Intellectual property valuations as an aid and add-on to accounting valuations
Clients often enquire about the necessity of an intellectual property (IP) valuation as opposed to a standard accounting valuation. An IP valuation, unlike an accounting valuation, identifies, as a first step, proprietary know-how utilized by a business as well as the competitive strengths and protectability of the know-how; and thereafter, assesses its contribution to the revenue generation and the operating profitability of that business in order to determine a (notional) stand-alone value for such proprietary know-how. As such, it supplements a purely accounting valuation of the business and, in appropriate circumstances, it can be used to motivate an opportunity cost premium, supplementary to the accounting valuation, for purposes of establishing a purchase price for a business.
The proprietary know-how identified as a first step in the aforesaid valuation process includes efficiencies (technical and commercial) refined through trial and error, innovation such as software codes, formulae, compilations and technical information protected in law (i.e. copyright, patents, designs, trade marks and trade secrets) that ultimately provide a competitive advantage. It also includes an assessment of the efficacy of all systems developed to run the business and as such usually mirror-images the competence and entrepreneurial skill (human capital) of the business in question.
Warren Buffett refers to proprietary know-how of the kind that is the subject matter of an IP valuation, as the “franchise” or the “moat” that confers on it a competitive advantage, and the ability sustainably to price its products and service at an appropriate margin. If such a “franchise” or “moat” is not present, the Berkshire Hathaway investment group, which he heads, will not invest in the target business.
An IP valuation is invariably based on internally generated intangible assets such as proprietary production processes and customer-and-supply management processes. Another important aspect to consider during an IP valuation is company’s “share of voice” or the reputation and standing of the business’s brands in the marketplace. An IP valuation requires an in-depth understanding of what intangible assets drive the revenue streams of a business.
The due diligence component of the IP valuation canvases the technology landscape in which the business operates, with a view to exposing potential disruptive technology developments, and the business’s ability to anticipate and deal with them. It considers market developments that hinder or in some cases, (if appropriately responded to), could increase future profitability. Pure accounting valuations rely principally on historical financials and formulaic projections and discount factors, without assessing the actual means whereby a business is able sustainably to compete and flourish in the future.
The following circumstances will typically require an IP valuation:
- mergers and acquisitions (conducting a due diligence);
- IFRIS mandated impairment (or revaluations) – entries on the balance sheet in respect of acquired intangibles;
- franchising & licensing (motivating licensing royalty rates);
- tax & transfer pricing i.e. to demonstrate which entity in a group’s global supply chain is contributing to the price charged inter-group for the given activity undertaken by the relevant other group entities; and
- expert witness evidence – to substantiate a damage claim (actual/ “reasonable royalty”).