Traditional intangible assets valuation techniques (Định giá tài sản vô hình theo phương pháp truyền thống)

The Cost Approach seeks to determine the value of intangible assets by aggregating the costs involved in their development.. Agreement B – $9MØ $4M now, $5M over two years Agreement C –

Traditional Intangible Assets Valuation Techniques

Traditional Intangible Assets Valuation Techniques

An excerpt from Chapter 4 of The Intangible Assets Handbook

By Weston Anson

Traditionally, the methods used to value intangibles have some elements in common with those used to value tangible assets such as real estate An important difference in most cases, though, is in the availability of the necessary data, such as finding comparable transactions or relevant historical financial information Often, comparable transactions

or benchmark information needed to establish a logical and intellectually sound basis for the valuation conclusions of intangible assets are unavailable

In the last two decades, the intangible asset valuation practice field has grown dramatically Traditionally, four different methodologies have been used to value assets, whether for transaction, tax or litigation purposes; in a going-concern valuation or in liquidation We also present herein a fifth method that is frequently used for technology valuation

The Cost Approach

The Cost Approach is based on the economic principle of substitution Essentially, the premise is that potential buyers will pay no more for an asset than it would cost them to develop or obtain that same asset or an asset with similar utility in other cases The Cost Approach seeks to determine the value of intangible assets by aggregating the costs involved in their development On the face of it, this may seem fairly straightforward However, there is more involved in the process than simply adding up the receipts for expenditures associated with the intangibles Indeed, there are two distinct Cost Approach methods: Reproduction Cost and Replacement Cost

“Reproduction Cost” measures the level of expenditures necessary to reproduce the exact same asset It is appropriate in situations such as litigation involving specific patents or when return on investment needs to be measured Alternatively, the “Replacement Cost” method measures the expenditures necessary to develop an asset with similar utility and

is appropriate in situations such as determining a target price prior to negotiations or calculating a basis for suitable royalty rates or transfer pricing

An important requirement for both methods is that the costs not be determined in accordance with the historical expenditures that actually took place Instead, the necessary expenditures and costs to replace or reproduce the asset should be determined

as of the valuation date For example, many factors relevant to the asset’s development may have once been proprietary, but are now in the public domain, and could therefore

be acquired at a much lower cost than was actually included initially Also, research methods may have improved in the interim, to the point where only half of the historical research time is needed to accomplish the same achievements, and this also would affect the value of the asset

The costs included when calculating value with this approach must be considered within the appropriate economic environment Only the expenditures necessary in relation to the environment in existence on the valuation date should be included Remember that the appropriate valuation date may be current or it may be a historical date, and costs would

be estimated as of that date When using an historical date, it is crucial to utilize the necessary expenditures related to that date, and not rely on the actual levels of any expenditures made prior to that date

The impact of this requirement is twofold If the cost of any of the relevant components has changed since the initial expenditure, the current cost needs to be utilized in the calculations This will account for any inflation or deflation that has occurred Also, any developments during the interim that would materially impact the development process need to be factored in as well For example, an invention that took a team of ten researchers to develop may only take a team of four now

All costs encountered during development of an intangible should not be included, only those necessary to duplicate the asset or produce an asset of similar utility Typically, these consist of both direct expenditures and opportunity costs The direct expenditures will include items such as materials needed in the development process, labor costs, and some overhead items One must ensure that the salaries, benefits, and other employment costs being attributed to researchers associated with the development effort are based on current practices, not on expenditures from historical efforts

Overhead and management costs, such as project supervision, utilities, and administrative costs, should be pro-rated to reflect their true level of involvement with the development process Also, when projecting the timetable needed to develop the assets in question, consideration must be given to the probability of success Another aspect to remember is the fact that not all expenditures contribute equal value to an intangible asset For example, it is doubtful that expenditures on Super Bowl ads increased the value of the

trademarks and other marketing assets of the brands being advertised anywhere close to the tens of millions of dollars that are spent each year

Opportunity costs consist of value of the other courses of action and investment opportunities that have been passed on, to pursue the development of the subject assets Essentially, this analysis should measure the impact of a delayed market entry In other words, what could be earned during the period of development if the assets were licensed today? Also, whether utilizing the reproduction method or the replacement method in a current or historical environment, the risk of obsolescence needs to be incorporated into the analysis

The Cost Approach is most useful in cases where there is no economic activity to review, such as early-stage technology that is not yet producing revenue It also is effective at establishing a maximum price for the asset if the context is a proposed transaction This situation exists when there are many candidates for substitution available The main drawback associated with the cost approach is that it does not recognize any economic benefits associated with marketplace activity For example, there is no mechanism to incorporate revenue or profit data, and it therefore ignores important data by which the value of assets is typically measured Costs that should be quantified in this analysis include:

· Legal fees

· Application/registration and other fees

· Personnel costs

· Development costs

· Production costs

· Marketing and advertising costs

In any event, the Cost Approach can often (but not always) be looked upon as providing a floor or minimum value for the intangible assets in question Exhibit IV-1 illustrates how reproduction costs can often be different from historical costs:

EXHIBIT IV-1

REPRODUCTION COST APPROACH

Data Development

Labor / Research Costs Legal Fees

Technology Development Other

Historic Cost

$1000

$1,000

$1,000

$10,000

$1,000

Current Cost

$0

$5,000

$5,000

$1,000

$10,000

Totals

$14,000

$21,000

The Market Approach

In the Market Approach methodology, intangible assets are valued by utilizing actual transaction values derived from the sale, license or transfer of similar assets in similar markets This approach is best if an active market exists that can provide several examples of recent arm’s length transactions and adequate information on their terms and conditions However, most intangible assets are not traded frequently enough to be able

to establish a value using market-based comparables Since most intangible assets are considered unique by definition, it is also difficult to ensure that a truly comparable situation exists Moreover, it is often very difficult to get enough details on the few available transactions to be certain that all the elements that make for a good comparable have been revealed

When the necessary data can be found, the Market Approach has increasingly become the preferred approach in the valuation of intangible assets This is because the Market Approach is practical, logical, and applicable to all types of intangible assets In contrast

to the other methodologies, the strength of the Market Approach is its reliance on market sales, rents, and transactions

In addition to the type of asset, information necessary to establish comparability includes the relevant industry, geographical constraints, exclusivity, payment mechanisms and timeframe, among others It is also important to know if the transaction was related to a bankruptcy filing, litigation, judgment or other forced transactional divestiture These may render the comparable transaction unsuitable for the analysis in the absence of compensating adjustments as they will reflect forced/artificial values Also, pay close attention to the conditions of the market at the time a transaction takes place, as these will influence the sales or license terms Along with the possible adjustments listed above, the price information contained in comparable sale and licensing transactions will frequently have to be adjusted using a common reference point such as sales, profit margin or net income

As with the Income and Relief from Royalty Approaches discussed below, the value conclusion can be reviewed at any time subsequent to the analysis to see if any adjustments are necessary When reliable transaction data are available, the Market Approach is considered the most direct and systematic approach for determining an accurate value for intangible assets

EXHIBIT IV-2

MARKET COMPARABLES APPROACH

Agreement A – $8M cash

Agreement B – $9M

Ø $4M now, $5M over two years

Agreement C – $10M

Ø $2M per year over five years

Agreement D – $8.5M cash

Agreement E – $9M cash

CONCLUDED VALUE = $8M - $9M

*Based on comparable data interpolation

The Income Approach

Estimating the future income streams expected from the use of the intellectual property or intangible asset being valued is the core concept of the Income Approach The future income streams are then discounted via present value calculations to determine their current value This is one of the most widely used approaches, because the information necessary to determine value using this approach is usually relatively accurate, and often readily available The parameters used include:

· Future income stream

· Number of years of the income stream

· Risk associated with the generation of the income stream

The most common error in applying this approach is the failure to differentiate between the business enterprise value and the value of the intellectual property that supports the business One must separate the intellectual property income stream and value from the value and income stream of the business as a whole While related to the Income Approach, the Relief from Royalty and Technology Factor Approaches presented below are two methods for better ensuring that the analysis only measures the portion attributable to the intangible assets; since they analyze value or revenue attributable only

to the intangibles

With the Income Approach, an asset is worth the present value of the future economic benefits (income or net cash flow) that will accrue to its owner It requires a projection of

future income, an estimate of the likely duration of the income stream, and an estimate of the risk associated with generating the projected income stream The projection of future income incorporates expected sales of products or services that feature the intangible assets Of course, an accurate forecast of revenue depends on understanding the competitive and economic environment in place during the appropriate timeframe for the valuation The length of the forecast is dependent on an accurate estimate of the asset’s remaining useful life This will incorporate factors such as potential obsolescence, historical usage, and expiration of the period of transaction

The discount rate used in the present value calculations must incorporate the many risks associated with the generation of the future income These include the overall market risk, specific industry risk, and risks associated with the assets and operation being analyzed Although it may seem less precise than the cost approach due to the inclusion

of multiple estimates, the information needed to make these estimates can be accurately developed and verified Given sufficient data availability, an additional benefit of this approach is that it provides the ability to perform sensitivity analyses by adjusting the value parameters, which allows management to better understand the importance of the various factors driving value in their particular situation

EXHIBIT IV-3

INCOME APPROACH

Annual Company Revenues $60M

Portion Attributable to IP Portfolio 18%

Years of Future Use 4.5 years

Discount Rate 16.0%

VALUE = $40.8M

The Relief from Royalty Approach

With this method, the value of the intangible assets is calculated as the present value of the royalties that the company is relieved from paying as a result of ownership of the assets In other words, this approach provides a measure of value by determining the avoided cost The Relief from Royalty Approach measures value by estimating future revenue associated with the asset over its remaining economic life and then applying an

appropriate royalty rate to the revenue estimate Of course, if the assets generate revenue directly via licensing, the royalty stream is utilized in the valuation analysis

The royalty rate segregates the portion of value that is attributable to the intangible assets from the value of the overall operation The use of marketplace royalty rates in this part

of the analysis lends additional credibility to the value conclusions The present value of the estimated royalty payments is then calculated using a discount rate that incorporates all the associated risks involved in achieving the revenue forecasts and royalty streams When identifying appropriate royalty rates for this analysis, any license agreements that are reviewed should be of an arm’s length nature, and feature attributes similar to the circumstances surrounding the subject assets As with the comparables outlined in the Market Approach section, these parameters include the type of asset, relevant industry, geography, exclusivity, sub-licensing and advertising constraints, payment mechanisms and the appropriate timeframe

The range of applicable royalty rates discovered during the analysis will most likely be fairly wide For example, royalty rates for entertainment-oriented trademarks may range from 5% to 15% of net sales; and for various technologies, from 25% to 20% The differences among the various agreements will largely be due to the relative strength of the properties being licensed, product usage, competitive advantage, and their market share characteristics Of course, the profit margins associated with the products upon which they are being utilized will also have an impact on the level of appropriate royalty rates It goes without saying that, all else being equal, a property commanding a rate of 15% of net sales is going to be much more valuable than a property commanding 5% of net sales

Obviously, the key to an accurate valuation is to utilize the correct royalty rate in the calculation A relative strength analysis of the assets will help to narrow the range of royalty rates to one that is more appropriate Factors that will influence the relative strength analysis include growth rates, market share, duration of use, registration and legal protection, potential obsolescence, and barriers to entry The makeup of distribution networks and marketing campaigns will also have an impact Again, these are all elements in determining the context in which the assets are utilized and, thus, how their value should be measured

An objective analysis of factors such as these will determine if an appropriate royalty rate

is closer to the 5% rate or the 15% rate in our example Since this method uses royalty rates that are based on marketplace transactions and uses a forecast of revenue/royalty

income, the Relief from Royalty Approach is often considered to be a combination of the Income Approach and the Market Approach

A Note of Caution: In the last decade, The Relief from Royalty Approach has become misused and abused Too many valuations are based on theoretical “marketplace royalty rates.” It is true that some intellectual property, particularly trademarks, patents, brands, and copyrights, do have comparable market royalty rates that are readily established However, for many intangible asset valuations, comparable royalty rates are speculative

at best Also, there is no such thing as an “exact” comparable royalty rate, and any valuation project that claims to present exact comparables is flawed in its basic premise When appropriate royalty rate comparables and/or calculations are available, however, the Relief from Royalty Approach is a very effective valuation methodology

EXHIBIT IV-4

RELIEF FROM ROYALTY APPROACH

Annual Sales $1.0M

Royalty Rate 6.0%

Remaining Life 7 years

Discount Rate 16.5%

NET PRESENT VALUE = $350,700

The Technology Factor Approach

This is another method, applicable only to technology, which is gaining acceptance The Technology Factor Approach is designed to measure the portion of a business unit’s overall market value that is based on the utilization of the underlying technology The willing buyer/willing seller aspect of the fair market value definition is incorporated into this method by scoring a series of attributes as to whether they favor a buyer or a seller in

a hypothetical negotiation

As with the Relief from Royalty Approach, the first step is to project operating results for the organization using the technology The present value of this cash flow is then calculated using a discount factor that encompasses all risks associated with the generation of the estimated future results Accurate use of this technique depends on ascertaining the appropriate Technology Factor scale This factor is determined by

establishing an upper limit for the contribution of value provided by technology used in that particular industry, and then performing a relative strength analysis via various utility and competitive attributes, to narrow the contribution of the subject technology to a specific percentage within that upper limit

The upper limit represents the maximum percentage of total business value that can be attributed to technology in that particular industry Industries whose products feature large contributions from technology, such as scientific instruments and medical devices, will have relatively high upper limits, while those with products requiring little contribution from technology, such as minimal extraction will have relatively low upper limits

Once an appropriate upper limit has been determined, various competitive and utility attributes that reflect the strengths and weaknesses of the technology are reviewed Examples of utility attributes typically included in the analysis are the current stage of the technology, the level of capital required to commercialize the technology, the size of the potential market and the margins associated with the operation Competitive attributes may include the existence of alternative technologies, the potential for obsolescence, the likely response by competitors and the technology’s potential to displace existing products

These attributes are selected, weighted, and scored based on the circumstances specific to the unique valuation assignment Depending on how they are scored, some attributes may indicate a higher value, others a lower value, and others may be neutral to the final value Not all attributes will be of equal importance and are, therefore, weighted accordingly The utility and competitive attribute averages may also be weighted, according to their relative contribution to the overall determination of technology value The mean of these two averages (utility + competitive) is then taken to arrive at the final Technology Factor The resulting Technology Factor is then multiplied by the net present value of the subject business unit to arrive at the value of the technology The value of the technology is thus segregated from the value contributed by other assets of the business

Because the upper limit is based on the contribution of all intangibles to overall value, it limits the validity of the Technology Factor Approach when used on any operations that feature a mix of both technology and other intangibles Similarly, the presence of several different technologies in one product can lead to erroneous conclusions when trying to determine the value of only one of them The Technology Factor Approach is very effective, however, when analyzing a technology for licensing, or other situations where