Valuation of Intellectual Property for Indian MSMEs
Dr Rajendra Prasad
Founder, Technology-Patent.Com
10 September, 2012

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
SMEs in this field.
The approach adopted for this study was desk-based research by the author
covering literature both from India and other countries.
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  • Content
    1 Introduction
    1 - 5
    1.1 Growing importance of intangible assets
    … 1
    1.2 Economic Significance of SMEs vis-à-vis Special
    … 2
    Characteristics of Indian MSMEs
    1.3 Importance of IP as an Integral Part of Business Strategy
    … 3
    2 IP and Intangible Assets of SMEs in Global context
    5 - 9
    2.1 Lessons from US and Japan
    … 6
    2.2 European Initiatives
    … 6
    2.3 SMEs in UK
    … 7
    2.4 Recent Moves in China
    … 8
    2.5 European IPR Market
    … 8
    3 Indian SMEs and Intangible Assets
    9 - 11
    3.1 Technology Branding in Indian SMEs
    … 9
    3.2 Potential of Cluster Branding and GIs
    … 10
    4 How Can Intellectual Assets Help SMEs
    11 - 12
    4.1 IP as Business Assets
    … 11
    4.2 IP Enhancing Market Value and Competitiveness of SMEs
    … 11
    5 Valuation of Intangible Assets
    12 - 21
    5.1 Methodology of IP Valuation
    … 12
    5.2 Benchmarks of Valuation
    … 15
    5.3 Brand Valuation
    … 19
    5.4 Reporting Intellectual Capital and IFRS for SMEs
    … 21
    6 Lessons for Indian SMEs
    22 - 24
    6.1 Internal Assessment of Intangibles by SMEs
    … 22
    6.2 Promoting Trade Marks, Brands and GIs thro ’ Cluster Approach 22
    6.3 Utility Model Patents for Indian SMEs
    … 23
    6.4 Escaping IPR Infringement
    … 24
    7 Conclusion
    Valuation of Intellectual Property for Indian MSMEs - Rajendra Prasad
    Valuation of Intellectual Property for Indian MSMEs
    Dr Rajendra Prasad
    1. Introduction
    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
    in this field.
    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
    their competitive
    integration and
    reconfiguration of intangible resources.
    Page 2 of 27
    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
    Page 3 of 27
    in ‘informal sector’ and operate as unregistered units with a handful of employees
    with no access to institutional finance.
    Share of total
    Share of
    Share of
    Share of
    employment exports
    Criteria for recognition
    Fixed assets
    the data in respect of India is as
    reported in SME Times (Gupta, 2012)
    Paid up capital, assets and sales
    Sales or employment
    ( * 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
    Page 4 of 27
    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
    Chemical formulas
    Computer software
    Computerized databases
    Customer & client lists
    Patent applications
    Designs & drawings
    Cooperative agreements
    Product & process patents
    Food flavorings & recipes
    Distribution networks
    Product designs
    Laboratory notebooks
    Franchise agreements
    Proprietary processes
    Literary works / Manuscripts
    Joint ventures
    Proprietary products
    Royalty agreements
    Proprietary technology
    Procedural manuals
    Supplier contracts
    Trade secrets
    Training manuals
    Trained workforce
    Table 2: Illustrative List of Intangible Assets
    Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad
    Page 5 of 27
    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
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    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
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    Expert group, therefore, also recommended among other things to find solution to
    make IPR protection in Europe simple and affordable for European SMEs.
    2.3 SMEs in UK
    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
    ( 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
    up to 225%.
    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
    patented invention
    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
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    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
    Page 9 of 27
    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
    Indian SMEs.
    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
    Page 10 of 27
    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
    quite clear.
    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
    Page 11 of 27
    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
    Page 12 of 27
    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
    Page 13 of 27
    Following types of IP have been identified which have been found capable of
    valuation (Ernst & Young, 2001),
    Brand names
    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
    buyer and seller.
    Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad
    Page 14 of 27
    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
    market entry etc.
    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
    (Woodward, 2003).
    Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad
    Page 15 of 27
    D. Miscellaneous
    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
    Page 16 of 27
    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
    Page 17 of 27
    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
    Company A. Thus,
    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
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    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,
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    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.
    5.3 Brand Valuation
    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
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    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
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    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.
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    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
    the business.
    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
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    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 ( 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).
    Thus, it goes
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    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.
    7. Conclusion
    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.
    Valuation of Intellectual Property for Indian MSMEs – Rajendra Prasad
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