In recent years, the identification and valuation of intangible assets, specifically intangible assets related to intellectual property, has attracted increased attention around the world for a variety of reasons including increased compliance requirements for financial reporting, but certainly also in the field of leveraged finance such as credit institutions. continue to look beyond traditional collateral sources such as accounts receivable, inventory, and equipment.
In defining intellectual property, which is the type of intangible asset that has historically not been considered in leveraged finance deals, it should be viewed as the set of innovative technologies and/or processes that create a legally protected and marketable product or service that establishes the basis for sustained profits and brand development. In other words, the appraiser seeks to analyze how “product line technology” within a company has formed the basis for creating a marketable branded product. Common types of intellectual property include copyrights, trademarks, trade/brand names, headers, customer relationships, patents, engineering drawings, proprietary non-proprietary technology, software, and trade secrets.
During a merger/acquisition transaction, deciding which technique is best used to determine the fair value of intellectual property depends on many factors, but two of the biggest questions are: who’s asking? and because? Is the person requesting the valuation on the “buy side” or the “sell side”? Why do they need it? The request can be pre-negotiation, mid-transaction or post-sale. What do you plan to do with Intellectual Property? Block it or use it.
Motivation affects the intellectual property valuation methodologies that would be used. Different strategies require different techniques, models, value drivers, and data. The motivations can be classified as enabling: an intention to use or commercialize the intellectual property, or blocking: an effort to manage the competitive landscape. An enabling view requires a measure of internal benefits, while a blocking view measures the benefits that a competitor could gain.
Once perspective and motivation issues are resolved, business valuations and intangible asset valuation can begin. The starting point is to look at the three commonly accepted value approaches: revenue approach, market approach, or cost approach.
The income approach estimates value based on the amount of cash flow an asset is expected to generate over its useful life. There are many variations of the income approach; however, the most used in the valuation of Intellectual Property are royalty exemption, excess profit and cost savings.
royalty relief
As the most widely used business valuation methodology for determining the value of Intellectual Property, it measures value based on the premise that since the buyer would own the assets, they would not have to pay royalties to use them. This approach captures the value of the intellectual property that was recognized by the current owner as if he had to license it. However, this raises an important question: does it represent the value of the asset to other market participants or the value to a specific acquirer? This is a complicated issue, and each case must be evaluated on its own merits and potential use of the intellectual property. The underlying license assumptions require thorough analysis and verifiable documentation. Key assumptions include the selection of the appropriate comparable royalty rate to apply to the subject, the revenue streams to which the royalty rate will apply, and the cost of capital or investment risk. excess earnings
Certain intangible assets, such as customer relationships and contracts, may be valued using an excess earnings approach. This concept is based on the theory that a company’s gross income is generated using a combination of the company’s assets, including net working capital, real estate, personal property, and intangible assets. By first identifying the value of all other “contributing” assets, a residual income stream is available for the intangible asset in question. This leftover or surplus income stream is then used to perform a discounted cash flow analysis to estimate the value of the asset.
Cost savings
This business valuation method looks at the cost of producing an item with and without the intellectual property or markup of a branded product versus the markup of a similar unbranded product. The estimated operating profit differential between the two cost/revenues is applied against projected product sales over the estimated period in which the competitive advantages would exist.
Fair value can also be estimated from the prices paid in actual market transactions or from the sales price of similar assets available for purchase, also called the Market Approach. This approach is more difficult to apply in IP valuation because comparable transaction data is generally not publicly available for business transactions specifically involving IP; however, this approach should always be considered in conjunction with adequate research completed to determine if the approach can be applied.
The third approach to valuing intangible assets is the cost approach. This approach is generally used in the valuation of intangible assets that do not produce income, since it considers the current cost of reproducing the asset to determine its value. This approach generally provides minimal value for the intellectual property, as no buyer would spend the money to recreate an asset unless it provided as great a return as the money or effort invested.
Once the appropriate value approach has been determined, the relevant criteria must be converted into an intangible valuation model. This is where the motivation, which allows or blocks, determines the necessary framework. The challenge arises when the motivation is of a blocking nature, as a Market Participants Framework would be used. Converting Market Participant criteria into a valuation model is a relatively new exercise for the accounting community. There are few established IP or intangible asset valuation models that would fall into a “generally accepted” category. However, there is an ongoing body of knowledge associated with IP valuations in the litigation community, which is used to assess damages. The premise is that if you can measure IP damages in a courtroom, you can also measure IP benefits in a boardroom using a similar model.
One of these approaches is known as “Technology Applied to Solved Problems” or TAPS analysis. This analysis uses data found in the documentation presented by the inventor to the company’s patent committee, as well as in technical journals or through interviews with the inventor to present an analysis of the problems solved using Intellectual Property. A well-constructed TAPS analysis typically produces data that supports an estimate of revenue (revenue) to market participants from the use of the intellectual property. By applying royalty terms found in comparable intellectual property agreements, an estimated stream of royalty income arising from market participants’ income (expressed as net present value) can be determined. These royalties reflect fair value.
A business appraisal firm can help you turn intangible assets into tangible value, as they often recognize value that is invisible to others. By recognizing the true value of your company’s intellectual property, a business valuation firm can provide you with the information and perspective you need to make the best business decisions during a merger/acquisition transaction.
