing your innovative concept to work for your startup.
• Evidence of Innovation – Patent valuation for startups can be raised by demonstrating its capabilities. If the patent’s value is high, it signals to potential investors and acquirers that the startup can improve in the future. A high patent valuation for startup indicates that it has a unique, competitive technology, and investing in or purchasing it can benefit the intended parties. It also earns cash through licensing, which gives the firm an additional income stream.
• Increased Valuation – A patent can boost a startup’s valuation. Patenting your startup’s idea can raise its market worth because it protects intellectual property rights. A greater patent valuation for startup indicates that investors and shareholders see the startup’s potential and are willing to invest their money.
• Attractiveness to Investors – Irrespective of the industry the startup belongs to, patent protection is necessary. It prevents others from stealing the idea’s distinctive features. For instance, if your startup is involved in software development, you can safeguard your algorithms, data structures, and any other features linked to your invention by obtaining a patent for your startup.
• Legal Protection – Getting a patent can prevent people from utilizing your invention without your permission. Getting a patent for your business offers you the legal power to stop other people from creating, Selling, Using or Importing the patent. Even if someone were to do any of these things to your copyrighted startup idea, you may still take legal action against them, such as sending cease-and-desist letters or filing infringement lawsuits.

Key Components of Patent Valuation for Startups

There are three important components of patent value. Let’s break it down:

• Technological Strength and Innovation – This refers to the uniqueness and novelty of your patent. If your patent covers groundbreaking ideas and highly innovative technologies, its valuation will be higher as it provides stronger protection against competitors.
• Market Potential and Commercialization Opportunities – The patent valuation for startups often depends on its potential to generate revenue through commercialization. The following factors influence the patent’s value:
  • Market size
  • Demand for the technology
  • The ability to monetize through licensing
  • Product sales
• Legal and Regulatory Considerations – Your patent must be legally strong to withstand any challenges you might face from competitors and to protect the investor’s rights. Factors including:
  • Patent’s scope
  • Validity of the patent and
  • Potential infringement

All these can affect your parent’s legal strength and, eventually, its value. Regulatory considerations such as compliance with IP laws and industry standards can also impact your patent valuation for a startup.

Methods and Examples to value patents for startups and early stage ventures?

A precise patent valuation can help you with a reasonable value. When you patent your startup, there are always more benefits than drawbacks. In Order to find the value of patents for startups there are three main methods.

Market Approach

The market approach looks at comparable patent transactions and licensing deals to determine the patent’s market value. It is a commonly used method, as startup patents are often young and do not have strong enforcement potential yet.

Example of Market Approach

A startup owns a new phone case design patent with innovative cooling technology. They’re considering licensing it to a phone accessory company.

Estimated Royalties:

• They estimate the patent can command a 3% royalty rate on the selling price of phone cases using the technology. They believe the licensee will sell 200,000 phone cases annually at an estimated $50 per case.

Annual Income:

• Annual royalty income = Royalty rate * Selling price per unit * Units sold
• Annual income = 3% * $50 * 200,000 = $300,000

Patent Life & Discount Rate:

• The patent has a remaining lifespan of 5 years. To account for risk and the time value of money, they chose a discount rate of 8%.

Discounted Cash Flow (DCF) Analysis:

• We will perform a discounted cash flow analysis to determine the present value of the patent’s future royalty income.

Yearly Cash Flows:

• We can simplify by assuming a constant annual income of $300,000 for all 5 years.
• We’ll calculate the present value of each year’s income using the discount rate.

Discounted Cash Flows:

• PV1 = $300,000 / (1 + 0.08)^1 = $277,778
• PV2 = $300,000 / (1 + 0.08)^2 = $257,202
• PV3 = $300,000 / (1 + 0.08)^3 = $238,150
• PV4 = $300,000 / (1 + 0.08)^4 = $220,509
• PV5 = $300,000 / (1 + 0.08)^5 = $204,175

Total Present Value (PV):

• PV = PV1 + PV2 + PV3 + PV4 + PV5
• PV = $1,197,813

Estimated Patent Value:

• The present value of all future royalty income represents the estimated patent value using the income approach, which is approximately $1,197,813.

Income Approach

This approach estimates the future revenue or cost savings the patent can generate and calculates the net present value. For young startup patents income approach can be challenging to apply as they are uncertain about the future commercialization plan.

Example of Income Approach

Let’s consider a startup that holds a patent for a new type of smartwatch technology. To use the Market approach, we will look at comparable patents that have been sold or licensed recently.

• Patent A sold for $200,000.
• Patent B, with a 5% royalty rate, generated $50,000 annually.
• Patent C sold for $150,000, with additional technology included.

Now, let’s calculate the average value of these comparable transactions:

(Amount from Patent A + (Royalty rate from Patent B × Royalties per year from Patent B) + Amount from Patent C) / Number of transactions
= ($200,000 + ($50,000 × 0.05) + $150,000) / 3
= ($200,000 + $2,500 + $150,000) / 3
= $352,500 / 3
= $117,500

So, the average value of comparable transactions is $117,500. This could serve as a benchmark for valuing the startup’s smartwatch patent.

Cost Approach

Cost approach calculates the cost to develop or replace the patented technology. This method is generally not suitable and rarely used for valuation of startup patents.

Example of Cost Approach

Imagine a startup that developed a novel phone case design and secured a patent. Here’s a simplified example using the Cost Approach:

• R&D Costs:
  • Design team salaries – $100,000/year for 2 years = $200,000
  • Prototyping costs – $20,000
• Patent filing and maintenance fees – $10,000

Total Cost to Develop and Secure Patent – $230,000

Common challenges in patent valuation for startups

We already know that patent valuation for startups involves a few challenges as they are just beginning their corporate journey. The following are some common obstacles to remember while performing patent valuation for startups.

Legal Complexity

When you do a patent valuation for startup, a major challenge would be the legal consideration prevailing around the patent’s rights. These legal aspects can be complicated and vary across jurisdictions.

Different types of patents (utility, design) can have different valuation methodologies and legal considerations, such as:

• Patent validity
• Enforceability
• Infringement risks

All these factors can impact the valuation results.

Limited Revenue and Sales History

For a proper patent value, a company should have sales and profit records from the past, which may be accessible to startups later. When doing patent valuation for startup, it can be easier to determine a patented invention’s market potential and commercial value with a track record of success.

With enough information, stakeholders and investors can predict how much money the idea will make.

Uncertainty in Future Sales and Royalty Rates

Sales and royalties can be difficult for new businesses in changing industries to link to a patented idea. Determinants like:

• Market demand
• Competition
• Technological advancements
• Regulatory changes

All these can influence the licensing and success of the startup’s patent, adding complexity to the valuation process.

Risk Mitigation

Compared to more established businesses, startups sometimes face higher degrees of risk in terms of technology, the market, and execution.

Identifying and avoiding these risks is one of the biggest challenges for businesses when valuing patents. Investors could undervalue startups’ patent value because of uncertainties in:

• Technology development
• Market acceptance
• Regulatory risks
• Startup’s ability to execute its business plan effectively

Best Practices for Patent Valuation in Startups

Valuing your idea for a patent is difficult but necessary to keep others from copying and making the most of your invention. Startup patent valuation recommended practices are as follows:

Conducting Comprehensive Patent Due Diligence:

First, familiarize yourself with the startup’s patent, ensuring you understand its scope, validity, and potential for commercialization. It’s necessary to consider the patent’s individuality in the:

• The technology
• Market demand
• Competitive environment
• Any potential risks

If the startup does thorough research, it will know how much its patents are worth and what they can do.

Regular Monitoring and Updating of Patent Valuation Models:

Patent value is not a one-time process. You must constantly monitor and adjust it as necessary. Patent values may fluctuate if there is a change in:

• Market conditions
• Technologies
• Competition

As a result, startups should regularly review and update their valuation models to reflect market events, which can alter the patent’s value. Regularly monitoring rivals’ actions and new laws can help achieve this.

Leveraging Strategic Partnerships and Licensing Opportunities:

Patent valuation for startups can increase through strategic partnerships and licensing agreements. Partnering with established companies or entering into licensing arrangements might help commercialize the patented idea better.

It also provides access to the other companies:

• Resource
• Market
• Experience

As an entrepreneur, you can use this opportunity to maximize the patent’s value.

Make your Early-stage Startup Business Valuations Easy with Eqvista!

Is patent valuation for startup difficult, considering all the minute details? It depends on who performs it. If done independently, it will require much time and effort. So, it is better to consult a professional valuer to make the process easy.

This is where Eqvista can help you. We offer professional valuation services for startups and early-stage ventures. We also provide 409a valuations and cap table management, which could be beneficial when you distribute shares to the investors.

Our team has been assisting early-stage companies in reaching their objectives with their extensive knowledge and years of experience in the field. Working with a trustworthy partner like Eqvista will help you maximize efficiency and output. We are here to help in any way we can. Contact us to learn more!