An M&A event can generate huge excitement. Behind the scenes, however, a detailed due diligence process is needed to check financial, legal and commercial details of the proposed deal and to identify risks. However, one area that is often not considered by either party as fully as it should be is the real value of the intangible assets of the target acquisition company. This can make a big difference to the true value of a deal – or even whether an acquisition should take place at all.
Jim Asher, Head of Valuation, Coller IP writes for LES News Exchange
Many of today's most promising companies are built on intangible assets and, while businesses often have a good idea of how their tangible assets can leverage debt and equity instruments and help with the task of raising finance, they may not realise how important intangible assets (IA) may be when it comes to a merger or acquisition. Increasingly, investors recognise the vital role that intellectual property (IP) plays in the future success of a company.
Some investors do not highlight IP early enough in their due diligence process, and many business entrepreneurs do not make the most of the opportunity to showcase their IP either. IP is usually not accounted for on the balance sheet. If companies do not pinpoint effectively where their IP value lies, they will not fully demonstrate the commercial value in their business. Many entrepreneurs therefore miss an opportunity by not convincingly presenting IP as an asset to investors making investment decisions. Being clear about the value of the intangible assets can pay dividends – literally.
Not checking what intellectual assets are included in an acquisition can be costly, and neglecting to protect the IP properly could also pose a risk. We have found that there are many companies who do not know how to properly evaluate their IP, so when it comes to a merger or acquisition, they don't have their 'ducks in a row' to convince investors of the value of the IP. But valuing IP is more than just about counting patents or brands. It is important to understand the quality of what's there.
Putting such a value on intellectual assets is not straightforward. Valuing a patent portfolio for example in an acquisition scenario can be challenging – will its value readily transfer from one company to another? Does the portfolio actually cover the technologies and products involved? Factors that can limit the value of intellectual assets in a company include ownership issues such as poor chain of title; lack of technical relevance including claim coverage of patents; mismatches between patent country cover and market geography; brand impairment; and careless licensing dissipating rights.
The way in which IP is valued needs to take account of the purpose of the valuation and the commercial context. For an acquirer, the value of IP may be quite different to that for the current holder. A valuation to support a commercial negotiation between companies may take a different approach to a valuation required for specific tax purposes within a company.
For any business looking to be acquired, getting IP in order is a must. Identification and evaluation of all existing IP, along with ensuring that its protection is watertight, should always be the first steps. Knowing the value of your IP—or which parts of your IP are more valuable than others—is essential in making decisions about what parts of the business to develop. The process may reveal opportunities to license parts of your IP portfolio to gain additional revenue. Anyone involved in selling or acquiring a company should establish what intangible assets the target company owns, and whether associated IP rights are live and valid.
Identification of all the valuable intangible assets in a company involves undertaking an audit to identify them and assessing which of these may be of significant value. This includes assessing strengths and weaknesses of the IP relative to that of existing or potential competitors, while at the same time identifying possible opportunities for exploiting IP further.
The process should also include checking any weaknesses in patents and other IP from a legal position so as to identify risks and avoid potential pitfalls. One of the areas that it is important to look at is how well differentiated the technology and patent applications are from the 'prior art' – that is, previously published third-party patent documents in the same technology space. This involves searching international patent databases, to analyse prior publications and to establish whether third-party patents are still live.
Given the intangible nature of IP, can it be valued? The answer is an emphatic 'Yes', and the financial approaches that are used are not dramatically different to those used to value many tangible assets. It is the assessment of risk that requires specialist skillsets. The three basic approaches most commonly used to value IP, either singly or sometimes in combination, are:
- The Cost based approach considers the cost of reproducing the capability of an asset. This approach typically looks at the historic investment in creating the asset, for example R&D, software development costs, patent filing and prosecution costs, brand development investment, and applying discount factors to account for obsolescence. However, it comes with a strong caveat that historic cost is seldom a reliable indicator of future value.
- The Market-based approach seeks to establish a value by identifying comparable market transactions to provide benchmarks. This type of approach is common in valuation of other assets, such as real estate, where there are large numbers of similar transactions to review over many years. It is more challenging to find valid comparators for IP, given its very varied nature technically, the wide range of commercial contexts, and the constraint that many such transactions are kept confidential and therefore not visible.
- The Future income approach seeks to determine the estimated future cash that can be directly associated with ownership of IP, and is often the most appropriate approach of the three. It requires development of a scenario-based business model of future cash flows that are attributable to the IP. The value of future cash flows is then discounted back to today using a discount rate that is appropriate for the level of risk associated with the business and market volatility.
Valuation of patents is more challenging where they are held by early-stage companies for products or inventions which do not yet produce income or royalties as the future value of business dependent on them is much more uncertain than it would be for a company with established products and trading record. An assessment of the underlying technology and market is required.
There are many examples to show how IP can realise significant value in an M&A situation and also some examples where due diligence has revealed significant risks. By ensuring that all parties are clear about the value of the intangible assets in a potential transaction, whether they are fully protected and what opportunities may exist to further commercialise them, the organisations involved will be in a more robust position to judge on what basis a merger or acquisition should take place.
This article was published by LES News Exchange. To read "Having the right IP evaluation strategy for acquisitions" click here
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