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Valuation Methodologies

All valuations are based in part on one of the following traditional approaches:

•	Cost Approaches	e.g., historical cost or replacement cost
•	Market Approach	e.g. comparable market value or comparable royalty value
•	Income Approach	e.g. net earnings/cash flow, brand contribution or royalty

Advanced methods or approaches are for the most part, derivations of the above that include additional or special considerations. The approaches must be examined in the context of the asset being valued and the manner in which the asset gains its value.

In evaluating methodologies, the following criteria must be considered:

•	Credibility	The methodology must be credible and respectable from theoretical and practical perspectives
•	Objectivity	There may need to be a trade off between intellectual rigour of the methodology and the inherent degree of subjectivity. Consideration must be given to the quality and quantity of information available
•	Versatility	More credibility is given to methodologies which can be applied across companies, industries and classifications of intangible assets
•	Cost Effectiveness	The benefit arising from the valuation should be sufficient to justify the efforts to determine the valuation and to keep it updated
•	Consistency	Methodologies should be applicable on a consistent basis year on year
•	Reliability	Valuations should be verifiable, such that other valuers may replicate the process using similar measurement principles
•	Relevance	The valuation basis and methodology must be relevant to the requirements of the user
•	Practicability	Methods and underlying parameters must be clear and relatively easy to apply in practice

The following table summarises for various assets the order in which the approaches are preferred. The primary methods are those expected to provide the most credible results, secondary methods are those that may work but probably have deficiencies and weak approaches are those expected to provide the least credible indications of value.

	Primary	Secondary	Weak
Patents and technology	Income	Market	Cost
Trademarks and brands	Income	Market	Cost
Copyrights	Income	Market	Cost
Assembled workforce	Cost	Income	Market
Management Information Software	Cost	Market	Income
Product Software	Income	Market	Cost
Distribution Networks	Cost	Income	Market
Franchise Rights	Income	Market	Cost
Corporate Practices and Procedures	Cost	Income	Market

(Source: "Valuation of Intellectual Property and Intangible Assets" by G.V. Smith and R.L. Parr, Page298)

Valuation Approaches Incorporating Uncertainty
In an ideal world, there would be only one method of valuation leading to one answer independent of the valuer. However, by its very nature, valuation must deal with uncertainty associated with varying market perceptions, differing value propositions, different perceptions of time and money and differing perspectives of risk. As a result, there is a range of alternative approaches to valuation available depending on the degree of uncertainty associated with the asset being valued and as the degree of uncertainty increases, the judgement and experience of the valuer becomes paramount not only in the selection of the most appropriate approach, but also in how the methodology is applied.

The most commonly recognised valuation techniques include (1) Industry Standards, (2) Rating/Ranking, (3) Rule of Thumb, (4) Standard Discounted Cash Flow plus probability adjusted and risk adjusted discounting, (5) Monte Carlo Approach, (6) Probability and Decision Tree Approaches and (7) Options analysis. All of these approaches require critical analysis, but as the degree of uncertainty increases, the valuer is increasingly required to some subjectivity based on experience to arrive at a valuation result. A brief description of each of the above methods is provided below.

The diagram below indicates the usefulness or applicability of these methods as uncertainty increases.

The Industry Standard approach relies heavily on similarities - the existence of a market history such as a large available database of similar transactions which can be used as comparison to infer value on the basis of likenesses. As a result, this approach is usually used for the valuation of mature and commonplace technologies or other intangible assets where there is no or very limited uncertainty about application of the asset.

The Rating/Ranking approach relies on contrast in which the subject asset is distinguished from reference assets or arrangements to identify differences. These differences can then be appraised through the application of scoring criteria and the resulting scoring scale and associated weighting factors can be used to construct a decision table which enables the generation of a valuation range. This method can be used with the Industry Standard Method with the result from one method providing a reality check on the result from the other method.

The Rule of Thumb approach has been used for some time because of its simplicity, convenience and ease of use in non-litigation settings for example in licensing arrangements. The approach is also known as the 25% rule or the 25-33% rule and is based on practical experience that a quarter to a third of the total value created by or from a deal is apportioned to the licensor and the remainder to the licensee. The approach is usually used to distribute profit or earnings before interest and tax which the buyer or licensee of the asset realises with the lesser amount going to the licence fee or royalty. This approach should always be viewed as an approximation or guide and, as a result, the approach is always subject to exceptions. As uncertainty increases, whether due to the degree of further development or investment required or due to the degree of risk, the opportunity for exception increases and the less suitable the Rule of Thumb approach becomes.

The Discounted Cash Flow approach has come out of financial policy and management practice and is based around the formula, PV=FV/(1+k)t, where PV is the present value of money, FV is the future value of money, k is the rate of return and t is the time period for which an investment lasts. This method is a means of converting future cash flows into a present day equivalent. The very basis of this method is uncertainty: uncertainty about future cash flows, about the selection of a suitable discount rate or rate of return and uncertainty about the period over which future cash flows take place.

In Preparation