Intellectual property assets can provide a substantial portion of the value of a company and can have significant impacts on the funding, growth, and long-term health of that company, as well as the market, itself. However, there are many different approaches to the valuation of intellectual property (“IP”) that can drastically change based on the requirements and purposes of the exercise. As an example, IP valuations may look vastly different in a single merger transaction depending on if the valuation is undertaken using standards for reporting to governmental competition authorities, if undertaken by an acquiring entity that is considering the future market value of IP rights after the merger or if undertaken by the entity being acquired.
Understanding which approach is most appropriate under what circumstances, and properly gathering and analyzing the requisite information for IP valuation can be complicated. Accordingly, valuation teams would greatly benefit by having the presence of experienced IP specialists. We focus below on the valuation of IP assets for merger control purposes, factors to consider when determining the market value of IP assets (IP market value) and the implications for merger transactions and beyond.
Calculation of IP asset value for merger control purposes
Mergers impacting consumers remain a top enforcement priority for competition authorities around the world. Some regulators and industry experts are concerned about acquisitions with the potential to chill competition, such as through their combined IP holdings, but that escape review from competition authorities due to such transactions falling below monetary thresholds for mandatory notification. Monetary thresholds are usually based on the financial position of the target rather than the “value” of the combination, purchase price of the merger or IP market value of either party to the merger or the combined entity.
In many jurisdictions where financial thresholds determine whether a merger transaction requires notification to the competition authorities, the asset value thresholds are determined with reference to the gross value of the target company’s assets as recorded on the balance sheet for the immediately preceding fiscal year. Intangible asset, such as IP, values for merger control reporting requirements are often measured as their cost. Thus, IP asset values for merger control (IP balance sheet values) can be low in comparison to their current or future IP market values. Accordingly, reporting requirements may not be triggered when a target company’s turnover (e.g., income from sales/services) and reported asset values are low, even if the target company has a large market value.
The difference in IP balance sheet values and IP market values can allow for larger companies to acquire small startups having valuable IP assets without a regulatory assessment of the impact that the transaction might have on competition. Examples may arise in social media or digital solutions where the customer data or reputation has a significant value to advertisers or may arise in technologies – particularly in the startup phase – that have not yet scaled to their full impact.
Calculation of IP market value
In contrast, IP market values can be fact specific and may change drastically over even a brief period of time. However, IP market values can be a driving force, if not the main driving force, behind both the desire for a merger and the purchase price for the acquisition. IP market values can also be important, among many other reasons, for raising funds, determining budgets for obtaining/maintaining IP rights, and determining if costs for IP enforcement or invalidation is justified.
Total IP market value can include IP with balance sheet values (e.g., trademark registrations, trade dress registrations, patents) and IP that has no balance sheet values (e.g., unregistered copyrights, trade secrets, unregistered trademark/trade dress rights). However, balance sheet values may not reflect IP market values. IP market values looks beyond balance sheet values and can include at least the following analyses.
IP strength – Is the IP likely to withstand attacks to the validity of the IP rights?
IP scope – Is the IP protection easily circumvented?
IP protected products, knowledge, and services – If a competitor could make, use, sell, import, or export another’s IP protected product, knowledge, or service, would profits be impacted for either party?
Third party IP rights – Do third party IP rights block full use of another’s IP rights?
IP as a barrier to entry – Do the IP rights make it prohibitively expensive or time consuming for a competitor to enter the market?
Future value of IP – If IP protected early stage or future products, knowledge or services were to be fully developed and enter the market, would it likely outcompete competitors or increase efficiency/profits?
Consideration of these factors can be complex and sometimes require industry or niche market specific considerations. The impact of these factors can be analyzed through mechanisms such as an invalidity/validity search and opinion, an enforceability opinion, an opinion on coverage of a particular product or service, a due diligence review, a patentability search and opinion and a freedom to operate search and opinion.
Implications for mergers and beyond
Regulators globally are considering how to best address the potential imbalance of IP balance sheet values and IP market values to ensure merger transactions are not overlooked. In South Africa, for example, the Competition Commission has issued specific guidelines that require notification within six months of implementation for mergers that do not meet the typical financial thresholds. The guidelines provide that even if the usual thresholds are not met by the acquiring company, a filing must be made if the purchase price or the value of the target company meets the specific asset or turnover thresholds.
This approach places emphasis on the market values of target companies as opposed to balance sheet values and implicates IP market values to the acquirer may be significantly more relevant for reporting. As different jurisdictions have different and evolving guidelines, merging entities must carefully consider merger notification requirements, even where it may seem on first glance that the thresholds are not triggered.
Carefully considering the factors that impact the IP market values can be informative as to the potential value of a merger, the current and future market value of a company and also can be used to determine if costs associated with obtaining, maintaining, enforcing, or invalidating IP rights are justified, making these exercises worth undertaking in many situations. (This article first appeared as a Norton Rose Fulbright publication.)
Thomas Orsak, PhD is a senior associate in Norton Rose Fulbright’s Austin office. He focuses his practice on intellectual property matters, which include domestic and foreign patent prosecution, enforcement, and strategic development of patent portfolios.
Candice Upfold is a competition lawyer with Norton Rose Fulbright South Africa Inc. She has extensive experience acting for merger and joint venture parties in multi-jurisdictional merger filings and regularly assists clients to obtain merger clearance from competition law regulators.