Valuation of Intellectual Property for Indian MSMEs

In today’s competitive global knowledge economy, all businesses irrespective

of their size and scale are bound to create ‘intangible assets’ of various kinds

and their value may even exceed their ‘tangible asset s ’. This is true for SMEs

too; however, they remain mostly ignorant about their existence or true value

not only in India but in developed countries as well. The situation with regard

to Indian SMEs is more complex than their counterparts elsewhere due to

highly heterogeneous and unorganized character of the small industry.

This paper attempts to present an overview of the growing concept of

‘intangible assets’ and the challenges faced in their identification and

valuation and their use to drive competitive advantage with special reference

to SMEs. Starting with brief description of known methods of formal valuation

along with their limitations, a few newer and easy to follow approaches and

examples are presented for appreciation of Indian SMEs. Based on

developments now taking place at the global level, there are also some

lessons for the implementing agencies for providing support services to Indian

The approach adopted for this study was desk-based research by the author

covering literature both from India and other countries.

This paper was written on the instance of Federation of Indian Micro and Small & Medium Enterprises (FISME).

All intellectual property rights including copyright are vested with FISME.

Downloading and reproduction of this paper may not be done without explicit permission of FISME.

1.1 Growing importance of intangible assets

1.2 Economic Significance of SMEs vis-à-vis Special

Characteristics of Indian MSMEs

1.3 Importance of IP as an Integral Part of Business Strategy

2 IP and Intangible Assets of SMEs in Global context

2.1 Lessons from US and Japan

2.2 European Initiatives

2.4 Recent Moves in China

2.5 European IPR Market

3 Indian SMEs and Intangible Assets

3.1 Technology Branding in Indian SMEs

3.2 Potential of Cluster Branding and GIs

4 How Can Intellectual Assets Help SMEs

4.1 IP as Business Assets

4.2 IP Enhancing Market Value and Competitiveness of SMEs

5 Valuation of Intangible Assets

5.1 Methodology of IP Valuation

5.2 Benchmarks of Valuation

5.4 Reporting Intellectual Capital and IFRS for SMEs

6 Lessons for Indian SMEs

6.1 Internal Assessment of Intangibles by SMEs

6.2 Promoting Trade Marks, Brands and GIs thro ’ Cluster Approach … 22

6.3 Utility Model Patents for Indian SMEs

6.4 Escaping IPR Infringement

Valuation of Intellectual Property for Indian MSMEs - Rajendra Prasad

Valuation of Intellectual Property for Indian MSMEs

Founder, Technology-Patent.Com

In today’s competitive global economy, ‘knowledge’ with its concomitant commercial

use has emerged as the single most important determinant of success. Knowledge,

also variously known as ‘intangible assets’ or ‘intellectual property (IP)’ along with

legal use of the same in the form of ‘intellectual property rights (IPR)’ are now key

instruments for leveraging commercial value from creativity, innovation, and

This paper attempts to present an overview of the growing concept of ‘intangible

assets’ and the challenges faced in their identification and valuation and their use to

drive competitive advantage with special reference to small and medium enterprises

(SMEs). Starting with brief description of known methods of formal valuation along

with their limitations, a few newer and easy to follow approaches and examples for

assessing the values of intangibles are presented that can be imbibed by SMEs.

Based on developments now taking place at the global level, there are also some

lessons for the implementing agencies for providing support services to Indian SMEs

1.1 Growing Importance of Intangible Assets

Both tangible and intangible assets of the business are the building blocks of

enterprise value. Precise knowledge of the contribution of each of these building

blocks in value creation, and the linkages between them, is essential for corporate

strategy, IP management, and IP valuation. Successful enterprises including SMEs

reconfiguration of intangible resources.

In view of SMEs operating across various industries and making use of variety of

tangible and intangible assets for value creation, it is clear that their needs are not

homogenous and that “one size will not fit all”. Policy makers and implementing

agencies need to recognize this important fact and target the required support

1.2 Economic Significance of SMEs vis-à-vis Special Characteristics of Indian

SMEs have been widely considered the backbone of economic development as they

play an important role in creating jobs, social uplifting and provide a base for an

internationally competitive (Harvie, 2004 and Stuti, 2005). Different countries define

SMEs based on the level of investments made, sales achieved and the employment

generated as individual benchmarks or a combination of these. These definitions are

used for SMEs to qualify for state support of various kinds. In India, as per the

provision of Micro, Small & Medium Enterprises Development (MSMED) Act, 2006, a

unit having investment in plant & machinery up to Rs 25 lakh is considered as Micro;

and that between Rs. 25 lakh and Rs. 5 crore, Small; and that with an investment

between Rs. 5 crore and Rs. 10 crore is considered as Medium Enterprise in the

manufacturing sector. For the service industry, these norms are somewhat lower.

These definitions of SMEs are proposed to be revised upward in view of the entry of

single brand FDI in retail sector and mandatory tie ups with SMEs (Gupta, 2012). A

comparison of key attributes of SMEs across various countries, as given in Table 1

shows their importance in their economies.

It is important to bear in mind that underlying this impressive data, the real concern

in respect of Indian SMEs is that the large number of these units are owned by

SC/ST and backward communities which operate in a highly challenging

environments and suffer on account of disadvantaged locations with poor

infrastructure, low level of education and training. A large number of these are also

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

in ‘informal sector’ and operate as unregistered units with a handful of employees

with no access to institutional finance.

Criteria for recognition

the data in respect of India is as

reported in SME Times (Gupta, 2012)

Paid up capital, assets and sales

( * as per revised definition in 2012)

Share holder’s funds & employment

Table 1 (Source: Pandey et al, 2007)

On the other hand, the number of educated self-employed entrepreneurs entering

into hi-tech manufacturing and service industry is also slowly growing not only in

urban but also in rural areas. Many of these units in engineering, information

technology and biotechnology areas are being promoted by the Government

initiatives of ‘Technology Incubation Centers’, ‘Knowledge Parks’, ‘Biotechnology

Parks’ and the like along with the initiatives like ‘Technology Development Board’

and upcoming venture funds.

1.3 Importance of IP as an Integral Part of Business Strategy

Traditionally, physical assets have been considered responsible for the overall

value, competitiveness and growth of a company. In recent years, however, the

situation has dramatically changed. Due to growing importance of information

technology based products, automation and a upcoming service industry, the

intangible assets are often becoming more valuable than the physical assets of the

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

Powerful software and innovative technologies are increasingly replacing large

warehouses and factories all over the world. SMEs with substantial intangible assets

have begun to outperform larger firms with tangible assets. SMEs have shown their

market value enhance substantially almost overnight as a result of their acquisition

of important patents in key technologies in many parts of the world. Similarly, a good

trademark with a good reputation among consumers may also decisively enhance

company’s current value .

Thus, acquisition and protection of IP makes intangible assets quite like ‘tangibles’

by turning them into valuable exclusive assets that can often be traded in the market

place. However, if the innovative ideas, creative designs and powerful brands of a

SME are not legally protected by IP rights, they are liable to be copied and used by

the competitors depriving the original creator from these benefits.

What are the ‘intangible assets’? It is important to briefly look at what could actually

constitute ‘intangible assets’. Intangible assets are often referred as ‘intellectual

capital’ which may inclu de human capital, structural capital and intellectual assets or

property. Intellectual assets are the codified physical descriptions of specific

knowledge that can be owned and readily traded. Intellectual assets receiving legal

protection become intellectual property of which there are five main types: patents,

copyrights, trademarks, trade secrets, and know-how.

Brand names / Trademark

Computerized databases

Customer & client lists

Cooperative agreements

Product & process patents

Food flavorings & recipes

Distribution networks

Laboratory notebooks

Franchise agreements

Proprietary processes

Literary works / Manuscripts

Proprietary products

Proprietary technology

Table 2: Illustrative List of Intangible Assets

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

SMEs often fail to capitalize on the opportunities offered by their intangible assets,

particularly the intellectual properties. Table 2 identifies some commonly observed

intangible assets which are generated by most SMEs during the course of their

business operations. The list of such intangible assets could be quite large

depending on the type and location of the business, e.g., one author (Mard et al,

2000) enlists as many as 90 intangible assets in its illustrative list.

2. IP and Intangible Assets of SMEs in Global context

The ownership of intellectual property (IP) rights on 'intangible assets' has become

central to the development and growth of companies both in high-income as well as

low and medium income countries. Between 1982 and 2001, the proportion of

intangible assets in the total assets in many companies in the United States, on an

average, jumped from 38% to as high as 70%. It has been reported (Technology-

Patent.Com, 2011) that while there are over 7 million patents in force worldwide, the

demand for patents has risen from 800,000 applications worldwide in the early

1980s to 1.8 million 2009. The demand for Trademark, similarly, has increased from

just below one million registrations per year in the mid-1980s to 3.2 million

trademark registrations by 2009. The demand for Design is also similarly

increasingly all over.

The process of innovation is no longer dependent entirely on radical breakthroughs.

Intangible assets other than R&D are now attracting significant investments, such as

corporate reputation and advertising, organizational competence, training and know-

how, new business models, software and IP (copyright, patents, trademarks and

other IP forms. Investment in intangible assets in United States is estimated to be of

the order of US$ 1.2 trillion per year for the period 2000-2003 in comparison to that

on scientific R&D that makes up about US$ 230 billion.

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

2.1 Lessons from US and Japan

An IPR Expert Group (European Union, 2007) points out to the lessons to be

learned from the USA and Japan in promoting the use of IPRs in industry and refers

to US SCORE service to SMEs from a network of experts that pro-actively gives

advice on IPR matters on pro bono basis among other things. The case of Japan

has been commended for its sheer magnitude of the efforts following from Prime

Ministerial announcement of 2002 of making Japan as an IP-based nation. As a

result of such a resolve, not only an IP Task Force was created in 2005 to help

SMEs develop IP strategies, IPR has been integrated into syllabi of high schools,

universities etc., so that the general public is now more aware of IP issues.

The IPR culture is stated to have spread far and wide in Japan due to the multiplier

effect of the above policy resolve. Valuation of IPR is appreciated well and large

corporations are seen to cooperate with SMES more frequently on the basis of their

intangible assets. More importantly, the financial institutions both in private as well

as public sector freely accept patents as collaterals for loan.

2.2 European Initiatives

As per the European IPR Expert Group (European Union, 2007), the Government

support agencies should build the matters related to intellectual asset management,

including IP into the basic business planning and not treat them as stand-alone or

add-on topics. It also suggests introducing subjects of innovation and intellectual

assets management early enough in the educational system.

It may be noted that the regional patent of European Patent Organization turns out

to be more than 10 times the cost of a similar patent in US or Japan due to multiple

translation and processing costs in member countries. Clearly the European SMEs

are quite disadvantaged with regard to patent protection within Europe. The IPR

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

Expert group, therefore, also recommended among other things to find solution to

make IPR protection in Europe simple and affordable for European SMEs.

UK was found to have no recognizable market for SME intangible assets by a recent

study (Martin & Hartley, 2007). It has been suggested that in order to stimulate

intangible asset market, impetus must be given to developing an acceptable

valuation methodology. It points out that many entrepreneurs in high-growth

business areas having substantial intangible assets face significant problems in

accessing debt / equity finance since the market for venture capital which takes into

account the intangible assets is underdeveloped in UK (and also elsewhere in

Europe) as compared to that in USA.

Some important changes have been made in the Finance Act 2012 of UK

(www.legislation.gov.uk) that could affect UK SMEs beneficially with effect from 1

April 2013. These are:

 The rate of tax deduction for qualifying R&D expenditure has been enhanced

 The requirement for a company to spend at least £10,000 for qualifying to

avail tax deductions on R&D has been withdrawn.

 A new provision in the finance Act referred as Patent-Box Relief (PBR) comes

into operation. Accordingly, an extra deduction (reducing the tax burden to

10% from the present 22-26%) of company’s profits would be applicable to:

o Income from sale of products or spare parts designed to incorporate a

o Royalty income from the licensing of patents.

o Income derived from the sale of patents.

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

2.4 Recent Moves in China

China’s move of driving domestic innovation and assisting local businesses in

acquiring IPRs, especially patents has been one of the most successful policy

initiatives in recent history. Having logged a one millionth patent recently by SIPO,

China has emerged as the highest patent filer in the world. This is hardly surprising

given the fact that it is a standard practice for state and local government to

subsidize patent applications. In its forceful campaign of spreading IPR culture

throughout China, it has not even spared the SME sector as evident from its

notification issued in August 2010, "Notification on Enhancing IPR Pledge and

Valuation Management to Support Development of Small and Medium-sized

Enterprises" which mandates all banks and financial institutions to extend financial

support to small and medium-sized enterprises for filing and acquiring patents

(Harris, 2010). Such an edict carries weight given the fact that most banks in China

are publicly owned. A centralized IPR management system for SMEs comprising of

IPR training, development, services for applying for and prosecuting patent

applications is operational since 2010.

2.5 European IPR Market

A study was commissioned recently by European Commission aimed at defining the

concepts, challenges and opportunities to establish a European IPR Market that

would attract investments in R&D and innovation (Bader et al, 2012). To identify

company motivation and rationales for participating in the IPR Market, the study

conducted an empirical analysis of a survey of the top 1000 EPO applicants in 2010.

The companies in the sample are concentrated in technology-intensive industrial

areas like chemistry, electrical engineering or mechanical engineering. The

proposed European IPR Market would have two important components: i) ‘IPR Asset

Market’ and ii)‘IPR Financial Market’; of these only former exist informally through

private networks of patent sellers, brokers, dealers and vehicles (e.g., funds,

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

companies, SPVs, etc.). The latter which does not exist at present would operate

through vehicles that would create financial products (shares, bonds, etc.)

The report also recommends increased engagement of European research

institutions and SMEs in the IPR Asset Market by way of fostering greater IPR

awareness as well as industry specific valorization services.

3. Indian SMEs and Intangible Assets

It has often been said that despite cultural, educational, financial constraints, and

inadequate infrastructural support, Indian MSMEs have successfully faced the global

competition both in terms of quality and price. In this process they do create value

out of their hidden intangible assets which usually remain hidden. Further, these

enterprises continue to remain ignorant of their existence and value and, therefore,

fail to capitalize on them. There are no reliable data available for patents and

trademark filings by SMEs; these are believed to be too little to merit any

assessment. This situation, nonetheless, calls for strong policy intervention and

support programme that helps fully exploit the innovative and creative capacity of

The Ministry of Micro, Small and Medium Enterprises (MSME) through its National

Manufacturing Competitive Council (NMCC) has recently launched a National

Campaign for Investment in Intellectual Property. It has plans and schemes to create

awareness about IPRs including patents, trademarks and designs and encourage

innovation and participation in research & development programmes amongst

3.1 Technology Branding in Indian SMEs

A recent study (IIFT, 2009) on technology branding in SMEs conducted at Indian

Institute of Foreign Trade recognized that branding of businesses and their

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

innovative products with new and improved technologies offer enormous benefits in

expanding the client base and in entering into the international markets.

Detailed surveys of responses in two important industrial segments viz., automotive

and textiles revealed that few companies, if any made investments to showcase the

logo and brand name of their products. There was a general feeling among the

respondents that investing in a website was more for academic interest. While most

did have logo and brand name for their company, no conscious effort was made to

highlight the same. There is a general feeling that though pursuing branding

activities was important, it is an expensive proposition and the real benefits are not

Potential of Cluster Branding and GIs

A key finding of the technology branding report (IIFT, 2009) was that some of the

SMEs surveyed operated in industrial clusters and it may be feasible to promote

them through ‘cluster branding’ . The option of cluster branding provides the way

forward to highlight the region and the efforts of the group as a whole.

It has also been similarly advocated by many experts that for a country like India,

Geographical Indications (GIs) can be suitably employed in certain situations

especially where rural and tribal communities are engaged in manufacturing unique

products. Das (2009) provides a detailed account of socio-economic implications of

protecting Geographical Indications in India and strongly advocates using this form

of IPR in strengthening the position of many rural and tribal based businesses as is

already being done by countries like China and Taiwan particularly in traditional

handicrafts. It may be recalled that GIs confer rights and help accruing benefits to

entire communities of producers of genuine products from different regions.

Apparently, India has done well by bringing hundreds of traditional businesses under

the protection of GIs since the provisions of new GI law became operative in India.

However, there are many instances where the granted GIs could not be promoted

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

like brands due to several management problems. Thus, seeking GI protection alone

is not sufficient; promoting them to creating brand value is as essential.

4. How Can Intellectual Assets Help SMEs

4.1 IP as Business Assets

The assets of an enterprise may be broadly divided into two categories: a) physical

assets - including buildings, infrastructure, machinery, working capital and other

financial assets and b) intangible assets - including human and intellectual capital

comprising of creative and innovative capacity, ideas, know how, patents, designs

and brand reputation.

Thus, during the course of business, a firm may create and own various intangible

assets that include customer goodwill, human skills embodied in its workers, good

management practices as well as IPRs in the form of patents, designs and

trademarks. These IPRS are particularly seen as means of providing returns to

innovation and creative activities. Firms invest in R&D and new product design in

order to gain profitable outcomes by launching new products and using more

efficient processes of production. Once the plans of product or process innovations

have been made, firms can often use IPRs to protect the returns from their

investment from being depleted by imitation.

4.2 IP Enhancing Market Value and Competitiveness of SMEs

It has been demonstrated that the strategic utilization of IP assets can substantially

enhance the competitiveness of SMEs. It is important that SMEs should begin to

realize the value of IP as a valuable business asset. Like physical assets, IP assets

must be acquired, maintained and managed carefully to extract their full value.

It has been widely realized that IPRs could assist SMEs in various aspects of

business development and competitive strategy ranging from product development

to product design, from delivery of services to marketing, from raising financial

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

resources to exporting etc. IPRs can also help SMEs expand business abroad

through licensing or franchising.

It is important therefore that the SMEs should pay attention to their business model

in relation to IP. The business strategy of the SME may be such that the best option

is not to apply for IPR protection. But it is important that such an informed decision

is made carefully ensuring that no important opportunities such as that of licensing

or attracting investments are missed and there are no undue business risks caused

by lack of protection.

It is also important to bear in mind that while investing in R&D for creation of

patentable inventions by independent contractors or by the firm’s employees,

appropriate rights are transferred to the company through written assignment or

through suitable clause in the employee contract since patent rights are primarily

granted as a personal property to the inventor as per law. Likewise, it is also

important to create new and separable brand of a new or improved product through

appropriate trademark registration.

5. Valuation of Intangible Assets

5.1 Methodology of IP Valuation

Valuation of an intellectual property on a formal basis for reasons of trading and

merger or acquisition of business is a fairly involved process. Valuers try to assess

the value based on future income by the use of the property in given circumstances.

Thus, the value of an intellectual property cannot be stated out of context; it is more

appropriately expressed in terms of particular place, time, and the circumstances

and still remains at best a guesstimate and not a precise or exact value.

Different valuation methods provide different perspectives on an asset’s value and in

practice several different methods are employed to determine the final value and

often settled through negotiations between the parties involved.

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

Following types of IP have been identified which have been found capable of

valuation (Ernst & Young, 2001),

 Broadcast licenses

 Distribution rights

 Scientific knowledge

 Non-compete agreements

Further, IP to be capable of being evaluated should have the following attributes:

 Separately identifiable;

 Transferable or saleable;

 Legally protected or capable of protection through a de facto right; and

 Enduring in nature.

There are several economic models for valuation of intellectual property and

intangible assets developed during the past few decades and vast literature is

available on the subject; an excellent review of most commonly applied methods is

given in an article by Matsuura (2004). A brief summary of these is given here under.

A. The Cost-based Method

The Cost-based method measures the value of an asset by the cost incurred to

create the asset e.g., on research and development to improve the process or a

product and / or to acquire a patent for the same. From the point of view of the

buyer of IP, the principle of ‘Replacement/Substitution of Cost’ is usually applied

which refers to a hypothetical cost to be incurred now for creation of an identical

asset. From practical standpoint, the cost already incurred is taken as ‘sunk cost’

but the principle of ‘replacement of cost’ may put a higher or lower price than the

costs already incurred. This method generally fails to provide a true value of the

asset and yet used as a starting point in valuation process which is further

moderated by likely transaction cost, legal cost and opportunity cost to both

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

B. The Market-based Method

This method essentially looks at comparable market valuations. Assets that are

comparable to those in question are identified, and the valuation is based on their

past licensing revenue. Thus, finding comparable transactions is the key to the

market valuation method. This is easier said than done; no two assets are the

same and the markets in which they could be traded may vary significantly, thus

making comparisons quite difficult. Additional factors that affect the comparisons

on one-to-one basis may include the relative market positions of the past IP

buyers and sellers, industry structure and concentration, market size, barriers to

C. The Income-based Method

This method bases the value of an IP asset on its potential for future earnings.

Forecast of future revenues are made to estimate the current value of the asset,

on the basis of which licensing modality including royalty rates could be decided.

This method adopts a forward-looking perspective and envisages immediate

commercial exploitation of the asset. However, different companies may apply

widely differing projections of revenue forecasting. Negotiating parties can,

nonetheless, arrive at an agreement based on some logic and projected cash-

flow figures. This valuation process could again be influenced by factors like

transaction cost, legal cost and opportunity cost to both buyer and seller.

The Income-based method presents a serious difficulty when people apprehend

certain risks in the potential revenues and are skeptical about placing a value on

future income. Such situations are not quite uncommon for which probability-

weighted present value of future income streams are suggested to be used

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

Economists have developed several other analytical models of valuation besides

the most common ones described above. Pitkethly (1997) brings ‘options’ into

play, whereas Chiu et al (2007) consider various aspects of four dimensions, viz.,

technology essence, cost dimension, product market and technology market. The

real options valuation methodology is effectively an extension of a discounted

cash flow model and has been suggested to be used fruitfully for biotechnology

based IP assets (Ernst and Young, 2001).

5.2 Benchmarks of Valuation

For valuation of an intangible asset, several benchmarks have been developed by

economists. The implications of these benchmarks and the process of valuation for

practical use by SMEs can be best understood by a hypothetical case given below

which is based on the example given in a book chapter by Contractor (2000). While

this example takes a case of product development through internal R&D, the

methodology used here can, in fact, be applied to any intangible asset which is fit for

licensing. Let us suppose that a firm, Company A, has developed a technology at a

cost of Rs. 45 lakh spent on R&D, prototype development, test marketing and legal

fees for protection of IP. The product has been successfully launched in India and

company is keen to develop export market. It has, in fact, started exporting the

product to Country B at a modest level but the true potential is too large. It estimates

its export sales over the next 10 years as shown in the second column of Table 3.

Company A has identified Company B in Country B for licensing its technology for

exploiting full market potential. Company B understandably is a market leader in

Country B and achievable sales through Company B in Country B is estimated to be

considerably higher as shown in the col. 4 of Table 3. The licensing package would

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

include the right to manufacture and sell the product in Country B with licensed IP

along with training of the staff of Company B. The price, based on the valuation of

IP from either side, may include payment of a lump sum fee and a yearly royalty

based on the sales achieved in country B.

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

It may be further assumed that Company A is required to incur some expenses on

training the staff of Company B as shown in col. 8 of the Table 3. Company A would

also relinquish its direct export and consequently incur certain losses on this

account. The col. 3 shows these lost margins on exports with their present values @

10% in the parentheses. With the expected sales turn over as shown in col. 4, the

expected incremental profit margins @16% of the sales of Company B are shown in

col. 5 along with their present value also @ 16% in the parentheses.

Assuming that a royalty rate can be pegged either at 4% or at 6%, the likely returns

to Company A on these bases are shown in cols. 6 and 7 respectively along with

their present values in parentheses.

The moot question here is how much Company A should ask the Company B to pay

for this deal given the fact that Company A spent Rs. 45 lakhs in developing the IP in

question. Could Company A ask for a price to recover all that it spent on developing

the IP? No, unless it was undertaken as a contract research. The R&D was

motivated in this case based on the intrinsic value of the project as perceived by the

Valuation Benchmark 1 : R&D costs are generally ‘sunk costs’ except in case of

‘contract research’ and have little bearing on the valuation of deve loped intangible assts.

From the point of view of Company B, the direct visible costs of transfer of

knowledge are as shown in col. 8 at Rs. 3.5 lakh spread over two years. Could the

Company B expect to close the deal at this price. No, this could be the absolute

minimum and the direct incremental cost of licensing. Company A would certainly

expect a substantial amount over and above this to partially recover its R&D costs.

Valuation Benchmark 2 : The marginal cost of knowledge transfer comprises only a

“floor price” or minimum value for the knowledge.

Market Value: The true market value of the IP could be gauged by the expected

sales volumes of Company B as shown in col. 4. At an expected 16 percent profit

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

margin, Company B’s profits shown in the col. 5 have a discounted PV of Rs. 18.92

lakh. This then is the maximum, in principle, Company A can expect from Company

B. But it would make no business sense for Company B to go ahead, if it were to

pay this much. Further, since not all innovations are made for making new products

or services; sometimes the objective is to reduce cost of production or delivery of the

existing product or service. In such case, the cost savings from the transfer of IP

provides the bas is of a ‘ceiling price’ of payable value. Thus,

Valuation Benchmark 3 : The profits to be made or cost savings to be achieved in a new

market as a result of a new knowledge transfer comprise a “Ceiling Price” or maximum

value payable to the knowledge supplier.

Opportunity / Consequential costs: We may consider the direct opportunity cost to

Company A as a sum of the cost of training as in col. 8 along with the missed

opportunity of earning through direct export as in col. 3. Company A may further

apprehend some loss / risk for fear of slippage of key information and knowledge to

third parties through Company B. Thus,

Valuation Benchmark 4 : The direct loss of profits to knowledge supplier, as a result of

the knowledge transfer as well as the anticipated loss due leakage, increased

competition and degradation of intellectual property value, comprise a possible addition

to the floor price, or minimum compensation needed to justify the transfer.

Industry ‘Norms’ : Reference is ofte n made to industry ‘norms’ if there are

comparable instances already known. However, there is no logical basis to accept

these norms as standards. One prevalent norm for calculating royalties is the ’25

percent of incremental profits of the licensee’ consi dered as fair value in IP

In this example, the present value of the incremental profits to Company B is Rs.

18.92 lakhs over the next 10 years period (col. 5). Against this, the present value of

the 4% royalty and a lump sum of Rs. 1 lakh for Company A works out to Rs. 6.01

lakh (Col. 6) which is already ~32%. Company A would, however, still like to pitch

for 6% royalty as in col. 7 whereas Company B would find the royalty at 3% to work

better for it, even if were to pay a marginally higher lump sum fee. Thus,

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

Valuation Benchmark 5 : Negotiators’ demands are often moderated by reference to

“industry norms” such as sector averages and the “25 percent criterion.”

These are some of the important valuation benchmarks. However, there are quite a few other

benchmarks to deal with other circumstances, such as ‘Options’ available to both IP supplier

and licensee and various other indirect benefits and costs to parties involved. The net result,

in IP licensing negotiations, however depends on the relative position of each party and their

ability to find a win:win situation.

We all know intuitively the enormous value certain well known brands carry with their

names. How much is the Coca-Cola brand worth? Interbrand, the world ’ s largest

brand consultancy in its 2011 report ranked Coca Cola as world ’ s No. 1 brand

valued at US$71.8billion. For many of us it may be jaw-dropping news but few would

disagree with Interbrand ’ s assessment. Brand is not just another name of the logo or

trademark. However, most SMEs can hardly make any distinction between these

Brand or trademark is recognized as a company’s identity and encompasses names,

terms, signs, symbols and designs, or indeed, a combination of these. They identify

goods, services or entities that create distinctive images and associations in the

minds of customers, and may ultimately generate economic value and benefit. While

trademark carries the legal right of its owner, the brand is something that carries

value associated with it and can be nurtured and is now a highly regarded tangible

A brand can be evaluated like any other intellectual property as described in the

previous section; it usually calls for additional qualitative and quantitative analyses,

combining the results of market research and financial analysis. Roberts (2011)

provides an excellent overview of brand valuation techniques in her article. Owing to

the importance of the subject of brand valuation, the International Organization for

Standardization (ISO), recently issued an international standard, ‘ BSI ISO: 10668

Brand Valuation: Requirements for Monetary Brand Valuation ’. This standard

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

prescribes procedures and methods of monetary brand measurement which include

objectives, bases, approaches and methods of valuation.

The three most common approaches for brand valuation are: market approach, cost

approach and income approach which are also suitably covered under financial

analysis in the above mentioned international standard. It also stipulates that before

performing the financial analysis, it is important to carry out a legal analysis and

behavioral analysis to ensure that all relevant facts are suitably considered. Legal

analysis has been prescribed with a view to get correct information on the ownership

of the brand / trademark and its validity since brand valuation is a fairly expensive

It may not be necessary for an SME to value the worth of its brands or trademarks

on day to day basis. What needs to be appreciated, however, that a brand is one of

the most important assets an organization can own. And if the firm is manufacturing

certain unique products having features distinct from similar products available in the

market, it could consider having a separate trademark for the product different from

that of the firm. It is important to realize that if any value is associated with the

chosen brand at any time, it can be capitalized through sale or license only if that

has a separate identity and is legally protected.

Brand building is a continuous process and should be considered as a long term

investment. It is not just for large companies with big budgets but even for small

businesses providing simple products and services maintaining certain quality and

improvising further through continuous innovation. SMEs should not simply remain

engrossed in producing quality goods or services but actively pursue brand

management which need not be through expensive campaigns. It is important to

choose meaningful brand names that successfully differentiate the products and

services from those of the competitors and connect with potential customers easily

at the emotional level. Appropriate brand strategy may be chosen which may include

low budget advertising, door-to-door campaign, cash discounts and having simple

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

but informative website and easy-to-remember domain name. More importantly,

attention needs to be given to the proces s of ‘Internal Brand Management’ by

promoting a culture within the company that helps its employees to fully understand

the value and quality of its offering represented by the brand name.

5.4 Reporting Intellectual Capital and IFRS for SMEs

There has been a growing importance of ‘intellectual capital’ statements as part of

the business reporting or otherwise as a management tool to reflect on the true

value of the business (European Commission, 2006 and InCas, 2007).

Standard accounting practices as of now do not treat ‘intangibles’ as assets.

Generally, under accounting rules, an asset must be tangible and it must have a

known cost or a market value.

Thus, the scientific knowledge along with

sophisticated skills is not an accounting asset, but laboratory equipment is. The

balance sheets, essentially, represent tangibles assets. Businesses with leading

bands and goodwill often find their balance sheets short of reflecting their true worth,

particularly for putting the company on the market for sale.

Faced with the above difficulties, the International Accounting Standards Board

(IASB, 2009) issued in July 2009 new standards for accounting framework for SMEs

known as ‘IFRS for SMEs’ . It is a simplified version of full IFRS keeping only

provisions that are relevant for SMEs. It defines SMEs as entities that do not have

public accountability and publish general purpose financial statement for external

users. Thus, a large number of Indian SMEs, those which are not listed, would

come under the purview of these new standards. It is learnt that India has, in

principle, agreed in 2011 to conform to these standards and these may be

operationalised after mandatory internal approval process is completed (Joshi,

The Indian SMEs could now switch over to new accounting standards to have their

intangible assets duly reflected in their financial statements.

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

6. Lessons for Indian SMEs

Having reviewed various aspects of identifying and valuation of intangible assets

with reference to SMEs both in India and abroad, we may now answer to queries

raised in the ‘aide memoire’ to call for this paper.

6.1 Internal Assessment of Intangibles

Without going into formal valuation of their IP, SMEs can easily determined the

gross value of their intangible assets by first estimating an overall value (multiple of

sales, earnings, current replacement value etc.) and then subtracting the net value

of the assets (tangibles). After calculating the total value of the intangibles, it is often

useful to apportion the value of intangibles to specific rights the company owns.

Examples of these are trademarks, patents, copyrights, franchise contracts,

exclusive distribution rights, proprietary products etc.

It is advisable that such an assessment and review of intangibles be done

periodically by owners of SMEs with some solid working papers delineating the

underlying assumptions. Such exercises of periodic reviews of the intangibles can

help them consolidate and further invest in augmenting the perceived strengths of

6.2 Promoting Trade Marks, Brands and GIs through Cluster Approach

The case of MSMEs (or SMEs) is distinctly different from large / corporate sector or

R&D institutions not only in India but in other advanced economies as well. Trade

Marks and Designs are easy to promote and regulate as exemplified by the success

of ‘Office of Harmonization for the Internal Market (OHIM)’ in promoting European

trademark. However, strong support services are required to create awareness on

trademarks and brand valuation in the Indian SMEs.

There is a need for promoting ‘cluster’ approach not only for promoting small units

themselves but for promoting and protecting their intangible assets as well. In some

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

cases, a group of very tiny units may be facilitated to form ‘cooperatives’ not only to

achieve scales of economic production but also promote their brand value through

cluster based trade mark of the new cooperatives. In certain regions, the provisions

of ‘geographical indications’ can also be suitably invoked (Gupta 2010).

6.3 Utility Model Patents for Indian SMEs

The case of standard patents in SME sector in India is somewhat misplaced due to

low level of inventiveness in new products and processes coming out from most of

the small units except in a small number of science based start-ups. Many countries

around the world offer a second tier of patenting regime to their industries that lack

true and higher level of scientific and technological inventiveness in their inventions

but are still quite innovative and serve a useful purpose for the society and the

market. ‘Utility Model’ patents in China, Germany and Japan are the examples of

such a system; a similar system in Australia is known as ‘Innovation Patents’.

Government of India has also been thinking of promulgating a similar system

essentially to boost the SME sector. It is a high time that widespread support for the

new second tier patenting regime is found and the same is brought into force.

An unprecedented surge in patenting in China comes from this ‘Utility Model’

system. It is also insightful to peep into the patenting scene in some of the industries

in China vis-à-vis other countries. For example, USPTO is understandably has

granted more than 3000 patents on umbrella ( http://en.wikipedia.org/wiki/Umbrella) till

date and yet scores of ‘utility model’ patents are now being filed in China as 90%

world’s production of umbrella has shifted to China. Similarly, while in the LED

lighting field, Chinese ‘Utility Model’ patents are ruling the market with innovative

designs that find applications in automobiles, dental equipment, kitchen appliances,

audio electronics, street lighting, traffic lighting etc., the related semiconductor field

of LED technology dealing with fundamentals of indium gallium nitride or gallium

arsenide and the like find large high-tech companies from China, Korea, Japan and

USA in the neck-to-neck race (Technology-Patent.Com, 2010).

Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad

without saying that in the interest of SMEs, we need ‘Utility Model’ patent system in

India as early as possible.

6.4 Escaping IPR Infringement

SMEs keen on building their IP portfolios as business assets should not only protect

themselves from IPR infringement but also actively participate in taking adequate

measures to prevent IPR infringing goods entering into the various stages of the

supply chain. SMEs should determine the authenticity and genuineness of the raw

materials and components used in their production. The IP enforcement agencies

may also undertake educational campaigns to inform consumers, retailers,

manufacturers, distributors as well as importers and exporters about the overall

harm caused by counterfeit and pirated goods and also the severity of penalties

associated with their unlawful distribution.

In the new knowledge economy, all businesses, big or small have to increasingly

survive on the basis of value creation through intangible assets. It is, therefore,

essential that we understand the true value of our own intangible assets and get an

insight into the methodologies of enhancing, protecting and valuation of these and

adopt ‘intellectual capital’ reporting in business financial statements.

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Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad