Valuation of Intangible Assets

Intangible Assets (IA) and Intellectual Properties (IP) cannot be valued using conventional valuation techniques alone. This is because IA and IP have a fluid non-physical existence. IP often exists as an idea before it is commercially developed. The development of IP into a commercially viable product or service can take many paths before it is commercially offered to customers. New inventions usually take a period of time before they find their highest and best use value application in the market. The fluid nature of new ideas and inventions causes their inventors and organizers to constantly reconsider how large an investment they should be making in a project; whether they should develop the invention with partners; what is the inventions highest and best use; how long it will be before the invention obtains commercial viability; whether they should scale up or scale down the project based on their perception of demand for the product. These projects tend to be long term and new information about the prospects for an invention are constantly being generated prior to commercialization that provide for substantial managerial flexibility; flexibility in terms of 1) Expanding an investment if prospects for the invention become extremely bullish, or 2) Scaling down or abandoning a project if prospects are diminishing, or merely 3) Deferring further investment until the market improves for the invention. Standard NPV analysis will not capture the value of this flexibility. For these kinds of projects Real Option valuation frameworks are required.

Xerox-Parkís invention of the GUI (Graphical User Interface) was intended for Xeroxís fleet of copiers with management never realizing that its highest value would be in personal computers. Bell Labís patent of the transistor was expected to replace vacuum tubes but also gave rise to the integrated computer chip. The combination of Real Option and Decision Tree Analysis (DTA) allows the investor to dynamically value an invention relative to the probabilities and payoffs of its alternate applications. Real Option analysis captures the value of managerial flexibility. DTA allows management to incorporate expert opinion into the likely path of an inventionís expected development when there is insufficient data to use history as a precedent. The technical and theoretical issues of combining DTA and Real Option pricing in a simulation environment are non trivial and represent a discipline at which Predyct Analytics specializes.

Conventional net present value (NPV) analysis simply wonít capture the dynamic value of these types of investments. Real Option analysis provides an investment framework that allows the project manager to price in this kind of flexibility allowing many intangible and intellectual property projects to show a positive return that would fail standard NPV tests. But there is another very important consideration to using Real Option and DTA valuation techniques: the undervaluation of IA and IP using standard valuation techniques has resulted in corporations substantially undervaluing IA thereby resulting in highly suboptimal management and loss of these resources.

There are many famous cases of corporations losing control of their most valuable assets simply because they had not assigned enough value to make them a high management priority. This includes Xerox-Parc allowing its GUI to pass to Apple for very little consideration; or Bell Labs development and patent of the transistor which it failed to defend and that ultimately led to the development of the integrated circuit at Intel; or more recently the Winklevoss Twins who agreed to settle their claims against Mark Zukerberg for purloining their idea for Facebook rather than pursue their claims in court. The presiding judge subsequently indicated that he would have probably ruled in the twins favor had they not settled their claim with Zuckerberg. Later realizing their terrible error of undervaluing the Facebook concept the twins attempted to go back after Zuckerberg with another suit but it was too late as the judge refused to hear the case. These are but three of thousands of cases where firms have mismanaged their IA and IP for two very big reasons; 1) They didnít understand the value of the IA and 2) These assets were not capitalized on their balance sheets and were thus invisible (even to themselves). Corporate managers manage balance sheets not invisible assets that are not included in their companiesí financial reporting. Predyct Analytics specializes in Real Option and DTA valuation of IA and IP. Contact us if you believe you may have intellectual properties that may be undervalued.