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A new method for valuing intellectual property divides intangible assets into three components. The result, says its inventor: better deal terms and more accurate transfer-pricing.
Marie Leone, CFO.com | US
November 13, 2006
Branding products may not be his forte. But Rick Nathan seems to have a pretty good handle on valuing brands—and other intellectual property. Nathan, a senior managing director with Trenwith Valuation, has come up with relatively new methodology for valuing IP assets, but he doesn't have a name for it. Nevertheless, he claims, his Fortune 500 clients have been using the nameless methodology successfully for the past two years.
While it's hard to define success in the secretive IP industry—Nathan declined to disclose the names of his clients—the methodology seems to be a repackaging of standard valuation techniques, but with one new twist. Nathan "trifurcates" the value of an IP asset. By his lights, that gives IP owners an advantage in two key business areas: asset sales and tax planning related to transfer pricing.
Traditionally, IP assets—patents, trademarks, trade secrets, and brands—are valued as a whole. That is, the assets are assigned a value by calculating a net present value, for example, based on such things as royalty revenue streams, cash flow from licensing agreements, comparable asset sale prices. Sometimes values are calculated based on options valuation models like the Black-Scholes or binomial methods.
Nathan's trifurcation method also uses options modeling and other standard measures. But it breaks down the asset into three discrete components—legal entitlement; legacy brand, or know-how in the case of patents; and exploitation. Since each component is assigned it own value, IP owners are armed with more a granular valuation for asset sale negotiations and tax planning, says Nathan. Further, isolating each part makes it easier for companies to determine which segment "is driving return," which is something a valuation that uses just market data and options modeling can't do, he adds.
Lately, figuring out better ways to value intangible assets has become more important to companies that hold sizeable IP portfolios. For one thing, more companies are relying on IP to raise capital by securitizing revenue streams or using the asset as collateral to back loans. What's more, shareholders are becoming more interested in IP and prodding management to show evidence that IP assets are being fully exploited.
The trifurcation methodology was originally developed as a transfer-pricing tool, says Nathan. Transfer-pricing rules mandate that related parties—units in the same company but in different countries and tax jurisdictions—charge market rates for services they perform for one another. Instead of using the entire value of the IP to calculate the tax liability, notes Nathan, the parent company can identify which IP component its subsidiary is using, and calculate the tax bill on that portion.
Well-known in the IP community, the trio of components in Nathan's model has never been divided before now, he says. The legal entitlement component gives the owner the right to sell the asset as well as protect it from infringement violations. The legacy brand component represents the royalties or licensing fees paid to the IP owner. And the exploitation segment gives the owner the right to use the IP differently from the way it is currently being used. For instance, an owner of a chewing gum brand could exploit the asset by branding a line of iced tea or dog treats using the gum's moniker.
It's still too early to tell whether the trifurcation method can stand up to an Internal Revenue Service challenge in tax court. It usually takes three years for the IRS to audit tax payers, and the new methodology has only been in circulation for two years. Other IP experts are also wary of Nathan's formula, mostly because the proprietary nature of the methodology makes it hard to evaluate its merits.
Robert D'Loren, chief executive officer of NexCen Brands, a company that acquires and manages IP assets, says he has never heard of a valuation methodology that trifurcates IP value, although he's familiar with newer methodology that uses options modeling. But he's not keen on the concept. According to D'Loren, NexCen likes to value IP the "old fashioned" way, by looking at cash flow. "When the calculation gets too complex, it can't be relied upon," he asserts.
Trifurcating IP assets is new to patent attorney Stephen Schreiner, too. But the Hunton & Williams partner calls Nathan's use of options modeling "smart." He points out that options valuation techniques, which have been used for valuing IP for about a decade, recognize contingencies and uncertainties associated with the asset, and he thinks that's useful. For example, options modeling can take into consideration whether the market for the IP is broad or narrow, whether licensing agreements are exclusive, or if the IP is protected from infringement for the next five years or 99 years.
As for trifurcation, Schreiner says that it might be helpful, but without examining the inner workings of the methodology, or seeing the results of, say a peer review, it's difficult to deliver a verdict on Nathan's method. "To a typical business person, the methodology looks somewhat esoteric."