May 29, 2017 | Valuations
Most Maine-based businesses today have valuable intellectual property. Valuing it can be difficult, as the most commonly applied valuation methods of market, income and cost, aren’t always effective when valuing intellectual property. For this reason, professional valuators often turn to the the royalty method for these unique assets.
Most intellectual property generally falls into one of four broad categories: patents, copyrights, trademarks and trade secrets. But it also may include unpatented proprietary technology, trade names, trade dress, brands, computer software, customer lists and other assets.
There are many reasons for valuing intellectual property. They include financial reporting, tax compliance, litigation, and sale or licensing transactions.
Financial Accounting Standards contain information critical to valuing intellectual property. Businesses are required to:
1. Allocate the purchase price of an acquired company among the tangible and intangible assets being acquired (Accounting Standards Codification 805, Business Combinations).
2. Test acquired goodwill and other intangibles annually for impairment and write them down if their fair values drop below their carrying amounts (Accounting Standards Codification 350, Intangible Assets – Goodwill and Other).
Testing goodwill for impairment is a particularly complex process. However, the value of goodwill usually depends on the value of a company’s tangible and identifiable intangible assets, which does include intellectual property.
While intellectual property assets can be valued using one or more methods within the three basic valuation approaches of market, income and cost, there are limitations to these methods. Valuators can’t identify and quantify all of the costs involved in creating an intellectual property asset. And the cost of creation may have nothing to do with the value of the intellectual property. The market approach may not work because it can be difficult to get comparable transactional data.
In light of these limitations, the royalty method can be an effective alternative. It is categorized as an income-based method, although it may also share some attributes of the market and cost approaches.
A Time-Tested Approach
The royalty method basic idea is that the asset’s value is equal to the value of the royalty payments from which the company is relieved by virtue of owning the asset.
A valuator applies the method by selecting a royalty rate based on available market data for licenses involving similar assets, industries, territories and other characteristics. Then the valuator selects an appropriate, risk-adjusted discount rate to determine the present value of the royalty payments.
Typically, this hypothetical license is treated as a perpetual license. To estimate the value, the valuator calculates the present value of projected royalty payments over a certain period and then calculates the present value of the residual at the end of that period.
Although the royalty method approach may seem new, professional valuators have been using it for many years. The royalty method may be the best method of reaching an accurate appraisal, no matter the reason for valuing intellectual property. Meet with Filler & Associates to discuss more details.