Startup Company Valuation Goes Up With Patents

Startup Company Valuation Goes Up With Patents

High quality, investment-grade patents can have spectacular impact on a startup’s valuation.  In the early stages of a company, especially when technology risks and market risks abound, the patents may be the most valuable asset the company has.

An investment in a single, well-crafted, defensible patent that matches a company’s business prospects can easily raise the value of the company by the cost of the patent multiplied 10x – if not more.

There are several methods for valuing patents, many of which mimic the valuation methods for businesses as a whole.[1]

One simple way of calculating a patent’s value is a reasonable royalty rate method based on the 25% rule.  Determine the total addressable market of the invention and the product’s margins.  The patent value is approximately 25% of gross margins times the total addressable market.[2]

Note that this is one of the more conservative ways to value a patent.  A startup that had 100% of a market that was completely protected by a patent would receive 100% of the gross margins.

Remember that patents have a lifespan of nearly 20 years[3], so the value of the patent should reflect royalties on a discounted cash flow basis over the 20 years.  Reduce the total value by various risk factors, and that produces a value of the patent.

For startup companies who have not proven the technology or who do not have market traction, the value of the patent (and the value of the company) assumes that the company will be successful, but on a risk-adjusted basis.

Any valuation of a startup company should include a valuation of the patent assets as well.  In many cases, the patent assets may be the most valuable assets the company has.

Over time and in highly competitive marketplaces, a startup company with a well-positioned patent may attract competitors, and those competitors may infringe the startup’s patents.  In this case, the value of the patents are based on the actual royalties that could be collected from the infringers.

[1] In the due diligence section in Chapter 4, the 25% rule-of-thumb valuation analysis is discussed in more detail.  There are dozens of more complicated ways to assess an invention’s value.

[2] Note that sometimes the 25% rule only applies to the improvement in a product, not to 25% of the gross margins of the entire product.  A license on a cell phone antenna will not necessarily be applied to 25% of the entire phone.

[3] The patent expires 20 years after the date of filing, but the Patent Office will extend the patent term to be a minimum of 17 years.  The Patent Term Extension occurs when the Patent Office takes longer than 3 years to examine the patent.  Like with everything from the USPTO, there are exceptions and rules, so the details of a specific case may differ.

This is an excerpt from “Investing in Patents” by Russ Krajec.

Investing In Patents is available at Amazon.com.