Unlocking the Value of Trade Secret Assets: Business Valuation Strategies
The valuation methods for trade secret assets are discussed here.
In recent years, there has been a change in how much money businesses are worth from their physical assets, or “bricks and mortar,” to their intangible assets, such as their intellectual property (IP). While every corporation does not hold patents, trademarks, copyrights, and other types of intellectual property, trade secrets are something that almost every business owns. Today, trade secret valuations are essential in strategic planning, financial reporting, and business deals. While some companies may have a system to track trade secrets, the vast majority do not. The valuation methods for trade secret assets are discussed here. Therefore, valuation experts might benefit from learning more about the importance of trade secret asset valuation and the factors affecting the value of trade secret assets.
Trade Secret Assets and Valuation
To standardize trade secret protection across jurisdictions, the American Bar Association formed a special committee in 1968 to investigate the feasibility of creating a unified trade secret statute. Due to these efforts, the Uniform Trade Secrets Act (UTSA) was drafted.
The Defend Trade Secrets Act of 2016 (DTSA) added federal protection for trade secrets to the existing state protections before 2016. Information that can be considered a trade secret is cataloged in the Uniform Trade Secrets Act and the Data and Transparency Act. Let’s understand the trade secret assets and their importance in this section.
Understand Trade Secret Assets
A trade secret can be defined as an asset that serves as data that, since it is not common knowledge, has the potential to generate economic benefits on its own. It has significance for those unable to access it lawfully and is the subject of measures commensurate with its importance to preserve its confidentiality.
A trade secret can no longer exist if the three conditions above are no longer met. Otherwise, there is no time restriction on how long a trade secret may remain confidential. When it comes to intellectual property, trade secrets can’t be undervalued. It’s safe to assume that companies of all sizes, from the smallest startups to the largest conglomerates, have unique secrets they’d want to keep under wraps.
Importance of trade secret asset valuation
The importance of trade secret asset valuation cannot be overstated. However, the following are a few reasons why the valuation is crucial.
- By putting a dollar value on a company’s trade secrets, management may better allocate resources, determine priorities, and assess new business prospects.
- Accurate valuation guarantees financial transparency and conformity with accounting rules and gives shareholders, investors, and other stakeholders insight into the value and effect of trade secrets.
- Risk management, including the implementation of protection plans, security measures, and education and training initiatives, is made easier with the information obtained from a valuation of a company’s trade secret assets.
- It strengthens the reliability of investment and financing choices, facilitates negotiating advantageous conditions, and demonstrates the appeal of trade secrets as investment prospects.
- The results of a valuation study may significantly impact settlement discussions, damages analysis, and the quantification of the monetary loss resulting from the theft of trade secrets or other intellectual property.
Valuation Methods for Trade Secret Assets
The value of trade secret assets is proportional to the economic advantages gained from keeping them secret and protecting them from unauthorized disclosure. Trade secret assessments are based on revenue and development expenses (including negative knowledge) since there is almost no publicly available information on market deals involving trade secrets. When attempting to price intellectual property, experts may use several strategies, such as the following.
With the cost technique, the trade secret valuation is determined by assessing how much it would cost to replicate or replace the asset. It considers the number of variables to determine how much time and money will be needed to duplicate the trade secret. Replicating a trade secret’s quality, usefulness, and economic advantage would require substantial investment in R&D funds, technical advances, and the necessary resources, time, and effort.
When calculating the total cost to create a trade secret, the cost method factors in direct and indirect expenses. Expenses incurred before, during, and after a project’s execution are considered direct costs. Overhead expenditures, such as employees, rent, utilities, and administration, are considered indirect costs if they are essential to the development process.
The income technique is one way to calculate the trade secret assets valuation by considering its prospective earnings. It factors in the anticipated financial gains made as a result of using the trade secret during its predicted lifespan. The following methods are used when applying the income approach for valuation:
- Relief from Royalty (RfR) Method – This technique for estimating the trade secret assets valuation involves figuring out the amount of money that would be saved on royalties if the trade secret was owned by the user rather than licensed by a third party.
- Multi-period Excess Earnings Method (MPEEM) – The current value of the future profits that will be generated through the trade secret property is calculated using MPEEM. This calculation considers several different elements, including anticipated revenues, costs, and discount rates.
- Incremental Value Method (IVM) – IVM calculates the value difference between a company with a trade secret property and a similar company that does not, considering the extra revenue the asset produces.
Here, one might look at how other comparable assets have been traded to determine a fair price for a trade secret’s value. Market data and past deals are used to estimate the trade secret’s worth. If you look at the going rate for a similar trade secret, you can calculate what yours would be worth. This approach uses the following methods to estimate valuation:
- Comparable Transaction Method (CTM) – CTM determines trade secret valuation by comparing it to similar trade secrets purchased or sold in the open market. It considers aspects such as the transactions’ pricing, terms, and circumstances.
- Market Multiple Method (MMM) – MMM calculates the estimated worth of a trade secret by relating market-based multiples (for instance, revenue or profits multiples) to the financial indicators of comparable firms with trade secret assets equivalent to the trade secret in question.
Factors Affecting the Value of Trade Secret Assets
A number of different circumstances may dramatically impact the value of an asset’s potential as a trade secret. A trade secret’s acceptability and possible financial gain are both determined by the following elements:
- Legal protection – The value of a trade secret might be affected by the extent to which it is legally protected. Legal safeguards, such as trade secret regulations and non-disclosure agreements (NDAs), increase a trade secret’s value by making it more difficult for unauthorized parties to steal the information.
- Age and life cycle – A trade secret’s worth may decline as its age and usefulness decline. Newer trade secrets with a longer predicted life cycle are more valuable than older ones. The worth of a trade secret might decrease as its development stages progress or as its usefulness becomes obsolete. A trade secret’s worth may depend on how long it can remain hidden and provide an edge over the competition.
- Level of secrecy – Generally, the value of a trade secret increases in proportion to the degree to which it is guarded and kept hidden. Keeping a trade secret hidden and protecting its value requires stringent security measures and strict confidentiality procedures.
- Competitive advantage – Unique manufacturing techniques, formulae, or consumer insights are examples of trade secrets that fetch the highest prices. The value of a trade secret depends on how much it helps a firm stand out from the competition, gain market share, or outperform its rivals.
- Technical feasibility – The value of a trade secret is affected by how easily it may be put to use in actual situations. The value increases when they can be quickly and easily incorporated into existing goods, processes, or services. The trade secret’s potential and worth may be reduced in proportion to the difficulty of acquiring and using the requisite information and technology.
Risk Assessment in Trade Secret Asset Valuation
Several crucial aspects must be considered when evaluating a trade secret valuation risk. These considerations aid in identifying and assessing the dangers related to trade secrets, which may affect their value. There are four primary factors to consider when evaluating risk when valuing trade secret assets:
Assessing market risk entails determining how prospective market circumstances may affect trade secret value as the following:
- Looking into how trade secrets could be affected by changes in market demand and consumer tastes.
- Consideration of rival firms and the introduction of disruptive technology or new entrants to the market might erode the value of trade secrets.
- Taking into account economic and sectoral shifts that might affect trade secret-based product demand
- Considering the likelihood that the trade secrets may become obsolete due to technical developments like new discoveries.
- Analysis of the extent to which continuing R&D is required to maintain technical competitiveness of the trade secrets.
- Examining the potential for cyber assaults, data breaches, or illegal access to compromise trade secrets.
Legal and regulatory risk
- Analyzing how trade secret regulations and non-disclosure agreements function in practice, as well as the likelihood that these laws will undergo any changes that might affect the enforcement of trade secrets.
- Assessing the potential for expensive litigation over intellectual property issues or infringements and the loss of protection for trade secrets.
- Reducing possible legal and regulatory risks, by taking into account adherence to relevant laws and industry norms, such as those governing data protection or export controls.
- Examining the efficiency of information management techniques, access restrictions, and other safeguards put in place to protect trade secrets from leaks or abuse.
- Evaluating the potential for trade secret disclosure due to human mistake, employee negligence, or other internal weaknesses.
- Examining the effectiveness of safeguarding trade secrets and risk management training programs for staff members.
Integration of Trade Secret Asset Valuation in Business Valuation
The value of intangible assets may be better understood by including trade secrets valuation within the larger context of company valuation. As an organization’s most prized intangible asset, trade secrets are crucial to the success of every enterprise. Businesses may make educated judgments, manage resources efficiently, and take a strategic stand in the market by precisely estimating and utilizing trade secret valuation. Let’s understand the outcomes better in this section.
Determination of Total Enterprise Value
When calculating a company’s worth, it helps to include an estimate of the value of any trade secrets the company may own. A more complete picture of a company’s worth may be gleaned by factoring in the value of its trade secrets throughout the appraisal process. This all-encompassing evaluation of the company’s worth considers its physical assets and its intangible goodwill. Access to this data is crucial for making informed business decisions, filing tax returns, and gauging the firm’s financial stability.
Allocation of Value Among Assets
The valuation of trade secrets helps determine how much value should be allocated to each asset. Businesses may assess how each employee contributes to the organization’s total worth by evaluating trade secrets. Allocations like this are crucial for tax filing, combining businesses, and forming partnerships. It helps parties involved in negotiations and decision-making understand the value of the company’s trade secrets and how they contribute to that value.
Use of Trade Secret Asset valuation in Decision Making
It’s important to know the value of your trade secret assets so you may use that information in making choices in all aspects of your organization. Businesses may better judge resource allocation, investment, and expansion if trade secrets are properly valued. They can determine whether any profit will be made through licensing agreements, collaborations, or acquisitions and calculate the value of their trade secrets. Insights from valuation exercises help companies better use their trade secrets, guiding their strategic objectives toward sustained growth.
Get your Trade Secret Assets valuation from Eqvista!
Valuing a company’s trade secret assets is essential since it helps businesses determine the real worth of its intangible assets. A company’s ability to strategically allocate resources, plan for the future, and make the most of its intellectual property is greatly enhanced when trade secret assets value is implemented. There are various rationales for performing a trade secret valuation or economic analysis. Irrespective of the specific purpose necessitating the assessment of trade secret value, the valuation analyst evaluates all three acknowledged approaches for estimating value.
Consider using Eqvista’s services if you want a precise and thorough trade secret asset appraisal. Eqvista allows you to accurately evaluate the worth of your proprietary information, make educated choices, and utilize the maximum value of your IP portfolio. Want to learn more about our services, call us today!