FITT Toolbox: Valuation Methods


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This practice is dedicated to quantitative approaches to valuation of intangible assets. It focuses on the key advantages and drawbacks of various cost, market and income approaches. Reading this document, the reader will understand how and which method to use in order to practically estimate a financial value of research and development projects outcomes.

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FITT Toolbox: Valuation Methods

  1. 1. Valuation Methods FITT– Fostering Interregional Exchange in ICT Technology Transfer – www.FITT-for-Innovation.euExcept where otherwise noted, this work is licensed under a Creative Commons Attribution 3.0 License.
  2. 2. Valuation PracticeValuation is the practice of estimating a defined monetary value for a single or pooled intangible asset Valuation processes are performed either for transactional (such as commercial activities) or notational (such as accounting activities) purposes. Three main approaches to valuation exist (cost, market & income approaches), each of which have specific strengths & weaknesses, and therefore answer different needs2 | April 2011 Valuation Methods
  3. 3. Valuation in practice General A valuation process is structured in similar manners (tasks), whichever approach (cost, market and/or income) is chosen The different tasks include for such process • Objective definition Data • Standard of value selection collection & analysis • Appraised asset description • Valuation date or period selection • Valuation approach(es) selection and related calculations • Results reporting Always remember that a value is subjective, whereas a price is objective3 | April 2011 Valuation Methods
  4. 4. Valuation in practice Cost approach Cost approach : Measure the value of an intangible asset by taking into account all relevant occurring costs and investments related to the appraised asset  Historic costs : accounting all costs (effective and sunk) directly related to the appraised asset (such as securing, research, development, and licensing-in costs)  Replacement costs : valuing the costs for buying an asset bringing the same utility than the appraised one  Reproduction costs : valuing the costs induced in creating, at the time of the appraisal, a similar asset based on actual knowledge Cost approach is generally used in situations of high uncertainty and limited information exist4 | April 2011 Valuation Methods
  5. 5. Valuation in practice Market approach Market approach : Value consists in the price of a comparable asset in a similar market transaction Market approach relates to the quantification and adjustment of pricing multiples in order to create theoretical comparable conditions Lack of active and transparent market for IP transactions and market dynamics have to be taken into account in the process5 | April 2011 Valuation Methods
  6. 6. Valuation in practice Income approach Income approach : Measure the value of an intangible asset by reference to the expected and actualized benefits, incomes or saved costs over the remaining life of the asset Such prospective-based quantification of financial flows needs to take into account various risk-related factors such as  Endogenous : Extend of IP protection, nature of competition, …  Exogenous : Substitute product development risks, maturity of market, …6 | April 2011 Valuation Methods
  7. 7. Valuation process Part 1 : Objective and standard of value definition Clear definition and overview of the valuation objective is fundamental This part of the process should answer the following questions  What is the intangible asset under valuation?  Why and for which use is the valuation done?  For whom is the valuation appraised, in which context? Such definition helps clarifying the motives for valuation, which are not neutral. Such motives could be related to :  Business and management (Mergers and acquisitions - M&A, Risk analysis, Joint Venture funding, …)  Technology (Licensing in/out, Transfer pricing, …)  Accounting and financial (Liquidation, Fiscal benefits, …)7 | April 2011 Valuation Methods
  8. 8. Valuation process Part 2 : Appraised asset description and valuation date Intangible assets can be described based on various criterias such as  Physical (example: what is the asset under valuation - single or bundled?)  Functionnal (example: what does this asset do?)  Technical (example: is the technology incremental or disruptive?)  Economical (example: what is the economic utility of the asset?)  Business (example: what is the market of this asset?)  Juridical (example: is there a title of ownership?) Clear asset description is needed in order to select appropriate valuation approach Valuation date and/or time periods are used for appropriate actualization8 | April 2011 Valuation Methods
  9. 9. Valuation process Part 3 : Valuation approach selection and calculation Valuation approach selection is based on the information gathered related to previous tasks in the valuation process (see previous slides)  Cost approaches relate to past (certain) or present (reduced uncertainty) information. However, value is usually not correlated to costs.  Market approach relates to the financial adjustment of similar market transactions to the valued asset. Uncertainty can be high, as market, technological, and more generally techno-economic environmental conditions can strongly differ.  Income approach, based on a prospective analysis of future economic incomes, relies entirely on the validity of business and future economic benefits analysis. Uncertainty, although adjustable, is therefore high. Income approach is however the most used approach for valuation.9 | April 2011 Valuation Methods
  10. 10. Valuation process Part 4 : Results reporting Valuation results reporting depends on the reasons underneath the valuation process Particular attention should be given on  Confidentiality issues  Level of engagement related to the validity of the results10 | April 2011 Valuation Methods
  11. 11. When is valuation needed? Valuation of intangible assets can either be a regular process or a specific, on demand practice (to avoid confusion with FITT processes and activities)  As a regular practice, valuation activities could be conducted among organizations at various key moments within a R&D project lifecycle.  As an on-demand practice, reasons for valuation needs are varied, such as :  Active IP management & TT strategies (license pricing, …)  M&A  Litigation management …11 | April 2011 Valuation Methods
  12. 12. Who is implied in a valuation process? Key stakeholders in a valuation process are • Valuator • Client • Individual project members • Management • Employees implied in support-related activities • Third party experts Experience shows that valuation processes benefit from implying as many players related to the appraised asset as possible, in order to manage in the information gathering process the natural routine-related myopia developed in conducting day-to-day work.12 | April 2011 Valuation Methods
  13. 13. Pro’s & Cons Pro’s • Valuation is a mean to answer fundamental needs in terms of financial economic appraisal Cons • Valuation will always remain a mix between an art and a science Approach Cost Market Income Pro’s Reduced Simple theoretical Always right (at uncertainty issues applicability moment of valuation) Cons Future value is not Information Mostly wrong (due correlated to costs asymmetry to uncertainty)13 | April 2011 Valuation Methods
  14. 14. Practical example : software valuation Why was valuation done? Rationale for valuation • Context relates to the need for information in order to (1) decide on an IP management strategy for the results of a R&D project and (2) gather information for a technology license pricing negotiation • This valuation was done on a free software licensed development, bundled with a restricted trademark with strong goodwill and a key role in a community of creative users • The fact that the license for the software was free (Open Source) meant that no monopoly for the software from a technical standpoint could be transferred (therefore valued) • The software as such was protected only by copyright (no patents were involved) • Business model for asset exploitation by licensee relied on a software as a service (SAAS) strategy14 | April 2011 Valuation Methods
  15. 15. Practical example : software valuation Why was valuation done? Impact of valuation practice • Valuation methods used where based on cost and income approaches • Precise historical financial data was available, hence historical costs were valued (Human resources, investments, …) • Clear overview of technology was available (complete technology and IP assessment was done), allowing us to value replacement costs • A “light” business plan was created, in order to gather all necessary data for income approach valuation • This multiple approach gave us a useful “range of value” • This process was successful because it gave us information for license pricing negotiations, therefore reducing uncertainty • The business plan done for the income approach also gave us strong arguments in the course of this technology transfer operation15 | April 2011 Valuation Methods
  16. 16. Practical example : software valuation Outcome of the valuation process Outcomes of this process are positive • However, technical difficulties and time-to-market issues were underestimated by project team • As exposed previously in this document, the valuation date is an important factor, therefore our valuation results needed updates (raised costs, evolving market, …) • Fortunately, the technology transfer operation can now be considered as a success (and valuation played a key role in this)16 | April 2011 Valuation Methods
  17. 17. Valuation Methods: tested by ICBSThe valuation methods were tested by ICBS (Imperial College Business School) Context of Test:  IE&D program  The excelsheet was used during the workshops to offer the students guidance in assessing the value of their IPR Difference in context:  IE&D: pedagogical context Objective: value the IPR of the IE&D projects Modification of practice needed before testing: no17 | April 2011 Valuation Methods
  18. 18. Valuation Methods: lessons learned by ICBS Remarks after testing:  The students that tested the tool all acknowledged the usefulness of the tool  Quick overview and fast & reasonable evaluation  The tool is applicable for many different projects  Quality of the valuation still depends on the quality of the input data available to make the calculation Suggested Changes:  For some of the indicators it might be useful to include some more explanation, for instance:  Tax rate: indicate tax rate for various countries  Risk free rate: explain what type of bond is usually used  Annual inflation rate: f. ex. Expected economic growth  Or the sheet could provide some links where this information can be obtained18 | April 2011 Valuation Methods
  19. 19. Outcome of this process Plans for the future? • This process, based on several best practices, will be upgraded • A tool is actually under creation (excel sheet), which will facilitate the various calculation and parameterisation needed for each approaches • A separate useful document (under creation) relates to the choice- impacting factors for valuation methods based on information availability (list of criteria related to technology, legal, organizational and market and how their characteristics could favour the choice of a given method) • Finally, our income approach model is based on endogenous royalty (or income) increasing or decreasing factors. Such factors (i.e. parameters) need to be developed further in order to be more representative of free and open source software licensing issues19 | April 2011 Valuation Methods
  20. 20. Suggested Readings Codebook linksValuation – Tudor – IP Management Other readings ISO/DIS 10668 - Brand valuation - Basic requirements for methods of monetary brand valuation | April 2011 Valuation Methods