2. VALUATION CONSULTING
STARTING AT THE TOP AND TRYING
TO BUILD DOWN.
THE LAWS OF PHYSICS
AND VALUATION
SUGGEST THAT THIS IS NOT
POSSIBLE.
3. VALUATION CONSULTING
OCCASIONS FOR VALUING
INTELLECTUAL PROPERTY
• Mergers & Acquisitions
• Portfolio Review and risk assessments
• Arrange a loan - securitisation
• Tax purposes
• Licensing
• Balance Sheet purposes
• Joint Ventures
• Selling your Company
• Selling your IP
• Insurance
4. VALUATION CONSULTING
METHODS OF VALUATION
Market Based
• Comparable market transactions
5. VALUATION CONSULTING
COMPARABLE MARKET TRANSACTIONS
• Few Sales
• Lack of Information
• Separate Values
• Special Purchasers
• Different Negotiating Skills
• Distorting Effects of Varying Values
• Assets Not Always Comparable
7. VALUATION CONSULTING
HISTORICAL OR REPLACEMENT COST
Caveats
• Economic Benefits Excluded
• Duration of benefit-economic life
• Obsolescence difficult to quantify
• Maintenance
• Time value of money
8. VALUATION CONSULTING
METHODS OF VALUATION
Income Approach
• Capitalisation of historical profits
• Future economic benefits
9. VALUATION CONSULTING
CAPITALISATION OF HISTORICAL PROFITS
DRAWBACKS
Profitability
• Problems of averaging
• Problems of extrapolating from past performance
• Decline & other key variables
• Net tangible assets not separately assessed
Multiple
• No reference point for price earnings multiple
• Often no regard to established marketplace
• Often no reconciliation with market capitalisation
10. VALUATION CONSULTING
MODERN VALUATION ANALYSIS IS EFFECTIVELY DCF
APPLIED TO THE BUSINESS ENTERPRISE UNDER
CONSIDERATION
• The Net Present Value (NPV) of a strategy or business is the sum of its
expected free cash flows to a horizon (H) discounted by its cost of
capital (r)
NPV = Year 1 Cash Flow + Year 2 Cash Flow ... to say Year 5 Cash Flow
(1 + r) (1 + r) ² (1 + r)H
PLUS
The terminal value which is the value of the business at a horizon (HV)
HV = Cash Flow
(r - growth)
Also discounted back to present value
13. VALUATION CONSULTING
GROSS PROFIT DIFFERENTIAL METHOD
Limitations
• Net Tangible Assets and Rate of Return ignored
• Cost & production efficiencies not isolated
• Economies of scale not considered
• Information about other product’s cost, volumes, etc not
available
• No generic brand name for comparison
• If so differences in quantity, quality, availability
• Market trends over time
• Bias towards industries with lower variable costs to total costs
14. VALUATION CONSULTING
EXCESS PROFITS METHOD
Features
• Calculate current market value of Net Tangible Assets
• Estimate Rate of Return to calculate required profits
• Excess above required level to induce investment
• Attribute excess to intangibles
• Capitalise this return
• Ensure careful segregation to identifiable products
• Those unidentifiable must be goodwill
15. VALUATION CONSULTING
EXCESS PROFITS METHOD
Limitations
• Rate of Return can be a reflection of other factors
• Does not allocate between parts
• Tangible assets often incorporate intangible value ie value in
use basis
• Information about technological developments often not
available
• Assets being valued not employed in best manner
• Asset values & reported profits often calculated on a different
basis
• Erosion of margin over time by competitive pressures
• Benefit of lower depreciation of branded products
• Required Rate of Return often an ingredient in sale price
• Method ignores potential profit from extensions
16. VALUATION CONSULTING
ROYALTIES FOREGONE/RELIEF FROM ROYALTY
Features
• Estimate future royalty stream
• Basic premise sale & lease-back
• Usually maximum basis with acceptable Rate of
Return
• Alternatively payment for your use
• Royalty equivalent to excess profit component
• Greater availability of independent economic & trade
association forecasts
• Facilitates comparison with Royalty Rates of
similar intellectual property in marketplace
17. VALUATION CONSULTING
ROYALTIES FOREGONE/RELIEF
FROM ROYALTY
Problems
• Separation of intangible components
• Other factors often an ingredient in determining
current Royalty Rate
eg geographical goodwill
or monopoly
• Comparable
may be out of date
lack of detailed information
arrangements may preclude extensions
20. VALUATION CONSULTING
MONTE CARLO
• Effectively a DCF multiplier
• Numerous DCF calculations accounting for
various scenarios, say of revenue, market
share, costs, internationality and other
risks
• With just 4 scenario changes of the stated
assumptions above this means 256 models!
• That is 4 values for each of income, different
market share, costs, international penetration
i.e. 4 x 4 x 4 x 4 = 256
21. VALUATION CONSULTING
1-10 – 100 RULE
• Often scarce capital resources
• Each stage in a technical development
costs 10 times as much as the previous
one
• Assumption of success – the probability of failure
at each stage could be 90% +
• Even with 50% probability an inventor needs two
‘up his sleeve’, at each stage
• Multiplier effect