The Debate: Valuing intellectual property

Not as easy as it looks

Accountants can do a lot of things, but they can’t value intellectual property. I can understand how an auditor, looking at a one-dimensional financial picture, arrives at what seems to be a justifiable valuation.

But it frustrates me that so few accountants are able to go beyond the black and white numbers.

To get a true valuation of intellectual property you need to assess a number of factors in addition to conducting a historical analysis: the legal status of the assets, current (and likely future) market conditions, knowledge management processes, and the quality of IP management in the organisation generally.

Accountants should understand the legal definitions of value and appropriate case law. And there’s another point – conflicts of interest. How much notice is taken of the 1993 ICAEW rules which state that auditors can not audit specialist valuations that have been prepared by their own or an associate practice in the UK or abroad?

Aside from conflict issues, we are in an age when the value of intangible assets frequently outweighs tangible ones, and as far as I am concerned, the approach most accountants use is outdated.

Too often this revolves around a superficial assessment of hard IP assets including trademarks and patents. Where each item in a portfolio of 50,000 FMCG trademarks might have had a value 25 years ago, subsequent consolidation and globalisation means only a small number are likely to deliver real value today.

In addition, many trademarks are ‘soft’ and can be cancelled if they have not been used for five (or in some cases, three) years. Yet it’s not uncommon to see accountants slap a substantial value on them. Equally, coming ‘off patent’ affects the value of IP. US sales of Prozac, Eli Lilly’s $2.6bn-a-year antidepressant, fell 80% in a month after its core patent expired in August 2001.

When considering the real value of intellectual property, accountants should question whether things are as clear cut as they may seem. In one example I was involved in, a publisher wished to sell-off a division, with the rights to a popular children’s book forming the jewel in the crown.

Unfortunately, a licensee had been allowed to register most of the trademarks relating to the character. When it came to light these vital rights were missing, the purchase price was significantly reduced. This had escaped the accountants’ attention.

While I am not suggesting that accountants shouldn’t play a role in valuing intellectual property, I believe businesses are better served if the accountants’ contribution is put in a much wider context. To rely on number-crunching alone in valuing IP is seriously negligent.

  • Ben Goodger of Willoughby & Partners, the UK legal arm of IP specialist Rouse & Co International

Standing up to audit scrutiny Attributing a value to intangible assets in a UK company’s balance sheet has always been a controversial subject, because the UK accounting standard setters and some members of the business community do not believe that the commonly used methodologies are capable of producing a robust fair value.

In order to calculate the value of an intangible asset, it is important to understand how the asset creates value. In very simple terms, most intangible assets create value by generating improved profits for their owners, either through increased revenues or reduced costs.

There are several widely used methods of valuing intangible assets, which may be loosely grouped under the headings of cost, market and income based.

Briefly, the cost-based methods calculate the cost to get the asset to its present location and condition, the market based methods estimate the value of the asset by reference to transactions in similar assets and the income based methods are designed to quantify the improved profits generated by the asset.

There are variations on the income approach, promoted by some consultancies and applied specifically to brands, whereby a scoring system is applied to determine the strength of the brand and the resulting score is factored into the discount rate.

Income based approaches, such as royalties foregone, are considered the most robust methods as they calculate the ‘premium’ cash flows that the asset generates for its owner. The cost of creating an intangible asset is unlikely to bear any relation to its current value and whilst transactions in individual intangible assets do take place, they are rare and it is therefore difficult to draw meaningful conclusions from the available data.

It is also important that the valuations must be able to stand up to audit scrutiny and indeed in some cases to review by regulatory authorities.

Thus the valuation process must be robust, clearly documented and based on empirical evidence. A ‘black-box’ valuation or one that uses highly subjective methodology is unauditable and will thus lack credibility.

Accountants, who are also valuers, have the skills to prepare a rigorous analysis of the company’s financial information to extract the details of the net incremental income arising from the ownership of the intangible and understand the market.

They also have a disciplined and logical approach and are aware of the qualities which the asset must have in order to be separately capitalised and the level and quality of information required to meet the auditors’ and regulators’ requirements. Accordingly a valuation prepared by accountants should satisfy even most sceptical Doubting Thomas.

  • Caroline Woodward, director, PricewaterhouseCoopers Valuation & Strategy.

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