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Valuation methods
The document discusses various methods for valuing intellectual property, including market-based comparable transactions, cost-based historical cost replacement, and income-based approaches like discounted cash flow analysis and excess profits methods. It notes challenges with each method and emphasizes that modern valuation commonly uses a discounted cash flow approach to determine the net present value of a business's expected future cash flows.
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Valuation methods
- 1. Valuation Consulting 49-50 The Hop Exchange, 24 Southwark Street, London, SE1 1TY Tel: 020 7403 3344 Fax: 0207 499 2266 e-mail: valconsult@valconsulting.co.uk www.valuation-consulting.co.uk
- 2. VALUATION CONSULTING STARTING ATTHE TOP AND TRYING TO BUILD DOWN. THE LAWS OF PHYSICS AND VALUATION SUGGEST THAT THIS IS NOT POSSIBLE.
- 3. VALUATION CONSULTING OCCASIONS FOR VALUING INTELLECTUAL PROPERTY • Mergers & Acquisitions • Portfolio Review and risk assessments • Arrange a loan - securitisation • Tax purposes • Licensing • Balance Sheet purposes • Joint Ventures • Selling your Company • Selling your IP • Insurance
- 4. VALUATION CONSULTING METHODS OF VALUATION Market Based • Comparable market transactions
- 5. VALUATION CONSULTING COMPARABLE MARKETTRANSACTIONS • Few Sales • Lack of Information • Separate Values • Special Purchasers • Different Negotiating Skills • Distorting Effects of Varying Values • Assets Not Always Comparable
- 6. VALUATION CONSULTING METHODS OFVALUATION Cost Based • Historical or replacement cost
- 7. VALUATION CONSULTING HISTORICAL ORREPLACEMENT COST Caveats • Economic Benefits Excluded • Duration of benefit-economic life • Obsolescence difficult to quantify • Maintenance • Time value of money
- 8. VALUATION CONSULTING METHODS OF VALUATION Income Approach • Capitalisation of historical profits • Future economic benefits
- 9. VALUATION CONSULTING CAPITALISATION OF HISTORICAL PROFITS DRAWBACKS Profitability • Problems of averaging • Problems of extrapolating from past performance • Decline & other key variables • Net tangible assets not separately assessed Multiple • No reference point for price earnings multiple • Often no regard to established marketplace • Often no reconciliation with market capitalisation
- 10. VALUATION CONSULTING MODERNVALUATION ANALYSIS IS EFFECTIVELY DCF APPLIED TO THE BUSINESS ENTERPRISE UNDER CONSIDERATION • The Net Present Value (NPV) of a strategy or business is the sum of its expected free cash flows to a horizon (H) discounted by its cost of capital (r) NPV = Year 1 Cash Flow + Year 2 Cash Flow ... to say Year 5 Cash Flow (1 + r) (1 + r) ² (1 + r)H PLUS The terminal value which is the value of the business at a horizon (HV) HV = Cash Flow (r - growth) Also discounted back to present value
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- 12. VALUATION CONSULTING GROSS PROFITDIFFERENTIAL METHOD Assessment of margins • Generic or unbranded • Branded • Prices • Volumes • Maintenance
- 13. VALUATION CONSULTING GROSS PROFIT DIFFERENTIAL METHOD Limitations • Net Tangible Assets and Rate of Return ignored • Cost & production efficiencies not isolated • Economies of scale not considered • Information about other product’s cost, volumes, etc not available • No generic brand name for comparison • If so differences in quantity, quality, availability • Market trends over time • Bias towards industries with lower variable costs to total costs
- 14. VALUATION CONSULTING EXCESS PROFITS METHOD Features • Calculate current market value of Net Tangible Assets • Estimate Rate of Return to calculate required profits • Excess above required level to induce investment • Attribute excess to intangibles • Capitalise this return • Ensure careful segregation to identifiable products • Those unidentifiable must be goodwill
- 15. VALUATION CONSULTING EXCESS PROFITS METHOD Limitations • Rate of Return can be a reflection of other factors • Does not allocate between parts • Tangible assets often incorporate intangible value ie value in use basis • Information about technological developments often not available • Assets being valued not employed in best manner • Asset values & reported profits often calculated on a different basis • Erosion of margin over time by competitive pressures • Benefit of lower depreciation of branded products • Required Rate of Return often an ingredient in sale price • Method ignores potential profit from extensions
- 16. VALUATION CONSULTING ROYALTIES FOREGONE/RELIEF FROM ROYALTY Features • Estimate future royalty stream • Basic premise sale & lease-back • Usually maximum basis with acceptable Rate of Return • Alternatively payment for your use • Royalty equivalent to excess profit component • Greater availability of independent economic & trade association forecasts • Facilitates comparison with Royalty Rates of similar intellectual property in marketplace
- 17. VALUATION CONSULTING ROYALTIES FOREGONE/RELIEF FROM ROYALTY Problems • Separation of intangible components • Other factors often an ingredient in determining current Royalty Rate eg geographical goodwill or monopoly • Comparable may be out of date lack of detailed information arrangements may preclude extensions
- 18. VALUATION CONSULTING HOW LONGFOR? (TIME PERIODS)
- 19. VALUATION CONSULTING AT WHAT RISK? (COST OF CAPITAL)
- 20. VALUATION CONSULTING MONTE CARLO • Effectively a DCF multiplier • Numerous DCF calculations accounting for various scenarios, say of revenue, market share, costs, internationality and other risks • With just 4 scenario changes of the stated assumptions above this means 256 models! • That is 4 values for each of income, different market share, costs, international penetration i.e. 4 x 4 x 4 x 4 = 256
- 21. VALUATION CONSULTING 1-10 – 100 RULE • Often scarce capital resources • Each stage in a technical development costs 10 times as much as the previous one • Assumption of success – the probability of failure at each stage could be 90% + • Even with 50% probability an inventor needs two ‘up his sleeve’, at each stage • Multiplier effect