Insights Featured Articles A Matter of Perspective: Determining the Value of IP in an M&A Transaction

       

A Matter of Perspective: Determining the Value of IP in an M&A Transaction

This article was originally jointly presented by AccuVal Associates, Incorporated and Creative IP Solutions as a whitepaper. Key points from the original document have been summarized in the following article; however, the whitepaper is available in its entirety on our website: Determining Fair Value of IP in a Merger/Acquisition Transaction: A Buyer’s Perspective.

One of the questions AccuVal receives all the time is, “how much is the IP worth?” The answer is complex.

Deciding which technique is best used to determine IP’s fair value really depends on a lot of factors, but two of the most important questions are: who is asking and why. Is the person requesting the valuation on the “buy side” or “sell side”? Why do they need it? The request may be in advance of negotiation, mid-transaction or post-sale. What do they plan to do with the IP? Block it or use it.

Motivation impacts the valuation methodologies that would be used. Different strategies require different techniques, models, value drivers and data. Motivations can be classified as Enabling – intent to utilize or commercialize the IP, or Blocking – an effort to manage the competitive landscape. An Enabling view requires a measurement of internal benefits whereas Blocking measures the benefits that could be garnered by a competitor.

Once the matters of perspective and motivation have been resolved, the valuation work can begin. The starting point is to look at the three methodologies, or approaches to value – income 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, those most frequently used in the valuation of IP are relief from royalty, excess earnings and cost savings.

• Relief from Royalty - As the most widely used valuation methodology for determining the value of IP, it measures the value based on the premise that, since the buyer would own the assets, royalties would not have to be paid in order to use it. This approach captures the value of the IP that was recognized by the current holder as if they had to license it. This raises an important question though – 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 the potential usage of the IP. The underlying licensing assumptions require a thorough analysis and verifiable documentation. Key assumptions may include the royalty rate, the revenue streams to which the royalty rate will be applied, and the cost of capital or riskiness of the investment.
   
• Excess Earnings - Intangible assets are frequently valued using an Excess Earnings approach; however, this method can also be adapted to determine the value of IP. By estimating future sales and cash flow from the IP, taking into account the expected decay rate of the IP in the years to come and reducing it to account for a normal return on the assets employed or required to generate the cash, the remaining balance is ascribed to the IP.
   
• Cost Savings - It looks at the cost to produce an item with and without the IP or the profit margin for a branded product to the profit margin for an unbranded product. The estimated operating profit differential between the two costs/profits 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 transaction or from the asking price for similar assets available for purchase, also called the Market Approach. This approach is generally not used in the valuation of IP because comparable data is usually not publicly available for those market transactions involving IP.

The third valuation approach is the Cost Approach. This approach is generally used in the valuation of non-income producing intangible assets as it considers the current cost of reproducing the asset in order to determine its value. This approach can only provide a minimum value for IP as no buyer would spend the money to recreate an asset unless it provided a utility which was as great as the monies or effort expended.

After the appropriate value approach has been determined, relevant criteria must be converted into a valuation model. This is where the motivation – enabling or blocking – determines the framework necessary. The challenge arises when the motivation is blocking in nature, as a Market Participant Framework would be utilized. Converting Market Participant criteria into a valuation model is a relatively new exercise for the accounting community. There are few established IP valuation models that would fall within a category of “generally accepted”. However, there is a standing body of knowledge associated with IP valuations in the litigation community, which is used to assess damages. The premise is, if you can measure the IP damages in a courtroom, you can also measure the IP benefits in a boardroom by using similar modeling.

One such approach is known as a “Technology Applied to Problem Solved” 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 the IP. A well constructed TAPS analysis generally yields data that supports an estimate of Market Participant Revenues (income) from use of the IP. Applying royalty terms found in comparable IP agreements, an estimated stream of royalty revenue arising from the market participant revenue (stated as a net present value) can be determined. These royalties reflect the fair value.

AccuVal uses a variety of proven valuation methodologies and keen business acumen to turn intangible assets into tangible value. Our professionals are immersed in the marketplace and benefit from practical experience, able to recognize value that is invisible to others. Read how AccuVal was able to bundle intellectual property to enhance its value and increase its appeal to investors and banks.

Recently, sister company, LiquiTec Industries was engaged to sell the IP of a half century old, high performance auto parts manufacturer. Also included in this sale was product line dedicated machinery and inventory. The proceeds realized from this sale were 2-1/2 times more than the estimated value of the assets had they been offered for sale separately. The key to the success of this transaction was in recognizing the real value of the company’s trade name and trademarks, technical drawings and bills of materials, customer base and excellent reputation, and marketing these assets appropriately. It is LiquiTec’s ability to consistently identify the best strategy for corporations to maximize the value from the sale of IP and other surplus and/or none strategic assets that contributes to making AccuVal’s IP appraisals more than a sophisticated financial analysis. This real world perspective keeps our evaluations grounded in the reality of the marketplace allowing us to provide our client partners with the information and perspective needed to make the best business decisions.