How to Estimate the Value of a Patent
The idiom “beauty is in the eyes of the beholder” applies to estimating the value of a patent. The owner of a patent tends to see a thing of beauty without any blemishes, and thus values it too high. In contrast, the buyer of a patent tends to see an ugly thing marred by warts, and thus values it too low. In reality, most patents have both beautiful traits and ugly traits. Here is how to estimate the value of a patent.
Step 1: Perform Due Diligence on the Patent
The first step in estimating the value of a patent is to perform due diligence on the patent’s history, validity and ownership. Get a copy of the patent, its prosecution history, and a copy of any prior art cited during prosecution of the patent. Check when the term of the patent will end, which is usually 20 years from the date the patent was filed. Check if the maintenance fees have been paid, since the patent will expire if these fees were not paid. Get the status of any foreign counterparts, since patents are worth more when they have greater geographical coverage. Do a litigation search to see if the patent has been involved in any litigation. If so, find out what happened. Get the ownership history of the patent by searching for any assignments recorded in the U.S. Patent Office’s registry. There’s no point getting involved in any negotiations involving a patent unless the ownership is known.
The owner of a patent should check if any actions could be taken to clear up any potential blemishes on the patent in order to maximize its value. If any material prior art is found that was not considered when the patent was examined, consider asking the U.S. Patent Office to reexamine the patent to have that prior art considered. If any maintenance fee was not paid, try to pay it. If the ownership history shows any gap in the chain of title, get the paperwork in place to bridge that gap. If any other patents or technology could be bundled with the patent to increase its value, try to create an intellectual property package of higher value.
In contrast, the buyer of a patent should look for any warts that make the patent less valuable. For example, conduct a search to look for any other prior art that could make the patent invalid or lessen its scope. Investigate the actions of the inventors to see if they might have publicly disclosed the invention more than one year before the application was filed, or taken any other action which would invalidate the patent. Check if all the maintenance fees were paid on time, if the patent was found invalid or interpreted narrowly in prior litigation, or if the patent's ownership history shows a gap in the chain of title. If, for example, one of the inventors did not assign his interest in the patent to the owner, consider approaching that inventor to ask about purchasing or licensing his interest.
Step 2: Interpret the Scope of the Patent
The next step in estimating the value of a patent is to interpret the scope of the patented invention. Just as a surveyor’s map defines the boundaries of a piece of real estate, the claims of a patent define the boundaries of a patent. To interpret the claims, read the claims in light of the rest of the patent application (called the “specification”), the prior art, and any arguments made during the prosecution of the patent before the U.S. Patent Office. The words used in the claims are defined by the way they are used in the specification. The prior art constrains the scope of the claimed invention, since claims cannot be read so broadly that they encompass the prior art. Any arguments made by the applicant to the U.S. Patent Office also constrain the scope of the claimed invention, since an applicant cannot argue one thing to get the patent allowed and make a conflicting argument later.
Similar to the due diligence step, the owner of a patent should seek interpretations of the patent’s scope that maximize its value, while the buyer should look for blemishes minimizing its value. For example, the owner can look for statements in the specification that support a broad interpretation of the claims, while the buyer can look for statements supporting a narrow interpretation. The owner can review the arguments made during prosecution to find support for broader interpretations of the claims, while the buyer can look for arguments which narrow the scope.
Step 3: Apply an Economic Valuation Approach
Once the proper scope of the patent has been determined, any of several economic valuation methods can be used to estimate the value of the patent. The methods include the cost-based approach to patent valuation, the market-based approach, and the income-based approach.
The cost-based approach to patent valuation attempts to determine the value by estimating the cost of replacing the patented technology with an alternative technology. This is typically done by calculating all of the costs that went into developing the patented technology and then adjusting for present value. The advantage of this approach is its simplicity. The major disadvantage is that the costs of developing a patented technology may be unrelated to the value of its use in future products. For example, some extremely valuable inventions have been discovered with only minimal costs, while some major R&D efforts costing millions of dollar may not result in any patents of commercial value.
The market-based approach to patent valuation attempts to use recent transactions involving the sale or licensing of similar patents and technologies to value the patent. This is analogous to the way a real estate agent attempts to value a house based on sales of similar houses in the neighborhood. There are two major problems with this approach. The first is that the existence and financial terms of patent transactions are typically kept confidential, and thus are not known to most people. The second is that each patent is, by definition, a unique piece of intellectual property different from any other patent. Thus, it is difficult to find patents similar enough to be useful. This approach is most useful in organizations with a long history of buying or licensing patents.
The income approach to patent valuation attempts to determine the value of a patent by calculating the present value of any future income streams attributable to the patent. This calculation usually involves three factors: the extra price that can be earned from sales of products using the patented invention; the duration of those income streams; and the discount rate needed for the present value calculation. This approach works well with patents that are licensed and generating streams of licensing income. It can also be used with patents for inventions that save identifiable amounts of money over time. The main problem with this approach is it does not work for patents which generate no income. For example, this approach does not work for patents used only in cross-licenses.
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Disclaimer: The author has retired from the practice of law. This cursory article is for information purposes only, is not legal advice, and does not establish any attorney-client relationship. The author encourages any reader with questions about estimating the value of a patent to contact an attorney.