The nature of big business has changed dramatically over the years. Up through the 1970s in the US most big business was manufacturing oriented, including the distribution of manufactured products (wholesalers and retailers). These types of businesses are tangible asset heavy – they own real estate, manufacturing facilities, distribution assets and the like. In fact, these types of assets accounted for nearly 80 percent of the total market capitalization (value of the S&P 500 companies in 1975 – leaving only about 20 percent of the market capitalization associated with intangible assets – including intellectual property (or “IP”).
Today that is not the case. Many of the big manufacturers are gone – either completely or off-shored to manufacturing facilities in China and other countries. The big publicly traded companies today are technology, communication and media companies – all of which depend on tangible assets to a much lesser extent than their predecessors. So much so that the proportion of tangible assets attributable to the market capitalization of the S&P 500 companies today are represent less than 25 percent of the total. That means the balance, or 75 percent or more of the market capitalization, is associated with intangible assets, including intellectual property.
But intellectual property does not exist solely in the domain of big business. Small businesses, professionals, artists, musicians, and other similar individuals and entities can call generate valuable intellectual property.
What is intellectual property? The World Intellectual Property Organization (www.wipo.int) defines intellectual property as “creations of the mind, such as inventions; literary and artistic works; designs; and symbols, names and images used in commerce.” Most people think of patents, trademarks, copyrights, and similar items as IP – and they are correct. These types of IP items are “statutory” in nature. That is, they exist because of some legal construct. Someone can patent an invention at the US Patent Office (or one or more of many governments) and obtain legal protection against infringement by others attempting to use the same invention without permission.
Often the owner of IP will license its use to third parties on some basis. This is referred to as licensing the IP. Such licensing can be unlimited in scope or limited in terms of time, exclusivity, or application.
There are many reasons for valuing intellectual property, including to support a transaction of IP, the valuation of IP for accounting and financial reporting purposes, for estate planning, and in the context of a litigated dispute.
Many will remember the case – and subsequent movie, “Flash of Genius” (2008) – where Robert Kearns takes on the Detroit automakers who he claims stole his idea for the intermittent windshield wiper. He had tried to license the technology to all the Detroit auto makers in the 1960s but was turned down. Even so, the automakers introduced the intermittent windshield wiper in 1969. After a very protracted series of lawsuits, Mr. Kearns eventually won more than $30 million.
Advent has been valuing IP for more than 20 years, including patents, copyrights, royalty contracts for movies and TV shows, famous musician’s record catalogs, brand names, software, and customer, advertiser, and patient lists. What do we need to know to value these types of assets? While that may vary from type of IP to type of IP, here’s a list of things we almost always need to know:
- Who owns the IP? Is the owner is an individual or entity? Sometimes we are asked to value the IP. Other times we are asked to value a specific, and oftentimes limited, interest in the IP. Ownership structure and rights impact value. The legal documents identifying ownership and rights to the IP should be made available.
- Has the IP been published, patented, or registered? IP without protection is more vulnerable to third party exploitation, adding an element of risk and potentially impacting value dramatically.
- What is the economic life of the IP? Not to be confused with statutory life, which is determined by law or statute, the economic life is a key driver of value. Take patented micro-chips for cellular phones, for example. While they may have a 20 year statutory life, the useful, or economic, life may only be two years or less – until a better, more advanced featured chip is developed.
- Are royalties currently or historically being received? If not, it’s possible that the IP is not a valuable asset. Alternatively, what are the potential uses for the IP and are the alternative IPs that are essentially competitive to the IP? The answer to this question helps identify the potential economic benefit that could be generated by the IP.
- Is the future income stream fixed or variable? A variable income stream is riskier because it depends on certain conditions to occur that may not. A fixed fee agreement is paid regardless of potential exploitation occurring or not. A “percent of revenue” licensing arrangement ties the licensing benefit directly to future – and unknown – sales success. At the end of the day, the value of IP is based upon the economic benefit it generates to the holder of the IP. Related, if there are additional expenses associated with perfecting or exploiting the IP, such will likely impact value.
- What development costs are needed to optimize revenue? Most licensing agreements are based on a percentage of revenues or a fixed amount of units sold. If the additional costs to commercialize are unduly high, the licensee(s) may not be willing pay these costs as the deal may end up being uneconomic for them. Think of this in these terms: would you pay the same price for a partially completed house as you would if it was fully finished?
- Do the rights to exploit the IP expire or are they perpetual? Statutory rights don’t last forever, and the duration depends on the nature of the property. Regardless, the licensing arrangement can be open ended or have a specific term.
- If the IP is a patent, how solid is its claim? What is the probability that others will claim it infringes on their patents. Such impacts risk and value.
Valuing IP is very fact specific, both to the type of IP and the characteristics of the IP; legal, operational, contractual, and financial. These types of questions – and others – help Advent professionals identify the inputs necessary to develop an opinion of value.
Questions? Call us at 845.567.0900 or 212.308.4151