Valuation of intellectual property or valuation of intangible assets in a merger and acquisition transaction

In recent years, the identification and valuation of intangible assets, particularly intellectual property-related intangible assets, has increased globally for a variety of reasons, including heightened compliance requirements for financial reporting, but certainly also in the leveraged finance space as lending institutions , attracting increased attention, continue to look beyond traditional sources of collateral 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 transactions, it must be viewed as the group of innovative technologies and/or processes that create a legally protected and marketable product or create a service that establishes the basis for sustained profits and brand development. In other words, the evaluator seeks to analyze how the “product line technology” within a company forms the basis for the creation of a marketable branded product. Common types of intellectual property include copyrights, trademarks, trade/brand names, legal notices, customer relationships, patents, technical drawings, proprietary unpatented technologies, software, and trade secrets.

During a merger/acquisition transaction, deciding which technique is best to use to determine the fair value of intellectual property depends on many factors, but two of the most important questions are: Who is asking? and why? Is the person requesting the review on the “buy side” or “sell side”? Why do you need it? The request can be made before the negotiation, during the transaction or after the sale. What do you plan to do with the intellectual property? Block it or use it.

The motivation affects the intellectual property valuation methods that would be used. Different strategies require different techniques, models, value drivers and data. Motivations can be classified as enabling – intent to use or commercialize the intellectual property, or blocking – an attempt to manage the competitive landscape. An activation view requires a measurement of internal benefits, while a block measures the benefits that could be gained by a competitor.

Once perspective and motivation issues have been clarified, the company valuation and the valuation of intangible assets can begin. The starting point is the consideration of the three generally accepted valuation approaches – income approach, market approach or cost approach.

The income approach estimates value based on the amount of cash flow that an asset is expected to generate over its useful life. There are many variations on the income approach; However, the most commonly used in intellectual property valuations are royalty exemption, excess revenue, and cost savings.

Liberation from the royal house

As the most widely used business valuation method for determining the value of intellectual property, it measures value based on the premise that since the buyer would own the assets, no royalties would need to be paid to use them. This approach captures the value of intellectual property that has been recognized by the current owner as if they 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 subject 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 selecting the appropriate comparable royalty rate to apply to the subject, the revenue streams to which the royalty rate is applied, and the capital cost or risk of the investment. excess income

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 sales are generated through the use of a combination of the company’s assets, including net working capital, real estate, personal property and intangible assets. By first determining the value of all other “contributing” assets, the intangible asset concerned has a residual income stream. This residual or excess income stream is then used to perform discounted cash flow analysis to estimate the asset’s value.

savings measures

This method of business valuation looks at the cost to produce an IP and non-IP item, or the profit margin for a branded product versus the profit margin for a similar unbranded product. The estimated operating profit difference between the two costs/profits is applied to the projected product sales over the estimated period over which the competitive advantages would exist.

Fair value can also be estimated using prices paid in actual market transactions or the asking price for similar available-for-sale assets, also known as the market approach. This approach is more difficult to apply when valuing intellectual property because comparable transactional data for business transactions that specifically involve intellectual property is not typically publicly available; However, this approach should always be considered along with the relevant research conducted to determine if the approach can be applied.

The third valuation approach for intangible assets is the cost approach. This approach is generally used when valuing non-revenue-generating intangible assets because it takes into account the current cost of reproducing the asset to determine its value. This approach typically provides a minimum value for intellectual property, since no buyer would spend the money to recreate an asset unless it provides a benefit as great as the monies or effort expended.

After the appropriate valuation has been determined, relevant criteria must be transferred to an immaterial valuation model. Here the motivation – enabling or blocking – 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 valuation models for intellectual property or intangible assets that would fall into the ‘generally accepted’ category. However, there is a consistent body of knowledge related to intellectual property valuation in the litigation community that 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 similar modeling.

Such an approach is known as “technology applied to problem solving” or TAPS analysis. This analysis uses data found in documentation submitted by the inventor to the company’s patent committee, as well as in peer-reviewed journals or through interviews with the inventor, to present an analysis of the problems that have been solved using the intellectual property. A well-constructed TAPS analysis generally provides data supporting an estimate of the revenues (revenues) made by market participants from the exploitation of the intellectual property. Applying licensing terms found in similar intellectual property agreements, an estimated stream of royalty income can be derived from market participants’ income (expressed in net present value terms). 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.