Intellectual Property Valuation Zach Eubank, JD, MBA, CVA July 17, 2017

Introduction Zach Eubank Director RSM Valuation Services / Des Moines, IA Business Valuation zach.eubank@rsmus.com

Table of Contents Intellectual Property Valuation Introduction to Intellectual Property Valuation 4 IP Valuation Process 13 Traditional Valuation Methodology 18 Valuation of Various Types of Intellectual Property 24 Valuation of IP in Varying Contexts 31 Q & A 36

Introduction to intellectual Property

IP Landscape IP and intangible assets represents approximately 80% of the corporate value in the US Stock prices reflect the importance/value of all intangible assets (including IP) Almost every industry currently relies on a significant number of IP and intangible assets

IP Landscape (continued) The generation of patented technology is accelerating Commercialization of IP accounts for several trillion dollars in revenue annually. Licensing intellectual property is a core strategy for many companies

IP Valuation Process

IP Valuation Process Overview The steps for completing a valuation of an intangible asset or asset bundle are generally as follows: Define the engagement Gather the information on the subject asset Analyze the information Determine indication of value for the subject asset Communicate the results to the appropriate parties

IP Valuation Process – Key Considerations What context assets or bundles are being valued? What is the purpose of the valuation? Common reasons for an IP valuation include, among others: Mergers and acquisitions Tax-based transfer Donation Outright sale Bankruptcy/reorganization Litigation or arbitration Intercompany royalty rates The specific purpose of the valuation helps determine the applicable standard of value

IP Valuation Process – Key Considerations (continued) When is the asset to be valued? (i.e. the valuation date) Time-based scenarios will have an impact on value – consider info that is “known” or “knowable” as of the valuation date Consider the applicable standard of value (e.g. fair value vs. fair market value) & premise of value (e.g. going concern vs. orderly liquidation) Consider the various valuation approaches and determine which methods are applicable

Valuation Methodologies

Traditional Valuation Approaches The four generally accepted intangible asset valuation approaches include: Cost approach Market approach Income approach Relief-from royalty approach (hybrid approach) The applicable valuation approach is determined based on the consideration of key facts and circumstances regarding the subject asset

Cost Approach Two common variations of the cost approach: Historical cost basis Replacement or reproduction cost Historical cost approach- asset value based on historical costs incurred associated with the asset Historical costs may include items such as: Legal fees Application fees Personnel costs Production costs Development costs Replacement/reproduction cost- value based on current costs required to duplicate the asset today. Incorporates adjustments reflecting inflation/deflation Cost approach provides the absolute minimum value, does not reflect economic benefit to the owner Appropriate approach when no specific market application or benefit can be identified

Market Approach Assets are valued by comparing to recent sales or other transactions involving similar assets in the market Utilizes actual transaction values derived from sale or licensing agreements Practical, logical approach when market data is available Considered the most direct and systematic approach when reliable data is available Active market and/or reliable data may not exist in many cases

Income Approach Based on expected future income streams related to the asset One of the most widely used approaches when valuing intellectual property/intangible assets Inputs can be relatively accurate and obtainable Important to distinguish between cash flows associated with the enterprise vs. cash flows associated with a specific IP asset Value of the asset is based on the present value of future economic benefits (cash flow) The significant inputs required to utilize the income approach include: Future income stream Duration of the income stream Risk associated with the generation of the income stream (discount rate)

Relief-from Royalty Approach Common approach for valuing IP Incorporates aspects of the income approach and market approach Value of the asset is based on the present value of royalties avoided due to ownership of the asset Selected royalty rate is based on marketplace transactions of similar assets Often used to establish damages in litigation cases Inclusion of market information adds credibility to the analysis

Valuation of various types of intellectual property

Trademark Valuation Initial assessment should be performed to determine if value exists: Does the trademark differentiate the product/service with which it is associated? Would others (third parties) be interested in using the trademark? Would third parties pay a fee to license the trademark? If the answer is “yes” to these questions, then there is value. Question then becomes how to determine/quantify the value of the asset Context and time-frame in which the asset is being valued is critical to the valuation process

Trademark Valuation (continued) Cost approach- not commonly used when valuing trademarks. Historical costs does not necessarily represent “value” Income approach- can be utilized if an income stream directly attributable to the asset can be identified. Variations of the income approach include: Cost savings method Relief-from royalty method (also considered a market approach) Allocated earnings or excess earnings method Market approach- most consistently used method to value trade names Comparative in nature, premised on law of substitution Requires knowledge of comparable sales and licensing agreements

Additional key valuation considerations: Patent Valuation Initial assessment should be performed to understand the stage of development Additional key valuation considerations: The uniqueness of the patent or technology The depth of the patent/technology Competing or existing technology Time & effort to commercialize the technology Ability to protect the patent Size of the market and future prospects for that market

Patent Valuation (continued) Cost Approach- seldom used to value patented technology unless the asset is in very early stages of commercialization Income Approach (excess earnings method)- appropriate if the patent is fully developed or mature technology The relief-from royalty approach may be utilized if the technology is ready to go to market and an income stream can be identified Market approach- may be utilized if a market for similar technology exists. Finding appropriate comps can be problematic

Trade Secret Valuation Cost approach is not appropriate given the nature of a trade secret Market approach- not practical as an active market for a similar trade secret rarely exists Income approach- Appropriate approach is to use the net present value of future cash flows Inputs required to determine the NPV of future cash flow: Total amount of future cash flow The discount rate/required rate of return The probability that the cash flows will occur

Valuation of copyrights falls into three categories: Copyright Valuation Valuation of copyrights falls into three categories: Traditional valuation (tax or financial reporting) Transfer pricing Litigation (damages) Copyright value is based on the following components: Current value of the IP based on sales/licensing fees Possible future new uses of the IP Copyrights can be valued using any of the four traditional valuation approaches

Valuation of IP in Varying Contexts

“Value” has many definitions depending on the context of the valuation Fair Value “Value” has many definitions depending on the context of the valuation Accounting definition under ASC 820 Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Legal definition The definition varies from jurisdiction to jurisdiction as specified in state statutes and developed in the state’s case law precedents.

Fair Market Value – 2 definitions The price at which the property would change hands between a willing buyer and a willing seller, when the former is not under any compulsion to buy and the latter is not under any compulsion to sell: both parties having reasonable knowledge of the relevant facts. [Revenue Ruling 59-60] The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller acting at arm’s-length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts. [IGBVT]

Intrinsic Value and Investment Value The value of a prudent investor considers using available facts Does not reflect the current market, but what the market will eventually realize Investment Value The value to a particular investor based on individual circumstances and expectation of that individual investor

Summary of Different Values The type of engagement (litigation, financial reporting, etc.) impacts the applicable standard of value. The value may be different depending on the standard of value. It is important to understand the nature of the project and to understand the unique differences under each standard of value.

Sources of Information American Society of Appraisers, BV301- Valuation of Intangible Assets Intellectual Property Valuation: A Primer for Identifying and Determining Value. Chicago, IL: American Bar Association, Section of Intellectual Property Law, 2005 "Intellectual Property: Valuation, Exploitation, and Infringement Damages”. Russell L. Parr, Gordon V. Smith International Glossary of Business Valuation Terms IRS Revenue Ruling 59-60 www.oceantomo.com/2011-intangible-market-value

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