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Iplb vol 21 no 5 - bmail.pdfWhen will an IP valuation be helpful in inform- Tim Heberden BRAND FINANCE AUSTRALIA Tax planning
Intellectual property valuations can inform a range of legal Many multinationals are structuring their IP in spe- issues, including commercialisation, licensing, litigation, cialist IP-holding companies (IPCos) for commercial transfer pricing, IP audits and mergers and acquisitions and tax reasons. Operating benefits can be significant, particularly from a brand management perspective. The This article is intended to help lawyers identify when a tax benefits of locating the IPCo in a low tax jurisdiction can be important. However, the envisaged tax benefits Essential features of IP valuations are discussed to help lawyers effectively brief and interpret valuation reports.
can swiftly evaporate if capital transfers and royaltiesbetween related parties fail to satisfy tax authorities.
Two-thirds of global enterprise value is contributed by intangible assets.1 In this environment, it is not M&A planning
surprising that companies are devoting more attention to With intangible assets contributing the bulk of the creating, exploiting and protecting intellectual property.
value of many acquisitions, one would expect due At many points in the IP development process, legal diligence to include rigorous evaluation of intangibles.
decisions can be informed by knowledge of the current This is not always the case, and value destruction is and potential value of the IP. Below are examples of often the result. Valuers should be aware of the profit and tax impact of the allocation of value between Commercialising IP
Large companies often have a large amount of Portfolio rationalisation
early-stage technology, and many designs and trademarks. Yet resources are limited. A valuation framework A bloated portfolio ties up capital and management can guide resource allocation by quantifying the relative time in underperforming assets. Value can often be economic potential of the IP, together with each item’s unlocked by selling, licensing or terminating part of the investment requirements and associated risks. At the portfolio. Management needs to know the value impli- other end of the spectrum, small companies often require equity partners to commercialise new inventions. Nego-tiation is much easier with a credible business plan that Auditing a client’s IP
articulates the value potential of the invention.
In addition to having intangible characteristics, most IP is not visible on the balance sheet, as only acquired Licensing
intangibles can be capitalised. In line with the concept of Royalty rate determination is the flip side of the “what gets measured gets managed”, we have found that valuation coin. The common factor is the economics of otherwise well-managed companies have a poor grasp of the IP. In one instance, this is expressed as a dollar the intangible assets that contribute to their enterprise amount, and in the other as a percentage of revenue. All value, and the specific IP within each category.
too often royalties are determined by crude rules of Value mapping can be used to split the total value of thumb or a poorly informed haggle, rather than knowl- the business between tangible assets and the different edge of the revenue and cost savings generated by the IP.
categories of intangibles. Visibility of the value andcommercial contribution of intangible assets provides Litigation
senior management with the incentive to identify and The need for a valuation in support of a damages claim or other dispute is clear. However, the resulting The following example shows how communication benefit depends on the valuation being properly scoped between lawyers and valuers can ensure that a legal and sufficiently robust to withstand close scrutiny from document meets the client’s requirements.
without the benefit of Daimler Benz design, engineering and service? Similarly, would the Zantac brand be Prior to the IPO of easyJet, a European airline, it assigned incomplete without the Ranitidine patent? How would some of its IP to its parent company, easyGroup. Included in the Guinness brand fare without the recipe and produc- the assignment were the easyJet trade marks. These were to be licensed back from the easyGroup on a royalty-free basisin perpetuity.
Briefing a valuation
Brand Finance was briefed to determine whether the pro-posed reorganisation resulted in a transfer of value between the companies. The legal and corporate finance advisers There is currently not a distinct professional body and initially assumed that the combined effect of the assignmentand licence would be value neutral, as easyJet enjoyed qualification for business valuers in Australia. However, indefinite, royalty-free use of the trade marks.
control is exerted through regulatory and professional Our analysis determined that certain clauses of the proposed licence made it materially less valuable than ownership of Although the valuation community has significantly the trade marks. These included loss of control of the visual increased its focus on intangibles, valuers lag behind the identity and positioning of the brand, loss of brand extension legal profession in that IP valuation is generally not opportunities, and increased risk from the possibility of treated as a specialist field. There are few valuers that inappropriate licensing by easyGroup.
specialise in IP valuation; in many instances the task is Through collaboration with the client’s legal advisers, the entrusted to business valuers. This is not ideal given the terms of the license were amended so that the transfer ofvalue was minimised, and the directors’ requirements met.
intricacies of intellectual property and its complex rolein value creation.
When assisting a client to appoint a valuer, lawyers Value characteristics of intangible assets
should ensure that the candidate can demonstrate: Valuation of intangible assets requires an understand- • a suitable financial qualification and professional ing of their characteristics and role within the business model. These are the key attributes and their valuationimplications: • extensive valuation experience and a high level of • There are generally no efficient markets for intan- • an understanding of the purpose of the valuation, gibles, and they are typically sold as part of a and the required output; for instance, this could be business combination. As a result, the market an opinion on damages incurred, an appropriate approach to valuation is seldom possible.
• There is seldom a linear relationship between • sound knowledge of IP in general and the particu- investment and returns. Therefore the cost approach to valuation is often not appropriate.
• Non-financial metrics regarding the quality of • Intangibles are not diminished by use, and are non-rival, meaning that simultaneous use is pos- A weakness observed in IP valuations is a lack of sible. This can lead to rapid growth and high clarity in the definition of the asset being valued. The following categories of intangible assets are referred toby International Financial Reporting Standards: • Value often results from interactions with other assets, causing a complex value chain.
• artistic — copyright, design rights; The final point merits further discussion. Baruch Lev, • customer based — customer lists, customer con- Professor at New York University’s Stern School of Business, has stated that, “when such interactions are • contacts — licenses, use rights, distribution con- intense, the valuation of intangibles on a standalone basis becomes impossible”.2 It is sometimes necessary • marketing — trade marks, domain names, market- to group complimentary intangibles for valuation pur- poses. Value maps can be used to explore the interac- • technology — software, patents, databases.
The interaction between intangible assets is particu- These are broad categories. More detailed and precise larly important when valuing brands. Would the Mercedes definitions are required, particularly for legal and tax brand command such fierce loyalty and price premium valuations. The following example illustrates why the term “technology” is too broad, and should be described in terms of specific patents, trade secrets, designs and The level of detail and rigour required in a valuation ranges between an indicative valuation and a formal valuation opinion. It is clearly important to match deliverables with the purpose of the valuation. If a client A recent valuation that Brand Finance carried out on behalf wishes to know whether a potential damages claim will of a tax authority provides an interesting example of impre- be material, an indicative valuation will meet their requirements, and will cost far less than a formal The taxpayer commissioned a valuation to support the valuation opinion. On the other hand, it is inappropriate assignment of technology to a related party offshore — an IP to commission an indicative valuation for the purpose of management company in a low tax jurisdiction. The valua-tion report did not clearly define the elements of the litigation, financial reporting or transfer pricing.
technology, and contended that it had limited commercial An important distinction can be made between tech- relevance. The value placed on the technology for the nical and commercial valuations. The former are gener- purpose of the assignment was several hundred thousand ally conducted for the purposes of financial reporting, tax planning, litigation, securitisation and M&A. They Technology was simultaneously licensed back from the focus on providing a robust, independent opinion on the offshore company. The transfer pricing documentation stated value of the IP at the valuation date. Commercial that this package of technology (not clearly defined) played valuations are used for strategic planning, portfolio a significant role in revenue generation. It commanded a highroyalty which resulted in royalty payments of several million management and budget allocation. Such valuations dollars per annum. The taxpayer contended that this was a often address the value of the IP under different sce- broader package of IP than was assigned.
narios and assess the impact of flexing valuation assump- A detailed analysis of the business model, together with the assignment and license agreements, revealed that the assignedtechnology was the same as the licensed technology.
Requirements of a valuation report
Clarification of the components of the technology influencedthe independent valuer’s opinion on both the value of IP The Accounting Professional and Ethical Standards assigned and the subsequent transfer pricing.
Board recently issued a standard on Valuation Services(APES 225). This is effective from 1 January 2009, but The asset that is most prone to poor definition is early adoption is encouraged. Standards issued by the “brand” — a term that is loosely used to describe International Valuation Standards Committee (IVSC) are different groupings of complimentary IP. In our experi- widely accepted by valuers around the world. Although ence, there are three different concepts, all of which are the IVSC’s initial focus was real property, its scope now includes business and intangible assets valuation. In2007 the IVSC released a discussion paper on the • The narrow definition is trade marks, copyright in devices, and associated goodwill. (It is ultimately Both of these sources list the requirements of valua- the goodwill that consumers associate with the trade mark that influences their behaviour andgenerates cash flows.) • the scope of the valuation and any limitations or • In other instances, a broader group of rights is bundled together as a “brand”. It can be appropri- • the purpose for which the valuation report has ate to group complimentary assets — for instance, beer trade marks will seldom be licensed or sold • a clear description of the asset being valued; without the accompanying recipe and brewing • the date at which the value has been determined, guidelines. Other marketing intangibles such as and the date on which the report has been issued; domain names, product design rights, copyrightsin advertising visuals and written copy can be • the basis, approach and method of valuation; included in a wider the definition of “brand”.
• In commercial valuations, “brand” is sometimes • sufficient details of the valuation and underlying used to describe a branded business unit incorpo- assumptions to allow a reader to understand how rating both tangible and intangible assets.
• the name and qualifications of the valuer.
Different groupings of brand-related IP are suitable in different situations. The constant is the need for a precise We find it helpful to express the valuation findings in definition if a brand is the subject of a valuation report.
a commercial context. This means explaining the role of the IP in driving business value. It is useful to remember The relief from royalty method is commonly used for that value is a function of three primary variables — patent and trade mark valuations. It is based on the premise that if the IP were not owned, it would have tobe licensed from a third party, and a royalty paid. The Valuation approaches and methods
value of the IP is equated to the present value of the These are matters for the valuer to decide. However, notional royalty stream that ownership relieves the an understanding of them aids a lawyer’s interpretation business from paying. Selection of an appropriate roy- alty rate is a key aspect of the valuation. The most compelling evidence is gained from arm’s length licenses Value is in the eye of the beholder, so it is essential to for the specific IP being valued. Where no such agree- determine whether an asset is to be valued from the ments exist, evidence can be gained from a study of perspective of a typical purchaser (market value) or a specific purchaser (investment value). Market value is Earnings split methods require a detailed analysis of the most commonly used basis of valuation, and the the operating profits of the firm. Typically a charge is 1907 definition from Spencer v Commonwealth still made for tangible assets; the intangible earnings are then attributed between specific intangible assets based onquantitative research, or the valuer’s judgment of their The price that would be negotiated in an open andunrestricted market between a knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not In some technical valuations, the use of several anxious seller acting at arm’s length.
valuation methods is required to determine a robust, Non-market value bases include investment value defensible valuation. Additionally, it is recommended (the value of the property to a particular investor), value that IP valuations should be supported by a valuation of the enterprise or business unit in which it operates. Thisprovides an additional layer of cross-checks.
Whatever the basis of valuation, the valuer will apply Conclusion
one or more of the cost, market or income approaches.
A value-based approach to IP management enables The cost approach determines value on the basis of companies to make rational economic decisions regard- the cost to create a similar property. This is generally not ing which IP to invest in, what royalty rate to apply, suitable for unique intangibles such as trade marks and whether to proceed with a transaction, and what dam- patents as there is not a close relationship between their cost and economic worth. The approach can be used for Lawyers should be able to advise their clients when valuing replicable IP such as software.
The market approach establishes value by reference to sales of similar or substitute properties. This is not suitable for most IP as there is insufficient comparable data due to the lack of an active market.
The income approach is normally the most appropri- ate for the valuation of IP and is the most widely usedapproach for business valuation. This determines the Footnotes
value of an asset as the present value of the future cash ‘Global Intangible Tracker’ 2001 to 2007, Brand Finance Plc at Lev B Intangibles: Management, Measurement, and Reporting Within the income approach there are several avail- ‘Determinination of Fair Value of Intangible Assets for IFRS able methods of intangible asset valuation. The most Reporting Purposes’ International Valuation Standards Com- widely used are relief from royalty and a variety of Spencer v Commonwealth (1907) 5 CLR 418.
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