When IP Valuation Is Necessary: The Sales/ Commercial Transaction
By Weston Anson
There are many situations in which intellectual property or intangible assets may need to be valued—whether for transaction reasons, litigation reasons, tax reasons, estate planning, mergers, or other scenarios. Regardless of the scenario, the most important underlying concept in all IP valuation is that it is very much context-specific. What we mean by this is that the contextual environment can change how an asset is valued, for what period of time the asset is valued, whether the asset is valued at today’s value or under some other scenario, etc.
In general practice, not all of these complex intellectual property issues come up. Nonetheless, at some time all general practitioners are going to face one or more situations in which clients have specific needs to value intellectual property. In this chapter, we have selected what we believe to be the most frequent reasons that intellectual property needs to be valued—particularly in the case of a non-specialist general practice law office. We are going to focus on the six most important areas for general practitioners—important in the sense of those that tend to come up most often. Our coverage for each of these contexts is relatively brief. It is intended to give a flavor of the issues that arise in each of these contexts. Below are some of the contextual situations in which clients most often need help, and that most general practice attorneys will face in terms of intellectual property valuation:
• sale or other transaction,
• estate planning,
• licensing of IP, and
We have already addressed valuation in general in earlier chapters and have dealt in some depth with specific valuation methodologies. In chapter 5 of the book from which this article was excerpted, we set the scene for a philosophical overview of valuation guidelines, which we believe is important. In addition, we also addressed in another chapter the impact of a depressed economic environment as it affects IP valuation (and, in general, all valuations).
In the previous chapter, we provided a detailed overview of how different types of intellectual property have different valuation considerations, approaches, and concerns.
In this article, it is time to look at specific IP valuation situations in which a general practice attorney’s client base will most often need advice. In this way, we discuss the final but most important underlying issue of intellectual property valuation—context.
Perhaps the best way to illustrate what we mean by context is to look at Exhibit 1. The reader can see that eight different situations or contexts are listed, including a going concern sale, reorganization or bankruptcy, estate settlement, divorce, etc. In general, and specifically for this discussion, we will assume that the same intellectual property is being valued, but the valuation is taking place in different situations and under different conditions and contexts.
Value Is Context Specific
- Going concern sale
- Reorganization / bankruptcy
- Estate settlement
CONTEXT + TIME = VALUE
Exhibit 1: Various Valuation Contexts
Before we take a somewhat more detailed view of these different contexts, a brief overview might be helpful. In bankruptcy, that particular context will drive down the value of all IP—virtually without exception. In divorce, the context will clearly affect how each party not only looks at the value of their IP, but how they perceive the current ownership and possible future benefits. On the other hand, for tax or donation purposes, one must be sure that the valuation meets the standards of the taxing authorities, as well as certain standards in regard to the commercial value of the IP. Licensing may bring a large value, but one that’s realized only over a much longer term. Finally, in litigation, the environment is much more complex, and the value conclusions are clearly based on the perceptions of the litigation that each side may hold.
To further illustrate how context can affect valuation of intellectual property, in some situations value can be even more substantial. There can be as many as four different values for a given bundle of intellectual property. In bankruptcy, valuation is even more context-driven than in other situations. As a company moves from going concern to liquidation, the value of its intellectual property will change precipitously.
In Exhibit 2, we see four value curves labeled as context continuums. In the first curve, one assumes that the company is a going concern and is merely going through a financial reorganization. In that context, the value of IP will stay steady or even rise. If that same company goes through a formal reorganization, shedding some of its hard assets and making itself a leaner corporate entity, then the value of the intellectual property will likely drop in the initial period of the reorganization but, as the curve shows, may very well regain its value over time. The next contextual scenario in bankruptcy is an orderly disposal. In that case, one can see that the value will drop immediately after the announcement of the orderly disposal is made, and then continue to drop further as time goes on. Finally, in liquidation, the value of intellectual property drops precipitously as soon as liquidation is announced and tends to continue to fall over time.
Exhibit 2: The Context Continuum
Now we will look at each of the six most likely situations in which the need for IP valuation will occur. These areas are particularly appropriate to general practice, where client needs will tend to be less esoteric and where the reason for valuation will be more common.
Sales of intellectual property or other commercial transactions, such as a merger or a joint venture, is the context that is most reflective of true market values. When a client is engaged in a sale or transaction, typically true arm’s-length values will be arrived at on the assumption that there is a willing buyer and a willing seller. These sales or transactions can occur through a number of mechanisms or contexts. For example, there can be a one-on-one negotiation in which a buyer has approached an owner, and the negotiations will certainly be based on an arm’s-length market value. Similarly, a client may own a portfolio of intellectual property and choose to negotiate with several people. That negotiation can take place through sealed bids, a sequestered auction, or even an open cry auction. Or, the seller can engage in traditional negotiations with each of two or more possible buyers at the same time.
Examples of commercial transactions and sales range across all types of intellectual property. Some recent simple examples include the following:
• Within the last two years, Citigroup sold one of its classic trademarks, the red umbrella, to St. Paul Travelers, a large insurance entity. While the total amount of the compensation was not announced, reliable sources placed the number in the low eight figures. In return, Citigroup continues to operate under its Citi name and what it refers to as a “red arc” design. Once Citigroup had made the decision to change its logo, it suspected that it had a ready buyer in the insurance industry because, dating back several decades, the Travelers Insurance Co. had been using the red umbrella as its signature trademark. The St. Paul Travelers Insurance Co. was delighted to regain exclusive use of the umbrella, and continues to use it effectively in the unification of its branding.
• A business method patent sold recently for $2.6 million. The patent was unique because it was based on a technology of location matching. In other words, the system works with location-aware devices, such as laptops that are connected to a remote server. This allows users of a social network service, for example, to make connections with other users based on specific geographic preferences and/or proximity. For example, a user who subscribes to a mobile social networking service can set up his or her profile to indicate the types of people he or she would be interested in meeting and locations for those meetings—with specific geographies in mind. Clearly it’s a patent that social websites such as MySpace, Facebook, or Match.com would theoretically be eager to use.
• The Tower Records name and trademark were sold for approximately $2 million within the last few years. While at one time Tower was the nation’s largest retailer of music, the business model of music purchase and download has changed dramatically. Although as a company Tower decided to exit its physical stores, its name, trademark, and associated web-based assets were attractive to several bidders. As a result, a substantial price was reached for a trademark that theoretically was no longer in business.
• Other intangible assets are sold in open-market transactions on a regular basis. Most obviously, of course, are domain names, which have a vibrant marketplace in which new and established domain names are constantly being offered for sale. Similarly, databases and information-based assets are also being bought and sold in a true market-based sale or transaction.
As one would expect, the most appropriate valuation approach in a market sale or other transaction is, of course, the true market-based approach. Since one assumes there are willing buyers and willing sellers, we know that, wherever appropriate, the market-based approach will be used in this context. In the best case where comparable transactions of similar assets can be found, that will give guidance to both parties in terms of true market value. On the other hand, where assets such as uncommercialized technology are sold, the two parties may try to establish value based on either reproduction or replication cost. Finally, the projected future income that the asset may bring to its current or new owner will often be the basis of value.
The important thing to realize is that each party will get what it believes to be true market value from its own specific perspective—again, perspective being part of the context of a market-based sale. What is most important to remember is that the perspective of the willing buyer ultimately sets the value and determines whether a transaction will take place. If, on one hand, the prospective buyer establishes that, from its market point of view, value is less than what the seller perceives, there will be no transaction. Conversely, if the potential purchaser sees greater value than the current owner can believably extract from the asset, then there will be a transaction.
Some specific issues need to be considered in sale and transaction valuation environments, including the following:
• The form of sale to use, such as direct negotiation vs. sealed bid vs. auction.
• The number of buyers—whether there is one buyer or multiple buyers.
• The value that is most important is the value to the buyer or buyers, as they will determine whether they can reach a level where the seller believes it is getting economic benefit from the sale.
• Financial considerations, of course, are important, including whether an all-cash transaction will take place.
• A matter for consideration is whether potential exists for a long-term licensing agreement as opposed to an outright sale (within that context of licensing is a wide range of sub-issues, which we will discuss later).
Finally, one must consider whether the purchaser is a private or public company and how various financial and accounting regulations may affect it. In its broadest definition, a business transaction includes sales, acquisitions, mergers, spinoffs, licensing, and joint ventures that involve transferring title of intellectual property from one entity to another. The valuation process is obviously driven by business issues. However, national and international tax and accounting regulations and standards also play a role in these transactions. In the United States, the most important of these regulations, particularly for public companies, are FASB sections 141, 142, 144, and 147.
This is an area of great complexity, and we provide this overview simply to alert the general practitioner that expert tax advice is typically needed in addition to expert IP valuation advice. Briefly, however, these FASB sections primarily speak to valuation and the booking of assets. They require that all business combinations must use the purchase method of accounting and must value all the intangibles in what is known as a purchase price allocation report. This purchase price allocation also must be updated on a regular basis for so-called “impairment tests,” to see if the value of the intangible asset has been impaired or reduced in value.
In addition, these regulations also provide standard provisions for depreciating the remaining useful life of intangible assets and address how those assets will be amortized. Again, these sections require that any intangible asset or IP that has a finite useful life must be valued, capitalized, and then depreciated. However, those intangibles with indefinite useful lives (e.g., many trademarks) are not amortized.
IP and intangible asset valuation methodologies under FASB are somewhat affected. However, the normal market, cost, and income valuation method approaches are accepted, as is the relief from royalty methodology. The IP and other intangible assets must be valued on an asset-by-asset basis in what is known as a stand-alone value. So what does all this mean? We are simply signaling that some of the practical issues affecting value and valuation in mergers and acquisitions can be complex. There is more detail and more complexity, while at the same time, the regulations are striving for more transparency and more frequent verification of the value of intangibles. This is a very complex topic and is not well understood by many who are not specialists in IP and the accounting aspects of these regulations.
Weston Anson is chairman of CONSOR, an intellectual asset consulting firm specializing in trademark, patent and copyright licensing, valuation, and litigation support. He can be reached at firstname.lastname@example.org or 858-454-9091.
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This article is an excerpt from IP Valuation and Management
, Weston Anson, pp. 95–98. Copyright 2010 © by the American Bar Association. Reprinted with permission. This information or any or portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
© Copyright 2010, American Bar Association.