India: Intellectual Property Valuation And Transaction In India

Last Updated: 11 February 2019
Article by CR Jacob

Introduction

In the process of nation's capacity building and economic resurgence, the business community within India witnessed major economic policy reforms in the last couple of years. Beginning with demonetization, GST, the introduction of the Insolvency and Bankruptcy Code, 2016 (IBC), adherence to General Data Protection Regulation (GDPR) standards, all these reforms had an impact on the business community so much so that, the World bank in one of its latest reports have assessed India to be ranked at 77thrank among 190 countries in ease of doing business, a recorded jump of 23 positions against its rank of 100 in 2017.One of the established ways for a nation's capacity building is by means of Technology Transfer. While technology transfer from foreign entities via a Foreign Direct investment (envisioned inthe Make in India program) or cross-border Mergers and Acquisitions, are definite channels for technological advancement and skill enhancement, it is also important that there exists a conducive eco system of technology transfer between the academia, R&D institutions, small, medium and large business organizations.

Technology Transfer and IP Transaction

Typically, technology transfer involves licensing or sale of a technology/intellectual propertywhich may or may not trigger a commercial transaction also referred to as an Intellectual Property transaction. In the event of an IP transaction, it is imperative that a right IP valuation method and an appropriate value is arrived for transacting.While valuation methods like the 25% rule are increasingly becoming obsolete, methods like the cost method, the market method and the income method, all derived from thewell-established principles ofaccounting, still rules when it comes to valuation. However, choosing the right approach is an art as well as a science and it comes with experience combined with cues taken from best practices followed in other matured and evolving markets around the world.

Valuation Methods

Choosing a valuation method is usually context driven. One may choose the cost approach when the technology is at a nascent stage, just out of the R&D lab and so on.In the cost approach, one calculates R&D expenses including manpower and material costs, development or scale up costs, addsprofit margin, opportunity/replacement cost, deducts depreciation and arrives at the royalty value. Market approach is based on market insights, comparable transactions and industry benchmarking. It is not uncommon to find in matured markets, especially in the west, that IP transactions are based on market data. Matured markets stand to benefit from historical data on successfully completed transactions with established royalty rates for various industries. The same doesn't hold good for evolving markets such as India. Our past track record on the number of deals completedhaving IP transactions is not at par with matured markets in the west. Indian industries depend largely on data based on compound annual growth rate (CAGR) for understanding growth in a specific market segment. Secondly, India is going through the digital wave and most business organizations,in private sector and government sector, are re-organizing to comply to these changes. Thirdly, worldwide, industries are adapting and adopting to Industry 4.0, which is a blend of advanced analytics, Big Data, Robotics & Automation, Artificial Intelligence, Internet of Things (IoT), Block chain etc. As the industry evolves due to these technological disruptions, so will our understanding of the market size and the valuation.Owing to these factors, the most common valuation approach used in IP transactions is the income method.Though, there are several income based valuation approaches, such as the Discounted Cash Flow (DCF) Method, the Relief from Royalty (RFR) Method, etc., IP valuations areusually done using the DCF method.

Often, experts on DCF say that it is a garbage in garbage out model, because to a large extend DCF is based on assumptions. In DCF method, one extrapolates the revenue for the life span of the intellectual property, deduct the expenses, amortize it over a discount factor to factor in time value of money, to arrive at the net present value (NPV). The real role of an Intellectual property professional/analyst begins once the NPV is agreed upon. The IP analyst needs to do IP due diligence, landscaping and arrive at the risk factors. Factoring risks such as, whether a patent may get a grant in a particular jurisdiction, whether there could be opposition, whether there could be infringement are some of the examples that an IP analyst needs to consider. Once the risk factors are identified, it is important to put these factors into a risk assessment model to find the cumulative or net risk. Upon arriving at the cumulative risk, the risk is factored in along with the NPV to further calculate the royalty rate.

Challenges

There is no one size fit all strategy for IP valuation and IP transactions. Typically, IP transactions are captured in the licensing/sale agreement.In addition to a well drafted agreement, one needs to take into consideration the regulatory guidelines, taxation, and intellectual property rules of a particular jurisdiction when doing an IP transaction. The challenges when it comes to IP valuation varybased on jurisdiction. For example, in the United States of America, where there is an established precedence for awarding damages in litigations, Daubert challenges against intellectual property experts, is becoming a growing concern. A Daubert challenge is a hearing conducted before the judge where the validity and admissibility of expert testimony is challenged by opposing counsel (definition courtesy https://definitions.uslegal.com/d/daubert-challenge/ ). The challengesIndia face now is of a different dimension and magnitude. Indian banks are faced with non-performing assets of an alarming magnitude. Checks and mechanisms are being introduced to curb this. While we have the Insolvency and Bankruptcy Code, 2016 (IBC) in place to act on companies burdened with bad loans, a more robust business valuation ground rules are being discussed by various industry stakeholders such as Central Board of Direct Taxes, the Securities and Exchange Board of India (SEBI),Institute of Chartered Accountants of India, Institute of Company Secretaries of India, Institute of Cost Accountants of India, the Reserve Bank of India, the ministry of corporate affairs, to name a few.These rules for business valuation when executed will set as a benchmark for corporate transactions like mergers and acquisitions and valuing intellectual property during IP transactions, and hopefully make India move up the ladder within the top 50 nations for ease of doing business in the coming years.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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