Valuing intellectual property (IP) often feels like trying to answer the question, “How long is a piece of string?” The complexity and variability involved make it a challenging task, influenced by numerous factors and circumstances. In South Africa, the economic landscape, shaped by international trends and local dynamics, provides a perfect backdrop to explore the intricacies of IP valuation. Recent developments in various sectors underscore the importance of understanding how to measure the value of intangible assets in an ever-evolving market.
Local innovators, entrepreneurs, and established ventures operate in a global arena where intellectual property plays a critical role. How do companies unlock value and determine the worth of their IP? The answer requires careful consideration and a deep understanding of various factors.
To properly value IP, one must first understand it as a broader concept: Intellectual Capital (IC). This broader perspective allows for a more comprehensive valuation, taking into account two critical premises: the purpose of the valuation and the stage of the venture during the IC valuation.
There are numerous reasons for conducting an IC valuation, but four primary scenarios stand out: early-stage IP-driven start-ups, financially distressed companies, mergers and acquisitions (M&As), and impairment. The stage of a venture during an IC valuation informs the approach required. Visionaries like Prof Wynand Coetzee and Geoffrey A. Moore solved this problem in the early 90s, highlighing the importance of the innovation chasm. This concept can be applied to all four IC valuation scenarios mentioned above, emphasising the ability of the IC to generate growth and positive cash flow.
Another researcher, Booysen, tackled the challenge of finding common ground in IC valuation. Her hypothesis is rooted in sustainability, illustrated by two interdependent trend lines – cash flow and growth. There will always be market pull, based on financial viability, and a technology (or product) push, based on product feasibility. Sustainability serves as the common ground, essential for the market and technology to coexist and function effectively.
Sustainability holds different meanings for opposing parties at various stages of a venture. NASA’s conceptualisation of technology readiness levels (TRLs) offers a framework to solve this problem, now used worldwide by research agencies and ventures. TRL-1 originated from the idea to go to the moon, and TRL-9 represents a successfully commercialized product. This concept extends to TRL-10, sustainability, emphasising the need for a safe return to Earth.
Moving from left to right, the tension between market pull and technology/product push becomes evident. There will always be equilibrium – or sustainability in this context. The question arises: who is best placed to conduct the IC Valuation? Should it be the operational, technical, and management teams, financial advisors, or IP and legal advisors?
There is always a risk profile associated with the underlying reason for the IC valuation. Therefore, it is prudent to start with a risk assessment considering legal, financial, technical, regulatory, and geopolitical risks, to name a few. A risk mitigation plan is the natural outcome of such an assessment and is useful for IP practitioners and auditors alike. Here are four examples to illustrate this point:
- Impairment: A patent about to expire can be strengthened by a good trademark portfolio. This legal risk mitigation approach should then be converted into a monetary value by the financial advisor and the company’s marketing team. This financial exercise becomes critical because an expired patent can turn the sales stream of a blockbuster patent into a commodity overnight, a common occurrence in the pharmaceutical industry. Likewise, a patent that is challenged in court on grounds for revocation will have a direct impact on the balance sheet of the venture.
- Financially Distressed Companies: A strong IP portfolio can be hypothecated. IP-backed financing is not new and is not the exclusive space of venture capitalists, with the conservative banking sector also entering this space. Proper due diligence is required to understand the inter-dependence of a company’s patents, trademarks, and trade secrets. Jigs and dies in the manufacturing and engineering sectors, often overlooked, represent years of know-how and trade secrets. Valuing these intangibles as scrap metal is detrimental. A skilled IC valuator would assess these assets to determine their potential value.
- Start-ups with Strong IP and Technology Portfolios: IC valuation for start-ups with disruptive IP portfolios is arguably the hardest because determining viability, feasibility, and sustainability is challenging. IP practitioners and venture capitalists struggle with this, and true value seems to be recognised only when an entrepreneur develops a minimum viable product (MVP). That MVP can then be protected by appropriate IP protection strategies, and only then can valuation techniques, such as the 25% relief-from-royalty method, be applied. Currently, only monetary considerations are applied, with VCs using financial metrics.
- Mergers and Acquisitions (M&As): In M&As, the market determines the value. One common reason for M&A failures is a lack of cultural fit. Company cultures, hard to value, are intangible assets. Some companies are transparent, while others protect trade secrets and distribution channels, making them difficult to assess even with the best due diligence.
Determining the value of intellectual property is much like pondering the length of a piece of string – there is no one-size-fits-all answer. The process is inherently complex, influenced by factors such as market dynamics, technological advancements, and the specific context of the business. Whether dealing with early-stage start-ups, financially distressed companies, or high-stakes mergers and acquisitions, the key lies in balancing market pull with technological push, all under the umbrella of sustainability.
Even the most thorough IC valuation will leave some residual risks, but by carefully considering legal, financial, technical, and geopolitical factors, companies can navigate these challenges effectively. Ultimately, the true value of intellectual property lies in its ability to drive innovation, generate revenue, and sustain long-term growth, much like the unmeasurable length of a piece of string that connects various elements of a business’s success.
Dr. Gerard Verhoef | Barnard
