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If a piece of bespoke software was developed by a company and the Intellectual Property was retained by the company that wrote it, but now the client of the software company wants to get that source code (and its IP) how much should it cost them? How would you calculate a fair cost for the purchase of that source and IP?

UPDATE: Just to add, the software in question is of no use to anyone else (for any legitimate purpose) as it ties in directly with the business processes of one company. It is not something that can be subsequently sub-licensed or installed outside the company in question. There are links of to third party services (but these were existing services that the bespoke software had to integrate with in the first place).

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3 Answers

up vote 4 down vote accepted

You saw there was value in retaining ownership in the IP and the source. So does your client. Are there royalties that would be eliminated by their purchase? Do they hope to deny competitors access to the IP? Are there other related markets that are served by the IP?

The question is how do you value the market for the IP and source code? There are many sources on the web to help you determine their value for these properties.

A paper by accounting and management consulting firm PWC outlines several possible methods:

  • Excess operating profits or premium profits method.
  • Premium pricing method.
  • Cost savings method.
  • Royalty savings method.
  • Market approach.
  • Cost approach.

A guide by valuation specialists Valuation & Forensic Partners focuses on market, cost, and income valuation methods and warns,

Optimistic IP developers tend to overestimate asset potential. So, valuators generally view internal projections skeptically, especially when valuing unproven technology or when management lacks industry experience.

But another question to ask yourself is how well can you translate ownership of these properties into capital (in the form of money or some other asset) on your own (either marketing them yourself or licensing them) versus selling them outright?

Edit: In response to your update, two questions that have direct bearing on how valuable the properties are:

  1. Can you mine the source for generalized components that are useful elsewhere?
  2. Now that patents on business processes are deemed valid and have become a key factor in determining business valuation, is securing your IP crucial to patenting their business processes?

If none of these are valid, you might just have to settle for valuing your properties on a cost basis.

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I doubt you can put a hard equation down for this one, it's very subjective. I guess some important things to consider would be:

How much of the software was custom built for them? If this number is high, you've probably billed them nearly the worth of the binaries + source.

Are others using this? Would your company losing the ownership of the IP potentially upset anyone else?

I'd also put a higher price on handing over the IP than I would on the source code.

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+1 for higher cost of IP over source code. get the customer to sign a license agreement saying what they can and can't do with your code, so as to protect your IP. –  Matt Ellen Oct 19 '10 at 12:06
    
How much is custom built: All of it. –  Colin Mackay Oct 19 '10 at 12:20
    
Are others using it? The company that developed it: No; The company that wants the IP to the software it commissioned: Yes (it's a website, if you consider those using the site to be "others using [the software]") –  Colin Mackay Oct 19 '10 at 12:21
    
Would your company losing ownership of the IP potentially update anyone else? My company is a third party to this. We are in a consultative role only to this and other issues. –  Colin Mackay Oct 19 '10 at 12:23
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As much as the client is prepared to pay.

Any more and the client won't buy. Any less and the developer is selling the IP for less than its market value.

So, how much is that?

1) How much would it cost to have someone else redevelop the product? All else being equal, the developer should charge a little less to ensure that s/he gets the business.

2) How urgent is the IP aquisition? It it is urgent, the developer can charge a premium for producing the source code immediately whereas another vender will have to work on it.

3) Are there any other benefits that the client has for buying from the developer? Or from elsewhere? The developer can charge for the former, discount for the latter.

Interestingly, the original cost of developing the product and its original licencing cost need have little to do with the present price of the IP, despite the appeal factoring these in to the sale price.

So, having decided on price point, the developer must decide if s/he is willing to sell at that price. This should be based on any long-term gains / losses from selling the IP:

a) Will transfer of the IP result in lost revenue? For example, retaining the IP may mean that the developer will be paid for updates and enhancements to the original product. Are these losses covered by the payment for the IP?

b) Will retaining the IP damage the relationship with the client, resulting in loss of future business? Or will the sale result in recommendations to other clients?

Finally, the developer and client need a clear and accurate written record regarding the terms of both the original licencing agreement and the terms of the IP sale.

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