Proposal for a Reality-Based Methodology for Measurement of Corporate Intangible Asset Value

Is your IP financial data reality based?

Is your IP financial data reality based?

In recent years, financial analysts came to believe that intangible asset value forms an increasing aspect of overall corporate value. These experts generally agreed that intangible asset value made up at least 70 % of the total market cap of the average corporation, an increase of an estimated 20 % in 1975. Not surprisingly, however, the recent global economic downturn has resulted in a steep decline in the amount of market cap attributed to intangible assets. Experts now say that the current (market adjusted) corporate value attributable to intangible assets is “less than 50 %.”

To someone who has toiled in the trenches of intangible asset protection at both the law firm and corporate levels, the at least 70 % generalization always possessed a sense of being pulled out of the air, as does the new sub-50 % number. I now understand that these values emanated from nothing more than a “guesstimation” of total corporate value that analysts believe should be accorded to an asset class that they do not fully understand. Put simply, analysts understood that corporate intangible asset value should amount to “a whole bunch” and they assigned a suitably large figure to allow calculation of that unknown amount. It is now evident that this figure was wrong and, since the sub-50 % figure does not appear to have been calculated with any more precision, it would appear that this recently assigned multiplier is likely inaccurate, too.

However, just because the numbers proposed for corporate IP valuation were (and are) wrong in the aggregate does not mean they were not otherwise real for many corporations. And, corporate intangible asset value can only continue rising as we become a primarily knowledge-based economy. To capture the asset value of our less tangible economy, we must certainly develop more “reality-based” methodologies to accurately quantify–or more substantively qualify–that aspect of corporate value associated with intangibles.

The question is how to better distinguish those corporations possessing real intangible asset value from those that are just riding on the coattails of others. To this end, I believe that analysts must develop methodologies that will allow them to “separate the wheat from the chaff” in terms of corporate intangible asset valuation.

Some commentators have proposed that estimation of intangible asset value, namely in the form of patent rights, could be improved by creation of a transparent market for intangible assets, such as a stock exchange or other type of marketplace where buyers and sellers could be matched and prices paid subject to full disclosure to the public. For me, however, such so-called “transparency” is not the answer to improve the accuracy of corporate intangible asset valuation. From tulips in the 16th century to housing prices today, we have seen that transparent markets and pricing models may create confidence for a short time, but more often confidence in such markets turns out to be unfounded when the bubble bursts.

Valuation of intangible assets primarily by what a willing buyer would pay on the open market also pre-supposes that corporate intangibles derive value only from their transactional value. To the contrary, when properly created and managed, intangible assets allow a corporation to significantly magnify overall corporate value independently of whether the intangible asset owner desires at any time to sell the asset. Good examples of this are the increased profits obtainable from patented non-commodity products and the market share improvements associated with brand name recognition and high corporate reputation.

Moreover, the vast majority of valuable corporate intangible assets will never make it to the market for sale or trade and, as such, will never be priced. Attempts to extrapolate the value for all intangible assets in the same class (patents, trademarks etc) from the prices set for a small number of assets that actually appear on the market would likely wildly mis-value IP held by corporations for business reasons. Basing corporate intangible value on the market price of an IP asset that is not actually comparable to another would effectively short-change those companies that have strong intangible asset management programs, but which have nonetheless decided that their best business strategy is to hold onto their intangibles.

In truth, I do not think there is any currently applied methodology that allows one to accurately value corporate intangible assets, which would explain the precipitous fall of intangible asset value in the last several months to the current sub-50 % level now reported. My view is that the at least 70 % value was too high for some companies and too low for some highly idea-heavy companies, such as technology start-ups. Similarly, the sub-50% is likely too high for many corporations today, especially those that have neglected to appropriately manage their intangible assets in recent years.

But just because we do not know how to accurately value intangible assets does not mean this asset class does not form a significant aspect of the market cap of many corporations. We must then decide what intangible asset valuation methodology will provide an objective and reality-based assessment of a corporation’s intangible asset value. My view is that we need to start looking at the people managing a corporation’s intangible asset programs. Put simply, a corporation that manages its intangibles as business assets and that appears to be doing a good job at establishing processes and staffing signals its seriousness about capturing, protecting and maximizing intangible asset value. In contrast, when a corporation maintains a traditional model of intangible asset management, such as operating IP as a legal cost center, analysts should receive a strong signal that the corporate management does not “get” intangible assets. The latter corporation should therefore not be accorded a market cap “bump” in intangible asset value because its management clearly does not deserve the credit.

Of course, assessment of a management and staffing processes from the outside is only a proxy for whether a corporation should be given an increase in market valuation resulting from intangible asset ownership. Nonetheless, it is common to review a corporation’s internal management structure when analyzing a corporation’s market value–Apple under Steve Jobs’ management is a great example of this. I believe that looking for intangible asset management signals emanating from within a corporation’s infrastructure can allow financial analysts to better identify companies likely to be winners in the intangible asset maximization game and that deserve to be giving additional market cap for intangible assets.

Admittedly, analysts seeking quantifiable numbers to associate with corporate intangible assets may desire more precise methodologies to assess market attributable to intangibles. However, those with this mind-set will be well-served to remember that fixation on absolute numbers to assess value is arguably part of the reason that the current crisis occurred. And, I submit that accurate qualification is better than dubious quantifying methodologies any day.

8 thoughts on “Proposal for a Reality-Based Methodology for Measurement of Corporate Intangible Asset Value

  1. Scott B. Garrison

    I agree with your assessment Jackie. Identification of a single valuation method would likely fail. It has long been a premise of the real estate market that there are three crucial factors to assess in the acquisition of real estate, they are: Location, Location, and Location. That means that you can take two identical cookie cutter houses or even mansions and place them in two entirely different areas, and you will get two completely different values. The reasons are many, but they are also somewhat intuitive: school systems, crime, taxes, infrastructure, etc.

    A number of years ago I learned a startling fact from my then General Counsel, and that was something along the lines of 85% of that company’s acquisitions had not turned a profit. Now since this was a corporate-wide speech I was unable to really ascertain the reasons, the metrics used, or any other details…however the impact of that statement on me was enormous. I began to analyze future acquisitions from a 50,000 foot perspective. The acquisitions were typically successful in the commercial marketplace with their patented product or service. And I noted that the cost of each acquisition was driven primarily by the perceived value of the IP portfolio. In most cases the due diligence performed on the strength of that portfolio during the negotiations was “right on point”. So for these cases logic would dictate that the cost to acquire was identical to the value received.

    So how come the acquisition did not pan out? I concluded that the differences in corporate culture, risk aversion, entrepreneurial vs. dinosaur mentality, adaptable infrastructure (i.e., ability to change), etc all played a part. To me this is the corporate world’s version of Location, Location, Location. One could take an extremely profitable business, purchase that business at a cost equal to its value, and ultimately kill the business itself if one would not or could not operate or capitalize on the IP in a similar manner.

    As you say, any standardization created which intends to value IP will inevitably fail unless you also factor in the acquirer’s business style and managements’ approach to the administration and monetization of their intangible assets.

    Scott
    http://www.linkedin.com/in/scottbgarrison

  2. Ian McClure

    Thanks for the great words, Jackie. After reading your comment under Joff Wild's post on IAM, I hastily posted a response. After reading some other responses and giving your words some more thought, I digress from my initial response slightly.

    I still believe transparency is the key to standardizing IP valuation. However, when I speak of such valuation, I do so in the transactional context. Your words, "valuation of intangible assets primarily by what a willing buyer would pay on the open market pre-supposes that corporate intangibles derive value only from their transactional value," are so true. There really is more "value" than a pricetag put on IP in the buy/sell context. As you point out correctly, that value is derived from "the market share improvements associated with brand name recognition and high corporate reputation." In this light, a company derives substantial worth from strategic preservation of some IP, especially that which is core to a corporation's operations. This IP brings value to the table that cannot, and will not, be measurable by any derivative measurement, rating system, or scientific formula.

    When I speak of transparency and its crucial importance to the burgeoning IP market, I do so from an investment perspective. However, as a corporate M&A attorney, I cannot forget the inherent corporate value resulting from the competitive advantage on which a company can capitalize by efficiently using (instead of licensing or selling) certain IP.

    Again, thanks for your insight.

    – Ian McClure, Wyatt, Tarrant, & Combs, LLP and author of ipprospective.com

  3. Jackie Hutter, Intellectual Property and Patent Business Strategist and "Recovering Patent Lawyer"

    Ian: I am so glad you chimed in. I read your comment on the IAM blog the other day and was going to dash off a response, but then I realized that our positions appeared so wildly divergent that there was little point. I am happy to see that we are closer in opinion than it first seemed.

    Also, you have read my mind–I have given much thought to the transparency issue, in particular as a result of your somewhat strong disagreement with me. In considering the thread on the IAM blog, I have now realized that there seems to be (at least) 2 camps (or interests) in the area of IP valuation.

    On one side, for that type of IP that actually derives value from its transactional value, transparency is absolutely necessary. On the other end is that IP that derives its value from the business value to the company that owns it. The former derives value from the market, the latter from the business benefit it provides to its owner. (I am sure there is an economic model for this, but I am not studied in the formalities of economics.)

    The existence these different classes means that there must be 2 different methods to value IP. I could go on and on, but I will save further discussion for an upcoming blog post.

    Again, thanks for reaching out, and I look forward to continuing to connect.

  4. Mary Adams

    Dollar-based valuations are nice if you want to sell off an asset. But they are not that valuable for managers. The real questions that managers need to answer include:

    >What are our critical intangibles (start with IP but also include processes, relationships and human capital)

    >Do we have the right intangibles to deliver on our strategy?

    >Are we doing what we need to do to prepare our intangibles for the future?

    >What are the risks associated with our intangibles?

    >What should we be doing differently?

    If you want to get really valuable answers, ask both external and internal stakeholders.

  5. Human Writes

    The search for a useful IP valuation methodology

    Thank you Jackie et al for your most interesting insights on this great topic.

    The one upside of the current credit crisis is the debunking of the old myth about 70% of corporate value being intangible or even IP assets.

    This is as spurious as to suggest a specific percentage value of human capital, cash on hand or even plant and equipment. Without going into the many reasons why it has seemed necessary to fix a proportional value, suffice it to say, few analysts would question the significance of the proportion and therefore definitely worth factoring into corporate or even asset valuations.

    As you suggest, it is also likely that a knowledge-based economy would seem to increase the role of intangibles in the corporate arsenal.

    There are in fact a plethora of sometimes conflicting methodologies for valuing intangible and IP assets ranging from the basic “bookkeeper” financial models (including DCFs and straight-line depreciated relief from royalty models) through to some rather exotic, algorithmically complex proprietary snake-oils which serve more to confuse than to assist the analyst.

    Apart from the oft touted three classic approaches (namely cost, market and income based models), there are a number of recent formulas which actually have improved our understanding of the challenge and, in some cases, allow for a simplified but useful indication of value.

    Quite correctly, one major challenge is to differentiate between those assets merely kept on the books of the owner and those that are functionally deployed as part of the corporate strategic business plan. It is for this reason that in the last four or five years analysts have worked on models to, as you put it, “separate the wheat from the chaff”. In the ideal world a company who is shown to effectively optimise the use of its IP resources may well be perceived as having real strategic value and possessing skills for optimising ALL of its assets. Arguably this is the signal role of management.

    One such formula does propose a transparent “stock exchange” of intangibles or IP assets. The approach presupposes a number of assumptions and seeks to establish an efficient market in these assets. This would then allow for a “market based approach” and would certainly provide comparative values on a willing buyer-seller valuation. Although I have studied a number of these proposals I must confess to a degree of scepticism and would doubt that this exchange is either functionally viable or even the best option.

    Although transparency is fashionably offered as the cure all to all value challenges, in this case the greatest threat is the contextual element of value. An IP asset such as a patent is greatly influenced by its strategic purpose and deployment and in some cases more so by its ownership. By way of example, a cardio vascular therapy is worth substantially more in the hands of a large scaled Pharma with the balance sheet know-how and network to effectively deploy it. It would also be prominently part of its strategic focus and attract maximum intellectual capital in its deployment.

    You rightly refer to 17th century tulip bubbles and MBS bubbles of today as evidence of confusion between transparency and contextual understanding. But the real issue is the understanding and, ultimately, confidence in the valuation methodology.

    I suggest the big hurdle is to avoid demanding more of intangibles and IP assets than of other tangible assets when valuing. The best example and one rather topical valuation is that of corporate and sovereign bonds. These are valued by rating agencies and in most cases relied upon for multi billion dollar trades every day. Yet their value is abstract and depends wholly on the analysts perception of their propensity to default and credit worthiness. In the past two years these ratings have been at best questionable- at worst irresponsible. Yet investors continue to invest and trade on their value estimates. Today the investor, having lost confidence in all values, must invest at a sizable discount to account for his/her insecurity but invest they do.

    The value or price determined by willing buyer and seller is a traditional market based benchmark but involves a possible asymmetry of asset information between buyer and seller and does, as you point out, not assist in the internal valuation of assets in the normal course of business. The network benefits of the assets within particular portfolios and within corporate contexts appear to demand better evaluation when assessing one or more intangible asset. I think it is worth stressing that the management of a company which represents a considerable component of overall corporate value implies a unique skill in optimising the deployment of all that corporations resources.

    A management that is perceived to be unable to appreciate fully the opportunities offered by any of its assets is underperforming and should ultimately lose the confidence of shareholders and potential suitors alike. Ignoring this would result in substantially invalid asset valuation and would account for the quoted 85% failure of mergers.

    No assets should be valued on their transactional values unless they are decidedly outside operating scope. The brands, the intellectual capital, networks and intellectual property all contribute to a complete corporate value. Whereas in the past analysts have worked on a gut-feel value for these intangibles as “goodwill”, the speed and efficiencies of modern commerce demand more clarity as indeed do the compliance authorities. Thus a reliable consistent valuation methodology is urgently called for.

    You suggest that there is no “currently applied methodology that allows one to accurately value corporate intangible assets” and that is arguably both right and wrong. There are in fact a number of methodologies applied here, pretending accuracy and none of these offer accurate valuations. The point being “is this important?

    All valuations are time-based and in fact are based on countless assumptions. An example is the bond discussed above. Even the best balance sheet valuation is based on ratios and estimates of value and future incomes. The value of a humble house may depreciate (even in the best area) if a power station is planned nearby. But as you say “just because we do not know how to accurately value intangible assets does not mean this asset class does not form a significant aspect of the market cap of many corporations”

    But to value any asset in strictly archaic cost centre terms is arguably reckless and poor management. It would indicate that management are out of touch with modern business and at risk of fiduciary neglect.

    The “fixation” on absolute numbers belongs in the realm of tax returns and historic costs. This refers to a different type of value outside the scope of this debate. Estimates of potential value will always depend on assessments of future markets and trading conditions and will thus remain strategically subjective.

    One issue raised by Scott Garrison is the variable criteria of value. He refers to “location” as a signal indicator in real estate values and a number of other influencers of “Value factors” may be posited.

    Management style, the expressed asset objective, risk aversion, adaptability, etc; all determine value. This raises the recent trend toward indicator based models. Ranging from the “black box”, one size fits all example to relatively productive offerings assessing statistically probable criterion such as citation indices.

    Although at a nascent stage, these models actually promise a fairly reliable and consistent approach to valuation which if widely accepted would allow for a freer trade in these assets. I have established and worked on a methodology which incorporates elements of this approach and which offers at least a better understanding of IP assets and their contributions to corporate value.

    Whilst transparency is the watchword in modern commerce, perhaps effective valuation depends on consistency, reliability and a systematic assessment of salient value factors.
    This would result in a better understanding of the asset, its context and ultimately its value in defined ownership.

    In my studies, I have indeed found two schools of thought in this arena: 1) those that specialise in intellectual property and intangible assets (including patent lawyers and IP managers) and 2) those specialising in financial valuation, accounts and corporate finance. This would include, in most cases, business consultants and financial analysts. The first category seems to seek a better understanding and appreciation of IP as a creditable asset class and the second, to narrowly define these assets in purely financial terms. Unfortunately, I have yet to find a good deal of debate or agreement between these agendas and suggest that a meeting of minds would greatly improve the discussion. There are a number of complex and attractive models for valuation but they need to be aligned with special understanding of this class and the need for reliability and asset confidence.

    Paul G Fairhurst

  6. Jackie Hutter, Intellectual Property and Patent Business Strategist and "Recovering Patent Lawyer"

    Dear Paul:

    Thank you for your comprehensive and thought-provoking commentary. (Have you thought of starting your own blog?–It would be great to see your comments more regularly.)

    With respect to your comments, it appears that we are in “violent agreement” on most things. Where we may diverge a bit is on the issue of whether there is a rationally-based methodology to value IP assets. Let’s deconstruct this, we both agree that no current method is accurate. You think that there is a way to figure out value that is accurate. I think so, too. As you say, it is necessary for there to be a meeting of the two “camps” (i.e., lawyers and finance folks) to come to agreement on a suitable methodology. So we’re in agreement here, too.

    I think the key is that everyone need to come to agreement about the accuracy of such valuation methodologies, as opposed to the precision. This will go a long way to making any valuation methodology more reality-based.

    Looking forward to hearing from you again!

  7. consensio

    I can only agree with what has been said so far. Adding to Paul's comments however, there is a third group of those that specialise in intellectual property and intangible assets and that is the actual people on the ground, who create IP for the company.

    It may seem strange but the struggle to evaluate and measure is not confined to the 'numbers and lawyers' department.

    In my experience, the classic in-house Marketing dept. is where it all starts with justifying expenditure on brand development.

    This is long before anyone is even looking at M&A and at the beginning of start-up creation. At the core of evaluating intangibles we also have to look at corporate governance and into the culture of conducting business.

  8. Paul G. Fairhurst

    Consensio makes a very valid point. The internal teams who are obliged to justify resource allocation often do most of the work in valuation. They are also often not recognised for this and their hands on understanding of the assets is hugely valuable. The best approach when data gathering is to identify all relevant sources of asset info before appraising it. What we do is accumulate data under four value dimensions of sepeciality and then analyse each independantly of the other. The final assimilation allows for optimal data process and arrives at both a comparitive value and a risk assessmemnt. This has been adopted by two German banks here (one for funds management )and a major Us concern with some success. The hope is that some day the role of corporate IP asset manager will be recognised as a full member of the strategic team particularly for long term financial management.

Leave a Reply

Your email address will not be published. Required fields are marked *