Startups are the drivers of cutting-edge inventions and innovations in the economy. They create numerous jobs and promote the spirit of entrepreneurship for the youth, leading to a stronger and healthier economy. India has the world’s third-largest startup ecosystem that contributes to 4-5% of its total GDP.
Intellectual Property (IP) plays an important role in helping start-ups occupy a special place in the minds of consumers. In today's scenario, if a person is considering starting their venture, they have to think about IP. Considering that technology is evolving continuously and driving changes in the global economy, tech companies are increasingly focusing on developing their IPs to maintain a competitive edge.
In such a scenario, proper IP valuation is increasingly becoming popular. It is defined as the process used to decide on the market value of IP assets. The benefit of IP valuation is not just limited to determining the value of an IP. It’s also used to determine the overall worth of a start-up.
Having a clear picture of the IP portfolio of a business is a prerequisite for IP valuation. Suppose a start-up owner plans to purchase, sell or license their IP, an IP valuation is mandatory to know the true value of the IP assets in question.
Why Are IPs Valuable Assets for Indian Start-Ups?
Intellectual Property is a culmination of inventive spirit and human ingenuity and covers a wide spectrum of intangible assets. Intellectual Property Rights (IPR) provide exclusive rights to innovators and creators enabling them to benefit from their inventions or creations.
The four important types of IPRs that shape India’s IP landscape include patents, trademarks, copyrights and trade secrets. These are valuable assets for Indian start-ups as they fuel growth, innovation and market competitiveness.
Patents
A patent enables its owner to prohibit others from exploiting or using the invention mentioned. It helps individuals and firms prevent their competitors from copying their inventions. Apart from providing start-ups with legal protection on inventions, a patent helps start-ups to commercialise their inventions.
Trademarks
A trademark is a distinctive sign or symbol used by a business organisation or an established legal entity. It's used to differentiate the products of one legal entity from that of its competitors. It establishes brand identity, facilitates its recognition and helps to build customer loyalty.
Copyrights
Copyrights protect the rights of authors or creators to profit from their creative pursuits. A copyright can be assigned to different forms of intellectual property including films, songs and artworks. Start-ups in creative industries depend on copyrights to protect their creative expressions and unique content.
Trade Secrets
Any design, formula, procedure or other intellectual property that is confidential and lends a business a competitive edge against its competitors is referred to as a trade secret. While its importance is often overlooked as intellectual property, trade secrets are crucial information that contributes to a start-up’s success and valuation.
An IP portfolio will be of immense value only if it's perfectly well-aligned with assets that bring the most value to a business. For example, patents are the most important assets of a tech company while trademarks would be the most important IP of a popular consumer brand. Trade secrets will likely be the most valuable IP of companies that deal mostly with data.
Intellectual property serves as a valuable asset for start-ups because it protects the business against imitators, paves the way for numerous growth opportunities and builds confidence in investors. Some of the reasons why IP valuation is so important for start-ups are illustrated below:
● Market Differentiation
Intellectual property helps Indian start-ups to create a separate niche in the market. It also sets businesses apart from their competitors. Moreover, it should not be forgotten that patents, trademarks, copyrights and trade secrets perform the role of brand identifiers. They help build up customer loyalty and brand recognition.
● Defence Against Imitators
Indian start-ups can use IPR to protect their innovative ideas and identities. The legal protection enables them to prohibit their competitors from producing similar products. As a result, it prevents the possibility of their market position being diluted.
● Investment Attraction
IPs improve the prospects of a business. A start-up with a strong IP portfolio is always more attractive to investors as it holds the promise of further innovations. Furthermore, IP protection fuels a start-up’s commitment to constant innovation which creates its ability to generate revenues in the long term. As a result, investors find such start-ups an attractive option for collaborations and partnerships.
● Revenue Generation
An important point to consider is that IPs can even be a source of steady revenue for start-ups. Strategic collaborations or cross-licencing IP rights to other businesses enable start-ups to monetise these valuable assets. Having a steady income allows start-ups to take risks and expand their reach.
● Risk Mitigation
The IP portfolio of a start-up also acts as a risk mitigation factor for the business. IP assets that are well-protected bring down the risk of expensive infringement lawsuits. Legal proceedings hold the potential of draining financial resources and hampering overall operations. A strong IP position results in the possibility of a favourable start-up valuation by mitigating the possibilities of legal liabilities.
Why Is IP Valuation Important?
Here are some important reasons for proper IP valuation:
● Licencing and Franchising
Conducting a valuation of a start-up’s IP assets results in informed decision-making and better negotiations while setting the terms and conditions for cross-licencing. It helps business owners to determine royalty rates. When it comes to franchising, both the franchisor and franchisee need to have a good understanding of the IP asset concerned.
● Mergers, Acquisitions, Joint Ventures and Strategic Alliances
IP valuation helps the entities involved to decide on the financial leverage strategy and the cost of capital when going through M&A, joint ventures and alliances.
The fact that IP valuation has a positive influence on a company’s value and share price cannot be disputed. IP valuation technique is an important part of strategies employed by established companies such as the Tata Group and Volkswagen Group for collaborating with other brands.
Strategic mergers and acquisitions are vital for expansion and growth. That is why a brand like Volkswagen owns Bentley, Audi, Skoda, Skoda and Porsche while the Tata Group owns Land Rover and Jaguar.
● Financial Reporting
There has been a recent shift in the way that accounting committees treat IP assets concerning financial reporting. It was a result of the increasing share of IP assets in the total market value of enterprises. The International Accounting Standards Board (IASB) has mandated that all acquired IP assets should be recognised as assets on the balance sheet of an entity acquiring them.
● Investment in Research and Development
IP valuation helps start-up owners make crucial decisions regarding resource allocation and budgeting. Let’s understand this better with an example. Suppose, a company is spending a substantial amount on internal research and development but is losing out on its competitors because of late or slow product introductions. If such is the situation, the company needs to re-formulate its R&D strategy.
Another important feature of IP valuation is that it provides crucial guidance regarding new product development, brand extensions and line extensions, prosecution costs and managing foreign fillings.
● Insurance of IP Assets
The increasingly important role of IP valuation has created a new market for IP insurance. Many established insurance companies in developed countries are coming up with insurance products related to the capital value of IP assets, specifically brands/trademarks. It must be pointed out here that IP valuation plays quite an important role as far as insurance of IP assets is concerned.
● Tax Optimisation
IP valuation is important because it helps to devise ways to optimise the tax payable by a start-up. Valuation of IP assets makes way for various opportunities for tax planning in companies in possession of IP assets. Opportunities for such tax optimisation are applicable for third-party transactions and various internal strategies, for example, cross-border transfer pricing.
Tax officials always ask for minute details about the process used for IP valuation, especially when concerning acquisitions and mergers. IP valuation helps to come up with fair transfer prices for making use of IP assets.
How Can An Entity Determine the Value of Intellectual Property?
Evaluating the valuation of intellectual property can be quite a difficult process. Choosing a suitable IP asset evaluation method depends upon certain factors—first, what will be the purpose of the IP valuation and secondly, what are the IP assets subject to valuation. Finally, one must assess the specific sections for IP valuation.
The different ways of IP valuation are discussed below:
Income Method
In this process, IP valuation takes place depending on the potential financial income generated by an asset. So, to evaluate, the revenue flow should be projected over the remaining life of an IP asset. These revenues should be offset by the costs of IP assets.
Moreover, one should use either a discount rate or capitalisation rate to deduct the risk from the total income. This method is appropriate for evaluating the value of an IP that holds a high potential of generating stable cash flows. However, the income method doesn't take into consideration any independent risks associated with valuable IP assets and groups all these risks together. The risks get adjusted in the discount rate.
Market Method
It’s a widely used method of IP valuation. The market method is based on the concept of comparing the price of an IP with the actual price paid for a similar IP asset under similar circumstances. The accuracy of an IP valuation depends on the correctness of the information on rights transferred and the circumstances of such transactions.
The first step in the market method process involves performing research about a suitable market from which one can obtain information regarding transactions about licencing of subject IP and sales. Next, one has to choose the relevant features of comparison, for instance, location, customer and drawing. Based on the information procured, one has to come up with a comparative analysis concerning profitability, industry, risk, strength of IP rights, company structure, etc.
Cost Method
In this method, IP valuation depends on the calculation of the costs of a similar IP asset. This method is useful when one can easily reproduce the IP asset and when one cannot quantify the economic benefits of an IP asset.
The cost method doesn’t take into consideration wasted costs. It doesn't even take into consideration the unique features of an IP asset.
Does a High IP Valuation Ensure a High Valuation for a Start-Up?
It’s true that in the world of Indian start-ups, IPs are considered to be immensely valuable. But, a high-value IP doesn’t necessarily give rise to the high valuation of a start-up. Many factors can influence the valuation of a start-up. Some of these factors include the stage of the start-up’s growth, its overall financial health and market size. While IP assets are important, it is simply one of the various components upon which the valuation of a start-up rests.
Conclusion
Valuation of IP assets can be quite challenging because there are many factors to consider when doing the calculations. One important factor to remember here is that the value of an IP can change over time. For instance, the value of an IP asset will increase or decrease depending on the increase or decrease in its uniqueness or strength.
While conducting an IP valuation accurately is a challenging process, it’s necessary to do it properly. While start-ups occupy an important position in the Indian economy, it is IP valuation that cements their position in the market.
Start-ups with a robust IP portfolio are lucrative options for investors. A business that relies heavily on certain IPRs and wishes to expand globally must ensure proper IP protection. Moreover, start-up owners should remember that it’s important to evaluate the potential outcomes and be rational while achieving proper IP valuation.