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Context is the ultimate arbiter of value. Special application to Intellectual Property and Intangible Assets

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  1. 1. by Daryl Martin and David C. Drews n part one of this three-part series, we discussed the concept of intellectual property used as collateral for securitization and lending. We stated that intellectual capital is more readily available for strategic use than ever before. Whether the IP owner is interested in a straightforward loan using valuable trademarks and customer lists as collateral, or in securitizing the royalty payments associated with licensed assets, there (Continued on page 24)22 THE SECURED LENDER
  2. 2. are options available today that will help to reduce risk, value of the intangibles. These factors differ from oneincrease return and provide flexibility for resourceful scenario to the next and the same asset will have differentowners of intellectual property. values when viewed in the context of a large corporation, a In part two, we bring forward a discussion of the joint venture, or a company going through reorganization.critical factors affecting the value of the intangible-assetportfolio. When considering the value of intellectual Asset identificationproperty used as collateral for lending or securitization, it An important part of identifying the valuation context isis important to understand that the value of these assets the determination of which assets are to be included in thewill vary depending on the context of the valuation. In fact, analysis. Patents, trademarks and copyrights are the usualthe context is the single most important determinant of focus. However, other intangibles can have a significantvalue. For example, the value of a trademark or other impact on the firm’s success. Among these are slogans,intangible asset is likely to be worth more to a large manu- characters, packaging design, non-compete clauses,facturer in a relevant industry than to a small business proprietary sales methods, effective customer lists, tradeentrepreneur just starting out. secrets and formulae. Intellectual property is not a finite asset in the way When considering the context of the analysis, itthat tangible assets are. When a manufacturing plant is makes sense to view these assets in terms of their relationpurchased and used according to its capacity, no additional to one another. For example, the intangible assets utilizedvalue can be extracted from the asset. Similarly, one in the marketing process may be more accurately valued ascannot sell the same plant over and over again. an integrated package of assets rather than as stand-alone In contrast, intellectual property has no such assets. This is because related assets tend to reinforcelimitations. A corporate brand can be applied to as many each other in the marketplace. With marketing assets, theproducts and as many units of those products as the overall package may consist of the brand name, logo andcorporation can produce. In a similar fashion, a patent worldwide trademark registrations, secondary trademarkscontains no limitation on the number of products featuring and logos, trade dress, Websites, and any other assets thatthe invention or units of those products that can be contribute to the promotion of the company, the brand orproduced over the patent’s useful life. Consequently, large the products.corporations can extract tremendous value from intellec- This bundling approach applies to all forms oftual property because they can typically produce, sell and intellectual property, whether the focus is technology suchdistribute substantially more products than a small as patents, trade secrets and formulae, or knowledge andentrepreneur. skills assets such as proprietary training manuals, operat- Large manufacturers typically possess more of the ing procedures or customer lists. Whatever package iscomplementary factors required to unlock the potential deemed most appropriate for the immediate context, thevalue of the intellectual property. These factors include bundling technique provides a solid foundation for aassets such as a skilled work force, abundant capital, an realistic valuation exercise. Listed below are the mosteffective marketing program and proven distribution common bundles of intangibles assets contained within achannels, among others. The presence or absence of any corporation’s IP portfolio: the marketing bundle, theone of these factors can have a significant impact on the technical bundle and the information technology bundle. Marketing Bundle Technical Bundle IT Bundle Primary Trademark Key Patents Operating Systems Corporate Name and Logo Trade Secrets Enterprise Solutions Marketing Umbrella Formulae Custom Applications Sub-brand Names Packaging Technology Data Warehouse Worldwide Trademark Registrations Manufacturing Technology Data Mining Copyrights Product Specifications Mailing Lists Secondary Trademarks Product Shapes and Sizes Domain Names / URL’s Packaging Design Proprietary Test Results Third Party Software Tools Trade Dress Technical Designs Certifications Product Names Drawings, Manuals Source Code24 THE SECURED LENDER
  3. 3. Valuation contextThe assets included in these bundles, along with thecomplementary factors, are not the only aspects of thecontext in which the intellectual property must be viewed.The current status and reasonable prospects for the owner/user of the property also must be considered whenevaluating the value of the intangibles to potentially beused as collateral. Whether the company is a goingconcern or is undergoing reorganization will have asubstantial impact on the IP value. Also, if the assets are tobe sold, can they be marketed under an orderly disposalscenario, or is the context one in which the assets are to beliquidated immediately? Each factor will likely lead to adifferent outcome for the valuation analysis. If a going concern, the value of the IP is determinedby the ability of the intellectual property assets to capturemarket share and command premium pricing in themarketplace. These characteristics will depend upon thecompetitive nature of the industry and the company’s The decline in asset values associated with a forcedrelative competitive status, as well upon the existence of liquidation are well documented and easily understood.the complementary factors outlined above. The IP value in Lesser known is the extent of the decline that will bethis situation is the price most likely to be achieved in an experienced by the intellectual property in a liquidation scenario. From experience, we have seen that assets that can be used in more than one industry, such as desks and trucks, tend to have a smaller liquidation discount than Daryl Martin is assets that are industry- or manufacturing-process specific. of While this will depend on the competitive aspects in place David C. Drews is founder and president of IP etrics LLC in San Diego, CA.orderly disposition of the assets, one in which a fair price is He can be reached at 858-538-1533 ornegotiated between unaffiliated parties that are under no to act. If the company is financially distressed, however, thevalue of the intellectual property will be negativelyaffected, even in an orderly disposition situation. The at the time, generally assets with more bidders will receive acompany’s resources are restricted to a greater extent than relatively higher portion of their “going concern” value thannormal and the company may feel compelled to accept a those with a smaller field of interested parties. The samelower price than it would in a more normal operating holds true for intellectual property. In general, higher bidderenvironment. interest translates into smaller liquidation discounts. When a company’s resources are restricted, it may Although there are many exceptions, technologynot have full access to manufacturing capabilities because assets such as patents, formulae and trade secrets gener-of the lack of credit from contract manufacturers. It may ally hold their value better than marketing assets such asnot have the marketing and distribution resources available trademarks and brand bundles. The reason for the financialduring more successful times. It may not be able to price distress may also have an impact on the value of the IP. Forits products appropriately, thereby resulting in lower profit example, if the financial distress is caused by out-of-controlmargins than normal. Or it may not be able to provide the expenses, the value of the IP will likely be higher than if thenecessary level of support for its existing customer base. financial distress is caused by a reduction in sales. WhetherThese severe consequences can jeopardize a company’s the target market is businesses or consumers also tends tocompetitive advantage, thereby resulting in lower sales make a difference in the impact on IP value. Businesses tendvolumes and lower margins. All of these events can have a to rely more on their last interaction with the company whilesignificant impact on the value of the associated intellec-tual property. (Continued on page 26)SEPTEMBER/OCTOBER, 2005 25
  4. 4. among others. Once the CASE STUDY #1 - Acquisition/Bankruptcy (Rental Car Company)* consulting firm went through Description Going-Concern Liquidation the valuation process, it was Trademark Assets $325M $63M able to establish going-concern Franchise Rights 82M 14M value, which was in excess of $450 million, versus liquida- Reservation System 38M 4M tion value, which was just under Customer Databases 5M 2M $85 million.* See the Case Airport Concession Rights 12M 0 Study #1 table. TOTAL VALUE $462M $83M The next case study involves a major film manufac- turing company and the valuation of its trademark and CASE STUDY #2 – Bankruptcy/Reorganization (Major Film Company)* brand assets. In addition, the Description Orderly Disposal Liquidation consulting firm valued the Total Technology Asset Value $15.3 – 19.5M $3.7 – 4.3M patents and technology assets within the company, which Total Brand Asset Value $30.8 – 45.2M $6.7 – 7.8M included 800+ patents within 52 NET VALUE (after all hard costs) $46.1 – 64.7M $10.4 - 12.1M clusters, 30,000+ proprietary molecules, instant digital printing technology and various patent licenses. The CASE STUDY #3 – Liquidation/Asset Sale* value of the assets took place Company: Fiber optics company during the company’s Chapter Context: Liquidation of subsidiary 11 reorganization and the Cause: Massive potential tax benefit focus of the work was to determine whether the value of Components: Eight independent fiber optics patent bundles the assets would be substan- Multiple trademarks tially greater in an orderly Valuation Approach: Components of value, liquidation value disposal, as opposed to an Going-Concern Liquidation immediate liquidation. The value of the trademark and TOTAL VALUE >$5.0M <$250,000 brand assets required knowl- edge of possible acquirers and competitors. As seen in thea consumer’s good first impression will often provide more Case Study #2, the orderly-disposal values for the assetsbreathing room for the troubled company. were in the $46 million-to-$65 million range, whereas the All of these examples are matters of degree. The liquidation values were between $10 million and $12actual discount associated with forced liquidation will million.* See the Case Study #2 table for additionaldepend upon the specific factors associated with each information. Note that the values shown in Case Study #2case. were net of hard costs of liquidation or disposal. In the final case study, the consulting firm was askedCase studies to identify all of the intellectual property with value, toLet’s look at three different case studies, as well as the identify acquirers, and to sell the assets for a large fiberunderlying cause and environment in which the intangible optics company in the midst of liquidating one of itsassets are being valued. In each case there were different subsidiaries. Working on a very tight time schedule, staffreasons for the undertaking of the valuation. In the first had to perform all of the valuation and disposition taskscase study, the company was in the midst of reorganization prior to the end of the then-current calendar year. As aresulting from severe cash-flow difficulties and was result, the consulting firm moved swiftly to identify andentertaining offers to be acquired by one of its competi- value the trademarks and other brand assets and also totors. The company was looking to secure $100 million of identify the group of technology assets with value. Ininterim funding to cover its short-term cash needs during liquidating these assets for the parent company, the goalthe acquisition period. The assets identified in the due- was simple: Dispose of the assets as quickly as possible,diligence phase included trademark assets, franchiseagreements, reservation systems and customer databases, (Continued on page 96)26 THE SECURED LENDER
  5. 5. Intellectual property valuation:Context is critical(Continued from page 26)without regard to maximizing cash from the sales. Thereason: by disposing of the assets prior to year end, thecompany could then be eligible for a tax refund in excess of$10 million as reimbursement for development costsincurred. See the Case Study #3 table.ConclusionsIdentifying and understanding the value of intellectualproperty is complex. A number of critical factors must beconsidered to provide an accurate and useful valuation. Thecontext of the valuation is critical in all cases and serves asthe key value determinant. The context is determined, thebundles of assets can be identified and the correct valua-tion approach can be applied to ensure accurate results.Some key thoughts to take away include: ➤ IP valuation is becoming increasingly complex ➤ Value can change over time ➤ It is a nonstatic process ➤ Context determines value. ▲* Names of case study companies have been withheld andactual results have been altered to protect clientconfidentiality. © 2005 All rights reserved.