THE VALUATION OF PATENTS : A review of patent valuation methods with consideration of option based methods and the potential for further research

Intellectual Property Rights (IPRs) are viewed as being of increasing importance in many fields of business. However, one potential hindrance to their being considered of significant value, is the lack of appreciation of practical methods of valuing them particularly early in their life under conditions of uncertainty about their future prospects. Lack of practical valuation methods under such conditions can lead to sub-optimal decision making in the course of managing an IP portfolio. This paper considers the case of patents whose value constantly needs assessing during the application process, on renewal and for licensing, purchase and sale negotiations. Current practice in patent valuations are reviewed as is relevant literature gathered from a number of fields including accounting methods, discounted cashflow (DCF), related decision tree analysis (DTA) methods, and econometric methods based on renewal and stock market data. Particular attention is also paid to option pricing theory based valuation methods for real assets and frameworks are proposed for its application to the task of valuing patents. In particular it is suggested that one implication of studies of renewal data based models by Pakes et al showing that option values decline with patent life is that conservative filing decisions are usually justified. Option based valuation approaches are thus proposed as a useful and potentially powerful framework in which to consider management of a company's patent portfolio and other IPR assets, and the difficulties of a rigorous application of the method form a fruitful field for future research.