The Secret to Valuing Trade Secrets

Every few years, the same intriguing trade secret rumors circulate the internet. “The formula for Coca-Cola has been discovered!” “The ingredients for KFC’s 11 herbs and spices have been revealed!” “Doubletree’s chocolate chip cookie recipe has been disclosed!”

Unfortunately, most of these proclamations are untrue. They do, however, reinforce the nature and value of trade secrets and their competitive edge. While these examples may be the most well-known, many businesses have trade secrets, from proprietary processes to software and formulas.

In accounting, trade secrets are considered intellectual property, which is a type of intangible asset. Intangible assets are non-monetary assets without physical substance. They must meet three criteria: identifiability, control, and future economic benefit.

Determining the value of a trade secret can be useful in tax and strategic planning, to raise capital, in licensing transactions, or to support litigation, bankruptcy, or dispute resolution.

Valuation analysts use several techniques to determine the value of intangible assets depending on the valuation purpose. The discounted cash flow (DCF) method is perhaps the most popular option, which takes into consideration the estimated future cash flows associated with the asset, discounted using cost of capital to reflect its present value.

Among the elements used in this calculation are the costs associated with developing and protecting the trade secret; how and when the secret might become obsolete or less valuable; its associated benefits, such as greater sales, improved efficiencies, or licensing potential; and associated risks.

Because of the nuanced nature of these types of valuations, it’s important to choose an analyst with experience in trade secret valuations. By the way, Doubletree has revealed its chocolate chip cookie recipe last April, and you can find it on the Doubletree website!

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