Here at Metis Partners, we acknowledge that the work of the IP valuation professional must be able to stand up to intense scrutiny, thus, it must be of the highest professional standard
We know that IP valuation is not an exact science, but this should never be taken as a caveat to cover for a lack of process or effective methodology. Many disciplines are not exact sciences – including law and auditing – but these are just as reliable, provided that they are performed by experienced professionals who adopt rigorous professional standards and accepted methodologies.
The methodologies we use to value IP assets (i.e. income, cost and market) are not new, and are widely acknowledged as being appropriate and relevant. Our skill is not in adopting a methodology, but in selecting the most appropriate method for the specific IP assets being valued.
To do this effectively, we need detailed knowledge of IP and, more specifically, a process for identifying the critical IP assets in a business – those that secure competitive advantage and contribute to revenues. Formal intellectual property is easy to identify and the associated costs often appear in a company’s financial statements. However, less formal IP assets, including brands, are hidden from users of accounts. For this reason, companies tend to report only the expense in creating and maintaining brands, without reflecting the potential value that they could generate.
Two vital reasons to correctly handle each IP asset
Accounting standards require that all of the acquired IP assets be classified separately and recognised in the financial statements. We have found that the process of correctly classifying and valuing each IP asset is crucial for two reasons:
- It can significantly affect potential write-offs in the future; and
- Different classes of acquired intellectual property are treated differently for tax purposes.
Seeking acquired IP in our changing valuation landscape
The recent changes to both accounting and tax rules have significantly changed our IP valuation landscape. Companies making acquisitions must now fully assess the assets and liabilities that they have acquired – not just those on the target’s balance sheet. Listed entities applying International Financial Reporting Standard 3 and now UK entities applying Financial Reporting Standard 102 must identify all the assets they acquire. These standards refer to existing and potential customers, contractual and non-contractual relationships, and registered and unregistered trademarks. Companies know that these assets exist – they are committing the resources to them, protecting and monetising them – but have neither had the need (nor perhaps opportunity) to recognise them.
The ecocomic ‘sell by date’ of intellectual property
Separately classifying each IP asset requires us to estimate the economic useful life (EUL) of each asset, in order:
- to determine the forecast calendar period which we use for the valuation calculation of that specific asset; and
- to help the acquirer assess the period of amortisation for each IP asset – instead of having to adopt FRS102’s default EUL period of five years.
It is no easy task, but it can have a significant effect on the IP valuation amount and therefore future write-offs for amortisation of the acquired IP. Our valuation team must assess the potential risk of obsolescence from functional, economic, technological and cultural factors which could affect the EUL of each IP asset and consequently its value. This requires us to gather relevant information on the products or services that the IP underpins and the market in which the products or services are sold.
Five processes for a ‘top notch’ valuation service:
- Quality of intellectual property
Rating the quality of the intellectual property is a vital part of our valuation process. From experience, we know that well-protected and effectively managed IP assets can achieve their potential only in the hands of an IP-savvy company. The valuation is carefully adjusted by us to reflect the relative strengths and weaknesses of each asset.
- Adjustments for risk and uncertainty
We discount future cash flows to reflect that the risk that the revenues the company is forecasting – and on which the valuation is based – may not be achieved. Risk can result from the products, markets and sectors in which the IP assets are being monetised, the ability of the management to fully exploit the intellectual property, the financial resources available or the investment required to enable scale up to achieve forecast revenues.
Is not an exact science, but still is an essential part of our valuation process – the valuation range must make economic sense. The questions we consider are:
- Does our valuation demonstrate that the IP is instrumental in driving the company’s revenues?
- Is the return on the IP assets in line with expectations, and how does it compare to returns from other company resources?
- Is the EUL of each IP asset in line with the sector norms (e.g. the EUL of customer relationships can differ significantly from one sector to another)?
4. Comparability and consistency
In our experience, building or being able to access a database of both previous IP valuations or sales and sector comparables can make the benchmarking exercise considerably less laborious and more consistent. Our skill is not in adopting a methodology, but in knowing IP, correctly classifying it, rating its quality and selecting the most relevant valuation methodology.
5. New discipline
IP valuation is a relatively new professional discipline and inevitably attracts new entrants, eager for a share of this growing market. Although there is little regulation or formal guidance, there are two bulldogs guarding public and corporate interests: the auditor and the tax collector. As a self-regulating profession, we must feel the full weight of this responsibility.
The essentiality of valuation
Valuation processes should be comprehensive, the assumptions justified, the valuations commercially viable and the work documented to provide the clearest of audit trails. Why? Valuations now form an integral part of commercial transactions and corporate reporting, and will directly affect the reported future profits of clients. How IP assets are classified will determine the tax allowances to which companies are entitled.