Why Value Intellectual Property?
George Gilder said that corporations today are masters not of land and material resources but of ideas and technologies.
The statement draws attention to a reality of modern commercial life that is widely recognised but still insufficiently appreciated: the extent to which, in many modern companies, the true source of corporate value lies not in the tangible assets of a business but in its intangible assets.
The value of Coca Cola, for example, as expressed by its share price in 1996, was $115 billion. The balance sheet of the corporation at the end of 1995, however, showed a net asset value of $15 billion. That leaves intangibles to the value of $100 billion.
This example illustrates the significant difference between the value of tangible assets of companies and their intangible assets. This is often the reason why the purchase price paid for the acquisition of the business often substantially exceeds the value of the tangible assets of the business.
In almost all businesses, along with goodwill, a proportion of the intangibles consists of various forms of Intellectual Property (IP). In South Africa, following global trends, the corporate world is increasingly realising not only the considerable value of the intangibles of a business, but also how an analysis, understanding, and valuation of those intangibles can translate into concrete benefits to a company and help it make informed business decisions.
First of all, the introduction of Capital Gains Tax (CGT) will in many cases make it of vital importance for companies to value their IP. IP acquired by a company at a certain value and later sold by that company for a higher value could result in a capital gain to the company.
Where there is a capital gain resulting from a disposal of an asset acquired before 1 October 2001, the proprietor of the asset may elect to determine the value of the asset at 1 October 2001 as:
- he market value of the asset; or
- 20% of the proceeds of disposal of the asset; or
- the time - apportionment base cost of the asset.
It is proposed that the window period during which a valuation may be obtained be 2 years (from 1 October 2001). IP owners consequently need to take advice on possible valuations of their IP in this window period.
Secondly, substantial tax advantages may be gained when acquiring an item of IP or a business which holds IP. Section 11 (gA) of the Income Tax Act provides for the deduction of expenditure incurred in acquiring IP under certain circumstances. Although Section 11 (gA) was recently amended to specifically exclude deductions for trade marks, deductions can still be claimed for other types of IP such as patents and copyright. Because virtually every business has some form of IP, virtually every business can take advantage of this opportunity.
The second benefit attached to IP valuations is linked to the international trend for modern accounting standards to permit the inclusion of valuable IP rights in the balance sheet. The resultant adjustment on the balance sheet may have significant advantages, adding to the equity value of the company and positively influencing the company's debt to equity ratio.
Listings and Private Placement of Shares
In the case of a listing or private placement of shares, prospective investors may be more willing to buy equity in a company if satisfied that valuable IP exists to drive the business.
Raising of Capital
Financial institutions have begun to appreciate the existence and value of IP rights when negotiating loans. A strong trade mark independently valued, may result in a lower risk assessment and a lower lending rate. Moreover, the new Trade Marks Act of 1993 makes provision for the registration of security interests in a trade mark, enabling a trade mark to be pledged as collateral.
Mergers, Acquisitions and Disposals
A valuation may assist in coming to an informed decision as to what a prospective seller or buyer should ask for, or offer to pay for, a business, or what the correct share exchange ratio should be in a merger or similar transaction.
Licensing of Intellectual Property Rights
IP rights are frequently licensed to third parties or companies within the same group of companies. Frequently, the owners of the IP as well as the prospective licensees have difficulty in determining appropriate royalty rates for the particular circumstances of the transaction.
Reliance is too frequently placed on royalties customarily charged in unrelated industries, or on even shakier grounds.
In the case of licence agreements within the same group of companies a valuation may be of assistance for two reasons:
firstly, in order to defend tax efficient inter-group royalty rate structures against attack by the receiver, it may be necessary to establish that royalties are charged on an arms-length basis; secondly, the group may be interested in pricing the licensed rights accurately, because it wants to measure the performance of group members correctly. A valuation may consequently improve the quality of information available to management.
In the case of each of the principal forms of IP, the relevant statute makes provision, in infringement proceedings, for courts to award in lieu of damages, a reasonable royalty that would have been payable by a licensee for use of the IP concerned. There may be circumstances in which, in such proceedings, it would be appropriate to undertake a valuation of the IP concerned in order to arrive at the amount of an appropriate claim or to establish a reasonable royalty rate.
Finally, a valuation may assist a company internally: in setting common goals and communicating those more effectively. Finance and marketing people in many large companies set priorities differently and may experience difficulty in communicating their perceptions. To attach a monetary value to an underlying asset of IP may, for example, enable the marketing department to justify its advertising expenditure and - in turn - be held accountable for it. Similarly, research and development expenditure may be related to and measured against the value of the IP it seeks to create.
Spoor & Fisher Consulting (Pty) Ltd is an acknowledged leader in the field of the valuation of IP. The valuation of IP requires a variety of skills: a specialised understanding of IP is essential; in addition, an understanding of valuation methodologies, and of financial and accounting techniques and standards, is required. Because of its speciality, Spoor and Fisher Consulting has succeeded in combining these skills and gaining a reputation for excellence in this field.
For further information on the valuation of IP, please contact Dina Biagio of Spoor & Fisher Consulting (Pty) Ltd.
SPOOR & FISHER CONSULTING (PTY) LTD