(Updated 27 Dec 2021.)
A realistic patent valuation can be determined using many of the same techniques used to value businesses. However, it all depends on whether someone is actively copying your invention. How to value a patent all depends on whether there is product in the market – not how “cool” the invention is. Patent valuations are very subjective and depend on the use case for the analysis.
- Patent valuation is tricky
- Use standard business valuation techniques to value patents
- Pricing patents using Options Pricing techniques
- Special cases where patent value is huge
- What if there is no infringement?
- Things that can kill your patent’s value
Patent valuation is tricky
Patents that are not infringed have no *real* value – yet. Patents are bets that the market will adopt your idea and want to copy it. Until someone copies the patented technology, the patent has only *speculative* value.
What is the value of the speculative utility patent? Hard to tell, but it is not in the millions of dollars. In all likelihood, the patent value is probably zero.
Intellectual property has some weird aspects to it which make patent valuation difficult. For example, having a patent on your product might keep competitors from directly competing with you. We can never measure how effective that patent was in deflecting competition – or if the competition even bothered to look to see if you had a patent at all.
A quick note about hiring someone to do a “patent valuation.” They are almost always badly done. It isn’t that the people who do them are nefarious, it is because there are too many unknowns and assumptions. When you pay someone to do a patent valuation, you inherently want a very high number. You are happy when you get a billion dollar patent valuation, but unhappy when the patent valuation is near zero.
So, there is a huge incentive for the patent valuation to be as high as possible.
This means your patent valuation person has an incentive to inflate the number. Because of so many weird incentives like this, most patent valuations are not believable.
The basic technique of valuing a patent uses similar techniques for valuing businesses.
Business valuation techniques
The value of a business is the net present value of future cash flows – on a risk adjusted basis. We use this same technique to value patents.
Ask these questions: how much cash will the patent generate? and what are the risks or likelihood that we can generate the cash?
This is why only *infringed patents* have value.
A patent generates cash when someone takes a license to it and pays royalties. If there are companies copying the invention, it will take a patent enforcement lawsuit to get them to pay.
Reasonable royalty rates
How much will the infringers pay? It depends on the technology and the industry, but an infringer might pay 0.5-5% of the wholesale price of the product. Each industry has their own standards, but in general patent royalties are 25% of the profit an infringer makes on each sale. There are resources that give standardized royalty rates for comparable patents.
Put these pieces together, and we figure out how many units the infringers are selling, apply the royalty rate, and calculate how much money we could collect over the remaining life of the patent. This is often called the future cash flows method of valuation or income approach.
The potential royalty rates of the future cash flow approach or income approach must be discounted to the present value. Future income has a higher risk and, due to inflation and time value of money, also has lower value.
Once we know the total amount we could collect, we need to evaluate the risks of enforcement. With a lawsuit, there is the risk that we lose and never collect a dime (and incur multi millions of dollars in expense.) There is the risk that the lawsuit might take several years before we win or lose. There is also the risk that the infringer might go bankrupt, discontinue their product line, or design around our intellectual property.
Because of all these risks, patent brokers routinely tell me that they need to show at least $50M of infringement before they can sell a patent portfolio. While this is not a hard and fast rule, an infringer where we can collect only $1M per year is not worth the expense and risk of enforcing (unless you have patent enforcement insurance, which dramatically changes the equation.)
The cost approach for a utility patent’s valuation is based on the cost to create these intellectual property assets. These costs include the cost of research and development as well as the cost of the patent attorney and filing fees.
The US average cost of a patent is about $50,000. This is a benchmark of comparable patents that can be used for the cost approach valuation technique.
In general, the cost approach method of patent valuation is not very favorable, so it is not widely used. Patent owners typically want to have their intellectual property be worth more than the cost to create it.
Cost savings approach
Cost savings valuation attempts to put a value on intellectual property based on the dollar amount of competitive advantage a patent offers. If we can determine that a patent represents a $3 cost reduction to a $10 product, we can establish a dollar value for the competitive advantage of the product to the patent owner.
All things being equal, a competitor may serve the market with a non-infringing product, and it will cost them $10 to produce. The patent owners or licensees can produce the patented product in the same market for $7. This difference is the “value” of the patent to the patent owner. This technique is the one that most closely tries to find the commercial value of the intellectual property rights.
The market approach to valuing intellectual property rights is just like valuing real estate and attempting to find the market value. The analyst merely finds similar market transactions of intellectual property, then does a comparison to adjust the price up or down.
The difficulty of the market approach is that comparable property is very difficult to find. Most patented technology is bought or sold under non-disclosure arrangements. Assuming we can find a transaction that includes intellectual property rights, we often have a single price for a host of individual pieces of intellectual property. It would be impossible to differentiate between the value of a company’s customer list and their patented technology when they sell a division of their company, for example.
Valuation of a patent portfolio
Most of this post focuses on patent valuation for a single patent. In most cases, the valuation of a patent portfolio is the value of each individual patent at the current market value.
However, valuing patents as a portfolio introduces one interesting factor.
Intangible assets like patents can rise and fall over time. A patent’s lifecycle is 20 years, and patents do not reach their peak value until year 12. The weirdness is that we file a patent application hoping that sometime in the next 20 years, that patent will become valuable.
Normal patent valuation analysis is done assuming the current day conditions. However, portfolios of intellectual property get an extra valuation boost because there are more chances that one of the patents in the portfolio become valuable.
For example, a patent portfolio of 100 intellectual property assets will likely have 2-5 very valuable patents and 10-15 that are moderately valuable. The weird thing is that the valuable patents may change over the 20 year lifespan of these intangible assets.
In other words, there may be a handful of valuable patents when one competitor enters the market. But over the next two decades, technology may shift such that other patents in the portfolio may become valuable while the first group diminishes in importance.
The key here: we might not know which of the IP rights will be the most valuable over their lifetime. But when we have a well-constructed patent portfolio, we generally expect that there will be something valuable in there at some point. This allows us to assign an extra amount of value to a patent portfolio that may be more than the sum of the value of the individual intellectual property assets.
Patent value using Options Pricing techniques
Patents behave very much like conventional stock options: they are a time-limited bet that the market will move in a certain direction. When you first file your patent, it is like an “out-of-the-money” call option. When the market moves in your direction, it becomes an “in-the-money” call option.
Because of this similarity, some have used Black-Scholes analysis to come up with pricing/valuation of patents.
Special cases where patent value is huge
Patents can have lottery ticket valuations in some interesting special cases.
Inventors and patent owners often identify an infringer and think that the infringer is the best buyer for their patent. Big Company infringes their patent, so wouldn’t Big Company want to take the patent off the market and reduce their risk? No, this rarely happens.
There is a concept of “efficient infringement,” where big companies figure it is cheaper to infringe a patent without paying and take the risk of a lawsuit.
When do patents really become valuable? When another Big Company is in a lawsuit with the infringer.
It is not that the infringer wants the patent – it is everyone who hates the infringer who actually wants the patent.
One great place to sell your patent is to anyone who has an ongoing lawsuit with the infringer. They will often pay top dollar to use your patent in their lawsuit. The purchaser is looking for weapons to go after the infringer, and your patent might be the weapon they need.
“The enemy of my enemy is my friend.”
What if there is no infringement?
If your patent is not infringed, your patent has speculative value, which should be worth something.
In general, patents without infringement are typically valued at their cost. This is because it is too speculative to know if the market will adopt the technology before the patent expires.
The average US patent costs about $50,000, plus or minus.
Some companies will buy patents in a specific field to build up their portfolio. Companies do this to negotiate cross licenses with their competitors, and the number of patents each company has makes a big deal in their negotiations.
Other companies might buy a bunch of patents prior to moving into a new market. Huawei bought up lots of wireless patent portfolios several years ago before moving into the US market for phones and network equipment. They needed an arsenal of IP to get on the same playing field as their US competitors, otherwise they would not have “chips” to trade if there was infringement.
For patents that are not infringed, expect to get $20-50K/patent – provided the patents are in a good field and there are no problems with the patents that would kill their value.
Things that can kill your patent’s value
Sadly, there are many seemingly innocuous things that can kill your patent’s value.
There are a whole host of small items that you or your patent attorney might do that invalidate the patent. This can range from an inventor sending a response to an Office Action for their company’s patents (not allowed under 37 CFR 1.33) or the patent attorney using “patent profanity” when they wrote the patent application.
Patent claims are notoriously the most difficult piece of legal writing known to man. Every word in the claims hurts you, but some hurt more than others.
If it is easy to design around the claims, the patent is worthless.
For example, a software patent that makes a “complete” copy of a video stream is absolutely worthless. I can copy the technology exactly, but drop one frame of a three hour movie video and not infringe.
In this case, the patent attorney did not think through the importance of each word in the claim and got their client an absolutely worthless patent.
Patent valuation is extremely difficult. In the final analysis, the patent is worth what someone is willing to pay. Because of all the variables and uncertain risk about future infringement, ability to enforce, and countless other items, the only true measure of value is a negotiated price.
95% of all patents are utterly worthless, and of the 5% that have value, there is just a sliver of them that have huge valuations. You have 20:1 odds that your patent is worthless right from the start, and even slimmer odds that your patent will rise to the level of the unicorn valuation.
In order to get as much patent value as possible, I generally recommend that startup companies do NOT file provisional patent applications, but instead file non-provisional applications and do everything they can to expedite the patent through the process. At BlueIron, our track record is to can get patents issued within 12 months. In that case, your company valuation would be much, much higher with issued patents than with mere patent applications.
Note: This post is from a Quora answer that I posted in reply to a question about how to value a company with patents.