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Trade Secret Valuation

Trade secrets have been an important part of business operations for as long as business has existed. Recognized with legal protection by the mid-1800s, trade secrets can be take the form of a method, proprietary technique, customer list, chemical formula, specialty program, tooling design, software, or schematic, among other forms.

In terms of protection, the Uniform Trade Secret Act provides comprehensive guidelines in terms of rights associated with trade secrets as well as damages that may be applicable and injunctive relief that is available. While not identical in its implementation among the various states, this Act defines trade secrets as information that gives a company an advantage if it fits the following guidelines:

  • Information not generally known outside of the trade secret holder’s sphere of operation;
  • Information that provides an economic benefit to the trade secret holder; and,
  • Information that has been the subject of reasonable efforts to keep it secret.

Valuation of trade secrets of trade secrets is somewhat more difficult that other intellectual property for a few basic reasons. First, the use of the market comparable approach is not a practical methodology because the sale of trade secrets is virtually unheard of. Secondly, no two trade secrets by definition would be the same, hence, the market comparables approach is never applicable in valuing trade secrets. In addition, the relief royalty approach, or any variation if the income approach, is difficult if not impossible to apply when valuing trade secrets — it is normally not possible to separate a specific stream of revenue that is directly attributable to a trade secret, as a trade secret revenue stream is most typically intertwined with other intellectual property.

As a consequence, a variation of the cost methodology is almost universally applied when valuing a trade secret. A build up methodology to get at cost would typically be found in an evaluation scenario outside of litigation. In litigation, however, one can look to calculating a loss profits or unjust enrichment by measuring defendant’s profits as a value of the trade secrets; and under the law a reasonable royalty can also be applied in those cases where an appropriate royalty stream exclusive to the trade secret can be identified.