In merger and acquisition deals, often a critical component of a target company’s valuation is its intangible assets – trademarks, patents, copyrights, trade secrets, industrial designs, products in development and so on. However, while the value of physical assets is relatively easy to determine, accurate valuation of intangible assets can be harder. This is an increasingly important issue as more businesses have values related to their technological or scientific capabilities.
Complex as they are to value, intellectual property (IP) assets form a significant part of the consideration in any acquisition of technology or science-based companies.
Valuing IP requires a combination of approaches, says Freddie Saunders, corporate finance director at PwC Ireland.
“The process must account for the uniqueness of the asset, its competitive advantage and its contribution to overall business value. For technology-focused companies, assessing scalability, patent portfolios and potential licensing revenue is critical. Collaboration with IP specialists and valuers ensures a thorough and defensible valuation.”
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While methods vary, there are three commonly used approaches.
The income-based approach values IP on the basis of the revenues it is expected to generate and is considered to be most useful for IP that has a direct impact on income generation, such as a patented product already on the market. Considerations here include projected revenues compared to the expenses directly attributable to the IP, the lifespan on the IP and an agreed discount rate reflecting the riskiness of projected cash flows.
The discounted cash flow method, meanwhile, relies on a forecast of future cash flows from the IP and discounts them back to present value using a risk-adjusted discount rate. This method is considered best for patents and technologies with predictable long term revenue streams and conversely is considered risky for new or unproven IP.
A third approach, known as the venture capital method, estimates the future resale value of a company or its IP and discounts it to the present using an expected rate of return demanded by venture capitalists. It is considered best for early stage companies where IP is a major element of their value but where future incomes are uncertain.
While useful for high potential start-ups where traditional cash flow methods are not practicable, a key downside is that it relies heavily on exit-stage valuations which are notoriously hard to predict.
From the point of view of an acquiring company, the opportunity to integrate existing IP into its operations can increase speed to market. The acquisition of technology with tested market potential can accelerate growth, expand market share more rapidly and steer research and development efforts on a steady course for future innovation.
The onus is on the seller, meanwhile, to demonstrate the value and future potential earnings associated with the intangible assets of its business. Key issues here include the degree of legal protection of the IP, market potential including likely future revenues, potential spin-offs from the IP and the potential negative impact of competitors.
Technology- and science-based industries by their nature are prone to rapid market change from new innovators, heightening risk to incumbents and thus making valuations even trickier – all the more reason for enterprises to address such issues well in advance of any potential deal.
Experts in the field suggest companies should review their intangible assets regularly to prepare for the possibility of a merger or acquisition. This should include preparing an inventory of IP assets and licensing agreements. A SWOT (strengths, opportunities, weaknesses, threats) analysis should be conducted to assess the risks associated with the IP and any weaknesses that could be addressed through, for example, strengthening patent and trademark protections.
Conducting a thorough due diligence process is a key part of the job of the acquisition enterprise, a process that can be helped by the vendor ensuring that its house is in order.
When it comes to completing an acquisition, ensuring that the right legal documentation is in place is vital; agreements should assign ownership of patents, trademarks, copyrights and associated rights to avoid disputes at a later stage. The status of pending patent applications is among the key issues a buyer needs to assess, as is whether trademarks, patents or other IP rights are up to date and if there is clear and unambiguous ownership by the vendors of all of these IP assets.
