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IN the coming weeks, I want to delve into the issue of the importance of the valuation of IP assets by SMEs. This is very crucial for SMEs to understand as it helps them make sound business decisions that enhance their operations. IP valuation is a process to determine the monetary value of subject IP. The prerequisites for undertaking an IP valuation are that the particular IP must be separately identifiable.

The IP asset must be subject to specific identification and a recognisable description and there should be some tangible evidence or manifestation of the existence of the IP asset (e.g., a contract, a licence, a registration document, a computer diskette, a set of procedural documentation, a listing of customers, recorded on a set of financial statements, etc.). It should be capable of being legally enforced and legally transferred and should be capable of having its income stream separately identifiable and isolated from the contribution of other assets employed in the business.

Factors influencing IP Valuation Licensing of IP assets; franchising
Before conducting negotiations for licensing-in or licensing-out of IP, a thorough understanding of the value of the IP assets ensures more informed negotiation and decision-making concerning the terms and conditions of the proposed licence, especially in determining fair and robust royalty rates for optimal exploitation of the IP asset. In franchising too, both the franchisor and the franchisee require a thorough understanding of the value of the IP assets, notably trademark(s) and trade secrets or know how.

Sale or purchase of IP assets
Before selling or buying IP assets, proprietary technology or a company, an SME needs to know the value of the relevant IP assets to decide whether to proceed with the sale or purchase and, if so, at what price.

Merger and Acquisition (M and A)
The primary reason for considering an M and A transaction is the value of the IP assets of the target company. In such a case, one should consider whether the stand-alone purchase or licensing-in of the relevant IP assets would suffice. If not, then only one should proceed to consider an M and A transaction. In both cases, IP valuation is crucial to making an informed decision. Valuation of the IP assets of the target company often identifies additional value that significantly enhances the final sale or purchase price. Doing so also ensures that deals are priced and structured by keeping IP risks and value realisation opportunities in mind. Further, IP valuation enables the parties to take an informed decision on the acceptable cost of capital or deciding on financial leverage strategy to be followed.

Understanding fully the strategic fit and value extraction opportunities of the target’s core and non-core IP assets facilitates post-deal IP integration and maximisation of the returns from the acquisition.

Joint Venture or Strategic Alliance
Before contemplating entering into a joint venture or other types of strategic alliances SMEs should make a comparative analysis of the value of IP assets involved in the various options under consideration. In structuring a joint venture deal, the parties should understand as to how much value IP assets contribute to it.

The same is true of a strategic alliance, as both parties would be well placed to take advantage of the deal if they are not only aware of the technological contribution of the IP assets but also of their monetary value.

Enforcement of IP rights; Calculation of Damages
Knowledge of the value of an IP asset influences the decision about the strategy to be used when it is infringed. IP valuation enables an entity to decide whether to pursue the infringement through a court action (by filing a suit for infringement), take recourse to alternative dispute resolution mechanisms, such as mediation or arbitration, or consider licensing of the IP asset to the infringer. In the event of a successful infringement prosecution IP valuation plays an important role in calculating damages, whether those damages are based on an assessment of the infringer’s profits or a reasonable royalty.

Internal Management of IP Assets
IP valuation helps in budgeting and resource allocation decisions. For example, if a company is spending a significant amount of money on internal R and D but is losing ground to competitors due to slow or late product introductions, it may need to rethink its R and D strategy and processes.

In today’s knowledge economy, more companies are turning to an open innovation model of actively buying and licensing innovations from other entities to supplement or even replace internal R and D. During an IP audit, the review of an IP portfolio provides an opportunity to identify IP assets whose value, for example, has become insignificant or markedly decreased. If such IP assets are used only in a non-core business activity or their strategic importance has become insignificant, it may be decided as to whether to continue maintaining such IP assets, license them, sell them or let these IP assets lapse. Thus, an informed decision to discontinue payment of maintenance fees may lead to substantial cost savings. IP valuation also provides strategic guidance for new product development, brand-extensions.

Strategic Financing and/or Raising Equity/Capital
Despite challenges in perfecting a security interest in IP assets, some banks and venture capitalists are relying on IP assets to secure debt financing.

Venture capitalists are beginning to look at patent strategies and patent portfolios. Usually, they do not engage in quantitative valuation of IP assets or of portfolios of IP assets. Rather venture capitalists prefer to value the company as a whole and consider the role of IP in that process.

Investor Relation
In the case of a listed company, an IP valuation helps to communicate the value of its IP assets to capital markets, supports its share prices, and helps to obtain funding from investors. Valuation of IP assets is also required for initial public offering (IPO) documents.

Financial Reporting
The recognition of the increasing share of IP assets in the total market value of enterprises has contributed to the change in the way the accounting community has begun to treat IP assets in financial reporting. The international accounting standards board (IASB) now recognises acquired and identifiable intangible assets (i.e. IP assets) and requires all acquired IP assets to be recognised as assets, separately from goodwill, on the balance sheet of the business acquiring the IP assets. IP assets, such as trademarks, with an indefinite useful life must undergo an annual impairment test. When a brand is acquired, IP valuation is done for the initial valuation as well as the periodical impairment tests for the derived values to be included in the balance sheet.

Bankruptcy/Liquidation
In a bankruptcy, the IP assets of the bankrupt company have to be valued, as also its physical assets, in determining how those assets are to be distributed.

Optimising Taxation
In devising ways to optimise the tax to be paid by a company, its assets, including its IP assets, require to be valued.

Tax authorities would like to know as much as possible about the basis for any value determination used when allocating portions of the purchase price associated with the acquisition of a company. In the past, many companies had allowed their affiliates to use their trademarks for little or no charge, but as the realisation has grown of the profit generating powers of trademarks, companies have increasingly taken to charging royalties for their use.

This has alerted tax authorities around the world to ask companies to charge their subsidiary operations for the use of their trademarks. Valuation of IP assets helps in assessing fair transfer prices for the use of IP assets, including brands, to subsidiary companies.

In my next article, I will continue on the topic of the valuation of Intellectual Property for SMEs and will look at the valuation methods available as well as their strengths and weaknesses.