Significant business value can often lie in its intellectual property. David Prosser looks at how you get to the heart of IP – and how you cost it in M&A.
Can you put a price on a good idea? In today’s economy, business owners, investors and dealmakers must do exactly that because the value of most companies is now dominated by the value of their intellectual property (IP). “Creations of the mind”, as the World Intellectual Property Organisation (WIPO) describes IP – meaning everything from inventions and artistic works to the designs, symbols, names and images used in commerce – account for an increasingly large proportion of the balance sheet.
In the US, Ocean Tomo, an American merchant bank that has been researching IP for many years, says intangible assets – largely IP-related – account for around 90% of the value of S&P 500 companies today, up from 17% in 1975. The figures, and certainly the trend, are broadly similar in developed economies around the world, including the UK.
“Almost every business has some sort of IP that defines what makes it special and gives it its value,” says Allison Mages, head of IP commercialisation at WIPO. “That means it is crucial to understand exactly what IP you have and what it is worth.” A company that has not considered this will struggle to make rational decisions about how and where to invest; and in any kind of M&A situation, it will find it harder to negotiate constructively.
In practice, every type of business needs to undertake this work. IP is often associated with sectors such as technology and pharmaceuticals, but it is not exclusive to these areas.
A recent study published by Brand Finance identified Apple, Microsoft, Alphabet and AbbVie among the world’s top 10 companies, ranked by the value of their IP. But representatives of industries including oil and gas, financial services and automotive made the list too, courtesy of Saudi Aramco, Visa and Tesla. In the UK, meanwhile, the Global Innovation Index study cites AstraZeneca as the country’s most IP-rich business. But British American Tobacco, Unilever, Diageo and Aon are also high up the list. IP, in other words, is found everywhere.
Identifying IP
The problem for businesses is that identifying and valuing IP can be challenging. For one thing, IP can be a nebulous concept that potentially spans multiple business assets – and some types of IP are more obvious than others.
Businesses that have come up with new innovations and inventions, or developed new creative work, probably don’t struggle to recognise that these are valuable assets. But it may be harder to see the signs that distinguish the business’s goods or services from those of its rivals – the kind of things that can be trademarked, for example – as IP. Similarly, designs also have value, even though they are the aesthetic element of the asset. Then there is IP such as trade secrets – the business’s secret sauce.
A second difficulty is that putting a specific value on IP, or even a range of value, is a subjective exercise, with plenty of room for disagreement. “There is no single standard for valuing a business’s IP,” adds Mages. “It’s always going to involve an element of professional judgement.”
Certainly, there are several well-established methodologies for valuing IP, but each has advantages and disadvantages. “The market comparison approach can work well, but it often proves hard to find assets that are genuinely comparable because IP is unique by its very nature,” says Adam Sutton, valuation partner at Grant Thornton. “The cost and income approaches therefore tend to be used more often. Where a piece of IP is a major contributor to revenues, the income approach makes sense; if it’s more peripheral, the cost method may be more appropriate.”
While these approaches are not mutually exclusive, they will inevitably produce different answers. “Generally speaking, an approach based on forecasting future revenues will produce a higher valuation for IP than looking at cost,” explains Waheed Mahroof, director of valuation services at BDO.
Given such complexities, it makes sense for businesses to keep their IP portfolios under regular review, says Josue Ortiz-Ramirez, a partner in Deloitte’s IP advisory team, rather than trying to value assets amid the pressure of a deal situation. “The velocity of M&A can make it difficult to present and value IP properly if you’re starting the work from scratch during the deal process,” he warns.
Sellers armed with an up-to-date perspective on valuation, by contrast, will be in a stronger position to negotiate a fair price for their IP. A buyer will naturally want to make their own assessment, but it’s in the interests of both parties to reach an agreement based on a robust evidence base. “Otherwise, sellers may be leaving value on the table because they haven’t considered what their IP is worth to a buyer and buyers may miss opportunities in post-deal integration work,” warns Ortiz-Ramirez.
Bear in mind that assessing IP isn’t just a question of totting up all the ways in which these intangible assets might drive value for the company. There are also factors to take into account that might reduce the final figure. Not least, it is important to recognise that the value of IP may reduce over time – as rival innovation emerges, for example, or as brand loyalty diminishes. In a deal situation, buyers will want to account for this in their IP valuations and due diligence work, especially where there are assumptions to be made about future revenues.
“Technology obsolescence is a key consideration – the question is how long an invention will continue to generate an advantage and at what rate that advantage will fall away,” says BDO’s Mahroof. “Similarly, if you’re valuing the IP in a business’s patent, its future cash flows may only be available for the lifetime of that patent, which will eventually expire.”
Customer attrition is a related concern. Data on churn rates, where available, can help buyers and sellers assess the future value tie-up in brand and customer relationships; some of today’s customers will inevitably fall away over time. There may also be costs that need to be factored into IP valuations. These could include the legal costs of maintaining and defending the business’s IP, for example. Or there may be costs associated with the ongoing innovation required to maintain the competitive advantage of IP.
The goal should be to take all the pluses and minuses into account to reach a realistic valuation of the business’s IP. That requires companies and their advisers – who will include specialist IP professionals – to think about how to weigh different considerations. From an M&A perspective, that may partly depend on the nature of likely suitors.
“Different types of buyers tend to have different mindsets,” says Ortiz-Ramirez. “At the risk of overgeneralising, trade buyers are often more focused on synergies – where IP overlaps with what they already have and where it fills an important gap for them. Private equity investors are often more focused on risk – certainty around IP ownership and control and any deficiencies there may be, and any future threats to the value or integrity of the IP.”
Grant Thornton’s Sutton agrees. “PE may need to do a lot more diligence to reach a point where it is comfortable that it understands the business’s IP and how to protect it,” he says. “Trade buyers often have a natural advantage here because they’re already used to working with these assets.”
Rights protection
One important area to probe and document is the extent to which IP is dependent on rights granted by third parties. Innovation may depend on licensing arrangements – giving access to third-party data for the business’s proprietary models, for example – which may not be easily transferrable if the IP is sold. This can undermine the value of the asset.
Importantly, all buyers will want to scrutinise the level of protection that the business has in place around its IP, says Selina Sagayam, a senior corporate finance lawyer at law firm Gibson Dunn. “This is core to the question of valuation and there will be a whole diligence process around rights protection,” she says.
For IP owners, this raises important questions. Patents, trademarks, copyright regulation and other legal remedies can all provide important reassurance that threats to IP can be repelled. But, in most cases, these protections have to be obtained separately in each jurisdiction in which the business operates, or might hope to do so in the future. “There are significant variations around the world in terms of what you can protect, and the cost and time required to secure that protection,” warns Sagayam.
That requires companies to think carefully about the markets in which they are prepared to take this work on. One element of the analysis is economic. In any given market where businesses are potentially considering putting their IP to work, the size of the prize – the future revenues available – will determine the importance of protection. That will depend on demand, but it may also be a question of how the business intends to exploit the opportunity – with direct investment or through a licensing deal, for example.
Equally, the potential to sell an asset or business to a buyer interested in that market may be relevant; sellers purchasing IP in order to target a new geography will be focused on whether or not they would be protected.
There are also practical questions to consider – if IP protection can’t be enforced, there is little point in paying for it. This is an issue in some developing economies, where the courts are not always supportive of international businesses accusing domestic players of infringements.
These are considerations that must be weighed carefully, says Deloitte’s Ortiz-Ramirez. “Too often, we see companies make decisions about IP protection only from the budgetary point of view,” he warns, “rather than thinking strategically about the future.”