Intellectual property (“IP”) in a divorce situation

1. Valuing Intellectual Property
in the Context of a
Divorce Proceeding
Brian R. Potter, CFA, CFE – bpotter@srr.com
Bruce W. Burton, CPA, CFF, CMA, CLP – bburton@srr.com
Scott Weingust – sweingust@srr.com
©2014 1
Intellectual property (“IP”) in a divorce situation is a growth
area at least from SRR’s perspective. In divorce, the IP to
be valued may be: personally owned or an asset of a sole
proprietorship, partnership, or corporation. In addition, some
of our experience flows from specific clauses of pre-nuptial or
ante-nuptial agreements.
Reflecting the upsurge in relevance of IP valuation in divorce
actions, SRR has chosen to publish through this article excerpts
from one of our webinars on this topic.
Due to space limitations, we have had to excerpt and edit the
original presentation made October 24, 2013, by Brian Potter,
Bruce Burton, and Scott Weingust of SRR. The full webinar is
available for viewing on our website at http://www.srr.com/
events/bruce-burton-scott-weingust-and-brian-potter-
presented-valuation-intellectual-property-contex.
Introduction to IP n n n
The four primary types of IP include patents, trademarks,
copyrights, and trade secrets.
Patents
A patent is a grant by the United States government of property
rights to an inventor. The right to grant a patent was written into
the Constitution in 1788. A patent conveys to the patent owner
the right to exclude others from making, using, selling, offering for
sale, or importing into the U.S. products that are covered by the
claims of that patent.
Most patents granted are called utility patents. If the invention
covered by a utility patent application is new, useful, and non-
obvious, a patent may be granted. Utility patents have a life
of 20 years from the date of application and, as a practical
matter, given that the grant date is usually 2-3 years after
the date of application and that a patented invention often
becomes obsolete before the patent expires, the useful life of a
patent is often much less.
Trademarks
A trademark is a word, phrase, or design that identifies and
distinguishes the source of the goods of one party from those
of another. The term of a trademark can last forever in certain
circumstances and, with certain exceptions, must be used
continuously. Examples of some companies with well-known and
recognizable trademarks include McDonald’s, Pillsbury, Apple,
Nike, and Coca-Cola. Some of these companies include the name
of the product within the symbol/logo, while others are symbols
that are recognizable. The Apple Corporation, for example, uses
the apple symbol, while the swoosh is used to represent Nike.

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Trade Secrets
A trade secret is valuable information that companies keep secret
to give them an advantage over their competitors. A trade secret
can be a formula, computer program, method, technique, customer
list, or other private information that is kept secret from those
outside the organization. If the information is disclosed to people
outside the company, it must be protected by a confidentiality
agreement, non-disclosure agreement, or other form of contract.
A trade secret can last forever, assuming it is kept secret. Once
a trade secret is known by the public, it is no longer protected.
In order to continue to protect a trade secret, it is important that
trade secret owners establish a variety of procedures to continue
to protect their trade secrets from inadvertent disclosure or theft. It
is not recommended to share trade secret information with others,
even with employees of the same company, generally, unless they
need the information in order to effectively perform their job. One
of the most well-known trade secrets is held by The Coca-Cola
Company (“Coca-Cola”). The secret formula for Coca-Cola is kept
under lock and key in a secure location in a bank vault, and only
very few people are allowed access.
Copyrights
A copyright is an exclusive legal right given to a creator of an
original literary or artistic work, including music, books, and/
or computer programs. While duration depends on a variety of
factors, for works created after 1977, protection lasts for the life of
the author plus an additional 70 years.
Each of these four types of IP can be relevant in a divorce
situation but undisclosed marital IP assets will most often be
in the form of patents.
Business Valuation vs. IP Valuation n n n
Business valuation generally involves the determination of the
enterprise value (“EV”) of a company. EV can be thought of in the
context of a house. EV is akin to the value of the entire house,
regardless of how the purchase of that house was financed. In
order to arrive at the value of the owner’s equity in the house, it
would be necessary to carve out the value of the mortgage (debt)
on the house from the EV. The process is similar in arriving at the
value of an equity interest in a business. Thus, it follows that the EV
of a business is comprised of the market values of debt and equity
of that company. The EV of a business can also be expressed as
the collective value of a company’s individual assets including net
working capital, tangible assets, and intangible assets.
There are three approaches that are generally accepted in the
valuation community and courts for valuing a company or business,
consisting of the Income Approach, the Market Approach, and
the Asset Approach. Within each of these approaches there are
various methodologies that can be employed to determine the EV
of a business. The majority of these methodologies consider the
Cash Flow generated by a company in arriving at EV.
Differentiating EV from the Value of IP Used
Outside the Business
Continuing with the value of a house example, we can show how
the EV of a company in a Fair Market Value context is usually not
equal to the Book Value of that company. Assume you bought
a house 20 years ago, and you paid $100,000 for that house.
However, based on a recent home appraisal, the market value
of your house is currently $200,000. If you were reviewing your
personal balance sheet, your house would be listed at $100,000
even though its market value is currently $200,000. The reason is
that book value for financial presentation is an accounting concept
that is based on historical cost rather than current market value.
Another difference between a company’s book value and Fair
Market Value is that certain assets, such as patents developed
internally by a company, are not “booked” or recorded on a
company’s balance sheet. Therefore, costs associated with
developing the patents will be expensed in the period incurred
and will not be on the balance sheet (this practice is deemed
appropriate due to the lack of certainty regarding future realization
of the benefits from the research and development supporting
the development of the patent). Finally, a company’s assets may
generate Cash Flows that support an EV that is in excess of the
combined value of its assets. This excess or residual value is
referred to as intangible value.
What are the components of intangible value?
There are two components of intangible value, including
identifiable intangible asset value, which is derived from intangible
assets that can be separated (i.e., sold, transferred, licensed,
etc.) from the business and unidentifiable intangible asset value,
which is derived from a company’s goodwill (either enterprise or
personal). The value of a company’s IP will be captured in its EV to
the extent that the IP is contributing to (and being reported in) the
Cash Flows of the company. However, there are certain instances
when a company’s IP may have value outside of the company’s
normal business operations, including:
n Pursuit of potential infringers through litigation
n License of that IP to outside parties
n Value flowing from the sale of the IP to outside parties
In general, IP value should be captured as part of a business
valuation to the extent it is being employed by the company to
generate operating Cash Flows. However, there may be value
associated with a company’s IP over and above that captured in
EV to the extent that: 1) the IP portfolio is creating positive Cash
Flows which are not being captured or recorded by the business,
or 2) the IP portfolio is not being fully or reasonably deployed by
the business and, therefore, it is not contributing to the business’
reported Cash Flows to the full extent of the IP’s value.

3. ©2014 3
The concept of IP contributing value outside of the normal course
of the business’ activities is somewhat analogous to an expensive
piece of company-owned art hanging in the executive office suite
of a manufacturing company. That work of art is not contributing
to the Cash Flows of the business going forward and, therefore,
is not a part of the operating value of the company, but since the
company owns that piece of artwork, it does increase the EV of
that company because it can be sold separate and apart from the
business operations of that company.1
Identifying Unvalued or Undervalued
Intangible Marital Assets n n n
IP value outside the normal operations of the business is properly
not included in a business valuation because its monetization
is typically not viewed as part of the normal operations of the
business. This normal and correct business valuation process may
miss important and integral parts of the inherent value of certain
types of IP. In turn, this oversight can cause the non-moneyed
spouse to entirely fail to identify significant amounts of IP value
that could be very significant to the total marital assets at issue.
For divorce counsel, it is typically relatively easy to identify the
existence of potentially relevant IP. Below are some characteristics
to look for:
n Business – If the business is unusually profitable, it’s
almost always attributable to some unique assets. The
unique assets may be physical assets, such as the
location of key business properties, but often the high
return is the result of intangible assets such as IP.
n Industry – Some IP-intensive industries include
telecommunications, media & entertainment,
pharmaceuticals, medical devices, and consumer goods.
n Identified or readily identifiable IP – IP might already
be identified as part of the business forecast or plan, but
typically it is not. If the IP is not identified or only partially
identified, counsel can usually find IP or additional IP
through inquiry or discovery with the company. Assets
such as the following can often be discovered:
n A valuable individual patent or a significant
patent portfolio.
n Trademarks practically licensable outside the business
— in many instances, it is not practical to license
trademarks outside of the trademark owners business
so there is no real value to the company’s trademarks
outside of the company. However, there can be licensing
opportunities associated with trademarks or copyrights,
as well.
n Copyrighted material practically licensable outside of
the business
n Books/websites
n Pictures/drawings/photographs
n Databases of results/findings
n Compilations of data
n Other
n Trade secrets are also potentially licensable,
but this is rare.
Identifying the relevant IP is an important first step that has to be
completed before the IP can be valued. However, after identifying
the potentially relevant IP, counsel and/or other advisors have to
evaluate the various IP assets to see if they are currently either
undervalued or not valued at all. Once IP has been identified, and
further determined to be potentially unvalued or undervalued,
it then has to be valued.
Key Attributes of an IP Valuation n n n
Like business valuation, IP valuation employs three primary
valuation approaches commonly referred to as: the Income
Approach, the Market Approach, and the Asset Approach.
However, IP presents some special valuation issues. Some of the
characteristics of IP that create special valuation issues reflect
that, by definition, they are unique, legally protected assets
with certain rights and associated value that is often extensively
defined through court decisions. Reflecting that intangible assets
have special characteristics, the below valuation methods have
been developed as specialized versions of the traditional valuation
approaches and are frequently used in conjunction with these
traditional approaches to reflect the distinct value characteristics
of various kinds of IP. These specialized approaches include:
n Hybrid – Combination of two or more of the
primary approaches
n Relief from Royalty -–The IP value is represented by
the present value of the notional royalty stream that
ownership relieves the business from paying for use
of the subject IP
n Litigation – Models based on techniques commonly
used in litigation
n Rules of Thumb – Mainly used for testing,
confirmation, checking results
Whenever possible, we find it is better to use at least two or more
valuation methods to triangulate on the value that we will ultimately
arrive at for the IP.
1
One difference from the accounting for IP of note is that generally the piece of art would be included on the balance sheet, whereas most non-purchased IP is not. (Unfortunately, accounting
guidance relating to IP is relatively complex and beyond the scope of this article.)

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Differences between Business
and IP Valuation n n n
Some important differences between business valuation and IP
valuation are summarized here:
n Both business and IP valuation use the same
conceptual approaches, but they require different
calculation methods.
n IP valuation entails valuation of a single asset,
or small group of similar assets, versus a collection
of diverse assets.
n Assessing a different income stream — total company
Cash Flows vs. incremental Cash Flows attributed to IP.
n Business valuation typically assumes the business will
continue as a going concern, whereas IP often has a
finite life or diminishing returns.
n The level, assessment, and quantification of risk
vary significantly.
n By definition, IP assets are unique, which typically makes
market approaches based on comparables more difficult.
n Business valuation includes certain discounts and
premia foreign to IP valuation.
IP Valuation in the Context
of a Marital Dispute n n n
In certain circumstances, IP valuation can add millions of dollars
to the marital estate. When working with the non-moneyed spouse
in situations where there may be significant IP, counsel should
consider what examination of IP is important and whether it
makes sense in light of the possibility of finding additional assets.
If counsel decides to consider the existence of IP assets, consider
the steps below.
If unvalued or undervalued IP is suspected:
n In order to identify possible sources of unvalued or
undervalued IP, consider relevant indicia such as:
n Characteristics of the relevant industry
n High profitability levels of the business
n Already identified or identifiable valuable
or significant IP
n Preliminarily evaluate potential incremental value
of the IP to the marital assets to ensure that the
value is worth pursuing.
n Determine the actual incremental value of the IP using
some sort of a phased approach to valuation starting
with what are expected to be the most valuable
IP assets.
As with any other type of valuation, certain cautions should be
employed. For evaluating IP in the context of a marital dispute:
n Care should be taken to avoid double counting
benefits from IP as part of the relevant business
value and again as additional marital assets.
n Monetization scenarios must be demonstrably
reasonable and practical.
n IP must be properly valued using defensible
techniques.
n Incremental IP value is still a somewhat novel marital
asset. Consequently, the acceptance of incremental
IP value outside of the business by a finder of fact
may be difficult to determine or confirm in advance.
n The identification/valuation process will likely be
difficult and highly contentious.
n The process will be time consuming, expensive,
and uncertain as to the outcome.
IP valuation is a well-established discipline that may, when there
is significant IP in the marital estate, be instrumental in adding
additional, supportable IP value to the marital assets calculation.
Brian R. Potter, CFA, CFE is a Director in the Dispute Advisory
& Forensic Services Group at SRR. He provides valuation,
litigation advisory, and forensic accounting services for
numerous purposes, including marital dissolutions and
shareholder disputes. Mr. Potter can be reached at
+1.312.752.3352 or bpotter@srr.com.
Bruce W. Burton, CPA, CFF, CMA, CLP is a Managing Director
in the Dispute Advisory & Forensic Services Group at SRR. The
focus of Mr. Burton’s practice is commercial litigation with a
special emphasis on IP litigation and IP valuation. Mr. Burton can
be reached at +1.312.752.3391 or bburton@srr.com.
Scott Weingust is a Director in the Dispute Advisory & Forensic
Services Group at SRR. He has over 17 years of experience
providing consulting services to corporations, law firms,
universities, and investment firms primarily in the areas of
IP litigation and valuation. Mr. Weingust can be reached at
+1.312.752.3388 or sweingust@srr.com.
This article is intended for general information purposes only and is not intended to provide,
and should not be used in lieu of, professional advice. The publisher assumes no liability
for readers’ use of the information herein and readers are encouraged to seek professional
assistance with regard to specific matters. Any conclusions or opinions are based on the
specific facts and circumstances of a particular matter and therefore may not apply in all
instances. All opinions expressed in these articles are those of the authors and do not
necessarily reflect the views of Stout Risius Ross, Inc. or Stout Risius Ross Advisors, LLC.