INTELLECTUAL PROPERTY - VALUATION
Barry Yen, So Keung Yip & Sin, SKYS
There are many ways of valuing intellectual property and the methods chosen are not always consistent. The minimum value of a license or such things as production lines are more easy to determine since they will have been recorded in the company books. Other types of knowledge such as drawings, technical data, technical specifications, quality control and management skills are more difficult to value.
There is an increasing awareness of the value of intellectual property rights and an increase in demand for accurate valuation. Giaxo Glaxo Wellcome in its 1995 Annual Report valued its goodwill at about $8,000 million. On the local front, a large local trade mark valuation was undertaken by the retailer Yaohan International Holdings in 1994 . Yaohan valued its trade marks at about US$50,000,000 with its goodwill comprising about US$10,000,000 of its total assets of US$350,000,000 in 1994 . Most of the goodwill is embodied in intellectual property rights but there are other factors which contribute to goodwill, such as the level of advertising, donations to charity and the promotion of community events.
In the past, intangibles like goodwill were commonly written off against reserves in the year of purchase. This was occasionally exploited by writing off more than necessary in order to defer profits. When that acquisition was sold again the goodwill previously written off could be written back as profits for the purpose of sale. Now companies are tending toward including the intangibles in the balance sheet and amortising them. The practice of doing so commenced in the mid 1980's in the United Kingdom. Hong Kong tends to follow the UK accounting practice. There is no universal agreement on how intellectual property should be valued. Some of the methods of valuing intellectual property rights, in very general terms, are:
- Examination of financial data - the accountant's valuation. This method considers such things as theoretical income projections and profitability. Past profits are used by accountants to measure likely future profits. It is assumed that future profits levels will be maintained. Even though this method may appear easier to quantify, there is a degree of uncertainty and probability. Judgment needs to be exercised in establishing values, estimating the time over which the future benefit will be derived and identifying the scope of future benefits.
Relief from royalty method. This method assumes that the business does not own the intellectual property and a price is determined by calculating what it would have to pay in royalty fees to use it exclusively for a certain period. Royalty rates can very tremendously according to the type of products and where they are sold. For example royalties may be as low as 0.25% in some food categories to as much as 15% in businesses such as personal accessories, jewelry or cosmetics. This method assumes that there will be no material change in the market.
Capitalising (adding to the balance sheet) actual royalty from licensing the intellectual property to others. This method is relatively easy for major corporations who license the use of their intellectual property but may prove more difficult for smaller local companies who do not license. The proponents of this method say that this is the only true way of determining the underlying value of the intellectual property rights; however, this alone would not provide the total picture since the company itself will probably be using the intellectual property as well.
In the case of trade marks, considering the difference between the profit margins of relatively unknown or non-brand name firms and well known brand name firms. This has also been called the "premium price to earnings method". This method is controversial because you are not always comparing similar qualities of goods or services. Further, it relies on there being a conveniently available business of similar size and kind which was recently sold without a familiar trade mark.
- Comparing prices at which comparable assets have been bought and sold. The problem with this approach is also the difficulty of making an accurate comparison.
This is of course a simplistic summary of how technology and intellectual property rights can be valued. The least accurate methods are 4 and 5. Methods 1 and 2 are probably the most frequently used methods. There are numerous accounting firms and specialist intellectual property valuers who use a hybrid or combination of these methods to value technology and intellectual property. Further, each method could be supplemented by a review of other components such as the extension potential, position, protection, status, transferability and future of the trade mark, copyright or technology in its particular sector. Having arrived at some value for the technology and intellectual property you must also consider whether further work needs to be done, and costs incurred, to exploit those assets to their fullest potential.
The value which is placed on technology or a bundle of intellectual property rights can be vastly different over a space of even a few years. The value may have crystallised at a time when it was purchased separately or as part of another business, but the value is constantly changing. For the value of technology and intellectual property to keep increasing it must receive input from advertising, marketing, research and product development. It is well recognised that reputation in a trade mark is built up slowly but can be lost very quickly. For example, a product recall due to a malfunction, a competitor's introduction of a new more advanced product, and increasing public awareness of environmental or social issues can all effect the value of company's technology and intellectual property.
Notwithstanding all these methods and possible combinations, ultimately the value will be determined by what someone else is prepared to pay for the intellectual property at a given time, rather than the value the owner places on its.
What then is the consequence of the valuation of intellectual property?
- It can be mortgaged or charged to raise money. Increasingly, the Trade Mark Registries around the region (for example in Australia, China, India, Hong Kong, Japan, Philippines and South Korea) are making provision for the recordal of charges of trade marks which can be searched when conducting due diligence. This recordal is usually voluntary except in South Korea where it is mandatory. In Japan recordal is necessary for the pledge to be effective against third parties.
- It can increase the book value of a company.
This memo has been prepared for background purposes only. It is not legal advice and it is not accounting advice.
Copyright 1997
Barry Yen
So Keung Yip & Sin - SKYS
