The valuation industry is changing. Currently, there is an ongoing consolidation in the appraisal industry, driven by the American Institute of Certified Public Accountants (AICPA) and The Appraisal Foundation.

Also, there are conflicting issues any time an opinion is rendered in a litigation matter. The following variables are critical and can determine the outcome of a valuation analysis:

• The standard of value (such as investment value, fair market value or fair value) which depends on the purpose and use of the consulting engagement;
• The premise of value (such as liquidation value, going concern value);
• The basis of valuation;
• Adjustments to the basis of valuation justified by case law; and
• Adjustments to the basis of valuation reflected in appraisal discounts and premiums.

Whenever intellectual property valuation services are contracted, these scope issues need to be established clearly and concisely in the engagement letter and in the written report.

Transfer Pricing Studies
Transfer pricing opinions in compliance with Internal Revenue Code Section 482, require consideration of the following valuation methods:

• Comparable Uncontrolled Price (CUP) Method;
• Comparable Profits Method (CPM); and
• Profits Split Method.

The IRS is concerned that companies doing business with subsidiaries across borders may be tempted to favorably construct transactions to avoid taxation since such transactions involve related parties. Any sale or licensing of intellectual property to a related party must be at fair market value and the related parties' right to use such assets should reflect pricing which is considered "arm's length."

Litigation Services
The need for litigation services generally results from damages caused by patent infringement, copyright infringement, trademark infringement or theft of trade secrets. The types of factors that are normally considered in the calculation of lost profits include:

• The time period during which the damages occurred;
• Timing and feasibility issues;
• Near term versus long-term lost sales;
• Effect on sales prices due to erosion resulting from increased competition; and
• Changes in relevant near term and long-term costs.

Failure to Register Intellectual Property
A royalty proxy can sometimes be used as an alternative to the lost profits calculation. The royalty can be established from prior licensing transactions involving the infringed intellectual property. Alternatively, comparable licensing arrangements (the market approach) can be used. The research and development of comparable royalty rates are complex and time-consuming processes.

Valuation Methodologies and Procedures for Intellectual Property
Discounted cash flows, comparables, rules of thumb, auction, direct cost and opportunity cost are some of the common methodologies used to value intellectual property. Each method has its own strengths and weaknesses and should only be used when appropriate for the intellectual property being valued or the particular valuation situation.

In order to properly understand the various valuation methodologies and their appropriate use, they must be understood within a conceptual framework. This framework is structured around methods based on the cost to create or recreate the asset (cost approach), methods based on sales of comparable intellectual property (market approach), and methods based on the future economic benefits produced by the intellectual property (income approach).

Market Approach Valuation Methods
The intellectual property valuation process usually involves an attempt to apply the market (sometimes called sales comparison) approach. This is because the market - that is, the economic environment where arm's length transactions occur between unrelated parties - is usually the best indicator of the value of an intellectual property. The valuer will analyze the market for both sales and license transactions.

The process used to apply the market approach to the appraisal of intellectual properties may be summarized as follows:

• Research the appropriate market for information on sales transactions, listings, and offers to purchase or license comparable intellectual properties. Comparability is judged in relation to factors such as intellectual property type, intellectual property use, industry in which the intellectual property functions and the date of the sale and/or license.
  
  
• Verify the information by confirming that the market data obtained is factually accurate and that the sales or license transactions reflect arm's length market considerations. This verification procedure may also elicit additional information about the current market conditions for the sale and/or license of the subject intellectual property.
  
  
• Select relevant units of comparison (e.g., income multipliers or dollars per unit) and develop a comparative valuation pricing analysis for each unit of comparison.
  
  
• Compare guideline intellectual property sales and/or license transactions with the subject intellectual property, using the elements of comparison, and adjust the prices of each guideline transaction appropriately to the subject property. If such an adjustment is not possible, eliminate the transaction as a guideline.
  
  
• Reconcile the various value indications into a single value indication or range of values.

There are ten basic elements of comparison generally considered in selecting and analyzing guideline intellectual property sales and/or license transactions:

1. The specific legal rights of intellectual property ownership conveyed in the guideline transaction;
   
   
2. The existence of any special financing terms or other arrangements;
   
   
3. Whether the elements of arm's length sale and/or license conditions existed;
   
   
4. The economic conditions that existed in the appropriate secondary market at the time of the sale and/or license transaction;
   
   
5. The industry in which the guideline intellectual property was or will be used;
   
   
6. The physical characteristics of the guideline properties, compared with the subject intellectual property;
   
   
7. The functional characteristics of the guideline properties, compared with the subject intellectual property;
   
   
8. The technological characteristics of the guideline properties, compared with the subject intellectual property;
   
   
9. The economic characteristics of the guideline properties, compared with the subject intellectual property; and
   
   
10. The inclusion of other nonintellectual properties in the guideline; this may include the sale of a bundle or a portfolio of assets, which could include tangible personal property and/or real estate, as well as intellectual properties.

The last phase of the market approach valuation analysis is the reconciliation. In this step, two or more value indications that have been derived from the guideline sale and/or license market data must be synthesized into an overall value estimate. In the reconciliation, the valuer summarizes and reviews the empirical data, the valuation analysis, and the result of each of the value indications.

These value indications are then resolved into a range of value or a single value indication. The valuer considers the strengths and weaknesses of each guideline value indication derived and examines the reliability and appropriateness of the market data compiled and of the analytical techniques applied.