How Much Is That Trade Secret Worth?

By Steve McDaniel, Technology Litigators | January 15, 2013

The law imposes a “value” standard on trade secrets.  A trade secret is valuable (in one rendition of such laws) and thus protectable if it gives its owner “an opportunity to obtain an advantage over competitors who do not know or use it.”  It does not say how valuable, it just establishes that it is valuable if it meets this criterion. Certainly, courts appear very willing to deny protection to any alleged trade secret that is deemed to be “valueless.”  “How much are our corporate trade secrets worth?” thus becomes a very important question under a variety of business and legal scenarios – restraining orders, injuctions, licenses, mergers, and overall company worth.

When is it the right time to determine the worth of your trade secrets?  That is a little tougher, and it is most certainly is a question to be handled on a case by case basis.  For instance, it may be that your customer lists are undoubtedly valuable to you and thereby qualify as a trade secret.  Were they to be stolen, while it would take an edge off your competitiveness, it might not do so to an extent that it would undermine your whole operation.  So, it might be prudent to wait until you must valuate these sorts of trade secrets. On the other hand, your latest and greatest formulation tweaks that are about to be launched into your newest resin system to boost your sales over a competitor may be so valuable that it would be hard to place a number on the trade secrets they embody.  In the latter case, it might be prudent to arm yourself here and now with greater-than-$$$,$$$,$$$ valuations in order to be ready to respond rapidly to threats of misappropriation or opportunities to sell or license to third parties.  

There certainly are times that you will be required to valuate your trade secret assets.  If you are a successful plaintiff in a trade secret lawsuit, then you will be required with reasonable certainty to prove the damage caused by the defendant’s misappropriation. There is a standard that courts require in such proofs and that is one of reasonableness (versus speculative).  So, let’s imagine two courtroom scenarios and ask ourselves which is more likely to convince the fact finder (a judge or a jury) that we should be awarded our estimated damages. SCENARIO ONE – We sue a competitor who we can show stole our trade secrets.  We win, he loses.  Now we bring in an outside expert who reviews our files and extracts a number out of our financials that he swears attribute our increased sales directly to the existence of our trade secrets.  He is countered by the defendant’s expert who conversely swears that there was a vanishingly small impact of these trade secrets on plaintiff’s bottom line.  The decision for the fact finder becomes one of determining which expert is lying the most (he assumes they are both lying).  SCENARIO TWO – At inception of our trade secret introduction into our commercial product, we have our accounting department track a line item expressly to determine the impact of the trade secret improvements on our product sales.  At trial, we don’t put an outside expert witness on the stand, rather we put the head of our accounting department.  That is, the contest becomes – our be-spectacled accountant simply reciting his dutiful number crunching, versus their high-dollar expert tap dancing around the hard cold factual numbers. Which would be more compelling if you were deciding the truth?

There are tried and true methods for placing a value on your trade secret assets.  Loss to the trade secret owner is often determined by profits lost due to the misappropriation by a defendant competitor.  These sorts of calculations need not wait on the actual infringement.  They can be determined hypothetically by a scientifically conducted survey of customers of a particular product.  So, for instance, a customer survey can ask what price the customer would be willing to pay for a sole source of a new product, versus what price that customer would pay if there were two, three, or more such sources for comparable product.  This sort of analysis can be used not only for predicting actual losses to a infringer, but also the anticipated price erosion caused by unfair competition.  More importantly in the case of yet to be launched products, such studies can be used to convince a court to award probable profits.  It can also be used to establish fair market value for use in negotiations for licenses, mergers, acquisitions and sales of a company.

Though more difficult to prove prophetically, another measure of the worth of a trade secret is by estimating unjust enrichment.  In this way of measuring value, a trade secret owner seeks to be awarded all of the net profits made by a misappropriator who wrongfully used the trade secrets. It is possible to actually be awarded 100% of such ill-gotten spoils. Yet another measure is estimating royalties that would have to be paid in a hypothetical license agreement where the trade secret owner reluctantly grants an interest in its secrets.  To do this right, one needs to examine the surrounding circumstances for hints of how such give and take might actually occur.  So, you might consider what effect will be caused to the competitive posture between the two parties to the negotiation, or what the terms of similar licenses have been, or the actual costs of development and protection of the trade secret you incurred, or how many uses of and what value to the new found knowledge may it give the hypothetical licensee.
While we are on the topic of licensing, let’s not forget to address the age-old “pig-in-a-poke” problem that plagues trade secret licensing.  This problem arises when a prospective licensee starts asking what is the true value of a trade secret it is interested in licensing.  It doesn’t want to pay for something that is valueless, and you are hesitant to fully divulge the selling price. If the licensor has historically tracked the value of a trade secret in its operations, it can set its price more reliably and verifiably, if needs be.
What are the take-home-lessons for us in the P&C industry?  Essentially they are these.  First, if we’ve done our business properly, we have identified our trade secrets and have a fairly good idea of which are critical to our operations using an audit or similar process.  On those we have deemed to be critical, we need to evaluate the advisability of determining a baseline value for them. 
Where it is likely that these critical assets might be the subject of litigation or an asset to be variously assigned to another party via contract, it will be prudent for us to have values at the ready.  And, there are well-known methods to get these valuations.

It kinda boils down to this.  If you’re ahead of the game (you are the trade secret owner), stay ahead of the game (by knowing exactly what your trade secrets are and what they’re worth), or put another way . . . . “One and one is two, and two and two is four, and five will get you ten if you know how to work it!” . . . the venerable Mae West.