What it means
A company's proprietary technology is the set of tools, methods and know-how that it has developed or acquired and keeps for its own use. Examples include a bank's risk-scoring model, a manufacturer's special coating process or a software company's source code.
The common feature is that the owner decides who may use it and on what terms. Legal protection comes in several forms.
Patents give a time-limited monopoly over an invention in return for public disclosure, copyright protects code and written material, and trade secrets protect valuable information that the company keeps confidential. Many firms also use contracts, such as non-disclosure and assignment agreements with employees, to make sure that what staff create belongs to the company.
For investors and buyers, proprietary technology is often a central reason for a high valuation. A business with unique technology may have better margins, stronger customer retention and more pricing power than rivals.
In an acquisition, buyers carry out due diligence on ownership, since a company that cannot prove it owns its code or inventions is worth much less. The accounting treatment can surprise people.
Under many accounting frameworks, costs of internally developed technology are largely expensed as research and development, with only certain development costs capitalised once strict conditions are met. This means that valuable technology may be missing from the balance sheet until it is acquired in a purchase, when it appears at fair value as an intangible asset.
There are risks, too. Proprietary technology can become obsolete, be copied despite protections, or leave with key employees, and maintaining it costs money.
Companies may therefore weigh whether to keep technology closed, license it to others for royalties, or release parts of it as open source to build a wider ecosystem.
In practice
Real-world examples.
Example
A logistics software company has built its own route optimisation engine, which cuts customers' fuel costs by 12%. It protects the code as a trade secret, and customers can use the service only under a subscription contract.
Example
A chemical manufacturer holds a patent on a new battery material. It earns $3,000,000 a year by licensing the patent to three other producers, while keeping the best grade for its own products.
Example
A larger firm buys a small start-up for $20,000,000. The purchase accounting assigns $8,000,000 to the start-up's proprietary technology as an intangible asset, to be amortised over its expected useful life.
Formula
Calculation
One common way to value proprietary technology is the relief-from-royalty method, which estimates what the owner saves by not having to license the technology from someone else:
Annual royalty saving = Revenue from the technology x Royalty rate
Value (simple, no growth) = Annual royalty saving x (1 - Tax rate) / Discount rate
Suppose a company earns $10,000,000 of revenue from products using its technology, a comparable royalty rate is 5%, the tax rate is 25% and the discount rate is 15%.
Annual royalty saving = $10,000,000 x 0.05 = $500,000.
After tax = $500,000 x (1 - 0.25) = $375,000.
Value = $375,000 / 0.15 = $2,500,000.
Real valuations also include growth and a limited useful life, so this simplified result is a starting point and not a final answer.Case study
Seen in the real world.
Quillfeather Analytics is an illustrative, fictional data company whose main asset is a proprietary algorithm that predicts customer churn. The founders never signed intellectual property assignment agreements with the two freelancers who helped write the first version.
When a larger firm offered to buy Quillfeather for $15,000,000, its lawyers discovered the gap in ownership. The buyer said it would reduce the price by $3,000,000 unless the freelancers confirmed in writing that the company owned the code.
The founders approached both freelancers, paid a modest fee for a formal assignment, and the full price was restored. The illustrative lesson is that proprietary technology is only valuable if the company can prove it owns it, and the paperwork should be put in place at the start.
Watch out
Common mistakes.
- Assuming that anything created by an employee or contractor automatically belongs to the company, without written agreements that confirm ownership.
- Expecting valuable internally developed technology to appear on the balance sheet, when most of its cost has been expensed.
- Treating proprietary technology as permanent, when it can become obsolete or be overtaken by competitors and open standards.
Questions
People also ask.
Is proprietary technology the same as a patent?
No, a patent is one legal tool for protecting an invention, while proprietary technology is the broader idea of technology the company owns and controls, which may be protected by patents, copyright or trade secrets.
How is proprietary technology valued?
Common methods include relief from royalty, cost to recreate and the income it generates, and a valuation specialist usually combines more than one.
What is the opposite of proprietary technology?
Open-source or publicly available technology, which anyone can use under defined terms, though many companies use both in their products.
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