For the majority of business owners, trade secrets are a vital part of business operations and a primary profitability driver for their business. Many of these trade secrets are so vital to the business that the business itself would bankrupt if it were not for the trade secret. Unfortunately, many of these business owners do not know the value of these trade secrets.
These business owners strategically plan for their business, all while not know the value of its most important asset – the trade secret. Some planning might involve selling the business or bringing in new partners to help run the business. Not knowing the value of the business’ trade secret can be a detriment to that business owner.
Imagine walking to the negotiating table, now knowing the value of your business’s trade secret? Most likely, the sellers looking to buy a business know the value. However, the business owner may make a bad business decision and agree to a price that is not market value. They are making critical decisions without knowing all the facts.
There are three approaches to valuing a trade secret: the market approach, the cost approach and the income approach.
- Market approach: The market approach uses market data to derive the value of a trade secret. Market data from previous transactions in the industry or looking at other comparable companies can be used to determine the value of the business’s trade secret.
- Cost approach: The cost approach considers the costs associated with creating the trade secret. Valuing trade secrets under the cost approach utilizes the costs (i.e. reproduction costs) that it would take for a competitor to recreate the trade secret.
- Income approach: This approach uses the present value of cash flows generated by the company’s trade secret to determine the value of the trade secret. This is the most common approach when valuing trade secrets.
As business valuation experts, we employ each of the approaches depending on the circumstances of the business and the trade secret. We advise business owners to know the trade secret value because it informs the business owner of its worth and allows them to make informed business decisions.
ZACHARY REICHENBACH, CFA, CPA / ABV, is a principal in Ellin & Tucker’s Forensic and Valuation Services Group and has been a member of the firm since 2008. Zach has extensive experience providing litigation services for domestic and international commercial damage and valuation engagements. He specializes in complex commercial damages, valuation, intellectual property, and forensic accounting assignments. Zach has worked on hundreds of cases ranging from simple contract disputes to complex litigation with millions of dollars at stake. He can be reached at firstname.lastname@example.org.