Valuation of Intellectual Property or Valuation of Intangible Assets in a Merger-Acquisition Transaction
Real EstateIn 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 realm of leveraged finance as lending institutions. continue to look beyond traditional collateral sources such as accounts receivable, inventory, and equipment.
When defining intellectual property, which is the type of intangible asset that has historically not been considered in leveraged finance agreements, it should be seen as the group of innovative technologies and/or processes that create a legally protected and tradable product or service that establishes the foundation for sustained profits and brand development. In other words, the valuer seeks to analyze how “product line technology” within a company has formed the basis for creating a branded marketable product. Common types of intellectual property include copyrights, trademarks, trade/brand names, mastheads, customer relations, patents, engineering drawings, non-proprietary 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 most important questions are: who asks? 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 the Intellectual Property? Block it or use it.
Motivation affects the IP valuation methodologies that would be used. Different strategies require different techniques, models, value drivers, and data. Motivations can be categorized as enabling: intent to use or commercialize the intellectual property, or blocking: an effort to manage the competitive landscape. An enable view requires a measurement of internal benefits, while a block view measures benefits that a competitor might gain.
With perspective and motivation issues 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 the exemption of royalties, excess profits and cost savings.
royal 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 assessed on its own merits and the 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 income streams to which the royalty rate will apply, and the cost of capital or risk of the investment. 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 surplus or excess 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 analyzes 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 costs/earnings is applied against projected product sales during the estimated period in which the competitive advantages would exist.
Fair value can also be estimated from 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 intellectual property valuation because comparable transaction data is generally not publicly available for business transactions specifically involving intellectual property; however, this approach should always be considered in conjunction with the appropriate research completed to determine if the approach can be applied.
The third approach to valuation of 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 intellectual property, since no buyer would spend the money to recreate an asset unless it would provide as great a utility 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 enabling or blocking motivation determines the necessary framework. The challenge arises when the motivation is blocking in nature, as a Market Participant 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 models of valuation of intellectual property or intangible assets that would fall into a “generally accepted” category. However, there is an ongoing body of knowledge associated with intellectual property valuations in the litigation community, which is used to assess damages. The premise is that if you can measure the damage to IP in a courtroom, you can also measure the benefits of IP 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 submitted 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 the Intellectual Property. A well-constructed TAPS analysis typically produces data that supports an estimate of revenue (revenue) to market participants from the use of intellectual property. By applying the royalty terms found in comparable intellectual property deals, an estimated stream of royalty income arising from the income of market participants (expressed as net present value) can be determined. These royalties reflect fair value.
A business valuation 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.