- Black-Scholes Formula
- Discounted Cash Flow
- Comparable Transactions
- 25% Rule
- Book Value or Cost Method

Professional options traders, corporate auditors, and other financial professionals seeking the standard method of pricing call options use the Black-Scholes formula. The formula was initially developed for Options trading as is used as the value basis for the Chicago Board of Options Exchange. When applied to Intellectual Property, this valuation calculation uses measurable features of a unit of IP to subject each asset to the exact same equation. It simply replaces each of the call option's inputs used in Black-Scholes. For example, the strike price (X), the amount of money that must be spent by the owner of a call option in order to receive the underlying stock, is analogous to the remaining product development cost. This is the amount of money that must be spent by the owner of an IP asset in order to obtain a commercial ready product. Each of the Black-Scholes variables is similarly "mapped," and the result is an objective, transparent intellectual property pricing formula, as illustrated above. When calculated by using published real-world technology and enterprise values, a correlation between the technology value and actual enterprise value is developed and is used as the basis for commercial potential.

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The net present value "PV" is the sum of each year's cash flow "C" less the cash "outlays" (expense or investment). However, there is an inherent uncertainty and risk associated with predicting actual cash flows and therefore "C" is discounted by "r." Specifically, "C" is the cash flow received in each year "n." Its PV is reduced by the uncertainty of that cash flow "r" which is an expression of that uncertainty and ranges from .05 for U.S. Treasury notes to .50 or more for biotechnology. As r or n increases, that is as the risk increases or as we move forward in time up to the limit year "L" the PV of C decreases.

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The Present Value "PV" is a function "ƒ" of what has been learned from previous deals "Dn". D is the value of previous deal "n". The aggregate sum of deals 1 through the limit "L" represents the whole known value of past experiences. For each deal D there is a weighting factor "β" that reflects the relevance of the historical deal to the current deal. For example, if there are ten relevant previous deals (L=10), and the first deal (n=1) was very similar to the next five while the last four deals (n=7-10) were relatively far removed, the β's might be .5 and .05 respectively. The sum of all the β's should equal 1. "x" is an additional correction factor that reflects background changes such as a major rise or fall in major financial indicators such as the Consumer Price Index or a technology loaded stock market value such as NASDAQ.

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The present value "PV" is equal to 25 percent of the profits made by the buyer of the Intellectual Property and adjusted for unique features to the specific IP in the present deal. Profits result from the difference between revenue "R" and expenses "E." "U" is a correction factor that represents negotiating clout. The weaker party often accepts a discount below 25 percent of profits (that is, U <1), while a stronger party may be able to negotiate a premium above 25 percent (that is, U>1). This also assumes that accurate records and tracking of legitimate expenses are auditable.

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Sometimes the value of an IP asset is negotiated against the accumulated costs of R&D, patent expenses, engineering time, supplies and labor. However, while this figure will reflect the actual cost to a company for development cost purposes, it has little or nothing to do with the real world value that the IP asset represents.

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