Valuing Intellectual Property in Divorce

When one of the divorcing spouses or a family business owns a patent, trademark, copyright, or trade secret (sometimes called “intellectual property”), there’s nearly always an issue about what it’s worth. This page spells out the typical issues.

For some businesses, the manufacturing process they use, or their customer list, or the trademarks they own, may be their most valuable asset. In divorce, as the husband and wife argue andnegotiate over their kids, the house, the retirement plans, and thetoaster, they can sometimes overlook this major asset. When they do, somebody gets cheated. Moral: ask about intellectual property, and make sure you understand what assets your spouse will be getting after your divorce.

Don’t Try This at Home

The valuation process for intellectual property is perhaps more complex and uncertain than that for any other category of asset. Intellectual property is intangible, meaning it’s not something you can hold in your hand and examine. Its value will change over time, typically downward. The owner of the intellectual property may have a good idea what it’s worth, but rarely will other lay people be able to know easily.

So what does that mean? It means that if your spouse owns a piece of intellectual property and you suspect it has a significant value, there simply is no substitute for having a knowledgeable professional determine its value, taking into account all the information the professional knows to gather.

Knowing what kind of professional to hire for an appraisal is sometimes as challenging as the valuation itself. Look for someone who has day-to-day working experience with the asset involved, rather than someone who markets himself or herself as an appraiser. If at all possible, you and your spouse should cooperate to hire one valuator. If you don’t, and if each of you hires your own appraiser, neither of you will have have much confidence in the other’s appraisal, and neither appraisal will move you any closer to resolution.

Ways To Value It

There are three primary ways to arrive at the value of intellectual property: Cost, Market, and Discounted Cash Flow.

Cost – This method asks what it would cost someone else to duplicate the intellectual property if they had to start from scratch. What people would they have to hire? What equipment would they have to rent or buy? What research would they have to perform? What information would they have to gather? Admittedly, this is a little artificial, but it may be a good sanity check for the valuations reached by other methods.

Market – This method looks at other transfers of similar property for which the price is known and makes adjustments to determine what this property is worth. This method would yield accurate results if you really could apply it, because you would be (presumably) evaluating arm’s length transactions involving well-informed buyers spending real money and well-informed sellers actually giving up their hard-won assets.

There are two fundamental problems with the market approach. First, it’s often difficult to find transactions that are comparable where the actual purchase price is known. Many transfers of intellectual property occur privately, and prices aren’t published. Second, every transaction is unique. The purchase price could be vastly different depending on whether there is a covenant not to compete involved, which industry is involved, or whether financing is involved. Also, as described below, values change over time, sometimes dramatically.

Capitalization of cash flows – This method looks at all the benefits of owning the intellectual property and discounts them to present value. Although it’s the most complex, it’s also probably the most accurate and the most ascertainable.

First, consider all the benefits of owning the intellectual property. How can it be used today? To get more customers? To make more widgets? To identify the best time to fish with chartreuse wooly worms? Each of these uses has a benefit, and each benefit can be reduced to a value. Then later, the property can be sold to someone else. This too is a benefit, but the benefit may have value only if somebody pays to update and maintain the process in the meantime. That maintenance has a cost. Do you get the idea?

The valuator states each of these costs and benefits, plots them out in time, and reduces them to their present value, applying principles of the time value of money. The percentage rate the valuator uses in this process is a science in and of itself, but it reflects primarily the risk inherent in this intellectual property, coupled with its useful life.

Today It’s Gold; Tomorrow It’s Sawdust

Time changes things. It’s true in divorce, and it’s certainly true when it comes to the value of intellectual property. Depending on the process, a patent or trade secret may lose more than half its value within a very short time. Consequently, an otherwise competent appraisal rendered two years ago may no longer be relevant, and an otherwise comparable transaction for the sale of intellectual property that occurred two years ago may no longer be relevant today.