FS Mo Iii

Module 3 ; Business Valuations;
1. Define the meaning of business valuation.

2. What is profit multiplier in business valuation?
3. What is positive and negative goodwill?
4. Explain the various steps to establish business worth.
5. Which are the business valuation approaches?
6. How the business is valued on asset approach?
7. What is spinoff, split off and carve out?
8. What is horizontal, Vertical and conglomeration of merger?
9. What is intellectual property?
10. Name the various intellectual properties.
11. What are the advantages and disadvantages of laws of intellectual properties?
12. How does the law protect the inventors of intellectual properties?
13. How does the intellectual property help for the development of economy?
14. Define the various methods for valuation of intangibles.
15. Which are the factors driving the value of intellectual property.
16. Which are the qualitative and quantitative factors for valuation of intangible properties?
17. Write the various reasons for merger or acquisitions.
18. What is hostile takeover?
19. Write the techniques to prevent hostile takeovers.
20. What is poison pill? Define various types of pills.
21. What is golden parachute?
22. What are Stand Still agreement, Green mail, and white knight and Pac man defense?
23. What is leveraged buyout? Write the reasons for LBO.
24. What are the benefits of leveraged buy outs?
25. What is stock or cash method under mergers and acquisitions? How does it affect?
26. What is the difference between fixed share and fixed value?
27. What is shareholder value at risk (SVAR)?
28. Write about the valuation pyramid.
Your business is your major asset and it is understandable that you want to know its value. Think the business valuation as
a "subjective science". The science part is when valuing your business - you have to apply standard valuation methods. The
subjective part is that every buyer’s circumstances and considerations are different, so for the same business two buyers
may propose two different offers. In general, no fixed rules or formulas apply to value how much your business is worth.
Its value will always be what you are willing to sell for and what the potential buyer is willing to pay. Nevertheless, there
are a few frequently used valuation methods that can help you to start the negotiation process.
1. Profit Multiplier; In profit multiplier, the value of the business is calculated by multiplying its profit. For example, if
your company’s adjusted net profit is $100,000 per year, and you use a multiple like 4, then the value of the business will
be calculated as 4 x $100,000 = $400,000. From the potential buyer’s viewpoint, this means that as long as the business
continues to make profits at the same level, they will get roughly $100,000 per year for the $400,000 investment, i.e. a 25%
return. After four years they will get the full return on the investment. Compared to the bank or other investments this is a
highly profitable return. The profit multiplier method is also known as the Price to Earnings or P/E Ratio, the price being
the value of the company and the earnings being the profit that the company generates.
Determine the multiple; If pre-tax profit is used, commonly applied profit multiples for small businesses would be between
3 to 4 and occasionally 5. The P/E multiples may be applied higher for larger publicly traded companies, normally
anything from 7 to 12 and in some cases, when they have high growth potential, even more. This is one of the main reasons
why large corporations can acquire a smaller business and instantly revalue them at a higher price.
Obviously, the multiple that you will use have a huge effect on the valuation of the company. A larger business with a track
record of good profits and with several potential buyers is likely to value by a higher profit multiple.
Adjusted profit; Adjusted profit essentially means as an owner, you can’t pay yourself a small salary to raise the value of
the business. For example, a company is generating $30,000 profit, but after some investigation, it appears that the
owners aren’t taking any salary. When the market-based salaries are taken into account, the profit is reduced to nothing.
Even the established business owners generally take salaries below market rate to improve cash flow or for tax reasons.
Buyers understand this process and expect the owner’s salary to be taken into account. This is the reason adjusted profit
is used. There may be other transactions that are exceptions, for example, you may work from home or own the business
premises. You will benefit from lower rent or no rent at all, which wouldn’t apply to the new buyer. Basically, the
potential buyer wants to rest assure that the profit is accurate and the company will generate the same amount after you
are no longer the owner of the business. That concept is also known as Seller's Discretionary Earnings (SDE). It is
measured by EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and adding owner’s salary,
compensations and perks.
Average or normalized profit; If, say, last year was a good year for your company in terms of profit generation, you
obviously want to highlight that period to the buyers, but professional buyers want the average profit calculation of the
last few years. EBIT and EBITDA For some companies, it is wise to make further corrections in a profit multiplier
calculation, such as EBIT or Earnings Before Interest and Tax. This is the adjusted profit that your company makes without
the effect of tax and interest. The EBIT calculation is frequently used when a business is valued or sold based on any
debts and surplus cash removed from the balance. The EBIT gives a demonstration of the earnings of the business
without the destabilizing effect of debts or surplus cash balance. You may be thinking why are valuations calculated
without any tax?;The reason is that once the company is merged into a larger group or corporation, the tax position of
the group as a whole may be different. The valuation is agreed based on the profit after tax and as long as both seller and
buyer understand and settled for this, there shouldn’t be any problem. But remember one thing, if they are based on pre-
tax profit, the multiples used to calculate the value will be less.
EBITDA or Earnings Before Interest, Tax reduction, Depreciation and Amortization are similar to EBIT. In addition, it
explains that profit or adjusted profit is without the effect of any corrections due to the devaluation of assets or
repayment of any business loans. Let’s take a hypothetical example. Imagine you own a successful business that is making
a profit of $60,000 for few years. Your business then has an excellent year and takes the profit up to $100,000 and left
you with a $50,000 retained profit. A potential buyer gets interested and says he will buy the company based on a 5-time
multiple valuations. It seems like an excellent offer, but you have to consider and clarify a few things before you can
accept the offer. If the 5 times multiple is based on any or all of the following factors, it will be far less attractive. If the
profit is adjusted based on your increased salary, it will reduce the profit by $20,000 each year. If it was based on an
average profit of the last 3 years, which is $53,000 instead of $100,000. Instead of taking the profit with you, you may
have to leave the $50,000 in the business as a part of the working capital figure. Based on the above figure, rather than
receiving $550,000 after the sale, you will walk away with only $265,000. The 5-time multiplier valuation doesn’t look
attractive now.
2. Comparables .A common valuation method is to look at a comparable company that was sold recently or other similar
businesses with known purchasing value. For example, office and home security companies typically trade at double the
monitoring revenue, and accounting firms trade at one time gross recurring fees. You can ask around at your annual
industry conference and find out what is the selling price of similar companies in your industry. The main problem with
the comparables method is that it often leads to an apples-to-bananas comparison. For example, if you try to compare
your company with similar fortune 500 counterparts, you will be disappointed.
3. Discounted cash flow method; The discounted cash flow method is similar to the profit multiplier method. This method
is based on projections of few year future cash flows in and out of your business. The main difference between
discounted cash flow method from the profit multiplier method is that it takes inflation into consideration to calculate
the present value. Present value; Present Value (PV) is today’s value of the money you will collect in the future. Let’s look
at another example to understand how it works. Let's think that I’m offering you $1000 now, or $100 a year for 12 years
(starting next year). Which would be a better offer for you? You may think that $100 for 12 years is a much better offer
(12 x $100 = $1200), i.e. $200 more. However, you have to take inflation rate into consideration. To make the calculation
simple, let’s assume an inflation rate of 5%, so the $100 that you are going to get next year is equal to circa $95 this year.
Take a look at the table below, the $100 you will get the following year will be worth even less and after 12 years the
present value of $100 will only about $56.
Table 1. The present value of $1000 today versus $100 for twelve years
Year $1000 up-front PV $100 per year PV
0 1000 0
1 0 $95
2 0 $91
3 0 $86
4 0 $82
5 0 $78
6 0 $75
7 0 $71
8 0 $68
9 0 $64
10 0 $61
11 0 $58
12 0 $56
Total $886
As you can see the installment offer seem much better offer at first, but after inflation calculation, it adds up to only
$886. Some may think it’s still an attractive offer, but there is something else to consider How-to video: Business
Valuation St. Louis presents a summary of valuation methods such as Income Approach and Discounted Cash Flow (DCF)
Model.
Opportunity cost; If you have received $1000 today then you could have invested the money in something profitable and
get a good return every year. With $1000 upfront you can invest and get a return, but with only $100 you don’t have that
opportunity, this is called the opportunity cost. If you had invested $1000 in something profitable and receive a flat
return of 10%, within 12 years your money would have grown to $2881, the amount would have a net present value of
$1605. You have to take all of these factors into account with a discounted cash flow valuation. How it is calculated; You
need to estimate the cash revenues coming into the business and expenditures going out of the business for a number of
years into the future to calculate a discounted cash flow valuation. Taking the expenses out of the profit will give you
each year’s net cash flow. Apply an accurate discount rate (also understood as the cost of equity) to each year’s figure to
get the net present value of the future profit. This gives the discounted cash flow. The potential buyer can compare your
business against other investment choices that they may have, each with their own different levels of risk and return. Just
like the profit multiplier method, this method also comprises a lot of details. Considering inflation and risk, what level of a
discount rate to apply for each year, how many years to calculate, and should you consider the net present value of the
business at the end of the period (known as "terminal value").To learn more, check out the How-to Guide on business
valuation based on discounted cash flows.
4. Asset valuation; With this method, it’s not the profit-generating capabilities of your business; rather than the net value
of the assets in your business. If everything in the business was sold and all debts were paid, this value would be
achieved. The net asset value of your company is the total market value of all the assets it holds, such as equipment,
machinery, computers, and properties; subtracting the value of any liabilities, such as debts, leases, finance or other
money or equipment owed. Basically, if you sold all your assets and paid all your debts, you will be left with net asset
value (or "book value"). Applying asset valuation is generally more realistic if your company has a large number of assets
and/or its long-term revenue generating capabilities are limited.
Market value; You can calculate the book value of an asset by deducting any depreciation from its original price. The
assets that the business owns, your company’s accounts will show the book value of those assets. However, the market
value of those assets might be different. Your business has to arrive at the market value of its assets to reach the net
asset valuation. This will require you to hire a CPA or qualified Appraiser to assess the value of the properties.
Other valuation aspects; Hopefully, you now realized from the profit multiplier valuation method, the simple general
rules contain a lot of numbers and details that have to be negotiated further. Following are a few more that you should
understand
Surplus cash and long-term debt; Businesses are generally valued without considering any surplus cash or long-term
debts. Valuation works on the basis as if there is no surplus or debt, the actual selling price is then adjusted to take them
into account. For example, imagine that a business valued at $500,000 has debts of $100,000. The buyer may offer to pay
$400,000 for the business and accept the $100,000 debt. This is basically the same result if the seller pays the $100,000
debt and sells the business for $500,000. You may have seen in the news that a business being bought for only $1 and
wondered how and why? This happens when a company has huge debt and can’t afford to repay. If any buyer purchases
the company, they have to pay the debt. So if the company has $1 million of debt and sold for $1 that means the business
is costing the buyer $1,000,001. For any contract to recognize as valid, there needs to be some give-and-take of value. It’s
called the consideration.
Surplus cash and working capital; Any company needs a certain amount of working capital to function for a reasonable
period into the future, any excess amount is considered as surplus cash. The amount differs from business to business
and the exact figures have to be discussed and agreed between you and the buyer. If your business has a large cash
surplus, then you may go through with the sale process and follow a tax-efficient way to take out the cash, but be careful
there are drawbacks.
Firstly, as a part of the business sale, the buyer may be ready to buy this cash from you. To compensate for their trouble,
they will pay you less than its actual value, for example, for every $1, they may pay 90c.
Secondly, if you want to take advantage of the tax benefits, you have to comply with a certain restriction on how much
money you can take out of the company. This is a complex area and you need guidance from your Tax Advisor or
Accountant.
Goodwill; When it comes to the valuation of your business, goodwill points out to the adjustment between the calculated
value of your business and its net assets. So if the market value of your business is $1 million but actually holds only
$600,000 worth of assets, the rest $400,000 of value belongs to goodwill.
It can be negative; If the value of your company is less than the value of its assets, then the difference between the two is
a minus number and become negative goodwill. If your business has a lot of assets, such as property or land, the negative
goodwill can occur. So use an asset-based approach when valuing your business. The buyer decides which method of
valuation he wants to apply to your business. If they decide your business is strategic, you will get a handsome profit for
your company, otherwise you may get less then you have hoped. I’m confident that these valuation methods will be
really useful for you when you start the valuation of your business. There is a saying in the capital industry "the real value
of a company is only what a buyer is willing to pay for it". In other words, the condition of the business, the market, how
skillfully you attract the investors and negotiate with them all determines the value of your business.
Five steps to establish your business worth; Business valuation is a process that follows a number of key steps starting
with the definition of the task at hand and leading to the business value conclusion. The five steps are:
Step 1: Planning and preparation; Just as running a successful business takes planning and disciplined effort, effective
business valuation requires organization and attention to detail. The two key starting points toward establishing your
business worth are: determining why you need business valuation, assembling all the required information. It may seem
surprising at first that the valuation results are influenced by your need for business valuation. Isn’t business value
absolute? Not really. Business valuation is a process of measuring business worth. And this process depends on two key
elements: how you measure business value and under what circumstances. In formal terms, these elements are known as
the standard of value and the premise of value.
Business value depends on how and why it’s measured; A few examples will illustrate this important point. Let’s say you
want to sell your business. Business has been good, with revenues and profits growing each year. You plan to market the
business until a suitable buyer is found. You want to pick the best offer and are not in a hurry to sell. In this situation your
standard of value is the so-called fair market value. Your premise of value is a business sale of 100% ownership interest,
on a going concern basis. In other words, you plan to sell your business to the highest and most suited bidder and it will
continue running under the new ownership. Next let’s imagine that you own a small business that has developed a
product of great interest to a large public corporation. They already approached you offering to buy you out. They have
some great plans for your product and want to sell it internationally. These people are even prepared to offer you some
of their publicly traded stock. As your CPA tells you this can significantly lower your taxable gain on the business sale. In
this scenario you have a synergistic buyer who is applying the so-called investment standard of measuring your business
value. Such buyers are often willing to pay a premium for a business because they can realize some unique advantages
through a business purchase. Now consider a situation where the business owners need to settle a large bill with one of
the business’ creditors who is tired of waiting. There is not enough cash in the bank to cover the amount, so
business assets need to be sold quickly. This is the case where the so-called forced liquidationpremise of value may apply
– business owners don’t have enough time to look for a suitable buyer and may have to resort to a quick auction sale.
Once you know how and under what conditions you will measure your business worth, it is time to gather the relevant
data that impacts the business value. This data may include the business financial statements, operational procedures,
marketing and business plans, customer and vendor information, and staff records.
Business facts affect business value; Here are a few examples of how information about the quality of operation affects
the business value. Well-documented financial statements and tax returns are essential to demonstrate the business
earning power. Steady, above industry norm earnings tend to translate into higher business value. Detailed written
business operating procedures make it easy to understand how the business works, who does what, and what skills are
required. Since it is easier to take over a well-organized business, there is higher business buyer interest and competition
among them tends to increase the business selling price. A good marketing plan provides the essential inputs into the
future business earnings projections. And accurate earnings projections are key to establishing the business value based
on its income. A look at the customer list quickly shows where the business gets its revenues. Businesses that do not rely
on a few large customers for most of their business sales tend to command a higher selling price. Let’s say that the
business enjoys an exclusive distribution agreement with a major vendor, a key competitive advantage. If this agreement
can be transferred to the business buyer, the business selling price is likely to be higher. Skilled and motivated staff is
essential to business success. Not surprisingly, if experienced long-term employees stay with the business after the sale,
the selling price is likely to reflect it. Some of the information will provide immediate and useful parameters to determine
the business value. Other parts of this data, notably the company’s historical financial statements,
require adjustments to prepare inputs for the business valuation methods. We discuss the financial statements
adjustment process in the following sections.
Step 2: Adjusting the historical financial statements; Business valuation is largely an economic analysis exercise. Not
surprisingly, the company financial information provides key inputs into the process. The two main financial statements
you need for business valuation are the income statement and the balance sheet. To do a proper job of valuing a small
business, you should have 3–5 years of historic income statements and balance sheets available. Many small business
owners manage their businesses to reduce taxable income. Yet when it comes to valuing the business, an accurate
demonstration of the full business earning potential is essential. Since business owners have considerable discretion in
how they use the business assets as well as what income and expenses they recognize, the company historical financial
statements may need to be recast or adjusted. The idea is to construct an accurate relationship between the required
business assets, expenses and the levels of business income these assets are capable of producing. In general, both the
balance sheet and the income statement require recasting in order to generate inputs for use in business valuation. Here
are the most common adjustments:.1. Recasting the Income Statement..2.Recasting the Balance Sheet.
Step 3: Choosing the business valuation methods; Once your data is prepared, it is time to choose the business valuation
procedures. Since there are a number of well-established methods to determine business value, it is a good idea to use
several of them to cross-check your results. All known business valuation methods fall under one or more of these
fundamental approaches:.1. Asset approach.2.Market approach.3.Income approach
Tools to Value a Business; The set of methods you choose to determine your business value depends upon a number of
factors. Here are some key points to consider: The complexity and value of the company’s asset base. Availability of the
comparative business sale data from the market. Business earnings history. Availability of reliable business earnings
projections into the future. Availability of data on the business cost of capital, both debt and equity.
Choosing the asset based business valuation methods; Determining the value of an asset-rich company may justify the
cost and complexity of the asset-based valuation methods, such as the asset accumulation method. In addition to valuing
the individual business assets and liabilities, the method can be helpful when allocating the business purchase price
across the individual business assets, as part of the asset purchase agreement. However, the method requires
considerable skill in individual asset and liability valuation which often makes its application costly and time consuming.
See example: Business Value = Assets + Business Goodwill
How the market based business valuation methods work; Market based business valuation methods focus on estimating
business value by examining the business sale transaction data available from the actual market place. There are two
types of transaction data that can be used: Guideline transactions involving similar public companies. Comparative
transactions involving private companies that closely resemble the subject business. The advantage of using the public
guideline company data is that it is plentiful and readily available. However, you need to be careful when selecting such
data to make an “apples to apples” comparison to a private company. In contrast, reviewing business sales of similar
private companies provides an excellent and direct way to estimate the business value. The challenge is gathering
sufficient data for a meaningful comparison. Regardless of which market-based method you choose, the calculations rely
on a set of so-called pricing multiples that let you estimate the business worth in comparison to some measure of the
business economic performance. Typical pricing multiples used in small business valuation include: Selling price to
revenue. Selling price to business earnings such as net income, SDCF, EBITDA, or net cash flow. Each pricing multiple is a
ratio of the likely business selling price divided by the respective economic performance value. So, for instance, the
selling price to revenue multiple is calculated by dividing the business selling price by business revenue. To estimate your
business value, you can use one or more of these pricing multiples. For example, take the selling price to revenue pricing
multiple and multiply it by the business annual revenue. The result is the business selling price estimate.
Valuation multiple formulas; More sophisticated market based business valuation methods, such as the Market
Comps in ValuAdder, use business pricing rules that make an intelligent choice of which pricing multiplies to apply when
valuing a business. In addition, the Market Comps let you account for key business attributes automatically: Business
revenue or profits, Inventory, FF&E, Tangible asset base
The income based business valuation. Income based business valuation methods determine business worth based on the
business earning power. Business valuation experts widely consider these methods to be the most accurate. All income-
based business valuation methods rely on either discounting or capitalization of some measure of business earnings. The
discounting methods, such as the ValuAdder Discounted Cash Flow, produce very accurate results by letting you specify
the details of the expected business income stream over time. The Discounted Cash Flow method is an excellent choice
for valuing a young or rapidly growing company whose earnings vary considerably. Alternatively, the so-called direct
capitalization methods, such as the ValuAdder Multiple of Discretionary Earnings, determine your business worth based
on the business earnings and a carefully constructed capitalization rate. The Multiple of Discretionary Earnings method
is an outstanding choice for valuing small established companies with consistent earnings and growth rates.
Step 4: Number crunching: applying the selected business valuation methods; With the relevant data assembled and
your choices of the business valuation methods made, calculating your business value should produce accurate and easily
justifiable results. One reason to use several business valuation methods is to cross-check your assumptions. For
example, if one business valuation method produces surprisingly different results, you could review the inputs and
consider if anything has been overlooked.
Step 5: Reaching the business value conclusion; Finally, with the results from the selected valuation methods available,
you can make the decision of what the business is worth. This is called the business value synthesis. Since no one
valuation method provides the definitive answer, you may decide to use several results from the various methods to
form your opinion of what the business is worth. Since the various business valuation methods you have chosen may
produce somewhat different results, concluding the business value requires that these differences be reconciled.
Business valuation experts generally use a weighting scheme to derive the business value conclusion. The weights
assigned to the results of the business valuation methods serve to rank their relative importance in reaching the business
value estimate. Here is an example of using such a weighting scheme:
Weighted
Approach Valuation Method Value Weight
Value
Comparative business
Market $1,000,000 25% $250,000
sales
Income Discounted Cash Flow $1,200,000 25% $300,000
Multiple of Discretionary
Income $1,350,000 30% $405,000
Earnings
Asset Asset Accumulation $950,000 20% $190,000
The business value is just the sum of the weighted values which in this case equals $1,145,000. While there are no hard
and fast rules to determine the weights, many business valuation experts use a number of guidelines when selecting the
weights for their business value conclusion:
The Discounted Cash Flow method results are weighted heavier in the following situations: Reliable
business earnings projections exist. Future business income is expected to differ substantially from the past. Business has
a high intangible asset base, such as internally developed products and services. 100% of the business ownership interest
is being valued.
The Multiple of Discretionary Earnings method gets higher weights when: Business income prospects are consistent with
past performance. Income growth rate forecast is thought reliable.
Market based valuation results are weighted heavier whenever:Relevant comparative business sale data is available.
Minority (non-controlling) business ownership interest is being valued. Selling price justification is very important.
The asset based valuation results are emphasized in the weighting scheme when: Business is exceptionally asset-rich.
Detailed business asset value data is available.
Business Valuation Approaches; Generally accepted ways of determining the value of small businesses and professional
practices. There are three broad approaches used for small business valuation. Each approach serves as a foundation for
a group of methods used to determine the business value. Income approach, Asset approach, Market approach. A
comprehensive business valuation model should include a choice of several methods under the above approaches.
Business Valuation based on Three Approaches. Income approach to business valuation. The Income approach methods
determine the value of a business based on its ability to generate desired economic benefit for the owners. The key
objective of the income based methods is to determine the business value as a function of the economic benefit. The
economic benefit such as the seller’s discretionary cash flow or net cash flow is capitalized, discounted or multiplied to
perform the valuation. Key to the effective use of the income-based business valuation methods is the proper selection of
the capitalization rate, discount rate, and valuation multiples. The well known methods under the income approach are:
Discounted cash flow method, Capitalization of earnings method, Multiple of discretionary earnings method. We discuss
the discounting and capitalization methods of valuing a business in our business valuation guide.
Asset approach to valuing a business; The Asset approach methods seek to determine the business value based on the
value of its assets. The idea is to determine the business value based on the fair market value of its assets less its
liabilities. The commonly used valuation methods under this approach are: Asset accumulation method, Capitalized
excess earnings method, Market-based business valuation. The Market approach based valuation methods establish the
business value in comparison to historic sales involving similar businesses. The business valuation methods under the
market approach that are typically used in professional business appraisals include: Comparative transaction method,
Guideline publicly traded company method. These methods rely on the so-called pricing multiples which determine a
relationship between the business economic performance, such as its revenues or profits, and its potential selling price.
Sales of businesses which closely resemble the business being valued are most commonly used to estimate the pricing
multiples. Statistical analysis of such actual business sale data is used to establish the business valuation Market Comps.
For a comparison of the different business valuation methods under the market approach, take a look at the market
business valuation section in our business valuation guide.
Business Valuation Approaches; Generally accepted ways of determining the value of small businesses and professional
practices. There are three broad approaches used for small business valuation. Each approach serves as a foundation for
a group of methods used to determine the business value. Income approach. Asset approach. Market approach A
comprehensive business valuation model should include a choice of several methods under the above approaches.
Income approach to business valuation; The Income approach methods determine the value of a business based on its
ability to generate desired economic benefit for the owners. The key objective of the income based methods is to
determine the business value as a function of the economic benefit. The economic benefit such as the seller’s
discretionary cash flow or net cash flow is capitalized, discounted or multiplied to perform the valuation. Key to the
effective use of the income-based business valuation methods is the proper selection of the capitalization rate, discount
rate, and valuation multiples. The well known methods under the income approach are: Discounted cash flow method,
Capitalization of earnings method, Multiple of discretionary earnings method. We discuss the discounting and
capitalization methods of valuing a business in our business valuation guide.
Guideline publicly traded company method. These methods rely on the so-called pricing multiples which determine a
A comprehensive business valuation model should include a choice of several methods under the above approaches.
Income approach to business valuation; The Income approach methods determine the value of a business based on its
ability to generate desired economic benefit for the owners. The key objective of the income based methods is to
determine the business value as a function of the economic benefit. The economic benefit such as the seller’s
discretionary cash flow or net cash flow is capitalized, discounted or multiplied to perform the valuation. Key to the
effective use of the income-based business valuation methods is the proper selection of the capitalization rate, discount
rate, and valuation multiples. The well-known methods under the income approach are: Discounted cash flow method,
Capitalization of earnings method, Multiple of discretionary earnings method. We discuss the discounting and
capitalization methods of valuing a business in our business valuation guide.
Guideline publicly traded company method .These methods rely on the so-called pricing multiples which determine a
Business Valuation; Business valuation is an exercise undertaken to determine the economic value of ownership interest
in a business. The theory and practice behind business valuation is complex and the exact approach depends on the
business size, size of ownership interest (minority vs majority) under consideration, definition of value (intrinsic value,
market value, breakup value, etc.) and purpose of valuation (legal, taxation, merger and acquisitions, etc.). Typically,
business valuation is carried out when: One business is merged with another: to determine the consideration to be paid
by the acquirer to shareholders of the target. One business line is separated from another: to determine the value to be
paid for the sold-off division. Ownership interest is purchased or sold: to determine the value at which shareholders
purchase/sell ownership interest. Taxation: to determine inheritance and capital gains taxes and find out the most
efficient estate planning approach. Dispute resolution: to resolve disputes between shareholders by transfer of
ownership stake between shareholders. Divorce: to determine settlement between partners
Methods; There are three main methods of business valuation: (a) market approach, (b) income approach, and (c) asset
approach.
Market Approach; In market approach, value of a business is determined by identifying comparable

companies/transactions, working out their price multiples such as price to earnings ratio, price to book ratio, etc. and
applying that ratio to the business under consideration. Market approach is a relative valuation method because under
this approach, value of a business is determined relative to similar companies and similar actual sale and purchase
transactions. Market approach is theoretically sound because the value is validated by actual market transactions.
However, lack of adequate comparable transactions in most cases limits usefulness of this method.
Income Approach; In income approach, value of a business is determined by discounting the future earnings of the
business (measured in terms of income or cash flows). Strength of the income approach lies in its flexibility and
effectiveness. Since it does not rely on comparable data, lack of relevant transactions data is not a limitation in this
approach. Future earnings/cash flows are determined keeping in view the company’s competitive position, its cost
structure and taxes, etc. The discount rate used in determining the value can be worked out using different models, i.e.
the capital assets pricing model and build-up approach.
Asset Approach; In asset approach, value of a business is determined by ascertaining the value of each individual asset of
the business. For example, inventories can be valued at the net realizable value, accounts receivable can be value after
allowing an appropriate provision for bad debts, fixed assets can be valued at their fair value less costs to sell, etc. In most
cases value of a business is significantly higher than the sum of values of all individual assets due to goodwill. Hence, the
asset approach to valuation is not the best approach in most cases. It is appropriate only in case of companies who are in
liquidation. In case be used for businesses in going concern only where the other two approaches can’t be reliably
applied.
Example; Robert Lee owns Lee Dental Arts, which he established 30 years ago in Charlottesville. He is 65 now and wants
to retire and sell the practice. In the initial meeting to discuss engagement, he disclosed that he started thinking about
retirement when one of class mates from his college who was also a dentist recently sold his practice, Jefferson Dental
Works, for $3,000,000. Lee’s revenues for the most recent were $1.5 million and Jefferson’s were $2.5 million. By
searching a popular valuation database, you found out that typical capitalization rate used for dental practices is 20%.
Lee’s net cash flows per year are $400,000. You visited the dental practice and obtained a list of fixed assets, which
costed $2 million, have written down value of $500,000 and can be sold for $800,000. Lee has receivables of $50,000
from different insurance companies of which $5,000 are not expected to be collected. An amount of $20,000 shall be
spent on liquidating all the assets. Determine his practice value based on the three common valuation approaches and
suggest which approach is the best. Let’s determine the value under the three approaches:
Market approach: Jefferson Dental Works generated revenue of $2.5 million per year and was sold for $3 million. Its price
to sales ratio is 1.2. Assuming both practices are identical, value of Lee Dental Arts should be $1.8 million (=1.2 * $1.5
million).
Income approach: Value of Lee Dental Arts equals the present value of its net cash flows. Since the cash flows are
assumed to be perpetual and we identified that approach capitalization rate is 20%, value should be $2 million
(=$400,000/20%).
Asset approach: Value equals the individual value of all assets. In case of Lee Dental Arts, value based on asset approach
equals $825,000 (=market value of fixed assets ($800,000) + net receivables ($50,000 - $5,000) – cost of liquidation
($20,000)). The best approach to value Lee Dental Arts is the income approach. Market approach is not very useful
because only one transaction data is available, that too 2-years old data from another city. Asset approach is not useful
because it assumes liquidation and doesn’t account for any goodwill. Asset approach is to be applied only if no willing
buyer can be identified for the whole practice.
Business Mergers: A merger is a corporate strategy of combining different companies into a single company in order to
enhance the financial and operational strengths of both organizations. A merger usually involves combining two
companies into a single larger company. The combination of the two companies involves a transfer of ownership, either
through a stock swap or a cash payment between the two companies. In practice, both companies surrender their stock
and issue new stock as a new company. There are several types of mergers. For example, horizontal mergers may
happen between two companies in the same industry, such as banks or steel companies. Vertical mergers occur between
two companies in the same industry value chain, such as a supplier or distributor or manufacturer. Mergers between two
companies in related, but not the same industry are called concentric mergers. These mergers can use the same
technologies or skilled workforce to work in both industry segments, such as banking and leasing. Finally, conglomerate
mergers occur between two diversified companies that may share management to improve economies of scale for both
companies. A merger sometimes involves new branding or identity of the merged companies. Otherwise, a merger may
lead to a combination of the names of the two companies, capitalizing on the brand identity of both companies.
WHY IT MATTERS: Mergers may result in a stronger company with combined assets, competencies, and markets. At the
same time, mergers may result in a dilution of the financial strengths of one of the companies, particularly if the new
company results in the issuance of more stock across the same asset base of the two merged companies. Finally, mergers
often fail because of the clash of corporate cultures between the two companies, a reluctance to restructure redundant
management and operations, incompatibilities of the technologies used by the companies, and disruptions in the
workforce. Because mergers are difficult to implement, most ultimately take the form of an acquisition, that is, the
purchase of a weaker company by a stronger company.
What does M&A encompasses? Mergers and acquisitions together with divestitures typically encompass numerous types
of company restructuring approaches. These can vary based on the type of control, purpose, and other criteria. Our
comprehensive M&A overview will help you to navigate through this topic.
How does it work? When two or more companies merge, they create a new entity that often benefits from both
merged parts (e.g. cost position, broader product/services offering, know-how, market access etc.). There are
numerous types of mergers described in detail further below. M&A Examples:● Disney and Pixar● Exxon and Mobile●
Comcast and Time Warner Cable, Acquisition is sometimes seen as an extreme case of a merger where one company
takes over another company incorporating it into it’s own entity.
M&A Examples:● Microsoft and Skype● TransCanada and

Columbia Pipeline Group● Dell and EMC
Divest
Companies often spin off creating separate entities out of divisions or subsidiaries. As a
result of a spin-off, shares of subsidiaries are distributed back to shareholders as a dividend. Examples:● GE and
Synchrony Financial● Siemens AG and Osram● Pfizer and Zoetis● Onex and Celestica● Shaw Communications and Chorus
Entertainment
A Split-off is when after separating a company division or subsidiary, the stakeholders have to choose
between keeping shares of the original company or changing some (or all) original shares into shares of the split-off
company. As a result of a spin-off shares of subsidiaries are distributed back to shareholders as a dividend. Examples:●
MetLife and RGA (Reinsurance Group of America)● Procter & Gamble and Folgers● Ebay and Paypal
A carve-out is a sale of a minority interest to other companies. Typically the seller

gets compensated through cash inflow or other financial compensation. Examples:● Thomas Reuters and IP&S●
Microsoft and Nokia
Types of Mergers and Acquisitions; Mergers and acquisitions come in all forms and shapes. They can vary by a control
degree of an acquired entity or by its purpose. The type of acquisition may often dictate the Post-Merger Integration
approach and also the degree of integration. By control degree
This type of acquisition is often used in order to preserve and grow the existing company
that already performs very well and, in particular, if it has an independent brand that carries significant value. M&A
Examples:● Microsoft and LinkedIn● Fiat and Ferrari● Desjardins Insurance and State Farm (CAN)
A merger under equals is considered when both sides bring considerable assets into the
merger e.g. from a market, product/service or capabilities perspective. M&A Examples:● Ernst and Young● Dow
Chemical and DuPont● Exxon and Mobil
A Take-over is an example of a full acquisition (sometimes also a hostile acquisition). In this case
most of the functions, and often a brand, are digested by the company that did the purchasing. M&A Examples:● HP and
Compaq● Vodafone and Mannesmann● Aviva Friends Life (UK)
By purpose
Acquisition of / a merger with a company which competes in the same space in terms of the value
chain. The main purpose here is to increase market share, drive economies of scale or Increase presence in other
geographies. M&A Examples: ● Daimler Chrysler● Marriott and Sheraton hotels● Groupon and Citydeal
Acquisition of a company or a merger with a company in way that both companies complement
one joint value chain. M&A Examples: ● Timewarner Cable and Turner● KPMG and Secor Consulting in Canada
Acquisition of / merger with a company which is active in a partly or entirely different space.
These are called respectively mixed or pure conglomerate mergers. M&A Examples:● P&G and Gillette● Walt Disney and
ABC● Microsoft and LinkedIn
Acquisition of a public company via a private company with the purpose of using the public
company as a shell. By merging both companies, the private company becomes public without IPO. It is a cheaper and
faster alternative to making a company public. M&A Examples: ● Aérospatiale and Matra● Atari and JT Storage● ABC
Radio and Citadel Broadcasting Corporation
Forms of intellectual property & methods of valuation. ;Intellectual property (IP) is a category of property that includes
intangible creations of the human intellect, and primarily encompasses copyrights, patents, and trademarks.[1] It also
includes other types of rights, such as trade secrets, publicity rights, moral rights, and rights against unfair competition.
Artistic works like music and literature, as well as some discoveries, inventions, words, phrases, symbols, and designs, can
all be protected as intellectual property.[2][3] It was not until the 19th century that the term "intellectual property"
began to be used, and not until the late 20th century that it became commonplace in the majority of the world.[4]The
main purpose of intellectual property law is to encourage the creation of a large variety of intellectual goods. To achieve
this, the law gives people and businesses property rights to the information and intellectual goods they create – usually
for a limited period of time. This gives economic incentive for their creation, because it allows people to profit from the
information and intellectual goods they create.[5] These economic incentives are expected to stimulate innovation and
contribute to the technological progress of countries, which depends on the extent of protection granted to
innovators.[6]The intangible nature of intellectual property presents difficulties when compared with traditional property
like land or goods. Unlike traditional property, intellectual property is "indivisible" – an unlimited number of people can
"consume" an intellectual good without it being depleted. Additionally, investments in intellectual goods suffer from
problems of appropriation – a landowner can surround their land with a robust fence and hire armed guards to protect it,
but a producer of information or an intellectual good can usually do very little to stop their first buyer from replicating it
and selling it at a lower price. Balancing rights so that they are strong enough to encourage the creation of intellectual
goods but not so strong that they prevent the goods' wide use is the primary focus of modern intellectual property law.
The Statute of Monopolies (1624) and the British Statute of Anne (1710) are seen as the origins of patent law and
copyright respectively,[8] firmly establishing the concept of intellectual property.The first known use of the term
intellectual property dates to 1769, when a piece published in the Monthly Review used the phrase.[9] The first clear
example of modern usage goes back as early as 1808, when it was used as a heading title in a collection of essays.[10]The
German equivalent was used with the founding of the North German Confederation whose constitution granted
legislative power over the protection of intellectual property (Schutz des geistigen Eigentums) to the confederation.[11]
When the administrative secretariats established by the Paris Convention (1883) and the Berne Convention (1886)
merged in 1893, they located in Berne, and also adopted the term intellectual property in their new combined title, the
United International Bureaux for the Protection of Intellectual Property. The organization subsequently relocated to
Geneva in 1960, and was succeeded in 1967 with the establishment of the World Intellectual Property Organization
(WIPO) by treaty as an agency of the United Nations. According to legal scholar Mark Lemley, it was only at this point that
the term really began to be used in the United States (which had not been a party to the Berne Convention),[4] and it did
not enter popular usage there until passage of the Bayh-Dole Act in 1980.[12] "The history of patents does not begin with
inventions, but rather with royal grants by Queen Elizabeth I (1558–1603) for monopoly privileges... Approximately 200
years after the end of Elizabeth's reign, however, a patent represents a legal right obtained by an inventor providing for
exclusive control over the production and sale of his mechanical or scientific invention... [demonstrating] the evolution of
patents from royal prerogative to common-law doctrine."[13] The term can be found used in an October 1845
Massachusetts Circuit Court ruling in the patent case Davoll et al. v. Brown., in which Justice Charles L. Woodbury wrote
that "only in this way can we protect intellectual property, the labors of the mind, productions and interests are as much
a man's own...as the wheat he cultivates, or the flocks he rears."[14] The statement that "discoveries are..property" goes
back earlier. Section 1 of the French law of 1791 stated, "All new discoveries are the property of the author; to assure the
inventor the property and temporary enjoyment of his discovery, there shall be delivered to him a patent for five, ten or
fifteen years."[15] In Europe, French author A. Nion mentioned propriété intellectuelle in his Droits civils des auteurs,
artistes et inventeurs, published in 1846. Until recently, the purpose of intellectual property law was to give as little
protection as possible in order to encourage innovation. Historically, therefore, they were granted only when they were
necessary to encourage invention, limited in time and scope.[16] This is mainly as a result of knowledge being
traditionally viewed as a public good, in order to allow its extensive dissemination and improvement thereof.[17] The
concept's origins can potentially be traced back further. Jewish law includes several considerations whose effects are
similar to those of modern intellectual property laws, though the notion of intellectual creations as property does not
seem to exist – notably the principle of Hasagat Ge'vul (unfair encroachment) was used to justify limited-term publisher
(but not author) copyright in the 16th century.[18] In 500 BCE, the government of the Greek state of Sybaris offered one
year's patent "to all who should discover any new refinement in luxury".[19] According to Jean-Frédéric Morin, "the
global intellectual property regime is currently in the midst of a paradigm shift".[20] Indeed, up until the early 2000s the
global IP regime used to be dominated by high standards of protection characteristic of IP laws from Europe or the United
States, with a vision that uniform application of these standards over every country and to several fields with little
consideration over social, cultural or environmental values or of the national level of economic development. Morin
argues that "the emerging discourse of the global IP regime advocates for greater policy flexibility and greater access to
knowledge, especially for developing countries." Indeed, with the Development Agenda adopted by WIPO in 2007, a set
of 45 recommendations to adjust WIPO’s activities to the specific needs of developing countries and aim to reduce
distortions especially on issues such as patients’ access to medicines, Internet users’ access to information, farmers’
access to seeds, programmers’ access to source codes or students’ access to scientific articles.[21] However, this
paradigm shift has not yet manifested itself in concrete legal reforms at the international level.[22] Similarly, it is based
on these background that the Trade-Related Aspects of Intellectual Property Rights (TRIPS) agreement requires members
of the WTO to set minimum standards of legal protection, but its objective to have a “one-fits-all” protection law on
Intellectual Property has been viewed with controversies regarding differences in the development level of countries.[23]
Despite the controversy, the agreement has extensively incorporated intellectual property rights into the global trading
system for the first time in 1995, and has prevailed as the most comprehensive agreement reached by the world.[24]
Intellectual property rights; Intellectual property rights include patents, copyright, industrial design rights, trademarks,
plant variety rights, trade dress, geographical indications,[25] and in some jurisdictions trade secrets. There are also more
specialized or derived varieties of sui generis exclusive rights, such as circuit design rights (called mask work rights in the
US) and supplementary protection certificates for pharmaceutical products (after expiry of a patent protecting them) and
database rights (in European law). The term "industrial property" is sometimes used to refer to a large subset of
intellectual property rights including patents, trademarks, industrial designs, utility models, service marks, trade names,
and geographical indications.[26]
Patents; A patent is a form of right granted by the government to an inventor or their successor-in-title, giving the owner
the right to exclude others from making, using, selling, offering to sell, and importing an invention for a limited period of
time, in exchange for the public disclosure of the invention. An invention is a solution to a specific technological problem,
which may be a product or a process and generally has to fulfill three main requirements: it has to be new, not obvious
and there needs to be an industrial applicability.[27]:17 To enrich the body of knowledge and stimulate innovation, it is
an obligation for patent owners to disclose valuable information about their inventions to the public.[28]
Copyright; A copyright gives the creator of an original work exclusive rights to it, usually for a limited time. Copyright may
apply to a wide range of creative, intellectual, or artistic forms, or "works".[29][30] Copyright does not cover ideas and
information themselves, only the form or manner in which they are expressed.[31]
Industrial design rights; An industrial design right (sometimes called "design right" or design patent) protects the visual
design of objects that are not purely utilitarian. An industrial design consists of the creation of a shape, configuration or
composition of pattern or color, or combination of pattern and color in three-dimensional form containing aesthetic
value. An industrial design can be a two- or three-dimensional pattern used to produce a product, industrial commodity
or handicraft. Generally speaking, it is what makes a product look appealing, and as such, it increases the commercial
value of goods.[28]
Plant varieties; Plant breeders' rights or plant variety rights are the rights to commercially use a new variety of a plant.
The variety must amongst others be novel and distinct and for registration the evaluation of propagating material of the
variety is considered.
Trademarks; A trademark is a recognizable sign, design or expression which distinguishes products or services of a
particular trader from the similar products or services of other traders.[32][33][34]
Trade dress; Trade dress is a legal term of art that generally refers to characteristics of the visual and aesthetic
appearance of a product or its packaging (or even the design of a building) that signify the source of the product to
consumers.[35]
Trade secrets; A trade secret is a formula, practice, process, design, instrument, pattern, or compilation of information
which is not generally known or reasonably ascertainable, by which a business can obtain an economic advantage over
competitors and customers. There is no formal government protection granted; each business must take measures to
guard its own trade secrets (e.g., Formula of its soft drinks is a trade secret for Coca-Cola.)
Object of intellectual property law; The main purpose of intellectual property law is to encourage the creation of a wide
variety of intellectual goods for consumers.[5] To achieve this, the law gives people and businesses property rights to the
information and intellectual goods they create, usually for a limited period of time. Because they can then profit from
them, this gives economic incentive for their creation.[5] The intangible nature of intellectual property presents
difficulties when compared with traditional property like land or goods. Unlike traditional property, intellectual property
is indivisible – an unlimited number of people can "consume" an intellectual good without it being depleted. Additionally,
investments in intellectual goods suffer from problems of appropriation – while a landowner can surround their land with
a robust fence and hire armed guards to protect it, a producer of information or an intellectual good can usually do very
little to stop their first buyer from replicating it and selling it at a lower price. Balancing rights so that they are strong
enough to encourage the creation of information and intellectual goods but not so strong that they prevent their wide
use is the primary focus of modern intellectual property law.[7] By exchanging limited exclusive rights for disclosure of
inventions and creative works, society and the patentee/copyright owner mutually benefit, and an incentive is created
for inventors and authors to create and disclose their work. Some commentators have noted that the objective of
intellectual property legislators and those who support its implementation appears to be "absolute protection". "If some
intellectual property is desirable because it encourages innovation, they reason, more is better. The thinking is that
creators will not have sufficient incentive to invent unless they are legally entitled to capture the full social value of their
inventions".[16] This absolute protection or full value view treats intellectual property as another type of "real" property,
typically adopting its law and rhetoric. Other recent developments in intellectual property law, such as the America
Invents Act, stress international harmonization. Recently there has also been much debate over the desirability of using
intellectual property rights to protect cultural heritage, including intangible ones, as well as over risks of commodification
derived from this possibility.[36] The issue still remains open in legal scholarship.
Financial incentive; These exclusive rights allow owners of intellectual property to benefit from the property they have
created, providing a financial incentive for the creation of an investment in intellectual property, and, in case of patents,
pay associated research and development costs.[37] In the United States Article I Section 8 Clause 8 of the Constitution,
commonly called the Patent and Copyright Clause, reads; "[The Congress shall have power] 'To promote the progress of
science and useful arts, by securing for limited times to authors and inventors the exclusive right to their respective
writings and discoveries.'"[38] ”Some commentators, such as David Levine and Michele Boldrin, dispute this
justification.[39]In 2013 the United States Patent & Trademark Office approximated that the worth of intellectual
property to the U.S. economy is more than US $5 trillion and creates employment for an estimated 18 million American
people. The value of intellectual property is considered similarly high in other developed nations, such as those in the
European Union.[40] In the UK, IP has become a recognised asset class for use in pension-led funding and other types of
business finance. However, in 2013, the UK Intellectual Property Office stated: "There are millions of intangible business
assets whose value is either not being leveraged at all, or only being leveraged inadvertently".[41]
Economic growth; The WIPO treaty and several related international agreements underline that the protection of
intellectual property rights is essential to maintaining economic growth. The WIPO Intellectual Property Handbook gives
two reasons for intellectual property laws: One is to give statutory expression to the moral and economic rights of
creators in their creations and the rights of the public in access to those creations. The second is to promote, as a
deliberate act of Government policy, creativity and the dissemination and application of its results and to encourage fair
trading which would contribute to economic and social development.[42] The Anti-Counterfeiting Trade Agreement
(ACTA) states that "effective enforcement of intellectual property rights is critical to sustaining economic growth across
all industries and globally".[43] Economists estimate that two-thirds of the value of large businesses in the United States
can be traced to intangible assets.[44] "IP-intensive industries" are estimated to generate 72 percent more value added
(price minus material cost) per employee than "non-IP-intensive industries".[45][dubious – discuss] A joint research
project of the WIPO and the United Nations University measuring the impact of IP systems on six Asian countries found "a
positive correlation between the strengthening of the IP system and subsequent economic growth."[46]
Morality; According to Article 27 of the Universal Declaration of Human Rights, "everyone has the right to the protection
of the moral and material interests resulting from any scientific, literary or artistic production of which he is the
author".[47] Although the relationship between intellectual property and human rights is a complex one,[48] there are
moral arguments for intellectual property. The arguments that justify intellectual property fall into three major
categories. Personality theorists believe intellectual property is an extension of an individual. Utilitarians believe that
intellectual property stimulates social progress and pushes people to further innovation. Lockeans argue that intellectual
property is justified based on deservedness and hard work.[49]
Various moral justifications for private property can be used to argue in favor of the morality of intellectual property,
such as: Natural Rights/Justice Argument: this argument is based on Locke's idea that a person has a natural right over
the labour and/or products which is produced by his/her body. Appropriating these products is viewed as unjust.
Although Locke had never explicitly stated that natural right applied to products of the mind,[50] it is possible to apply his
argument to intellectual property rights, in which it would be unjust for people to misuse another's ideas.[51] Locke's
argument for intellectual property is based upon the idea that laborers have the right to control that which they create.
They argue that we own our bodies which are the laborers, this right of ownership extends to what we create. Thus,
intellectual property ensures this right when it comes to production.
Utilitarian-Pragmatic Argument: according to this rationale, a society that protects private property is more effective and
prosperous than societies that do not. Innovation and invention in 19th century America has been attributed to the
development of the patent system.[52] By providing innovators with "durable and tangible return on their investment of
time, labor, and other resources", intellectual property rights seek to maximize social utility.[53] The presumption is that
they promote public welfare by encouraging the "creation, production, and distribution of intellectual works".[53]
Utilitarians argue that without intellectual property there would be a lack of incentive to produce new ideas. Systems of
protection such as Intellectual property optimize social utility.
"Personality" Argument: this argument is based on a quote from Hegel: "Every man has the right to turn his will upon a
thing or make the thing an object of his will, that is to say, to set aside the mere thing and recreate it as his own".[54]
European intellectual property law is shaped by this notion that ideas are an "extension of oneself and of one's
personality".[55] Personality theorists argue that by being a creator of something one is inherently at risk and vulnerable
for having their ideas and designs stolen and/or altered. Intellectual property protects these moral claims that have to do
with personality. Lysander Spooner (1855) argues "that a man has a natural and absolute right—and if a natural and
absolute, then necessarily a perpetual, right—of property, in the ideas, of which he is the discoverer or creator; that his
right of property, in ideas, is intrinsically the same as, and stands on identically the same grounds with, his right of
property in material things; that no distinction, of principle, exists between the two cases".[56] Writer Ayn Rand argued
in her book Capitalism: The Unknown Ideal that the protection of intellectual property is essentially a moral issue. The
belief is that the human mind itself is the source of wealth and survival and that all property at its base is intellectual
property. To violate intellectual property is therefore no different morally than violating other property rights which
compromises the very processes of survival and therefore constitutes an immoral act.[57]
Infringement, misappropriation, and enforcement; Violation of intellectual property rights, called "infringement" with
respect to patents, copyright, and trademarks, and "misappropriation" with respect to trade secrets, may be a breach of
civil law or criminal law, depending on the type of intellectual property involved, jurisdiction, and the nature of the
action.
Patent infringement; Patent infringement typically is caused by using or selling a patented invention without permission
from the patent holder. The scope of the patented invention or the extent of protection[59] is defined in the claims of the
granted patent. There is safe harbor in many jurisdictions to use a patented invention for research. This safe harbor does
not exist in the US unless the research is done for purely philosophical purposes, or in order to gather data in order to
prepare an application for regulatory approval of a drug.[60] In general, patent infringement cases are handled under civil
law (e.g., in the United States) but several jurisdictions incorporate infringement in criminal law also (for example,
Argentina, China, France, Japan, Russia, South Korea).[61]
Copyright infringement; Copyright infringement is reproducing, distributing, displaying or performing a work, or to make
derivative works, without permission from the copyright holder, which is typically a publisher or other business
representing or assigned by the work's creator. It is often called "piracy".[62] While copyright is created the instant a
work is fixed, generally the copyright holder can only get money damages if the owner registers the copyright.[citation
needed] Enforcement of copyright is generally the responsibility of the copyright holder.[63] The ACTA trade agreement,
signed in May 2011 by the United States, Japan, Switzerland, and the EU, and which has not entered into force, requires
that its parties add criminal penalties, including incarceration and fines, for copyright and trademark infringement, and
obligated the parties to active police for infringement.[58][64] There are limitations and exceptions to copyright, allowing
limited use of copyrighted works, which does not constitute infringement. Examples of such doctrines are the fair use and
fair dealing doctrine.
Trademark infringement; Trademark infringement occurs when one party uses a trademark that is identical or confusingly
similar to a trademark owned by another party, in relation to products or services which are identical or similar to the
products or services of the other party. In many countries, a trademark receives protection without registration, but
registering a trademark provides legal advantages for enforcement. Infringement can be addressed by civil litigation and,
in several jurisdictions, under criminal law.[58][64]
Trade secret misappropriation; Trade secret misappropriation is different from violations of other intellectual property
laws, since by definition trade secrets are secret, while patents and registered copyrights and trademarks are publicly
available. In the United States, trade secrets are protected under state law, and states have nearly universally adopted
the Uniform Trade Secrets Act. The United States also has federal law in the form of the Economic Espionage Act of 1996
(18 U.S.C. §§ 1831–1839), which makes the theft or misappropriation of a trade secret a federal crime. This law contains
two provisions criminalizing two sorts of activity. The first, 18 U.S.C. § 1831(a), criminalizes the theft of trade secrets to
benefit foreign powers. The second, 18 U.S.C. § 1832, criminalizes their theft for commercial or economic purposes. (The
statutory penalties are different for the two offenses.) In Commonwealth common law jurisdictions, confidentiality and
trade secrets are regarded as an equitable right rather than a property right but penalties for theft are roughly the same
as in the United States.[citation needed]
Criticisms; Further information: Criticism of patents and Opposition to copyright. Demonstration in Sweden in support of
file sharing, 2006. "Copying is not theft!" badge with a character resembling Mickey Mouse in reference to the in popular
culture rationale behind the Sonny Bono Copyright Term Extension Act of 1998
The term "intellectual property"; Criticism of the term intellectual property ranges from discussing its vagueness and
abstract overreach to direct contention to the semantic validity of using words like property and rights in fashions that
contradict practice and law. Many detractors think this term specially serves the doctrinal agenda of parties opposing
reform in the public interest or otherwise abusing related legislations; and that it disallows intelligent discussion about
specific and often unrelated aspects of copyright, patents, trademarks, etc.[65] Free Software Foundation founder
Richard Stallman argues that, although the term intellectual property is in wide use, it should be rejected altogether,
because it "systematically distorts and confuses these issues, and its use was and is promoted by those who gain from
this confusion". He claims that the term "operates as a catch-all to lump together disparate laws [which] originated
separately, evolved differently, cover different activities, have different rules, and raise different public policy issues" and
that it creates a "bias" by confusing these monopolies with ownership of limited physical things, likening them to
"property rights".[66] Stallman advocates referring to copyrights, patents and trademarks in the singular and warns
against abstracting disparate laws into a collective term. He argues that "to avoid spreading unnecessary bias and
confusion, it is best to adopt a firm policy not to speak or even think in terms of 'intellectual property'."[67] Similarly,
economists Boldrin and Levine prefer to use the term "intellectual monopoly" as a more appropriate and clear definition
of the concept, which they argue, is very dissimilar from property rights.[68] They further argued that “stronger patents
do little or nothing to encourage innovation”, mainly explained by its tendency to create market monopolies, thereby
restricting further innovations and technology transfer.[69] On the assumption that intellectual property rights are actual
rights, Stallman says that this claim does not live to the historical intentions behind these laws, which in the case of
copyright served as a censorship system, and later on, a regulatory model for the printing press that may have benefited
authors incidentally, but never interfered with the freedom of average readers.[70] Still referring to copyright, he cites
legal literature such as the United States Constitution and case law to demonstrate that the law is meant to be an
optional and experimental bargain to temporarily trade property rights and free speech for public, not private, benefits in
the form of increased artistic production and knowledge. He mentions that "if copyright were a natural right nothing
could justify terminating this right after a certain period of time".[71 . Law professor, writer and political activist
Lawrence Lessig, along with many other copyleft and free software activists, has criticized the implied analogy with
physical property (like land or an automobile). They argue such an analogy fails because physical property is generally
rivalrous while intellectual works are non-rivalrous (that is, if one makes a copy of a work, the enjoyment of the copy
does not prevent enjoyment of the original).[72][73] Other arguments along these lines claim that unlike the situation
with tangible property, there is no natural scarcity of a particular idea or information: once it exists at all, it can be re-
used and duplicated indefinitely without such re-use diminishing the original. Stephan Kinsella has objected to
intellectual property on the grounds that the word "property" implies scarcity, which may not be applicable to ideas.[74]
Entrepreneur and politician Rickard Falkvinge and hacker Alexandre Oliva have independently compared George Orwell's
fictional dialect Newspeak to the terminology used by intellectual property supporters as a linguistic weapon to shape
public opinion regarding copyright debate and DRM.[75][76]
Alternative terms; In civil law jurisdictions, intellectual property has often been referred to as intellectual rights,
traditionally a somewhat broader concept that has included moral rights and other personal protections that cannot be
bought or sold. Use of the term intellectual rights has declined since the early 1980s, as use of the term intellectual
property has increased. Alternative terms monopolies on information and intellectual monopoly have emerged among
those who argue against the "property" or "intellect" or "rights" assumptions, notably Richard Stallman. The backronyms
intellectual protectionism and intellectual poverty,[77] whose initials are also IP, have found supporters as well, especially
among those who have used the backronym digital restrictions management.[78][79] The argument that an intellectual
property right should (in the interests of better balancing of relevant private and public interests) be termed an
intellectual monopoly privilege (IMP) has been advanced by several academics including Birgitte Andersen[80] and
Thomas Alured Faunce.[81]
Objections to overbroad intellectual property laws; The free culture movement champions the production of content that
bears little or no restrictions. Some critics of intellectual property, such as those in the free culture movement, point at
intellectual monopolies as harming health (in the case of pharmaceutical patents), preventing progress, and benefiting
concentrated interests to the detriment of the masses,[82][83][84][85] and argue that the public interest is harmed by
ever-expansive monopolies in the form of copyright extensions, software patents, and business method patents. More
recently scientists and engineers are expressing concern that patent thickets are undermining technological development
even in high-tech fields like nanotechnology.[86][87] Petra Moser has asserted that historical analysis suggests that
intellectual property laws may harm innovation: Overall, the weight of the existing historical evidence suggests that
patent policies, which grant strong intellectual property rights to early generations of inventors, may discourage
innovation. On the contrary, policies that encourage the diffusion of ideas and modify patent laws to facilitate entry and
encourage competition may be an effective mechanism to encourage innovation.[88] In support of that argument, Jörg
Baten, Nicola Bianchi and Petra Moser[89] find historical evidence that especially compulsory licensing – which allows
governments to license patents without the consent of patent-owners – encouraged invention in Germany in the early
20th century by increasing the threat of competition in fields with low pre-existing levels of competition. Peter Drahos
notes, "Property rights confer authority over resources. When authority is granted to the few over resources on which
many depend, the few gain power over the goals of the many. This has consequences for both political and economic
freedoms with in a society."[90]:13
The World Intellectual Property Organization (WIPO) recognizes that conflicts may exist between the respect for and
implementation of current intellectual property systems and other human rights.[91] In 2001 the UN Committee on
Economic, Social and Cultural Rights issued a document called "Human rights and intellectual property" that argued that
intellectual property tends to be governed by economic goals when it should be viewed primarily as a social product; in
order to serve human well-being, intellectual property systems must respect and conform to human rights laws.
According to the Committee, when systems fail to do so they risk infringing upon the human right to food and health, and
to cultural participation and scientific benefits.[92][93] In 2004 the General Assembly of WIPO adopted The Geneva
Declaration on the Future of the World Intellectual Property Organization which argues that WIPO should "focus more on
the needs of developing countries, and to view IP as one of many tools for development—not as an end in itself".[94]
Further along these lines, The ethical problems brought up by IP rights are most pertinent when it is socially valuable
goods like life-saving medicines are given IP protection. While the application of IP rights can allow companies to charge
higher than the marginal cost of production in order to recoup the costs of research and development, the price may
exclude from the market anyone who cannot afford the cost of the product, in this case a life-saving drug.[95] "An IPR
driven regime is therefore not a regime that is conductive to the investment of R&D of products that are socially valuable
to predominately poor populations".[95]:1108–9 Libertarians have differing views on intellectual property.[citation
needed] Stephan Kinsella, an anarcho-capitalist on the right-wing of libertarianism,[96] argues against intellectual
property because allowing property rights in ideas and information creates artificial scarcity and infringes on the right to
own tangible property. Kinsella uses the following scenario to argue this point: [I]magine the time when men lived in
caves. One bright guy—let's call him Galt-Magnon—decides to build a log cabin on an open field, near his crops. To be
sure, this is a good idea, and others notice it. They naturally imitate Galt-Magnon, and they start building their own
cabins. But the first man to invent a house, according to IP advocates, would have a right to prevent others from building
houses on their own land, with their own logs, or to charge them a fee if they do build houses. It is plain that the
innovator in these examples becomes a partial owner of the tangible property (e.g., land and logs) of others, due not to
first occupation and use of that property (for it is already owned), but due to his coming up with an idea. Clearly, this rule
flies in the face of the first-user homesteading rule, arbitrarily and groundlessly overriding the very homesteading rule
that is at the foundation of all property rights.[97]
Thomas Jefferson once said in a letter to Isaac McPherson on August 13, 1813: "If nature has made any one thing less
susceptible than all others of exclusive property, it is the action of the thinking power called an idea, which an individual
may exclusively possess as long as he keeps it to himself; but the moment it is divulged, it forces itself into the possession
of every one, and the receiver cannot dispossess himself of it. Its peculiar character, too, is that no one possesses the
less, because every other possesses the whole of it. He who receives an idea from me, receives instruction himself
without lessening mine; as he who lights his taper at mine, receives light without darkening me."[98] In 2005 the RSA
launched the Adelphi Charter, aimed at creating an international policy statement to frame how governments should
make balanced intellectual property law.[99] Another aspect of current U.S. Intellectual Property legislation is its focus on
individual and joint works; thus, copyright protection can only be obtained in 'original' works of authorship.[100]
Expansion in nature and scope of intellectual property laws. Expansion of U.S. copyright law (Assuming authors create
their works by age 35 and live for seventy years)
Other criticism of intellectual property law concerns the expansion of intellectual property, both in duration and in scope.
In addition, as scientific knowledge has expanded and allowed new industries to arise in fields such as biotechnology and
nanotechnology, originators of technology have sought IP protection for the new technologies. Patents have been
granted for living organisms,[101] (and in the United States, certain living organisms have been patentable for over a
century).[102] The increase in terms of protection is particularly seen in relation to copyright, which has recently been
the subject of serial extensions in the United States and in Europe.[72][103][104][105][106] With no need for registration
or copyright notices, this is thought to have led to an increase in orphan works (copyrighted works for which the
copyright owner cannot be contacted), a problem that has been noticed and addressed by governmental bodies around
the world.[107] Also with respect to copyright, the American film industry helped to change the social construct of
intellectual property via its trade organization, the Motion Picture Association of America. In amicus briefs in important
cases, in lobbying before Congress, and in its statements to the public, the MPAA has advocated strong protection of
intellectual-property rights. In framing its presentations, the association has claimed that people are entitled to the
property that is produced by their labor. Additionally Congress's awareness of the position of the United States as the
world's largest producer of films has made it convenient to expand the conception of intellectual property.[108] These
doctrinal reforms have further strengthened the industry, lending the MPAA even more power and authority.[109] RIAA
representative Hilary Rosen testifies before the Senate Judiciary Committee on the future of digital music (July 11, 2000)
The growth of the Internet, and particularly distributed search engines like Kazaa and Gnutella, have represented a
challenge for copyright policy. The Recording Industry Association of America, in particular, has been on the front lines of
the fight against copyright infringement, which the industry calls "piracy". The industry has had victories against some
services, including a highly publicized case against the file-sharing company Napster, and some people have been
prosecuted for sharing files in violation of copyright. The electronic age has seen an increase in the attempt to use
software-based digital rights management tools to restrict the copying and use of digitally based works. Laws such as the
Digital Millennium Copyright Act have been enacted that use criminal law to prevent any circumvention of software used
to enforce digital rights management systems. Equivalent provisions, to prevent circumvention of copyright protection
have existed in EU for some time, and are being expanded in, for example, Article 6 and 7 the Copyright Directive. Other
examples are Article 7 of the Software Directive of 1991 (91/250/EEC), and the Conditional Access Directive of 1998
(98/84/EEC). This can hinder legal uses, affecting public domain works, limitations and exceptions to copyright, or uses
allowed by the copyright holder. Some copyleft licenses, like GNU GPL 3, are designed to counter that.[110] Laws may
permit circumvention under specific conditions like when it is necessary to achieve interoperability with the
circumventor's program, or for accessibility reasons; however, distribution of circumvention tools or instructions may be
illegal. In the context of trademarks, this expansion has been driven by international efforts to harmonise the definition
of "trademark", as exemplified by the Agreement on Trade-Related Aspects of Intellectual Property Rights ratified in
1994, which formalized regulations for IP rights that had been handled by common law, or not at all, in member states.
Pursuant to TRIPs, any sign which is "capable of distinguishing" the products or services of one business from the
products or services of another business is capable of constituting a trademark.[111]
Use in corporate tax avoidance; "It is hard to imagine any business, under the current [Irish] IP regime, which could not
generate substantial intangible assets under Irish GAAP that would be eligible for relief under [the Irish] capital
allowances [for intangible assets scheme]." "This puts the attractive 2.5% Irish IP-tax rate within reach of almost any
global business that relocates to Ireland." Intellectual property has become a core tool in corporate tax planning and tax
avoidance.[114][115][116] IP is a key component of the leading multinational tax avoidance base erosion and profit
shifting (BEPS) tools,[117][118] which the OECD estimates costs $100-240 billion in lost annual tax revenues,[119] and
includes: Using IP royalty payment schemes to profit shift income from higher-tax locations to lower-tax locations (such
as the Facebook 2012 double Irish and the Microsoft 2015 single malt BEPS tax schemes);[120][121Using IP royalty
payment schemes to overcome EU withholding tax protections (such as the circa 2007 Google dutch sandwich BEPS tax
scheme);[122] Using advanced IP GAAP accounting to create intangible assets which can be expensed against taxation in
certain IP-beneficial regimes (such as the Apple 2015 Irish capital allowances for intangible assets BEPS tax
scheme);[123][124] Using advanced IP GAAP accounting to maximize the effect of corporate relocations to low-tax
regimes (used by Accenture in their 2009 U.S. corporate tax inversion to Ireland).[125] In 2017-2018, both the U.S. and
the EU Commission simultaneously decided to depart from the OECD BEPS Project timetable, which was set up in 2013 to
combat IP BEPS tax tools like the above,[119] and launch their own anti-IP BEPS tax regimes: U.S. Tax Cuts and Jobs Act of
2017, which has several anti-IP BEPS abuse tax regimes, including GILTI tax and the BEAT tax regimes.[126][127][128] EU
Commission 2018 Digital Services Tax, which is less advanced than the U.S. TCJA, but does seek to override IP BEPS tools
via a quasi-VAT.[129][130][131] The departure of the U.S. and EU Commission from the OECD BEPS Project process, is
attributed to frustrations with the rise in IP as a key BEPS tax tool, creating intangible assets, which are then turned into
royalty payment BEPS schemes (double Irish), and/or capital allowance BEPS schemes (capital allowances for intangibles).
In contrast, the OECD has spent years developing and advocating intellectual property as a legal and a GAAP accounting
concept.[132] The EU Commission's €13 billion fine of Apple's pre 2015 double Irish IP BEPS tax scheme, is the largest
corporate tax fine in history.The Value of Intellectual Property, Intangible Assets and Goodwill Kelvin King, founding
partner of Valuation Consulting1
Intellectual capital is recognized as the most important asset of many of the world’s largest and most powerful
companies; it is the foundation for the market dominance and continuing profitability of leading corporations. It is often
the key objective in mergers and acquisitions and knowledgeable companies are increasingly using licensing routes to
transfer these assets to low tax jurisdictions . Nevertheless, the role of intellectual property rights ( IPRs) and intangible
assets in business is insufficiently understood. Accounting standards are generally not helpful in representing the worth
of IPRs in company accounts and IPRs are often under-valued, under-managed or under-exploited. Despite the
importance and complexity of IPRs, there is generally little co-ordination between the different professionals dealing with
an organization’s IPR. For a better understanding of the IPRs of a company, some of the questions to be answered should
often be: What are the IPRs used in the business? What is their value (and hence level of risk)? Who owns it (could I sue
or could someone sue me)? How may it be better exploited (e.g. licensing in or out of technology)? At what level do I
need to insure the IPR risk?
One of the key factors affecting a company’s success or failure is the degree to which it effectively exploits intellectual
capital and values risk. Management obviously need to know the value of the IPR and those risks for the same reason that
they need to know the underlying value of their tangible assets; because business managers should know the value of all
assets and liabilities under their stewardship and control, to make sure that values are maintained. Exploitation of IPRs
can take many forms, ranging from outright sale of an asset, a joint venture or a licensing agreement. Inevitably,
exploitation increases the risk assessment. Valuation is, essentially, a bringing together of the economic concept of value
and the legal concept of property. The presence of an asset is a function of its ability to generate a return and the
discount rate applied to that return. The cardinal rule of commercial valuation is: the value of something cannot be
stated in the abstract; all that can be stated is the value of a thing in a particular place, at a particular time, in particular
circumstances. I adhere to this and the questions ‘to whom?’ and ‘for what purpose?’ must always be asked before a
valuation can be carried out. This rule is particularly significant as far as the valuation of intellectual property rights is
concerned. More often than not, there will only be one or two interested parties, and the value to each of them will
depend upon their circumstances. Failure to take these circumstances, and those of the owner, into account will result in
a meaningless valuation. For the value of intangible assets, calculating the value of intangible assets is not usually a major
problem when they have been formally protected through trademarks, patents or copyright. This is not the case with
intangibles such as know how, (which can include the talents, skill and knowledge of the workforce), training systems and
methods, technical processes, customer lists, distribution networks, etc. These assets may be equally valuable but more
difficult to identify in terms of the earnings and profits they generate. With many intangibles, a very careful initial due
diligence analysis needs to be undertaken together with IP lawyers and in-house accountants. There are four main value
concepts, namely, owner value, market value, fair value and tax value. Owner value often determines the price in
negotiated deals and is often led by a proprietor’s view of value if he were deprived of the property. The basis of market
value is the assumption that if comparable property has fetched a certain price, then the subject property will realize a
price something near to it. The fair value concept, in its essence, is the desire to be equitable to both parties. It recognizes
that the transaction is not in the open market and that vendor and purchaser have been brought together in a legally
binding manner. Tax value has been the subject of case law worldwide since the turn of the century and is an esoteric
practice. There are quasi-concepts of value which impinge upon each of these main areas, namely, investment value,
liquidation value, and going concern value.
Methods for the Valuation of Intangibles; Acceptable methods for the valuation of identifiable intangible assets and
intellectual property fall into three broad categories. They are market based, cost based, or based on estimates of past
and future economic benefits. In an ideal situation, an independent expert will always prefer to determine a market value
by reference to comparable market transactions. This is difficult enough when valuing assets such as bricks and mortar
because it is never possible to find a transaction that is exactly comparable. In valuing an item of intellectual property,
the search for a comparable market transaction becomes almost futile. This is not only due to lack of compatibility, but
also because intellectual property is generally not developed to be sold and many sales are usually only a small part of a
larger transaction and details are kept extremely confidential. There are other impediments that limit the usefulness of
this method, namely, special purchasers, different negotiating skills, and the distorting effects of the peaks and troughs of
economic cycles. In a nutshell, this summarizes my objection to such statements as ‘this is rule of thumb in the sector’.
Cost-based methodologies, such as the “cost to create” or the “cost to replace” a given asset, assume that there is some
relationship between cost and value and the approach has very little to commend itself other than ease of use. The
method ignores changes in the time value of money and ignores maintenance. The methods of valuation flowing from an
estimate of past and future economic benefits (also referred to as the income methods) can be broken down in to four
limbs; 1) capitalization of historic profits, 2) gross profit differential methods, 3) excess profits methods, and 4) the relief
from royalty method.
1. The capitalization of historic profits arrives at the value of IPR’s by multiplying the maintainable historic profitability of
the asset by a multiple that has been assessed after scoring the relative strength of the IPR. For example, a multiple is
arrived at after assessing a brand in the light of factors such as leadership, stability, market share, internationality, trend
of profitability, marketing and advertising support and protection. While this capitalization process recognizes some of
the factors which should be considered, it has major shortcomings, mostly associated with historic earning capability. The
method pays little regard to the future.
2. Gross profit differential methods are often associated with trade mark and brand valuation. These methods look at the
differences in sale prices, adjusted for differences in marketing costs. That is the difference between the margin of the
branded and/or patented product and an unbranded or generic product. This formula is used to drive out cashflows and
calculate value. Finding generic equivalents for a patent and identifiable price differences is far more difficult than for a
retail brand.
3. The excess profits method looks at the current value of the net tangible assets employed as the benchmark for an
estimated rate of return. This is used to calculate the profits that are required in order to induce investors to invest into
those net tangible assets. Any return over and above those profits required in order to induce investment is considered
to be the excess return attributable to the IPRs. While theoretically relying upon future economic benefits from the use of
the asset, the method has difficulty in adjusting to alternative uses of the asset.
4. Relief from royalty considers what the purchaser could afford, or would be willing to pay, for a licence of similar IPR.
The royalty stream is then capitalized reflecting the risk and return relationship of investing in the asset.
Discounted cash flow (“DCF”) analysis sits across the last three methodologies and is probably the most comprehensive of
appraisal techniques. Potential profits and cash flows need to be assessed carefully and then restated to present value
through use of a discount rate, or rates. DCF mathematical modelling allows for the fact that 1 Euro in your pocket today
is worth more than 1 Euro next year or 1 Euro the year after. The time value of money is calculated by adjusting expected
future returns to today’s monetary values using a discount rate. The discount rate is used to calculate economic value
and includes compensation for risk and for expected rates of inflation. With the asset you are considering, the valuer will
need to consider the operating environment of the asset to determine the potential for market revenue growth. The
projection of market revenues will be a critical step in the valuation. The potential will need to be assessed by reference
to the enduring nature of the asset, and its marketability, and this must subsume consideration of expenses together
with an estimate of residual value or terminal value, if any. This method recognizes market conditions, likely performance
and potential, and the time value of money. It is illustrative, demonstrating the cash flow potential, or not, of the
property and is highly regarded and widely used in the financial community. The discount rate to be applied to the
cashflows can be derived from a number of different models, including common sense, build-up method, dividend
growth models and the Capital Asset Pricing Model utilising a weighted average cost of capital. The latter will probably be
the preferred option. These processes lead one nowhere unless due diligence and the valuation process quantifies
remaining useful life and decay rates. This will quantify the shortest of the following lives: physical, functional,
technological, economic and legal. This process is necessary because, just like any other asset, IPRs have a varying ability
to generate economic returns dependant upon these main lives. For example, in the discounted cashflow model, it would
not be correct to drive out cashflows for the entire legal length of copyright protection, which may be 70 plus years,
when a valuation concerns computer software with only a short economic life span of 1 to 2 years. However, the fact that
the legal life of a patent is 20 years may be very important for valuation purposes, as often illustrated in the
pharmaceutical sector with generic competitors entering the marketplace at speed to dilute a monopoly position when
protection ceases. The message is that when undertaking a valuation using the discounted cash flow modelling, the
valuer should never project longer than what is realistic by testing against these major lives. It must also be
acknowledged that in many situations after examining these lives carefully, to produce cashflow forecasts, it is often not
credible to forecast beyond say 4 to 5 years. The mathematical modelling allows for this in that at the end of the period
when forecasting becomes futile, but clearly the cashflows will not fall ‘off of a cliff’, by a terminal value that is calculated
using a modest growth rate, (say inflation) at the steady state year but also discounting this forecast to the valuation
date. While some of the above methods are widely used by the financial community, it is important to note that
valuation is an art more than a science and is an interdisciplinary study drawing upon law, economics, finance,
accounting, and investment. It is rash to attempt any valuation adopting so-called industry/sector norms in ignorance of
the fundamental theoretical framework of valuation. When undertaking an IPR valuation, the context is all-important,
and the valuer will need to take it into consideration to assign a realistic value to the asset. Valuation is considered as one
of the most critical areas in finance; it plays a key role in many areas of finance such as buy/sell, solvency, merger and
acquisition. There are numerous individual reasons or motivations for conducting an intellectual property valuation or
economic appraisal analysis. A valuation is prepared, for example, for transactions, pricing and strategic purposes,
financing securitization and collateralization, tax planning and compliance, and litigation support.
Factors driving the value of intellectual property; Intellectual property derives its value from a wide range of significant
parameters such as market share, barriers to entry, legal protection, IP’s profitability, industrial and economic factors,
growth projections, remaining economic life, and new technologies. The valuation process necessitates gathering much
more information as well as in-depth understanding of economy, industry, and specific business that directly affect the
value of the intellectual property. Therefore, such information may be gathered from external and / or internal sources.
Finally, the information is devoted to be turned into financial models to estimate the fundamental value of a particular
type of intellectual property based on such adapted International Valuation Standards. Uniform Standards of Professional
Appraisal Practice (USPAP) International Valuation Standards Committee (IVSC) (50 Countries) US Generally Accepted
Accounting Principles (GAAP) International Financial Reporting Standards (IFRS) Financial Accounting Standards Board
(FASB) The valuation analysts use numerous approaches in order to reach a reasonable indication of a defined value for
the subject intangible assets on a certain date which is referred to as the valuation date. The most common approaches
to estimate the fundamental or fair value of the intellectual property are defined as the following:
1. Cost approach: The cost approach is based on the economic principle of substitution. This principle states that an
investor will pay no more for an asset than the cost to obtain, by purchasing or constructing, a substitute asset of equal
utility. There are several cost approach valuation methods, the most common being the historical cost, replacement cost,
and replication cost.
2. Market approach: The market approach is based on the economic principle of competition and equilibrium. These
principles conclude that, in a free and unrestricted market, supply and demand factors will drive the price of an asset at
equilibrium point. Furthermore, it provides an indication of the value by comparing the price at which similar property
has exchanged between willing buyers and sellers. Data on such similar transactions may be accessed in several public
sources, including specialized royalty rate databases.[citation needed]
3. Income approach: This approach estimates the fair value of intellectual property by discounting the future economic
benefits of ownership at an appropriate discount rate.
4. Direct approach: The direct approach is based on the current value of shares of intellectual property in an Intellectual
Property (IP) Share Market.
5. Using the pay-off method on top of the four above mentioned methods is a way to enhance the valuation and analysis
of intellectual property [2]
In developed countries around the world, there is an ever-growing shift toward the knowledge economy, or industries
based on innovation and intangible assets. As of 2008, intangible assets have composed 31.2% of all wealth in Canada,
and the proportion continues to steadily increase. In the United States, intellectual property-intensive industries account
for over 1/3 of the national GDP; the figure is even more staggering in the European Union at 39%.
In such a climate, businesses that base their operations on intangible assets and innovation have a higher likelihood of
thriving. Intellectual property can help you legally protect and capitalize on these inventions. Contrary to popular belief,
the number one reason firms acquire intellectual property is not for litigation purposes, but to have legal and
transferable proof of ownership to some of their most important intangible assets. Intellectual property valuation can
help you determine the true value of your business and capitalize on assets that you may not have been aware of
possessing. It is estimated that approximately two-thirds of businesses in the United States have intangible assets that
are potentially eligible for intellectual property protections and the advantages they entail.
What are the advantages of intellectual property valuation? Registered and granted intellectual property rights, such as
granted patents, trademark registrations, and copyright registrations, which are acquired by application to intellectual
property offices, provide legal evidence of your ownership over intangible assets as well as give you the right to exclude
others from use of the rights. This means several things: you have means to protect yourself against infringement by
competitors, and an asset which can be profitably licensed or sold to others to provide them with rights they would
otherwise not have, and consequent to these benefits an increase to the total value of your business. The precise
monetary worth of intellectual property, however, can be challenging to determine, as there are a number of factors that
determine the value of the intangible assets in question. Registration or grant of an intellectual property right is
sometimes a precondition to valuation, especially quantitative valuation, and enables the process of monetizing your
intangible assets. Conducting a valuation of your intellectual property has significant benefits. Assessing the value of your
patent, trademark or copyright may simplify the licensing or assignment process, and help you determine the royalty
rates that should be paid to you as a result of using your intellectual property assets. Further, ascribing a reasonable
valuation to your intellectual property, if not currently accounted for, increases the overall value of your business and
provides you with collateral for loans or mortgages. Significantly for newer businesses, an accurate and substantiated
valuation of intellectual property assets is statistically likely to increase outside investment into your venture. See more
statistics on the value and importance of intellectual property.
The difference between quantitative and qualitative valuations; The value of intellectual property can be determined by
many factors, but the overarching principle guiding valuation is how much of a competitive advantage over others in the
industry your intellectual property provides. When determining the worth of intellectual property, two methods of
valuation have traditionally been used. Quantitative valuation relies on measurable data or numerical information to
produce an estimate of the value of your assets. It attempts to answer the question by providing a monetary value or
contribution that the intellectual property provides, whether directly to the business or indirectly by increasing the value
of other parts of the operation or appeal to investors. Sample metrics can include similar market transactions in the
industry, assessing the cost incurred in obtaining the intellectual property in question, and the cost of replacing the gains
made by the intellectual property in question with another method. Qualitative methods of valuation attempt to provide
a non-monetary estimate of the value of intellectual property by rating it on the basis of its strategic impact, brand
loyalty held by consumers, its impact on the company's future growth, and other intangible metrics that do not rely solely
on numbers. These two types of valuation should not be treated as mutually exclusive; depending on the needs of your
business, you may employ a variation of methods that fall into both of these categories. Quantitative and qualitative
attempt to tackle the question of firm value from different viewpoints, which may both come in useful depending on the
audience in question and the reason for valuation.
Quantitative Methods; Cost-based; Maintains that a link exists between the costs incurred in the process of developing
IP and its final value. Quantifies amount that would be required to replace IP and any gains it has made. Based on
principles of substitution and price equilibrium. Traditional cost method calculates all expenses incurred in obtaining IP
(fees, legal services, human resources) and tethers it to a specific date to account for later inflation. Variations on the
cost method include reverse cost method (determining the cost of acquiring IP in question at present time), prospective
cost method, cost savings method
Market-based; Studying market transactions of assets that are similar/comparable to the asset(s) being evaluated.
Similarity in utility, as well as perception within the market, must be assessed before this approach can be effective.
Comparative income differential method (comparing price of similar assets with and without the IP protections) falls
under this category. A number of conditions exist to determine that similarity is sufficient for the method to be valid
Income-based; Attempts to calculate the present value of future profits that will come to the firm as a result of the IP
asset. This method can be hindered by the need to separate income generated purely by the IP asset from income
generated by the company or product at large; further, inflation and liquidity can complicate calculating present value.
Discounted cash-flow method discounts future economic gains from the IP asset appropriately to reflect present
economic conditions. Other methods that fall under this umbrella are excess profits method and relief-from-royalty
method; both depend on selecting rates in the present to then calculate future results
Options-based; Uses options-pricing theory to value IP; usually based on approaches described above but able to be
more flexible to factor in the unique nature of IP assets. Three possible methods used: decision tree method, Monte
Carlo method and the real options method (often tethered to specific sectors in which IP assets are commonplace).
Methods focus on illustrating a variety of possible outcomes to highlight the uncertainty of the economic market and the
different scenarios that could occur in the future. All of these approaches typically result in a monetary value. However,
no method is complete in encompassing all variables that factor into a valuation. There exist other, less commonly used
methods of quantitative valuation that often encompass elements of the larger umbrella methods described above but
may focus on obtaining specific metrics. Such methods include the brand value equation method, liquidation value and
income differential analysis. Depending on the purpose you have for your prospective IP valuation, one or more of these
methods may be helpful.
Qualitative Methods; Rating/scoring; Multi-parameter scoring system that is used to arrive at a numerical value of the IP
asset; depends on non-quantifiable factors. There are several popular scoring rubrics that subscribe to this method; most
measure strategy, technological advancement and brand strength, as well as evaluating the risks and opportunities that
are involved with the asset. The rating/scoring system can also be used for IP asset classification, as seem in the PRISM
method, determining the type of function IP plays for the company and assigning a strategy based on the determination
made
Value indicators based; Based on collection and analysis of IP-related information and analysis of that information via a
statistical methodology. Includes rating methods like IP Quotient (IPQ), which primarily rate patents based on the
strength of the portfolio and the variables that affect patents to give a qualitative rating of their strength .Allows for
internal comparisons to be drawn on the basis of indicators
Competitive advantage; Assesses the competitive advantage that is brought by intellectual property by comparing it to
other non-branded companies in the market. Evaluates intellectual property on a number of characteristics (often a mix
of qualitative and quantitative elements) to determine the brand's performance and strength. Because of their largely
non-monetary nature, qualitative methods are often used for internal and/or strategic purposes. They can be used to
understand the profitability of an IP portfolio and evaluate opportunities and risks, and to develop an overall strategy for
your business. Qualitative methods often tend to be based on common-sense indicators as well, making them viable for
presentations to non-expert audiences and audiences without a strong financial grasp on the complicated quantitative
measures that yield valuation metrics.
Which method is best for me?; The method that will best serve your intellectual property needs is highly dependent on
the goals you have set as a result of valuation. Whether your valuation will be used for internal or external purposes, the
type of audience that the valuation results will be presented to and the scope of valuation necessary are all important
factors to consider.Before proceeding with selecting a method, it is important to ask three crucial questions: What is the
purpose to this valuation? What assets will be the subject of this valuation? For whom is this valuation being prepared?
Once you have established answers to these questions, you may proceed to selecting the valuation method(s). It is often
beneficial to select more than one method of valuation to ensure that the results are corroborated, and, if necessary,
that both a quantitative and a qualitative measure is provided. The above pyramid is a commonly used method of
valuation coined by Flignor and Orozco (2006), where each level of analysis is crucial to further analysis on the above
levels. It breaks down the process of selecting a method of valuation for an IP asset into four levels, going from
establishing the basic considerations to arriving at the method(s) that fulfil valuation goals. At level four, a deliverable
solution is implemented and evaluated to see if it has met the goals originally established at level one. The Flignor and
Orozco model, however, is limited in prescribing whether to choose a quantitative or qualitative valuation, and does not
comment on how a choice should be made; rather, it provides a framework of steps to follow when conducting a
valuation. A 2010 study entitled "Intellectual property valuation: how to approach the selection of an appropriate
valuation method" provides a more comprehensive framework of the factors based on which a valuation method should
be selected. It presents the process as a flow chart, in which the first step is determining the purpose of the valuation (i.e.
transaction, legal, financial) and the specific area for which the valuation is necessary (i.e. intellectual property dispute,
accounting purposes, securitization). The next step is to determine the specific audience, as well as their financial
competency and desired result (i.e. monetary value or qualitative value). The final step is identifying the type of
intellectual property to then determine a method of valuation from those described above. You can purchase a copy of
this study for further information here. Although this is by no means a comprehensive framework and circumstances
particular to your intellectual property asset should be given strong consideration, this should be a good start in
determining what method is best.
Conclusion; Determining the value of intellectual property can be a challenging process, but obtaining a valuation can
result in significant benefits for your business. Following the valuation models described above to break down the
process into simple steps, and establishing a clear purpose and audience for the valuation, can make valuation
manageable. An accurate estimate of the worth of your intellectual property can guide your business decisions and help
you determine a course of action to take with the assets in your possession which will be most profitable for you. If that
course of action is monetization, also see our resource on how to monetize intellectual property.
The reasons for merger or acquisitions (e.g. synergistic benefits). Reasons or Motivations for Mergers and Acquisitions,
Horizontal integration: Increasing market share and competitiveness as a motivation for mergers and acquisitions.
...Diversification of business: Exploring newer markets and segments through mergers and acquisitions.
10 Important Reasons for Merger; This article throw light upon the ten important reasons for mergers. The reasons are:
1. Economies of Scale 2. Operating Economies 3. Synergy 4. Growth 5. Diversification 6. Utilisation of Tax Shields 7.
Increase in Value 8. Eliminations of Competition 9. Better Financial Planning 10. Economic Necessity.
Reason # 1. Economies of Scale: An amalgamated company will have more resources at its command than the individual
companies. This will help in increasing the scale of operations and the economies of large scale will be availed. These
economies will occur because of more intensive utilisation of production facilities, distribution network, research and
development facilities, etc. These economies will be available in horizontal mergers (companies dealing in same line of
products) where scope of more intensive use of resources is greater. The economies will occur only upto a certain point
of operations known as optimal point. It is a point where average costs are minimum. When production increases from
this point, the cost per unit will go up.
The optimal point of production is shown with the help of a diagram also:
Reason # 2. Operating Economies: A number of operating economies will be available with the merger of two or more
companies. Duplicating facilities in accounting, purchasing, marketing, etc. will be eliminated. Operating inefficiencies of
small concerns will be controlled by the superior management emerging from the amalgamation. The amalgamated
companies will be in a better position to operate than the amalgamating companies individually.
Reason # 3. Synergy: Synergy refers to the greater combined value of merged firms than the sum of the values of
individual units. It is something like one plus one more than two. It results from benefits other than those related to
economies of scale. Operating economies are one of the various synergy benefits of merger or consolidation. The other
instances which may result into synergy benefits include, strong R &D facilities of one firm merged with better organised
production facilities of another unit, enhanced managerial capabilities, the substantial financial resources of one being
combined with profitable investment opportunities of the other, etc.
Reason # 4. Growth: A company may not grow rapidly through internal expansion. Merger or amalgamation enables
satisfactory and balanced growth of a company. It can cross many stages of growth at one time through amalgamation.
Growth through merger or amalgamation is also cheaper and less risky. A number of costs and risks of expansion and
taking on new product lines are avoided by the acquisition of a going concern. By acquiring other companies a desired
level of growth can be maintained by an enterprise.
Reason # 5. Diversification: Two or more companies operating in different lines can diversify their activities through
amalgamation. Since different companies are already dealing in their respective lines there will be less risk in
diversification. When a company tries to enter new lines of activities then it may face a number of problems in
production, marketing etc. When some concerns are already operating in different lines, they must have crossed many
obstacles and difficulties. Amalgamation will bring together the experiences of different persons in varied activities. So
amalgamation will be the best way of diversification.
Reason # 6. Utilisation of Tax Shields: When a company with accumulated losses merges with a profit making company it
is able to utilise tax shields. A company having losses will not be able to set off losses against future profits, because it is
not a profit earning unit. On the other hand if it merges with a concern earning profits then the accumulated losses of
one unit will be set off against the future profits of the other unit. In this way the merger or amalgamation will enable the
concern to avail tax benefits.
Reason # 7. Increase in Value: One of the main reasons of merger or amalgamation is the increase in value of the merged
company. The value of the merged company is greater than the sum of the independent values of the merged
companies. For example, if X Ld. and Y Ltd. merge and form Z Ltd., the value of Z Ltd. is expected to be greater than the
sum of the independent values of X Ltd. and Y Ltd.
Reason # 8. Eliminations of Competition: The merger or amalgamation of two or more companies will eliminate
competition among them. The companies will be able to save their advertising expenses thus enabling them to reduce
their prices. The consumers will also benefit in the form of cheap or goods being made available to them.
Reason # 9. Better Financial Planning: The merged companies will be able to plan their resources in a better way. The
collective finances of merged companies will be more and their utilisation may be better than in the separate concerns. It
may happen that one of the merging companies has short gestation period while the other has longer gestation period.
The profits of the company with short gestation period will be utilised to finance the other company. When the company
with longer gestation period starts earning profits then it will improve financial position as a whole.
Reason # 10. Economic Necessity: Economic necessity may force the merger of some units. If there are two sick units,
government may force their merger to improve their financial position and overall working. A sick unit may be required
to merge with a healthy unit to ensure better utilisation of resources, improve returns and better management.
Rehabilitation of si.ck units is a social necessity because their closure may result in unemployment etc.
Anti-Takeover Defense, Defenses Against Hostile Takeovers. Antitakeover defenses allow you to protect your company
from hostile takeovers. Ever wondered how to protect your company from a hostile takeover? There are plenty of
options for you to choose from. So, keep reading. This article introduces takeover techniques and defenses. Analyzing
various antitakeover defenses, the article emphasizes the ones that are most successful in protecting corporate interests.
The article also points out certain issues in defenses that may affect the interests of shareholders.
Hostile Takeover Issues; Hostile corporate takeovers and defenses against them have long been of great interest to legal
scholars, attorneys, and other professionals all over the world. This interest can be seen in the enormous amount of
literature on hostile takeovers and corresponding defenses. All of the court opinions, statutes, books, articles, and other
materials indicate the magnitude of issues in this complex area of corporate law. It is apparently impossible to cover most
of such issues within one article. It, therefore, concentrates on the most important issue forming the basis of many other
issues in the takeover area. The major issue is whom to defend and how. Who to defend specifically refers to whether
shareholders or directors are the main corporate constituency. How to defend refers to which mechanisms should ensure
the interests of the primary corporate constituency.
Antitakeover Responsibility; This article answers the above questions in favor of shareholders. It, particularly, argues for a
higher standard of responsibility of directors undertaking antitakeover actions. The main point of this article is that, in
order to protect the interests of shareholders better, the responsibility of directors in the antitakeover actions should be
higher. This objective can be accomplished by elevating the level of scrutiny of the directors’ antitakeover activity from
the enhanced scrutiny to a strict scrutiny. Such an improvement is expedient to increase the directors’ accountability to
the corporation and its shareholders. It would serve the best interests of the main corporate constituency, i.e., the
shareholders. Implementation of this approach would generally improve the corporate governance law and practice.
Corporate Takeovers; Corporate takeovers can generally be either friendly or hostile. This article focuses specifically on
the hostile takeovers. They raise more problems than friendly, negotiated ones. A takeover is hostile when the target’s
management opposes an acquirer’s effort to gain control of the target. Since the hostile takeovers normally happen with
regard to public corporations, this type of entity is the subject of analysis in this article. You can review the difference
between a corporation and limited liability company here.
Having decided to acquire a target, the acquirer usually deals with either of the two main corporate constituencies of the
target: management or shareholders. In a negotiated takeover, the acquirer deals with the management, while, in a
hostile takeover, the acquirer deals with the shareholders. A possibility or threat of a hostile takeover causes the target’s
board to adopt and implement antitakeover defenses. The main problem with such antitakeover activity is who to
protect first and how. Courts normally seek to strike a balance between the interests of shareholders and managers. As
this article demonstrates, however, the courts occasionally failed to reach this balance. The courts, namely, often
protected managers at the expense of shareholders. In the past, shareholder displeasure with the corporate governance
had forced such large companies as Pfizer, Bristol-Myers Squibb, Aetna, Omnicom, Coca-Cola, CSX, Hewlett-Packard, and
others to weaken their antitakeover defenses. Nevertheless, nearly all exchange-listed companies used to have at least
one significant anti-takeover provision, with many of them having adopted shareholder rights plans.
Hostile Takeovers; The acquirers usually employ the following hostile takeover techniques: Toehold acquisition – a
purchase of the target’s shares on an open market. They allow the acquirer to become a shareholder of the target and
provide an opportunity to sue the target later on if the takeover attempt turns out unsuccessful.
Tender offer – an acquirer’s offer to the target’s shareholders to buy their shares at a premium over the market price. A
partial, two-tier, front-end loaded tender offer usually involves a back-end merger. The takeover literature generally
treats tender offer as a hostile takeover technique. It should not be treated as hostile, however, if it favors the interests
of the majority of shareholders. Such a majority should be adequate to approve the relevant merger or acquisition. To
claim that any tender offer is hostile would make virtually any merger or acquisition hostile.
Proxy fight – a solicitation of the shareholders’ proxies to vote for insurgent directors. Proxy fights can run along with
“board packing,” where the number of board members increases and the acquirer intends to fill this increase with his
slate of directors. Numerous takeover terms may seem to be informal. The courts, nevertheless, widely use these terms
and hence make them appropriate in legal literature. For instance, “[i]n the modern takeover lexicon, [it is] consistently
recognized that defensive measures which are either preclusive or coercive are included within the common definition of
draconian,” according to the landmark case of Unitrin, Inc. v. American General Corp. Alongside, the board of directors is
“the defender of the metaphorical medieval corporate bastion,” and can act “defensively before a bidder is at the
corporate bastion’s gate.” The judicial use of these terms makes this area of law more interesting and engaging.
Antitakeover Defenses; In response to these hostile takeover techniques, targets usually devise the following defenses:
1. Stock repurchase; Stock repurchase (aka self-tender offer) is a purchase by the target of its own-issued shares from its
shareholders. This is an effective defense that successfully passed such prominent antitakeover defense cases as Unitrin
and Unocal v. Mesa Petroleum Co.
2. Poison pill; Poison pill (aka shareholder rights plan) is a distribution to the target’s shareholders of the rights to
purchase shares of the target or the merging acquirer at a substantially reduced price. What triggers an execution of
these rights is an acquisition by an acquirer of certain percentage of the target’s shareholding. If exercised, these rights
can considerably dilute the acquirer’s shareholding in the target and thus can deter a takeover. The poison pill is one of
the most powerful defenses against hostile takeovers. The pills can be flip-in, flip-over, dead hand, and slow/no hand.
Flip-in poison pill can be “chewable,” which means that the shareholders may force a pill redemption by a vote within a
certain timeframe if the tender offer is an all-cash offer for all of the target’s shares. The poison pill can also provide for a
window of redemption. That is a period within which the management can redeem the pill. This window hence
determines the moment when the management’s right to redeem terminates. “Dead hand” pill creates continuing
directors. These are current target’s directors who are the only ones that can redeem the pill once an acquirer threatens
to acquire the target. While the earlier court decisions restricted use of dead hand and no hand pills, the more recent
decisions uphold such pills. “No hand” (aka “slow hand”) pill prohibits redemption of the pill within a certain period of
time, for example six months.
3. Staggered board; Staggered board is a board in which only a certain number of directors, usually one third, is reelected
annually. It is a powerful antitakeover defense, which might be stronger than is commonly recognized. For the reason of
being too strong and reducing returns to the target’s shareholders, the latter happened to resist this type of defense.
4. Shark repellants; Shark repellants are certain provisions in the target’s charter or bylaws deterring an acquirer’s
desirability of a hostile takeover. This defense typically involves a supermajority vote requirement regarding a merger of
the target with its majority shareholder. This defense also includes other takeover deterrent provisions in the target’s
certificate of incorporation or bylaws.
5. Golden parachutes; Golden parachutes are additional compensations to the target’s top management in the case of
termination of its employment following a successful hostile acquisition. Since these compensations decrease the target’s
assets, this defense reduces the amount the acquirer is willing to pay for the target’s shares. This defense may thus harm
shareholders. It, however, effectively deters hostile takeovers.
6. Greenmail; Greenmail is a buyout by the target of its own shares from the hostile acquirer with a premium over the
market price, which results in the acquirer’s agreement not to pursue obtaining control of the target in the near future.
The taxation of greenmail used to present a considerable obstacle for this defense. Plus, the statute may require a
shareholder approval of repurchase of a certain amount of shares at a premium.
7. Standstill agreement; Standstill agreement is an undertaking by the acquirer not to acquire any more shares of the
target within certain period of time. A standstill agreement is an additional defense that usually accompanies the
greenmail described above.
8. Leveraged recapitalization; Leveraged recapitalization (aka corporate restructuring) is a series of transactions designed
to affect the equity and debt structure of a corporation. Recapitalization usually involves such transactions as (i) sale of
assets, (ii) issuance of debt, and (iii) distribution of dividends.
9. Leveraged buyout; Leveraged buyout is a purchase of the target by the management with the use of debt financing.
This defense burdens the target with the debt. In such a case, the management becomes a bidder and competes with a
hostile acquirer for control over the target.
10. Crown jewels; Crown jewels are options under which a favored party can buy a key part of the target at a price that
may be less than its market value.
11. Scorched earth; Scorched earth is a self-tender offer by the target that burdens the target with debt.
12. Lockups; Lockups are defensive mechanisms in friendly mergers and acquisitions designed to deter hostile bids. The
lockups include (i) no-shop covenant, (ii) termination/bust-up fee, (iii) option to buy a subsidiary, (iv) expense
reimbursement etc.
13. Pacman; Pacman is a target’s tender offer for the acquirer’s shares.
14. White knight; White knight is a strategic merger that does not involve a change of control and relieves the target’s
management of the responsibility to seek the best price available. An example is the case of Paramount Communications,
Inc. v. Time Inc.
15. White squire; White squire is giving by the target to a friendly party of a certain ownership in the target. This defense
is effective against acquisition by the hostile party of a complete control over the target by “freezing out” of minority
shareholders.
16. Change of control provisions; Change of control provisions is target’s contractual arrangements with third parties that
burden the target in the case of a change in its control.
17. “Just say no”; On top of all, the “just say no” approach is a board’s development and implementation of a long-term
corporate strategy which enables the board simply to reject a proposal of any potential acquirer who would fail to prove
that his acquisition strategy matches that of the target.
This non-exhaustive variety of defenses shows that the possibilities and, consequently, the power of directors in
responding to hostile takeovers are virtually unlimited. Some defenses are more effective than others. Not all of them are
necessarily “show-stoppers”, nevertheless. One example, a golden parachute may decrease the price that the acquirer
would be willing to pay for the target, but it may not necessarily stop the hostile acquisition. Another example, a poison
pill can easily lose its effect if the acquirer wins a proxy fight for the target and then redeems the pill. The above hostile
takeover techniques and defenses show the unlimited scope of power that the board enjoys in its antitakeover activity.
The more power requires the higher degree of responsibility therefore.
Comprehensive Analysis; Throughout this entire lesson we have focused our attention on making the merger and
acquisition process work. In this final part, we will do just the opposite; we will look at ways of discouraging the merger
and acquisition process. If a company is concerned about being acquired by another company, several anti-takeover
defenses can be implemented. As a minimum, most companies concerned about takeovers will closely monitor the
trading of their stock for large volume changes.
a. Poison pill; One of the most popular anti-takeover defenses is the poison pill. Poison pills represent rights or options
issued to shareholders and bondholders. These rights trade in conjunction with other securities and they usually have an
expiration date. When a merger occurs, the rights are detached from the security and exercised, giving the holder an
opportunity to buy more securities at a deep discount. For example, stock rights are issued to shareholders, giving them
an opportunity to buy stock in the acquiring company at an extremely low price. The rights cannot be exercised unless a
tender offer of 20% or more is made by another company. This type of issue is designed to reduce the value of the Target
Company. Flip-over rights provide for purchase of the Acquiring Company while flip-in rights give the shareholder the
right to acquire more stock in the Target Company. Put options are used with bondholders, allowing them to sell-off
bonds in the event that an unfriendly takeover occurs. By selling off the bonds, large principal payments come due and
this lowers the value of the Target Company.
b. Golden Parachutes; Another popular anti-takeover defense is the Golden Parachute. Golden parachutes are large
compensation payments to executive management, payable if they depart unexpectedly. Lump sum payments are made
upon termination of employment. The amount of compensation is usually based on annual compensation and years of
service. Golden parachutes are narrowly applied to only the most elite executives and thus, they are sometimes viewed
negatively by shareholders and others. In relation to other types of takeover defenses, golden parachutes are not very
effective.
c. Changes to the Corporate Charter; If management can obtain shareholder approval, several changes can be made to
the Corporate Charter for discouraging mergers. These changes include: Staggered Terms for Board Members: Only a
few board members are elected each year. When an acquiring firm gains control of the Target Company, important
decisions are more difficult since the acquirer lacks full board membership. A staggered board usually provides that one-
third are elected each year for a 3 year term. Since acquiring firms often gain control directly from shareholders,
staggered boards are not a major anti-takeover defense. Super-majority Requirement: Typically, simple majorities of
shareholders are required for various actions. However, the corporate charter can be amended, requiring that a super-
majority (such as 80%) is required for approval of a merger. Usually an "escape clause" is added to the charter, not
requiring a super-majority for mergers that have been approved by the Board of Directors. In cases where a partial
tender offer has been made, the super-majority requirement can discourage the merger.
Fair Pricing Provision: In the event that a partial tender offer is made, the charter can require that minority shareholders
receive a fair price for their stock. Since many countries have adopted fair pricing laws, inclusion of a fair pricing provision
in the corporate charter may be a moot point. However, in the case of a two-tiered offer where there is no fair pricing
law, the acquiring firm will be forced to pay a "blended" price for the stock.
Dual Capitalization: Instead of having one class of equity stock, the company has a dual equity structure. One class of
stock, held by management, will have much stronger voting rights than the other publicly traded stock. Since
management holds superior voting power, management has increased control over the company.
D.Re-capitalization; One way for a company to avoid a merger is to make a major change in its capital structure. For
example, the company can issue large volumes of debt and initiate a self-offer or buy back of its own stock. If the
company seeks to buy-back all of its stock, it can go private through a leveraged buy out (LBO). However, leveraged re-
capitalization require stable earnings and cash flows for servicing the high debt loads. And the company should not have
plans for major capital investments in the near future. Therefore, leveraged recaps should stand on their own merits and
offer additional values to shareholders. Maintaining high debt levels can make it more difficult for the acquiring company
since a low debt level allows the acquiring company to borrow easily against the assets of the Target Company. Instead of
issuing more debt, the Target Company can issue more stock. In many cases, the Target Company will have a friendly
investor known as a "white squire" which seeks a quality investment and does not seek control of the Target Company.
Once the additional shares have been issued to the white squire, it now takes more shares to obtain control over the
Target Company. Finally, the Target Company can do things to boost valuations, such as stock buy-backs and spinning off
parts of the company. In some cases, the target company may want to consider liquidation, selling-off assets and paying
out a liquidating dividend to shareholders. It is important to emphasize that all restructuring should be directed at
increasing shareholder value and not at trying to stop a merger.
Other Anti-Takeover Defenses; Finally, if an unfriendly takeover does occur, the company does have some defenses to
discourage the proposed merger: Stand Still Agreement: The acquiring company and the target company can reach
agreement whereby the acquiring company ceases to acquire stock in the target for a specified period of time. This stand
still period gives the Target Company time to explore its options. However, most stand still agreements will require
compensation to the acquiring firm since the acquirer is running the risk of losing synergy values.
Green Mail: If the acquirer is an investor or group of investors, it might be possible to buy back their stock at a special
offering price. The two parties hold private negotiations and settle for a price. However, this type of targeted repurchase
of stock runs contrary to fair and equal treatment for all shareholders. Therefore, green mail is not a widely accepted
anti-takeover defense.
White Knight: If the target company wants to avoid a hostile merger, one option is to seek out another company for a
more suitable merger. Usually, the Target Company will enlist the services of an investment banker to locate a "white
knight." The White Knight Company comes in and rescues the Target Company from the hostile takeover attempt. In
order to stop the hostile merger, the White Knight will pay a price more favorable than the price offered by the hostile
bidder.
Litigation: One of the more common approaches to stopping a merger is to legally challenge the merger. The Target
Company will seek an injunction to stop the takeover from proceeding. This gives the target company time to mount a
defense. For example, the Target Company will routinely challenge the acquiring company as failing to give proper notice
of the merger and failing to disclose all relevant information to shareholders.
Pac Man Defense: As a last resort, the target company can make a tender offer to acquire the stock of the hostile bidder.
This is a very extreme type of anti-takeover defense and usually signals desperation.One very important issue about anti-
takeover defenses is valuations. Many anti-takeover defenses (such as poison pills, golden parachutes, etc.) have a
tendency to protect management as opposed to the shareholder. Consequently, companies with anti-takeover defenses
usually have less upside potential with valuations as opposed to companies that lack anti-takeover defenses. Additionally,
most studies show that anti-takeover defenses are not successful in preventing mergers. They simply add to the
premiums that acquiring companies must pay for target companies.
LBO, ; A leveraged buyout (LBO) is the acquisition of another company using a significant amount of borrowed money to
meet the cost of acquisition. The assets of the company being acquired are often used as collateral for the loans, along
with the assets of the acquiring company. A leveraged buyout (LBO) is the acquisition of another company using a
significant amount of borrowed money to meet the cost of acquisition. The assets of the company being acquired are
often used as collateral for the loans, along with the assets of the acquiring company. The purpose of leveraged buyouts
is to allow companies to make large acquisitions without having to commit a lot of capital. In a leveraged buyout (LBO),
there is usually a ratio of 90% debt to 10% equity. Because of this high debt/equity ratio, the bonds issued in the buyout
are usually are not investment grade and are referred to as junk bonds. Further, many people regard LBOs as an
especially ruthless, predatory tactic. This is because it isn't usually sanctioned by the target company. It is also seen as
ironic in that a company's success, in terms of assets on the balance sheet, can be used against it as collateral by a hostile
company.
Reasons for LBOs; LBOs are conducted for three main reasons. The first is to take a public company private; the second is
to spin-off a portion of an existing business by selling it; and the third is to transfer private property, as is the case with a
change in small business ownership. However, it is usually a requirement that the acquired company or entity, in each
scenario, is profitable and growing.
History of LBOs; Leveraged buyouts have had a notorious history, especially in the 1980s, when several prominent
buyouts led to the eventual bankruptcy of the acquired companies. This was mainly due to the fact that the leverage ratio
was nearly 100% and the interest payments were so large that the company's operating cash flows were unable to meet
the obligation. One of the largest LBOs on record was the acquisition of Hospital Corporation of America (HCA) by
Kohlberg Kravis Roberts & Co. (KKR), Bain & Co. and Merrill Lynch in 2006. The three companies paid around $33 billion
for the acquisition of HCA.
An LBO in Process; LBOs are often complicated and take a while to complete. For example, JAB holding company, a
private firm that invests in luxury goods, coffee and healthcare companies, initiated an LBO of Krispy Kreme Doughnuts,
Inc. in May 2016. JAB was slated to purchase the company for $1.5 billion, which included a $350 million leveraged loan
and a $150 million revolving credit facility provided by the Barclays investment bank. However, Krispy Kreme had debt on
its balance sheet that needed to be sold, and Barclays was required to add an additional 0.5% interest rate in order to
make it more attractive. This made the LBO more complicated and it almost didn't close. However, as of July 12, 2016,
the deal went through. The basic idea behind an LBO is that the acquirer purchases the target with a loan collateralized
by the target's own assets. In hostile takeover situations, the use of the target's assets to secure credit for the acquirer is
one reason the LBO has a predatory reputation. #-ad_banner-#Private equity firms often raise money specifically to
conduct LBOs. These LBO funds are often hundreds of millions of dollars strong, which goes a long way considering that
these acquirers will borrow most of the money they'll need to purchase their targets. Many LBO funds are divisions of
major banks like J.P. Morgan or divisions of private equity firms such as Carlyle Partners or Blackstone Capital Partners.
To conduct an LBO, the acquirer ensures that the target's assets are adequate as collateral for the loan needed to
purchase the target. The acquirer must also create and study financial forecasts of the combined entities to make sure
that they generate enough cash to cover the principal and interest payments. In some cases, maintaining optimal cash
flow could be a challenge if the target's management team leaves after the acquisition. Once the buyer has determined
that the LBO is financially feasible, it works on acquiring enough cash for the acquisition by incurring debt. In some cases,
the ensuing liability comes directly from one or more banks. In other cases, the acquirer issues bonds in the open market.
Because the combined entity often has a high debt/equity ratio (near 90% debt, 10% equity), the bonds are usually not
investment grade (that is, they are junk bonds). Doing an LBO is expensive and the process can be complex. When a
particular deal is especially large, there is often more than one acquirer which allows for sharing of the risks, costs, and
rewards of the deal. Often the acquirer must hire an intermediary to negotiate the emotional matters of severance,
union contracts, reorganization plans, and other major post-acquisition issues with management, shareholders, and
directors. In addition, the use of an investment bank, a law firm, and third-party consultants is often necessary to
correctly structure the transaction. Generally, acquirers sell or take their LBO targets public five or ten years after their
purchase and make what are hopefully large profits, often 15% to 25% compounded annually. A sale doesn't always
mean the debt is paid off, however. The act of offering new shares to the public is frequently an attempt to obtain cash to
pay down the debt to a feasible level (this is called a reverse LBO). LBO activity usually increases when interest rates are
low (which reduces the cost of borrowing) and/or when the economy or a particular industry is underperforming (and
thus undervaluing the target firm's equity). However, increased LBO activity also means more competition for deals,
which tends to bid up the premiums paid for targets. Expensive acquisitions increase the debt needed to acquire targets
and increase the risk that a newly combined entity won't be able to support its larger debt obligations.
WHY IT MATTERS: The purpose of an LBO is to make a large acquisition without having to commit a lot of capital. The
acquirers also want to maximize shareholder value by attempting to create a stronger and more profitable combined
entity. The buyer needs to ensure that the expected synergies materialize in order to realize financial returns. The risks
associated with a LBO deal are why share prices often fall when a company announces news of a LBO. However, such a
price fall can be a buying opportunity if investors think the company will be able to pay down the debt, which increases
the value of the shares. The world's most famous LBO is the approximately $25 billion takeover of RJR Nabisco by private
equity firm Kohlberg Kravis Roberts in 1989. The deal was so famous (and so brazen) that it was immortalized by the book
and movie Barbarians at the Gate. In those days, many companies used LBOs to purchase undervalued companies only to
turn around and sell off the assets (these acquirers were called corporate raiders). Today, however, LBOs are increasingly
used as a way to make an average company become a great company.
Forms of consideration & terms for acquisitions (e.g. cash, shares, convertibles & earn-out arrangements), & their
financial effects. In an increasingly competitive and financially constrained environment, corporate leadership must
identify and pursue growth opportunities that will strengthen their organizations’ market position and financial
performance. Growth strategies include developing new service lines or markets, expanding existing service offerings and
markets served, entering into joint ventures to develop or expand services/markets, or merging with or acquiring existing
operations from competitors, or other providers.
Acquisition Benefits: The advantages of mergers and acquisitions frequently exceed those of other growth strategies.
Acquisitions can quickly and dramatically shift an organization’s position by offering the following:
Access advantages : improving accessibility to clients in new attractive markets and/or enhancing access in existing
markets.
Enhanced competitive position : fundamentally changing the market position, for example, by moving the organization
from a subordinate position to a more dominant position.
Program/service expansion : gaining the critical mass, capability, or position of strength in high impact or high margin
services or “rounding out”capabilities in areas of deficit.
Fortified barriers to entry : creating barriers that preclude the competitive entry into a market.
Enhanced relationships with service providers :gaining access to or improving relationships with important referral
sources, including specific service providers.
Increased operational efficiencies :facilitating reorganized service distribution and operations to significantly reduce the
cost of delivering services
Enhanced capacity and avoidance of capital expenditures :providing operational capacity for services at a lower cost
and/or in a better timeframe than would be required to create such capacity without an acquisition or merger.
Improved financial and credit position :enhancing the organization’s financial performance and credit rating, thereby
improving access to capital and lowering the cost of capital.
To realize these strategic and financial benefits, leaders will need to assess their current ability to pursue mergers and
acquisitions, and commit the time and resources needed to develop such capabilities, if currently limited or absent.
Cultural willingness to integrate planning and finance is vital, as described later.
The Seven-Step Process: Mergers & Acquisition; A proven process for evaluating and executing mergers and acquisitions
includes seven essential activities that occur as sequential steps. A description of each step is as follows,
Determine Growth Markets/Services: Leaders start the acquisition evaluation process by identifying growth opportunities
in business or service lines, markets served, or any combination thereof. To determine growth markets and services,
leaders must collect and analyze extensive data, including the following: client origin; demographics (population, age,
employment/unemployment rates, income); employers; other competitors; business, program, and service mix
(performance and profitability by service line); field staff; employees; utilization/case mix (demand projections);
competitive cost/charge position; and consumer preferences/ opinions. Example: ICICI must have seen lot of growth
prospects in acquiring Bank of Rajasthan in 2010 as the amalgamation will substantially enhance ICICI Bank’s branch
network, and especially strengthen its presence in northern and western India. The deal will combine Bank of Rajasthan’s
branch franchise with ICICI Bank’s strong capital base
Identify Merger and Acquisition Candidates: The second step of the acquisition process involves the proactive
identification of the universe of potential merger or acquisition candidates that could meet strategic financial growth
objectives in identified markets or service lines. This involves methodically identifying “likely suspects” as well as “outside
the box” possibilities based on management experience, research, the use of consultants, and other methods. Example :
Enam-Axis merger is a good example, from the Axis perspective and from the Enam perspective, it was a great deal. For
Axis, they were to start investment banking or start broking on their own, it may have took them a lot of time and lot of
effort, a lot of investment but here they have straightaway got a very good franchise. Enam was an excellent choice.
Assess Strategic Financial Position and Fit: At this stage following questions shall be answered, What are the likely
benefits of a transaction with this acquisition target?
What are the risks? How does this target compare to other targeted opportunities? Financial Position: A comprehensive
evaluation of the financial and credit position of the target and the combined entities is based on solid utilization and
financial forecasts. The assessment focuses on volume, revenue, cost, and balance sheet considerations. Example : Patni
Computer has been acquired by iGate along with private equity firm Apax Partners. Both the companies have done their
home work for assessing ‘Strategic Financial Position’ and sustainability of the deal. iGATE expects to finance the
purchase consideration of $1.22 billion through a combination of cash-in-hand, debt and equity financing, including a
potential public offering of up to 10 million shares.Viscaria Limited, a company backed by funds advised by Apax Partners,
will make an investment into iGATE in order to facilitate the acquisition of a majority stake in Patni.
Make a Go/No-Go Decision: Corporate leadership must determine the likely benefits and drawbacks of the proposed
acquisition or merger according to the questions discussed earlier and make a high-quality decision.During the decision-
making process, leaders identify whether the strategic value-added case for a combined entity is compelling enough to
proceed (or not). Example: Satyam-Mahindra deal is good example to explain this decision making step. After the Satyam
fiasco the leadership of Mahindra Group must have faced a lot of dilemma over ‘Go/No-Go Decision’. But the Mahindra
leaders made a brave decision after considering likely benefits and drawbacks of the proposed acquisition. The leadership
must have concluded that the benefits are heavily overweighing the likely drawbacks.
Conduct Valuation; The fifth step in the acquisition process involves assessing the value of the target, identifying
alternatives for structuring the merger or acquisition transactions, evaluating these, and selecting the structure that
would best enable the organization to achieve its objectives, and developing an offer.There are three key valuation
methods: discounted cash flow analysis, comparable transaction analysis, and comparable publicly traded company
analysis. To identify a realistic valuation range, corporate leadership should select best suitable method. Example: See the
deal of Reliance Infratel with GTL Infrastructure in 2010. According to Analysts, the deal may have been called off on
valuations. R-Com, being the larger company, would have been the dominant driver of valuation. If it found the cash and
swap ratio didn’t work out in its favor, it might have decided to call off the deal. Means it is evident that the companies
should not underestimate their value and at the same time don’t expect un-reasonable returns. After the decision-
making step, the ‘valuation’ is the most important step, as it can ruin your deal if goes wrong. Perform Due Diligence,
Negotiate a Definitive Agreement, and Execute Transaction: Once an offer on the table is accepted, leaders of the
acquiring organization must ensure a complete and comprehensive due diligence review of the target entity in order to
fully understand the issues, opportunities, and risks associated with the transaction.Due diligence involves a review of the
target’s financial, legal, and operational position to ensure an accuracy of information obtained earlier in the acquisition
process and full disclosure of all information relevant to the transaction.After due diligence is completed, the parties
negotiate definitive agreements. Any regulatory approvals necessary for consummation of the transaction are obtained
and the transaction is closedDuring transaction execution, the acquirer should monitor the acquisition or merger to
ensure that the negotiated transaction continues to meet the goals and objectives established for the transaction at the
end of the strategic assessment.
Implement Transaction and Monitor Ongoing Performance: The analysis seeks answers to such questions as, Will
management make the tough operational changes required to achieve the financial benefits? What are the HR
implications? Is there constituent support (management, board, service providers, community, and employees)? What
are the legal and regulatory challenges (Court approvals, SEBI Regulations, Tax implications, etc)? What are the financial,
organizational, and community-related risks of failure? A successful merger or acquisition involves combining two
organizations in an expedient manner to maximize strategic value while minimizing distraction or disruption to existing
operations. This includes having a ready mechanism to deal with any future problem in the implementation of the deal.
For example in latest Enam-Axis deal, Example: To secure smooth implementation of the deal, Enam Chairman Bhanshali
would be on Axis Bank’s board as an independent director. Manish Chokhani, director of Enam, would be the CEO of Axis
Securities. All these Enam directors’ experience will be certainly helpful in securing smooth implementation of the deal.
Conclusion:; We must acknowledge a hard fact that most of the deals are underachieved and fell short of expectations in
reality. The main reason for such poor performance is a failure to monitor strict implementation of all these steps. The
leaders normally do well to plan ideally for all these steps but once the process is started they fail to stick with it. Use of
the seven-step process described in this article will certainly ensure maximization of the merger or acquisition’s value and
contribution to improved market and financial performance. The substance can be summarized in a famous quote, The
decision to merge was emotionally difficult. Control is only useful if it creates value for the shareholders. If there is a way
to create more value for shareholders by relinquishing some control to a better or greater enterprise, then that is the
responsibility of the management.
Stock or Cash?: The Trade-Offs for Buyers and Sellers in Mergers and Acquisitions; The legendary merger mania of the
1980s pales beside the M&A activity of this decade. In 1998 alone, 12,356 deals involving U.S. targets were announced
for a total value of $1.63 trillion. Compare that with the 4,066 deals worth $378.9 billion announced in 1988, at the
height of the 1980s merger movement. But the numbers should be no surprise. After all, acquisitions remain the quickest
route companies have to new markets and to new capabilities. As markets globalize, and the pace at which technologies
change continues to accelerate, more and more companies are finding mergers and acquisitions to be a compelling
strategy for growth. What is striking about acquisitions in the 1990s, however, is the way they’re being paid for. In 1988,
nearly 60% of the value of large deals—those over $100 million—was paid for entirely in cash. Less than 2% was paid for
in stock. But just ten years later, the profile is almost reversed: 50% of the value of all large deals in 1998 was paid for
entirely in stock, and only 17% was paid for entirely in cash.
This shift has profound ramifications for the shareholders of both acquiring and acquired companies. In a cash deal, the
roles of the two parties are clear-cut, and the exchange of money for shares completes a simple transfer of ownership.
But in an exchange of shares, it becomes far less clear who is the buyer and who is the seller. In some cases, the
shareholders of the acquired company can end up owning most of the company that bought their shares. Companies that
pay for their acquisitions with stock share both the value and the risks of the transaction with the shareholders of the
company they acquire. The decision to use stock instead of cash can also affect shareholder returns. In studies covering
more than 1,200 major deals, researchers have consistently found that, at the time of announcement, shareholders of
acquiring companies fare worse in stock transactions than they do in cash transactions. What’s more, the findings show
that early performance differences between cash and stock transactions become greater—much greater—over time.
In a cash deal, the roles of the two parties are clear-cut, but in a stock deal, it’s less clear who is the buyer and who is the
seller. Despite their obvious importance, these issues are often given short shrift in corporate board-rooms and the pages
of the financial press. Both managers and journalists tend to focus mostly on the prices paid for acquisitions. It’s not that
focusing on price is wrong. Price is certainly an important issue confronting both sets of shareholders. But when
companies are considering making—or accepting—an offer for an exchange of shares, the valuation of the company in
play becomes just one of several factors that managers and investors need to consider. In this article, we provide a
framework to guide the boards of both the acquiring and the selling companies through their decision-making process,
and we offer two simple tools to help managers quantify the risks involved to their shareholders in offering or accepting
stock. But first let’s look at the basic differences between stock deals and cash deals.
Cash Versus Stock Trade-Offs; The main distinction between cash and stock transactions is this: In cash transactions,
acquiring shareholders take on the entire risk that the expected synergy value embedded in the acquisition premium will
not materialize. In stock transactions, that risk is shared with selling shareholders. More precisely, in stock transactions,
the synergy risk is shared in proportion to the percentage of the combined company the acquiring and selling
shareholders each will own. To see how that works, let’s look at a hypothetical example. Suppose that Buyer Inc. wants to
acquire its competitor, Seller Inc. The market capitalization of Buyer Inc. is $5 billion, made up of 50 million shares priced
at $100 per share. Seller Inc.’s market capitalization stands at $2.8 billion—40 million shares each worth $70. The
managers of Buyer Inc. estimate that by merging the two companies, they can create an additional synergy value of $1.7
billion. They announce an offer to buy all the shares of Seller Inc. at $100 per share. The value placed on Seller Inc. is
therefore $4 billion, representing a premium of $1.2 billion over the company’s preannouncement market value of $2.8
billion. The expected net gain to the acquirer from an acquisition—we call it the shareholder value added (SVA)—is the
difference between the estimated value of the synergies obtained through the acquisition and the acquisition premium.
So if Buyer Inc. chooses to pay cash for the deal, then the SVA for its shareholders is simply the expected synergy of $1.7
billion minus the $1.2 billion premium, or $500 million. But if Buyer Inc. decides to finance the acquisition by issuing new
shares, the SVA for its existing stockholders will drop. Let’s suppose that Buyer Inc. offers one of its shares for each of
Seller Inc.’s shares. The new offer places the same value on Seller Inc. as did the cash offer. But upon the deal’s
completion, the acquiring shareholders will find that their ownership in Buyer Inc. has been reduced. They will own only
55.5% of a new total of 90 million shares outstanding after the acquisition. So their share of the acquisition’s expected
SVA is only 55.5% of $500 million, or $277.5 million. The rest goes to Seller Inc.’s shareholders, who are now shareholders
in an enlarged Buyer Inc. The only way that Buyer Inc.’s original shareholders can obtain the same SVA from a stock deal
as from a cash deal would be by offering Seller Inc. fewer new shares, justifying this by pointing out that each share
would be worth more if the expected synergies were included. In other words, the new shares would reflect the value
that Buyer Inc.’s managers believe the combined company will be worth rather than the $100-per-share
preannouncement market value. But while that kind of deal sounds fair in principle, in practice Seller Inc.’s stockholders
would be unlikely to accept fewer shares unless they were convinced that the valuation of the merged company will turn
out to be even greater than Buyer Inc.’s managers estimate. In light of the disappointing track record of acquirers, this is
a difficult sell at best.
Why the Market Is Skeptical About Acquisitions. On the face of it, then, stock deals offer the acquired company’s
shareholders the chance to profit from the potential synergy gains that the acquiring shareholders expect to make above
and beyond the premium. That’s certainly what the acquirers will tell them. The problem, of course, is that the
stockholders of the acquired company also have to share the risks. Let’s suppose that Buyer Inc. completes the purchase
of Seller Inc. with an exchange of shares and then none of the expected synergies materialize. In an all-cash deal, Buyer
Inc.’s shareholders would shoulder the entire loss of the $1.2 billion premium paid for Seller Inc. But in a share deal, their
loss is only 55.5% of the premium. The remaining 44.5% of the loss—$534 million—is borne by Seller Inc.’s shareholders.
In many takeover situations, of course, the acquirer will be so much larger than the target that the selling shareholders
will end up owning only a negligible proportion of the combined company. But as the evidence suggests, stock financing
is proving particularly popular in large deals (see the exhibit “The Popularity of Paper”). In those cases, the potential risks
for the acquired shareholders are large, as ITT’s stockholders found out after their company was taken over by Starwood
Lodging. It is one of the highest profile takeover stories of the 1990s, and it vividly illustrates the perils of being paid in
paper. The story started in January 1997 with an offer by Hilton Hotels of $55 per share for ITT, a 28% premium over ITT’s
preoffer share price. Under the terms of the offer, ITT’s shareholders would receive $27.50 in cash and the balance in
Hilton stock. In the face of stiff resistance from ITT, Hilton raised its bid in August to $70 per share. At that point, a new
bidder, Starwood Lodging, a real estate investment trust with extensive hotel holdings, entered the fray with a bid of $82
per share. Starwood proposed paying $15 in cash and $67 in its own shares. In response, Hilton announced a bid of $80
per share in this form—ITT shareholders would receive $80 per share in cash for 55% of their shares and two shares of
Hilton stock for each of the remaining 45% of their shares. If the stock did not reach at least $40 per share one year after
the merger, Hilton would make up the shortfall to a maximum of $12 per share. In essence, then, Hilton was offering the
equivalent of an all-cash bid that would be worth at least $80 per share if Hilton’s shares traded at $28 or higher one year
after the merger. Hilton’s management believed it would clinch the deal with this lower bid by offering more cash and
protecting the future value of its shares.
Starwood countered by raising its offer to $85 per share. This time, it gave ITT’s shareholders the option to take payment
entirely in stock or entirely in cash. But there was a catch: if more than 60% of the stockholders chose the cash option,
then the cash payout to those shareholders would be capped at just $25.50, and the balance would be paid in Starwood
stock. Despite this catch, ITT’s board voted to recommend the Starwood offer over the less risky Hilton offer, and it was
then approved by shareholders. Ironically, while ITT’s board chose the offer with the larger stock component, the
stockholders actually had a strong preference for cash. When the votes were counted, almost 75% of ITT’s shareholders
had selected Starwood’s cash option—a percentage far greater than publicly predicted by Starwood’s management and
which, of course, triggered the $25.50 cap.
As a consequence of accepting Starwood’s offer, ITT’s shareholders ended up owning 67% of the combined company’s
shares. That was because even before the bid was announced (with its very substantial premium), ITT’s market value was
almost twice as large as Starwood’s. ITT’s shareholders were left very exposed, and they suffered for it. Although
Starwood’s share price held steady at around $55 during the takeover, the price plunged after completion. A year later, it
stood at $32 per share. At that price, the value of Starwood’s offer had shrunk from $85 to $64 for those ITT shareholders
who had elected cash. Shareholders who had chosen to be paid entirely in stock fared even worse: their package of
Starwood shares was worth only $49. ITT’s shareholders had paid a steep price for choosing the nominally higher but
riskier Starwood offer.
Fixed Shares or Fixed Value?; Boards and shareholders must do more than simply choose between cash and stock when
making—or accepting—an offer. There are two ways to structure an offer for an exchange of shares, and the choice of
one approach or the other has a significant impact on the allocation of risk between the two sets of shareholders.
Companies can either issue a fixed number of shares or they can issue a fixed value of shares.
Fixed Shares.; In these offers, the number of shares to be issued is certain, but the value of the deal may fluctuate
between the announcement of the offer and the closing date, depending on the acquirer’s share price. Both acquiring
and selling shareholders are affected by those changes, but changes in the acquirer’s price will not affect the proportional
ownership of the two sets of shareholders in the combined company. Therefore, the interests of the two sets of
shareholders in the deal’s shareholder value added do not change, even though the actual SVA may turn out to be
different than expected. In a fixed-share deal, shareholders in the acquired company are particularly vulnerable to a fall
in the price of the acquiring company’s stock because they have to bear a portion of the price risk from the time the deal
is announced. That was precisely what happened to shareholders of Green Tree Financial when in 1998 it accepted a $7.2
billion offer by the insurance company Conseco. Under the terms of the deal, each of Green Tree’s common shares was
converted into 0.9165 of a share of Conseco common stock. On April 6, a day before the deal was announced, Conseco
was trading at $57.75 per share. At that price, Green Tree’s shareholders would receive just under $53 worth of Conseco
stock for each of their Green Tree shares. That represented a huge 83% premium over Green Tree’s preannouncement
share price of $29.
Conseco’s rationale for the deal was that it needed to serve more of the needs of middle-income consumers. The vision
articulated when the deal was announced was that Conseco would sell its insurance and annuity products along with
Green Tree’s consumer loans, thereby strengthening both businesses. But the acquisition was not without its risks. First,
the Green Tree deal was more than eight times larger than the largest deal Conseco had ever completed and almost 20
times the average size of its past 20 deals. Second, Green Tree was in the business of lending money to buyers of mobile
homes, a business very different from Conseco’s, and the deal would require a costly postmerger integration effort. The
market was skeptical of the cross-selling synergies and of Conseco’s ability to compete in a new business. Conseco’s
growth had been built on a series of highly successful acquisitions in its core businesses of life and health insurance, and
the market took Conseco’s diversification as a signal that acquisition opportunities in those businesses were getting
scarce. So investors started to sell Conseco shares. By the time the deal closed at the end of June 1998, Conseco’s share
price had fallen from $57.75 to $48. That fall immediately hit Green Tree’s shareholders as well as Conseco’s. Instead of
the expected $53, Green Tree’s shareholders received $44 for each of their shares—the premium had fallen from 83% to
52%. Green Tree’s shareholders who held on to their Conseco stock after closing lost even more. By April 1999, one year
after announcement, Conseco’s share price had fallen to $30. At that price, Green Tree’s shareholders lost not only the
entire premium but also an additional $1.50 per share from the preannouncement value.
Fixed Value.; The other way to structure a stock deal is for the acquirer to issue a fixed value of shares. In these deals, the
number of shares issued is not fixed until the closing date and depends on the prevailing price. As a result, the
proportional ownership of the ongoing company is left in doubt until closing. To see how fixed-value deals work, let’s go
back to Buyer Inc. and Seller Inc. Suppose that Buyer Inc.’s offer is to be paid in stock but that at the closing date its share
price has fallen by exactly the premium it is paying for Seller Inc.—from $100 per share to $76 per share. At that share
price, in a fixed-value deal, Buyer Inc. has to issue 52.6 million shares to give Seller Inc.’s shareholders their promised $4
billion worth. But that leaves Buyer Inc.’s original shareholders with just 48.7% of the combined company instead of the
55.5% they would have had in a fixed-share deal. As the illustration suggests, in a fixed-value deal, the acquiring company
bears all the price risk on its shares between announcement and closing. If the stock price falls, the acquirer must issue
additional shares to pay sellers their contracted fixed-dollar value. So the acquiring company’s shareholders have to
accept a lower stake in the combined company, and their share of the expected SVA falls correspondingly. Yet in our
experience, companies rarely incorporate this potentially significant risk into their SVA calculations despite the fact that
the acquirer’s stock price decreases in a substantial majority of cases. (See the table “How Risk Is Distributed Between
Acquirer and Seller.”)
How Risk Is Distributed Between Acquirer and Seller; By the same token, the owners of the acquired company are better
protected in a fixed-value deal. They are not exposed to any loss in value until after the deal has closed. In our example,
Seller Inc.’s shareholders will not have to bear any synergy risk at all because the shares they receive now incorporate no
synergy expectations in their price. The loss in the share price is made up by granting the selling shareholders extra
shares. And if, after closing, the market reassesses the acquisition and Buyer Inc.’s stock price does rise, Seller Inc.’s
shareholders will enjoy higher returns because of the increased percentage they own in the combined company.
However, if Buyer Inc.’s stock price continues to deteriorate after the closing date, Seller Inc.’s shareholders will bear a
greater percentage of those losses.
How Can Companies Choose? Given the dramatic effects on value that the method of payment can have, boards of both
acquiring and selling companies have a fiduciary responsibility to incorporate those effects into their decision-making
processes. Acquiring companies must be able to explain to their stockholders why they have to share the synergy gains of
the transaction with the stockholders of the acquired company. For their part, the acquired company’s shareholders, who
are being offered stock in the combined company, must be made to understand the risks of what is, in reality, a new
investment. All this makes the job of the board members more complex. We’ll look first at the issues faced by the board
of an acquiring company.
Questions for the Acquirer. The management and the board of an acquiring company should address three economic
questions before deciding on a method of payment. First, are the acquiring company’s shares undervalued, fairly valued,
or over-valued? Second, what is the risk that the expected synergies needed to pay for the acquisition premium will not
materialize? The answers to these questions will help guide companies in making the decision between a cash and a stock
offer. Finally, how likely is it that the value of the acquiring company’s shares will drop before closing? The answer to that
question should guide the decision between a fixed-value and a fixed-share offer. Let’s look at each question in turn:
Valuation of Acquirer’s Shares; If the acquirer believes that the market is undervaluing its shares, then it should not issue
new shares to finance a transaction because to do so would penalize current shareholders. Research consistently shows
that the market takes the issuance of stock by a company as a sign that the company’s managers—who are in a better
position to know about its long-term prospects—believe the stock to be overvalued. Thus, when management chooses to
use stock to finance an acquisition, there’s plenty of reason to expect that company’s stock to fall.
If the acquirer believes the market is undervaluing its shares, it should not issue new shares to finance an acquisition.
What’s more, companies that use stock to pay for an acquisition often base the price of the new shares on the current,
undervalued market price rather than on the higher value they believe their shares to be worth. That can cause a
company to pay more than it intends and in some cases to pay more than the acquisition is worth. Suppose that our
hypothetical acquirer, Buyer Inc., believed that its shares are worth $125 rather than $100. Its managers should value the
40 million shares it plans to issue to Seller Inc.’s shareholders at $5 billion, not $4 billion. Then if Buyer Inc. thinks Seller
Inc. is worth only $4 billion, it ought to offer the shareholders no more than 32 million shares. Of course, in the real
world, it’s not easy to convince a disbelieving seller to accept fewer but “more valuable” shares—as we have already
pointed out. So if an acquiring company’s managers believe that the market significantly undervalues their shares, their
logical course is to proceed with a cash offer. Yet we consistently find that the same CEOs who publicly declare their
company’s share price to be too low will cheerfully issue large amounts of stock at that “too low” price to pay for their
acquisitions. Which signal is the market more likely to follow?
Synergy Risks; The decision to use stock or cash also sends signals about the acquirer’s estimation of the risks of failing to
achieve the expected synergies from the deal. A really confident acquirer would be expected to pay for the acquisition
with cash so that its shareholders would not have to give any of the anticipated merger gains to the acquired company’s
shareholders. But if managers believe the risk of not achieving the required level of synergy is substantial, they can be
expected to try to hedge their bets by offering stock. By diluting their company’s ownership interest, they will also limit
participation in any losses incurred either before or after the deal goes through. Once again, though, the market is well
able to draw its own conclusions. Indeed, empirical research consistently finds that the market reacts significantly more
favorably to announcements of cash deals than to announcements of stock deals.
A really confident acquirer would be expected to pay for the acquisition with cash. Stock offers, then, send two powerful
signals to the market: that the acquirer’s shares are overvalued and that its management lacks confidence in the
acquisition. In principle, therefore, a company that is confident about integrating an acquisition successfully, and that
believes its own shares to be undervalued, should always proceed with a cash offer. A cash offer neatly resolves the
valuation problem for acquirers that believe they are undervalued as well as for sellers uncertain of the acquiring
company’s true value. But it’s not always so straightforward. Quite often, for example, a company does not have
sufficient cash resources—or debt capacity—to make a cash offer. In that case, the decision is much less clear-cut, and
the board must judge whether the additional costs associated with issuing undervalued shares still justify the acquisition.
Preclosing Market Risk; A board that has determined to proceed with a share offer still has to decide how to structure it.
That decision depends on an assessment of the risk that the price of the acquiring company’s shares will drop between
the announcement of the deal and its closing. Research has shown that the market responds more favorably when
acquirers demonstrate their confidence in the value of their own shares through their willingness to bear more preclosing
market risk. In a 1997 article in the Journal of Finance, for example, Joel Houston and Michael Ryngaert found in a large
sample of banking mergers that the more sensitive the seller’s compensation is to changes in the acquirer’s stock price,
the less favorable is the market’s response to the acquisition announcement. That leads to the logical guideline that the
greater the potential impact of preclosing market risk, the more important it is for the acquirer to signal its confidence by
assuming some of that risk. A fixed-share offer is not a confident signal since the seller’s compensation drops if the value
of the acquirer’s shares falls. Therefore, the fixed-share approach should be adopted only if the preclosing market risk is
relatively low. That’s more likely (although not necessarily) the case when the acquiring and selling companies are in the
same or closely related industries. Common economic forces govern the share prices of both companies, and thus the
negotiated exchange ratio is more likely to remain equitable to acquirers and sellers at closing.
But there are ways for an acquiring company to structure a fixed-share offer without sending signals to the market that
its stock is overvalued. The acquirer, for example, can protect the seller against a fall in the acquirer’s share price below a
specified floor level by guaranteeing a minimum price. (Acquirers that offer such a floor typically also insist on a ceiling on
the total value of shares distributed to sellers.) Establishing a floor not only reduces preclosing market risk for sellers but
also diminishes the probability that the seller’s board will back out of the deal or that its shareholders will not approve
the transaction. That might have helped Bell Atlantic in its bid for TCI in 1994—which would have been the largest deal in
history at the time. Bell Atlantic’s stock fell sharply in the weeks following the announcement, and the deal—which
included no market-risk protection—unraveled as a result. An even more confident signal is given by a fixed-value offer in
which sellers are assured of a stipulated market value while acquirers bear the entire cost of any decline in their share
price before closing. If the market believes in the merits of the offer, then the acquirer’s price may even rise, enabling it
to issue fewer shares to the seller’s stockholders. The acquirer’s shareholders, in that event, would retain a greater
proportion of the deal’s SVA. As with fixed-share offers, floors and ceilings can be attached to fixed-value offers—in the
form of the number of shares to be issued. A ceiling ensures that the interests of the acquirer’s shareholders are not
severely diluted if the share price falls before the deal closes. A floor guarantees the selling shareholders a minimum
number of shares and a minimum level of participation in the expected SVA should the acquirer’s stock price rise
appreciably.
Questions for the Seller; In the case of a cash offer, the selling company’s board faces a fairly straightforward task. It just
has to compare the value of the company as an independent business against the price offered. The only risks are that it
could hold out for a higher price or that management could create better value if the company remained independent.
The latter case certainly can be hard to justify. Let’s suppose that the shareholders of our hypothetical acquisition, Seller
Inc., are offered $100 per share, representing a 43% premium over the current $70 price. Let’s also suppose that they can
get a 10% return by putting that cash in investments with a similar level of risk. After five years, the $100 would
compound to $161. If the bid were rejected, Seller Inc. would have to earn an annual return of 18% on its currently
valued $70 shares to do as well. So uncertain a return must compete against a bird in the hand. More than likely, though,
the selling company’s board will be offered stock or some combination of cash and stock and so will also have to value
the shares of the combined company being offered to its shareholders. In essence, shareholders of the acquired company
will be partners in the postmerger enterprise and will therefore have as much interest in realizing the synergies as the
shareholders of the acquiring company. If the expected synergies do not materialize or if other disappointing information
develops after closing, selling shareholders may well lose a significant portion of the premium received on their shares.
So if a selling company’s board accepts an exchange-of-shares offer, it is not only endorsing the offer as a fair price for its
own shares, it is also endorsing the idea that the combined company is an attractive investment. Essentially, then, the
board must act in the role of a buyer as well as a seller and must go through the same decision process that the acquiring
company follows. At the end of the day, however, no matter how a stock offer is made, selling shareholders should never
assume that the announced value is the value they will realize before or after closing. Selling early may limit exposure,
but that strategy carries costs because the shares of target companies almost invariably trade below the offer price
during the preclosing period. Of course, shareholders who wait until after the closing date to sell their shares of the
merged company have no way of knowing what those shares will be worth at that time. The questions we have discussed
here—How much is the acquirer worth? How likely is it that the expected synergies will be realized?, and How great is the
preclosing market risk?—address the economic issues associated with the decisions to offer or accept a particular
method of paying for a merger or acquisition. There are other, less important, issues of tax treatment and accounting
that the advisers of both boards will seek to bring to their attention (see the sidebars “Tax Consequences of Acquisitions”
and “Accounting: Seeing Through the Smoke Screen”). But those concerns should not play a key role in the acquisition
decision. The actual impact of tax and accounting treatments on value and its distribution is not as great as it may seem.
Shareholder Value at Risk (SVAR); Before committing themselves to a major deal, both parties will, of course, need to
assess the effect on each company’s shareholder value should the synergy expectations embedded in the premium fail to
materialize. In other words, what percentage of the company’s market value are you betting on the success or failure of
the acquisition? We present two simple tools for measuring synergy risk, one for the acquirer and the other for the seller.
A useful tool for assessing the relative magnitude of synergy risk for the acquirer is a straightforward calculation we call
shareholder value at risk. SVAR is simply the premium paid for the acquisition divided by the market value of the
acquiring company before the announcement is made. The index can also be calculated as the premium percentage
multiplied by the market value of the seller relative to the market value of the buyer. (See the table “What Is an
Acquirer’s Risk in an All-Cash Deal?”) We think of it as a “bet your company” index, which shows how much of your
company’s value is at risk if no postacquisition synergies are realized. The greater the premium percentage paid to sellers
and the greater their market value relative to the acquiring company, the higher the SVAR. Of course, as we’ve seen, it’s
possible for acquirers to lose even more than their premium. In those cases, SVAR underestimates risk. What Is an
Acquirer’s Risk in an All-Cash Deal? An acquirer’s shareholder value at risk (SVAR) varies both with the relative size of the
acquisition and the premium paid. Let’s see what the SVAR numbers are for our hypothetical deal. Buyer Inc. was
proposing to pay a premium of $1.2 billion, and its own market value was $5 billion. In a cash deal, its SVAR would
therefore be 1.2 divided by 5, or 24%. But if Seller Inc.’s shareholders are offered stock, Buyer Inc.’s SVAR decreases
because some of the risk is transferred to the selling shareholders. To calculate Buyer Inc.’s SVAR for a stock deal, you
must multiply the all-cash SVAR of 24% by the percentage that Buyer Inc. will own in the combined company, or 55.5%.
Buyer Inc.’s SVAR for a stock deal is therefore just 13.3%.
A variation of SVAR—premium at risk—can help shareholders of a selling company assess their risks if the synergies don’t
materialize. The question for sellers is, What percentage of the premium is at risk in a stock offer? The answer is the
percentage of ownership the seller will have in the combined company. In our hypothetical deal, therefore, the premium
at risk for Seller Inc.’s shareholders is 44.5%. Once again, the premium-at-risk calculation is actually a rather conservative
measure of risk, as it assumes that the value of the independent businesses is safe and only the premium is at risk. But as
Conseco’s acquisition of Green Tree Financial demonstrates, unsuccessful deals can cost both parties more than just the
premium. (See the table “SVAR and Premium at Risk for Major Stock Deals Announced in 1998.”) SVAR and Premium at
Risk for Major Stock Deals Announced in 1998 Data for calculations courtesy of Securities Data Company. The cash SVAR
percentage is calculated as the premium percentage multiplied by the relative size of the seller to the acquirer. The stock
SVAR percentage is calculated as the cash SVAR percentage multiplied by the acquirer’s proportional ownership. From
the perspective of the selling company’s shareholders, the premium-at-risk calculation highlights the attractiveness of a
fixed-value offer relative to a fixed-share offer. Let’s go back to our two companies. If Buyer Inc.’s stock price falls during
the preclosing period by the entire premium paid, then Seller Inc.’s shareholders receive additional shares. Since no
synergy expectations are built into the price of those shares now, Seller Inc.’s premium at risk has been completely
absorbed by Buyer Inc. In other words, Seller Inc.’s shareholders receive not only more shares but also less risky shares.
But in a fixed-share transaction, Seller Inc.’s stockholders have to bear their full share of the value lost through the fall in
Buyer Inc.’s price right from the announcement date. Although we have taken a cautionary tone in this article, we are not
advocating that companies should always avoid using stock to pay for acquisitions. We have largely focused on deals that
have taken place in established industries such as hotels and insurance. Stock issues are a natural way for young
companies with limited access to other forms of financing, particularly in new industries, to pay for acquisitions. In those
cases, a high stock valuation can be a major advantage.
Even managers of Internet companies like Amazon or Yahoo! should not be beguiled into thinking that issuing stock is
risk-free. But it is a vulnerable one, and even the managers of Internet companies such as America Online, Amazon.com,
and Yahoo! should not be beguiled into thinking that issuing stock is risk-free. Once the market has given a thumbs-down
to one deal by marking down the acquirer’s share price, it is likely to be more guarded about future deals. A poor stock-
price performance can also undermine the motivation of employees and slow a company’s momentum, making the
difficult task of integrating acquisitions even harder. Worse, it can trigger a spiral of decline because companies whose
share prices perform badly find it hard to attract and retain good people. Internet and other high-technology companies
are especially vulnerable to this situation because they need to be able to offer expectations of large stock-option gains
to recruit the best from a scarce pool of talent. The choice between cash and stock should never be made without full
and careful consideration of the potential consequences. The all-too-frequent disappointing returns from stock
transactions underscore how important it is for the boards of both parties to understand the ramifications and be vigilant
on behalf of their shareholders’ interests.
MODULE III.
Understanding the Different Forms of Intellectual Property; Intellectual property (or "IP") is a category of property that
includes intangible creations of the human intellect, and primarily encompasses copyrights, patents, and trademarks. It
also includes other types of rights, such as trade secrets, publicity rights, moral rights, and rights against unfair
competition. Artistic works like music and literature, as well as some discoveries, inventions, words, phrases, symbols,
and designs can all be protected as intellectual property.[1][2] Intellectual property law has evolved over centuries. It was
not until the 19th century that the term "intellectual property" began to be used, and not until the late 20th century that
it became commonplace in the majority of the world.[3] The main purpose of intellectual property law is to encourage the
creation of a wide variety of intellectual goods. To achieve this, the law gives people and businesses property rights to the
information and intellectual goods they create, usually for a limited period of time. Because they can then profit from
them, this gives economic incentive for their creation.[4] The intangible nature of intellectual property presents difficulties
when compared with traditional property like land or goods. Unlike traditional property, intellectual property is
indivisible – an unlimited number of people can "consume" an intellectual good without it being depleted. Additionally,
investments in intellectual goods suffer from problems of appropriation – a landowner can surround their land with a
robust fence and hire armed guards to protect it, but a producer of information or an intellectual good can usually do
very little to stop their first buyer from replicating it and selling it at a lower price. Balancing rights so that they are strong
enough to encourage the creation of intellectual goods but not so strong that they prevent their wide use is the primary
focus of modern intellectual property law.[5]
History[edit] Main articles: History of copyright law and History of patent law. The Statute of Anne came into force in
1710 The Statute of Monopolies (1624) and the British Statute of Anne (1710) are seen as the origins of patent
law and copyright respectively,[6]firmly establishing the concept of intellectual property. The first known use of the
term intellectual property dates to 1769, when a piece published in the Monthly Review used the phrase.[7] The first clear
example of modern usage goes back as early as 1808, when it was used as a heading title in a collection of essays. [8] The
German equivalent was used with the founding of the North German Confederation whose constitution granted
legislative power over the protection of intellectual property (Schutz des geistigen Eigentums) to the
confederation.[9] When the administrative secretariats established by the Paris Convention (1883) and the Berne
Convention (1886) merged in 1893, they located in Berne, and also adopted the term intellectual property in their new
combined title, the United International Bureaux for the Protection of Intellectual Property. The organization
subsequently relocated to Geneva in 1960, and was succeeded in 1967 with the establishment of the World Intellectual
Property Organization (WIPO) by treaty as an agency of the United Nations. According to Lemley, it was only at this point
that the term really began to be used in the United States (which had not been a party to the Berne Convention),[3] and it
did not enter popular usage there until passage of the Bayh-Dole Act in 1980.[10] "The history of patents does not begin
with inventions, but rather with royal grants by Queen Elizabeth I (1558–1603) for monopoly privileges... Approximately
200 years after the end of Elizabeth's reign, however, a patent represents a legal right obtained by an inventor providing
for exclusive control over the production and sale of his mechanical or scientific invention... [demonstrating] the
evolution of patents from royal prerogative to common-law doctrine."[11] The term can be found used in an October
1845 Massachusetts Circuit Court ruling in the patent case Davoll et al. v. Brown., in which Justice Charles L. Woodbury
wrote that "only in this way can we protect intellectual property, the labors of the mind, productions and interests are as
much a man's own...as the wheat he cultivates, or the flocks he rears."[12] The statement that "discoveries are..property"
goes back earlier. Section 1 of the French law of 1791 stated, "All new discoveries are the property of the author; to
assure the inventor the property and temporary enjoyment of his discovery, there shall be delivered to him a patent for
five, ten or fifteen years."[13] In Europe, French author A. Nion mentioned propriété intellectuelle in his Droits civils des
auteurs, artistes et inventeurs, published in 1846. Until recently, the purpose of intellectual property law was to give as
little protection as possible in order to encourage innovation. Historically, therefore, they were granted only when they
were necessary to encourage invention, limited in time and scope.[14] The concept's origins can potentially be traced back
further. Jewish law includes several considerations whose effects are similar to those of modern intellectual property
laws, though the notion of intellectual creations as property does not seem to exist – notably the principle of Hasagat
Ge'vul (unfair encroachment) was used to justify limited-term publisher (but not author) copyright in the 16th
century.[15] In 500 BCE, the government of the Greek state of Sybaris offered one year's patent "to all who should discover
any new refinement in luxury".[16] According to Morin, "the global intellectual property regime is currently in the midst of
a paradigm shift".[17] Indeed, up until the early 2000s the global IP regime used to be dominated by high standards of
protection characteristic of IP laws from Europe or the United States, with a vision that uniform application of these
standards over every country and to several fields with little consideration over social, cultural or environmental values or
of the national level of economic development. Morin argues that "the emerging discourse of the global IP regime
advocates for greater policy ﬂexibility and greater access to knowledge, especially for developing countries." Indeed, with
the Development Agenda adopted by WIPO in 2007, a set of 45 recommendations to adjust WIPO’s activities to the
specific needs of developing countries and aim to reduce distortions especially on issues such as patients’ access to
medicines, Internet users’ access to information, farmers’ access to seeds, programmers’ access to source codes or
students’ access to scientific articles.[18] However, this paradigm shift has not yet manifested itself in concrete legal
reforms at the international level.[19]
Intellectual property rights[edit] Intellectual property rights include patents, copyright, industrial design
rights, trademarks, plant variety rights, trade dress, geographical indications,[20] and in some jurisdictions trade secrets.
There are also more specialized or derived varieties of sui generis exclusive rights, such as circuit design rights
(called mask work rights in the US) and supplementary protection certificates for pharmaceutical products (after expiry of
a patent protecting them) and database rights (in European law).
Patents[edit] A patent is a form of right granted by the government to an inventor, giving the owner the right to exclude
others from making, using, selling, offering to sell, and importing an invention for a limited period of time, in exchange for
the public disclosure of the invention. An invention is a solution to a specific technological problem, which may be a
product or a process and generally has to fulfill three main requirements: it has to be new, not obvious and there needs
to be an industrial applicability.[21]:17
Copyright[edit].A copyright gives the creator of an original work exclusive rights to it, usually for a limited time. Copyright
may apply to a wide range of creative, intellectual, or artistic forms, or "works".[22][23] Copyright does not cover ideas and
information themselves, only the form or manner in which they are expressed.[24]
Industrial design rights[edit]. An industrial design right (sometimes called "design right" or design patent) protects the
visual design of objects that are not purely utilitarian. An industrial design consists of the creation of a shape,
configuration or composition of pattern or color, or combination of pattern and color in three-dimensional form
containing aesthetic value. An industrial design can be a two- or three-dimensional pattern used to produce a product,
industrial commodity or handicraft.
Plant varieties[edit] Plant breeders' rights or plant variety rights are the rights to commercially use a new variety of a
plant. The variety must amongst others be novel and distinct and for registration the evaluation of propagating material
of the variety is considered.
Trademarks[edit] A trademark is a recognizable sign, design or expression which distinguishes products or services of a
particular trader from the similar products or services of other traders.[25][26][27]
Trade dress[edit] Trade dress is a legal term of art that generally refers to characteristics of the visual and aesthetic
appearance of a product or its packaging (or even the design of a building) that signify the source of the product to
consumers.[28]
Trade secrets[edit] A trade secret is a formula, practice, process, design, instrument, pattern, or compilation
of information which is not generally known or reasonably ascertainable, by which a business can obtain an economic
advantage over competitors and customers. There is no formal government protection granted; each business must take
measures to guard its own trade secrets (e.g., Formula of its soft drinks is a trade secret for Coca-Cola.)
Objectives of intellectual property law[edit] The main purpose of intellectual property law is to encourage the creation of
a wide variety of intellectual goods for consumers.[4] To achieve this, the law gives people and businesses property rights
to the information and intellectual goods they create, usually for a limited period of time. Because they can then profit
from them, this gives economic incentive for their creation.[4] The intangible nature of intellectual property presents
difficulties when compared with traditional property like land or goods. Unlike traditional property, intellectual property
is indivisible – an unlimited number of people can "consume" an intellectual good without it being depleted. Additionally,
investments in intellectual goods suffer from problems of appropriation – while a landowner can surround their land with
a robust fence and hire armed guards to protect it, a producer of information or an intellectual good can usually do very
little to stop their first buyer from replicating it and selling it at a lower price. Balancing rights so that they are strong
enough to encourage the creation of information and intellectual goods but not so strong that they prevent their wide
use is the primary focus of modern intellectual property law.[5] By exchanging limited exclusive rights for disclosure of
inventions and creative works, society and the patentee/copyright owner mutually benefit, and an incentive is created
for inventors and authors to create and disclose their work. Some commentators have noted that the objective of
intellectual property legislators and those who support its implementation appears to be "absolute protection". "If some
intellectual property is desirable because it encourages innovation, they reason, more is better. The thinking is that
creators will not have sufficient incentive to invent unless they are legally entitled to capture the full social value of their
inventions".[14] This absolute protection or full value view treats intellectual property as another type of "real" property,
typically adopting its law and rhetoric. Other recent developments in intellectual property law, such as the America
Invents Act, stress international harmonization. Recently there has also been much debate over the desirability of using
intellectual property rights to protect cultural heritage, including intangible ones, as well as over risks
of commodification derived from this possibility.[29] The issue still remains open in legal scholarship.
Financial incentive[edit] These exclusive rights allow owners of intellectual property to benefit from the property they
have created, providing a financial incentive for the creation of an investment in intellectual property, and, in case of
patents, pay associated research and development costs.[30] In the United States Article I Section 8 Clause 8 of the
Constitution, commonly called the Patent and Copyright Clause, reads; "[The Congress shall have power] 'To promote the
progress of science and useful arts, by securing for limited times to authors and inventors the exclusive right to their
respective writings and discoveries.'"[31] ”Some commentators, such as David Levine and Michele Boldrin, dispute this
justification.[32] In 2013 the United States Patent & Trademark Office approximated that the worth of intellectual property
to the U.S. economy is more than US $5 trillion and creates employment for an estimated 18 million American people.
The value of intellectual property is considered similarly high in other developed nations, such as those in the European
Union.[33] In the UK, IP has become a recognised asset class for use in pension-led funding and other types of business
finance. However, in 2013, the UK Intellectual Property Office stated: "There are millions of intangible business assets
whose value is either not being leveraged at all, or only being leveraged inadvertently".[34]
Economic growth[edit] The WIPO treaty and several related international agreements underline that the protection of
intellectual property rights is essential to maintaining economic growth. The WIPO Intellectual Property Handbook gives
two reasons for intellectual property laws:
One is to give statutory expression to the moral and economic rights of creators in their creations and the rights of the
public in access to those creations. The second is to promote, as a deliberate act of Government policy, creativity and the
dissemination and application of its results and to encourage fair trading which would contribute to economic and social
development.[35] The Anti-Counterfeiting Trade Agreement (ACTA) states that "effective enforcement of intellectual
property rights is critical to sustaining economic growth across all industries and globally".[36] Economists estimate that
two-thirds of the value of large businesses in the United States can be traced to intangible assets.[37] "IP-intensive
industries" are estimated to generate 72 percent more value added (price minus material cost) per employee than "non-
IP-intensive industries".[38][dubious – discuss] A joint research project of the WIPO and the United Nations University measuring
the impact of IP systems on six Asian countries found "a positive correlation between the strengthening of the IP system
and subsequent economic growth."[39]
Morality[edit] According to Article 27 of the Universal Declaration of Human Rights, "everyone has the right to the
protection of the moral and material interests resulting from any scientific, literary or artistic production of which he is
the author".[40] Although the relationship between intellectual property and human rights is a complex one,[41] there are
moral arguments for intellectual property. The arguments that justify intellectual property fall into three major
categories. Personality theorists believe intellectual property is an extension of an individual. Utilitarians believe that
intellectual property stimulates social progress and pushes people to further innovation. Lockeans argue that intellectual
property is justified based on deservedness and hard work.[42] Various moral justifications for private property can be
used to argue in favor of the morality of intellectual property, such as:
1.Natural Rights/Justice Argument: this argument is based on Locke's idea that a person has a natural right over the
labour and/or products which is produced by his/her body. Appropriating these products is viewed as unjust. Although
Locke had never explicitly stated that natural right applied to products of the mind,[43] it is possible to apply his argument
to intellectual property rights, in which it would be unjust for people to misuse another's ideas. [44] Locke's argument for
intellectual property is based upon the idea that laborers have the right to control that which they create. They argue
that we own our bodies which are the laborers, this right of ownership extends to what we create. Thus, intellectual
property ensures this right when it comes to production.
2.Utilitarian-Pragmatic Argument: according to this rationale, a society that protects private property is more effective
and prosperous than societies that do not. Innovation and invention in 19th century America has been attributed to the
development of the patent system.[45] By providing innovators with "durable and tangible return on their investment of
time, labor, and other resources", intellectual property rights seek to maximize social utility.[46] The presumption is that
they promote public welfare by encouraging the "creation, production, and distribution of intellectual
works".[46] Utilitarians argue that without intellectual property there would be a lack of incentive to produce new ideas.
Systems of protection such as Intellectual property optimize social utility.
3."Personality" Argument: this argument is based on a quote from Hegel: "Every man has the right to turn his will upon a
thing or make the thing an object of his will, that is to say, to set aside the mere thing and recreate it as his
own".[47] European intellectual property law is shaped by this notion that ideas are an "extension of oneself and of one's
personality".[48] Personality theorists argue that by being a creator of something one is inherently at risk and vulnerable
for having their ideas and designs stolen and/or altered. Intellectual property protects these moral claims that have to do
with personality.
Lysander Spooner (1855) argues "that a man has a natural and absolute right—and if a natural and absolute, then
necessarily a perpetual, right—of property, in the ideas, of which he is the discoverer or creator; that his right of
property, in ideas, is intrinsically the same as, and stands on identically the same grounds with, his right of property in
material things; that no distinction, of principle, exists between the two cases".[49] Writer Ayn Rand argued in her
book Capitalism: The Unknown Ideal that the protection of intellectual property is essentially a moral issue. The belief is
that the human mind itself is the source of wealth and survival and that all property at its base is intellectual property. To
violate intellectual property is therefore no different morally than violating other property rights which compromises the
very processes of survival and therefore constitutes an immoral act.[50]
Infringement, misappropriation, and enforcement[edit] Violation of intellectual property rights, called "infringement"
with respect to patents, copyright, and trademarks, and "misappropriation" with respect to trade secrets, may be a
breach of civil law or criminal law, depending on the type of intellectual property involved, jurisdiction, and the nature of
the action. As of 2011 trade in counterfeit copyrighted and trademarked works was a $600 billion industry worldwide and
accounted for 5–7% of global trade.[51]
Patent infringement[edit] Patent infringement typically is caused by using or selling a patented invention without
permission from the patent holder. The scope of the patented invention or the extent of protection[52] is defined in
the claims of the granted patent. There is safe harbor in many jurisdictions to use a patented invention for research. This
safe harbor does not exist in the US unless the research is done for purely philosophical purposes, or in order to gather
data in order to prepare an application for regulatory approval of a drug.[53] In general, patent infringement cases are
handled under civil law (e.g., in the United States) but several jurisdictions incorporate infringement in criminal law also
(for example, Argentina, China, France, Japan, Russia, South Korea).[54]
Copyright infringement[edit] Copyright infringement is reproducing, distributing, displaying or performing a work, or to

make derivative works, without permission from the copyright holder, which is typically a publisher or other business
representing or assigned by the work's creator. It is often called "piracy".[55] While copyright is created the instant a work
is fixed, generally the copyright holder can only get money damages if the owner registers the copyright. [citation
needed]
Enforcement of copyright is generally the responsibility of the copyright holder.[56]The ACTA trade agreement,
signed in May 2011 by the United States, Japan, Switzerland, and the EU, and which has not entered into force, requires
that its parties add criminal penalties, including incarceration and fines, for copyright and trademark infringement, and
obligated the parties to active police for infringement.[51][57] There are limitations and exceptions to copyright, allowing
limited use of copyrighted works, which does not constitute infringement. Examples of such doctrines are the fair
use and fair dealing doctrine.
Trademark infringement[edit] Trademark infringement occurs when one party uses a trademark that is identical
or confusingly similar to a trademark owned by another party, in relation to products or services which are identical or
similar to the products or services of the other party. In many countries, a trademark receives protection without
registration, but registering a trademark provides legal advantages for enforcement. Infringement can be addressed by
civil litigation and, in several jurisdictions, under criminal law.[51][57]
Trade secret misappropriation[edit] Trade secret misappropriation is different from violations of other intellectual
property laws, since by definition trade secrets are secret, while patents and registered copyrights and trademarks are
publicly available. In the United States, trade secrets are protected under state law, and states have nearly universally
adopted the Uniform Trade Secrets Act. The United States also has federal law in the form of the Economic Espionage Act
of 1996 (18 U.S.C. §§ 1831–1839), which makes the theft or misappropriation of a trade secret a federal crime. This law
contains two provisions criminalizing two sorts of activity. The first, 18 U.S.C. § 1831(a), criminalizes the theft of trade
secrets to benefit foreign powers. The second, 18 U.S.C. § 1832, criminalizes their theft for commercial or economic
purposes. (The statutory penalties are different for the two offenses.) In Commonwealthcommon law jurisdictions,
confidentiality and trade secrets are regarded as an equitable right rather than a property right but penalties for theft are
roughly the same as in the United States.[citation needed]
Criticisms[edit] The term "intellectual property"[edit] Criticism of the term intellectual property ranges from discussing
its vagueness and abstract overreach to direct contention to the semantic validity of using words
like property and rights in fashions that contradict practice and law. Many detractors think this term specially serves the
doctrinal agenda of parties opposing reform in the public interest or otherwise abusing related legislations; and that it
disallows intelligent discussion about specific and often unrelated aspects of copyright, patents, trademarks, etc.[58]
Free Software Foundation founder Richard Stallman argues that, although the term intellectual property is in wide use, it
should be rejected altogether, because it "systematically distorts and confuses these issues, and its use was and is
promoted by those who gain from this confusion". He claims that the term "operates as a catch-all to lump together
disparate laws [which] originated separately, evolved differently, cover different activities, have different rules, and raise
different public policy issues" and that it creates a "bias" by confusing these monopolies with ownership of limited
physical things, likening them to "property rights".[59] Stallman advocates referring to copyrights, patents and trademarks
in the singular and warns against abstracting disparate laws into a collective term. He argues that "to avoid spreading
unnecessary bias and confusion, it is best to adopt a firm policy not to speak or even think in terms of 'intellectual
property'."[60] Similarly, economists Boldrin and Levine prefer to use the term "intellectual monopoly" as a more
appropriate and clear definition of the concept, which they argue, is very dissimilar from property rights. [61] On the
assumption that intellectual property rights are actual rights, Stallman says that this claim does not live to the historical
intentions behind these laws, which in the case of copyright served as a censorship system, and later on, a regulatory
model for the printing press that may have benefited authors incidentally, but never interfered with the freedom of
average readers.[62] Still referring to copyright, he cites legal literature such as the United States Constitution and case
law to demonstrate that the law is meant to be an optional and experimental bargain to temporarily trade property rights
and free speech for public, not private, benefits in the form of increased artistic production and knowledge. He mentions
that "if copyright were a natural right nothing could justify terminating this right after a certain period of time". [63] Law
professor, writer and political activist Lawrence Lessig, along with many other copyleft and free software activists, has
criticized the implied analogy with physical property (like land or an automobile). They argue such an analogy fails
because physical property is generally rivalrous while intellectual works are non-rivalrous (that is, if one makes a copy of
a work, the enjoyment of the copy does not prevent enjoyment of the original).[64][65]Other arguments along these lines
claim that unlike the situation with tangible property, there is no natural scarcity of a particular idea or information: once
it exists at all, it can be re-used and duplicated indefinitely without such re-use diminishing the original. Stephan
Kinsella has objected to intellectual property on the grounds that the word "property" implies scarcity, which may not be
applicable to ideas.[66] Entrepreneur and politician Rickard Falkvinge and hacker Alexandre Oliva have independently
compared George Orwell's fictional dialect Newspeak to the terminology used by intellectual property supporters as a
linguistic weapon to shape public opinion regarding copyright debate and DRM.[67][68]
Alternative terms[edit] In civil law jurisdictions, intellectual property has often been referred to as intellectual rights,
traditionally a somewhat broader concept that has included moral rights and other personal protections that cannot be
bought or sold. Use of the term intellectual rights has declined since the early 1980s, as use of the term intellectual
property has increased. Alternative terms monopolies on information and intellectual monopoly have emerged among
those who argue against the "property" or "intellect" or "rights" assumptions, notably Richard Stallman.
The backronyms intellectual protectionism and intellectual poverty,[69] whose initials are also IP, have found supporters as
well, especially among those who have used the backronym digital restrictions management.[70][71] The argument that an
intellectual property right should (in the interests of better balancing of relevant private and public interests) be termed
an intellectual monopoly privilege(IMP) has been advanced by several academics including Birgitte
Andersen[72] and Thomas Alured Faunce.[73]
Objections to overbroad intellectual property laws[edit] The free culture movement champions the production
of content that bears little or no restrictions. Some critics of intellectual property, such as those in the free culture
movement, point at intellectual monopolies as harming health (in the case of pharmaceutical patents), preventing
progress, and benefiting concentrated interests to the detriment of the masses,[74][75][76][77]and argue that the public
interest is harmed by ever-expansive monopolies in the form of copyright extensions, software patents, and business
method patents. More recently scientists and engineers are expressing concern that patent thickets are undermining
technological development even in high-tech fields like nanotechnology.[78][79] Petra Moser has asserted that historical
analysis suggests that intellectual property laws may harm innovation: Overall, the weight of the existing historical
evidence suggests that patent policies, which grant strong intellectual property rights to early generations of inventors,
may discourage innovation. On the contrary, policies that encourage the diffusion of ideas and modify patent laws to
facilitate entry and encourage competition may be an effective mechanism to encourage innovation.[80] Peter
Drahos notes, "Property rights confer authority over resources. When authority is granted to the few over resources on
which many depend, the few gain power over the goals of the many. This has consequences for both political and
economic freedoms with in a society."[81]:13 The World Intellectual Property Organization (WIPO) recognizes that conflicts
may exist between the respect for and implementation of current intellectual property systems and other human
rights.[82] In 2001 the UN Committee on Economic, Social and Cultural Rights issued a document called "Human rights and
intellectual property" that argued that intellectual property tends to be governed by economic goals when it should be
viewed primarily as a social product; in order to serve human well-being, intellectual property systems must respect and
conform to human rights laws. According to the Committee, when systems fail to do so they risk infringing upon the
human right to food and health, and to cultural participation and scientific benefits.[83][84] In 2004 the General Assembly of
WIPO adopted The Geneva Declaration on the Future of the World Intellectual Property Organization which argues that
WIPO should "focus more on the needs of developing countries, and to view IP as one of many tools for development—
not as an end in itself".[85] Further along these lines, The ethical problems brought up by IP rights are most pertinent
when it is socially valuable goods like life-saving medicines are given IP protection. While the application of IP rights can
allow companies to charge higher than the marginal cost of production in order to recoup the costs of research and
development, the price may exclude from the market anyone who cannot afford the cost of the product, in this case a
life-saving drug.[86] "An IPR driven regime is therefore not a regime that is conductive to the investment of R&D of
products that are socially valuable to predominately poor populations".[86]:1108–9 Some libertarian critics of intellectual
property have argued that allowing property rights in ideas and information creates artificial scarcity and infringes on the
right to own tangible property. Stephan Kinsella uses the following scenario to argue this point:
[I]magine the time when men lived in caves. One bright guy—let's call him Galt-Magnon—decides to build a log cabin on
an open field, near his crops. To be sure, this is a good idea, and others notice it. They naturally imitate Galt-Magnon, and
they start building their own cabins. But the first man to invent a house, according to IP advocates, would have a right to
prevent others from building houses on their own land, with their own logs, or to charge them a fee if they do build
houses. It is plain that the innovator in these examples becomes a partial owner of the tangible property (e.g., land and
logs) of others, due not to first occupation and use of that property (for it is already owned), but due to his coming up
with an idea. Clearly, this rule flies in the face of the first-user homesteading rule, arbitrarily and groundlessly overriding
the very homesteading rule that is at the foundation of all property rights.[87] Thomas Jefferson once said in a letter to
Isaac McPherson on August 13, 1813: "If nature has made any one thing less susceptible than all others of exclusive
property, it is the action of the thinking power called an idea, which an individual may exclusively possess as long as he
keeps it to himself; but the moment it is divulged, it forces itself into the possession of every one, and the receiver cannot
dispossess himself of it. Its peculiar character, too, is that no one possesses the less, because every other possesses the
whole of it. He who receives an idea from me, receives instruction himself without lessening mine; as he who lights
his taper at mine, receives light without darkening me."[88] In 2005 the RSA launched the Adelphi Charter, aimed at
creating an international policy statement to frame how governments should make balanced intellectual property law.[89]
Another aspect of current U.S. Intellectual Property legislation is its focus on individual and joint works; thus, copyright
protection can only be obtained in 'original' works of authorship.[90]
Expansion in nature and scope of intellectual property laws[edit] Expansion of U.S. copyright law (Assuming authors
create their works by age 35 and live for seventy years) Other criticism of intellectual property law concerns the
expansion of intellectual property, both in duration and in scope. In addition, as scientific knowledge has expanded and
allowed new industries to arise in fields such as biotechnology and nanotechnology, originators of technology have
sought IP protection for the new technologies. Patents have been granted for living organisms, [91] (and in the United
States, certain living organisms have been patentable for over a century).[92] The increase in terms of protection is
particularly seen in relation to copyright, which has recently been the subject of serial extensions in the United
States and in Europe.[64][93][94][95][96] With no need for registration or copyright notices, this is thought to have led to an
increase in orphan works (copyrighted works for which the copyright owner cannot be contacted), a problem that has
been noticed and addressed by governmental bodies around the world.[97] Also with respect to copyright, the American
film industry helped to change the social construct of intellectual property via its trade organization, the Motion Picture
Association of America. In amicus briefs in important cases, in lobbying before Congress, and in its statements to the
public, the MPAA has advocated strong protection of intellectual-property rights. In framing its presentations, the
association has claimed that people are entitled to the property that is produced by their labor. Additionally Congress's
awareness of the position of the United States as the world's largest producer of films has made it convenient to expand
the conception of intellectual property.[98] These doctrinal reforms have further strengthened the industry, lending the
MPAA even more power and authority.[99] RIAA representative Hilary Rosentestifies before the Senate Judiciary
Committee on the future of digital music (July 11, 2000) The growth of the Internet, and particularly distributed search
engines like Kazaa and Gnutella, have represented a challenge for copyright policy. The Recording Industry Association of
America, in particular, has been on the front lines of the fight against copyright infringement, which the industry calls
"piracy". The industry has had victories against some services, including a highly publicized case against the file-sharing
company Napster, and some people have been prosecuted for sharing files in violation of copyright. The electronic age
has seen an increase in the attempt to use software-based digital rights management tools to restrict the copying and use
of digitally based works. Laws such as the Digital Millennium Copyright Act have been enacted that use criminal law to
prevent any circumvention of software used to enforce digital rights management systems. Equivalent provisions, to
prevent circumvention of copyright protection have existed in EU for some time, and are being expanded in, for example,
Article 6 and 7 the Copyright Directive. Other examples are Article 7 of the Software Directive of 1991 (91/250/EEC), and
the Conditional Access Directive of 1998 (98/84/EEC). This can hinder legal uses, affecting public
domain works, limitations and exceptions to copyright, or uses allowed by the copyright holder. Some copyleft licenses,
like GNU GPL 3, are designed to counter that.[100] Laws may permit circumvention under specific conditions like when it is
necessary to achieve interoperability with the circumventor's program, or for accessibility reasons; however, distribution
of circumvention tools or instructions may be illegal. In the context of trademarks, this expansion has been driven by
international efforts to harmonise the definition of "trademark", as exemplified by the Agreement on Trade-Related
Aspects of Intellectual Property Rights ratified in 1994, which formalized regulations for IP rights that had been handled
by common law, or not at all, in member states. Pursuant to TRIPs, any sign which is "capable of distinguishing" the
products or services of one business from the products or services of another business is capable of constituting a
trademark.[101]
Intellectual property (IP) is a creation of the mind. They are intangible assets for which exclusive rights are granted by
law. These assets include artistic works, discoveries, inventions, designs, phrases, symbols, etc. Intellectual property is
granted similar protective rights as those granted to physical property, and the stealing of that property is regulated in
the U.S. at the federal level.
Protection of intellectual property affords the owner of the property exclusive rights to create, use and distribute the
work. Owners are granted a temporary monopoly on the idea, and with the exception of trade secrets, owners disclose
their process and/or original works to the government and the public. In theory, by granting the owners protection from
theft, IP regulation promotes creative and inventive progress. It allows owners to display their work to the public without
the worry of losing profit through imitation. Depending on the work, intellectual property falls into one of four
categories: copyrights, trademarks, patents and trade secrets. The following article is a brief overview of the various
forms of intellectual property; for greater depth and information on how to apply for IP protection, select the links at the
end of their respective sections.
1. Copyrights.Copyrights protect the expression of an idea. The expression can be in various forms, including but not
limited to literary, musical and dramatic works, motion pictures and sound recordings, pictorial, graphic and sculptural
art, and even computer programs. Copyrights give the owner exclusive rights to copy, modify, distribute, perform and
display his/her work. In general, copyrights last for the lifetime of the creator plus 70 years. But there are exceptions that
can alter the term of a copyright. For more info on copyright duration, visit the U.S. Copyright Office website. For an in-
depth guide on acquiring a copyright, click here.
2. Trademarks A trademark is a word or symbol that represents and identifies a product or a brand. To qualify for
trademark protection, the asset must be distinctive; it must distinguish your goods or services from those of
others.Trademarks grant exclusive rights of use to the owners. The trademark is protected by the U.S. Patent and
Trademark Office, but it is ultimately the responsibility of the owner to identify and prosecute infringements. As long as
the owner files the required maintenance fees and documents, protection of a trademark lasts indefinitely. The USPTO
has a useful guide on maintaining and renewing trademarks.For a step-by-step guide on how to register a trademark,
click here.
3. Patents. Patents protect inventions, original designs and novel processes. These inventions, however, must be new,
non-obvious and useful to ensure the granting of a patent.Patents give exclusive rights to the holder to exclude
competitors from making, using or selling the property throughout the U.S.; it also protects against importation of
imitation properties. With the exception of design patents (which last for 14 years), patents offer 20 years of protection.
In exchange for this protection, the holder must give full public disclosure of the work.
4. Trade Secrets.A trade secret is any information that, by remaining covert, offers a business a competitive edge or some
economic value. By definition, reasonable actions must be taken to maintain its secrecy in order for the information to be
considered a trade secret.Unlike other forms of intellectual property, which are afforded protection by the government,
trade secrets must be protected by the holder. The U.S. does not grant trade secrets; instead, it only regulates
infringement when misappropriation claims are made. Trade secrets last indefinitely and are valid until disclosed to the
public.Trade secrets can be protected in many ways. One of the most common methods to do so is by using a non-
disclosure agreement.
Conclusion; Intellectual property is a complex legal subject. If you plan on applying for IP protection, be sure to perform
due diligence. A good IP lawyer is also useful and can help determine what is best for you. He/she can also help with the
lengthy and frustrating bureaucratic process involved in filing. But keep in mind that, although IP protection is expensive
and time-consuming, it’s the only option that ensures your unique creation, idea or symbol remains yours.
The Value of Intellectual Property, Intangible Assets and Goodwill Kelvin King, founding partner of Valuation Consulting1
Intellectual capital is recognized as the most important asset of many of the world’s largest and most powerful
companies; it is the foundation for the market dominance and continuing profitability of leading corporations. It is often
the key objective in mergers and acquisitions and knowledgeable companies are increasingly using licensing routes to
transfer these assets to low tax jurisdictions. Nevertheless, the role of intellectual property rights ( IPRs) and intangible
assets in business is insufficiently understood. Accounting standards are generally not helpful in representing the worth
of IPRs in company accounts and IPRs are often under-valued, under-managed or under-exploited. Despite the
importance and complexity of IPRs, there is generally little co-ordination between the different professionals dealing with
an organization’s IPR. For a better understanding of the IPRs of a company, some of the questions to be answered should
often be: What are the IPRs used in the business? What is their value (and hence level of risk)? Who owns it (could I sue
or could someone sue me)? How may it be better exploited (e.g. licensing in or out of technology)? At what level do I
need to insure the IPR risk? One of the key factors affecting a company’s success or failure is the degree to which it
effectively exploits intellectual capital and values risk. Management obviously need to know the value of the IPR and
those risks for the same reason that they need to know the underlying value of their tangible assets; because business
managers should know the value of all assets and liabilities under their stewardship and control, to make sure that values
are maintained. Exploitation of IPRs can take many forms, ranging from outright sale of an asset, a joint venture or a
licensing agreement. Inevitably, exploitation increases the risk assessment. Valuation is, essentially, a bringing together of
the economic concept of value and the legal concept of property. The presence of an asset is a function of its ability to
generate a return and the discount rate applied to that return. The cardinal rule of commercial valuation is: the value of
something cannot be stated in the abstract; all that can be stated is the value of a thing in a particular place, at a
particular time, in particular circumstances. I adhere to this and the questions ‘to whom?’ and ‘for what purpose?’ must
always be asked before a valuation can be carried out. This rule is particularly significant as far as the valuation of
intellectual property rights is concerned. More often than not, there will only be one or two interested parties, and the
value to each of them will depend upon their circumstances. Failure to take these circumstances, and those of the owner,
into account will result in a meaningless valuation. For the value of intangible assets, calculating the value of intangible
assets is not usually a major problem when they have been formally protected through trademarks, patents or copyright.
This is not the case with intangibles such as know how, (which can include the talents, skill and knowledge of the
workforce), training systems and methods, technical processes, customer lists, distribution networks, etc. These assets
may be equally valuable but more difficult to identify in terms of the earnings and profits they generate. With many
intangibles, a very careful initial due diligence analysis needs to be undertaken together with IP lawyers and in-house
accountants. There are four main value concepts, namely, owner value, market value, fair value and tax value. Owner
value often determines the price in negotiated deals and is often led by a proprietor’s view of value if he were deprived
of the property. The basis of market value is the assumption that if comparable property has fetched a certain price, then
the subject property will realize a price something near to it. The fair value concept, in its essence, is the desire to be
equitable to both parties. It recognizes that the transaction is not in the open market and that vendor and purchaser have
been brought together in a legally binding manner. Tax value has been the subject of case law worldwide since the turn
of the century and is an esoteric practice. There are quasi-concepts of value which impinge upon each of these main
areas, namely, investment value, liquidation value, and going concern value.
Methods for the Valuation of Intangibles Acceptable methods for the valuation of identifiable intangible assets and
intellectual property fall into three broad categories. They are market based, cost based, or based on estimates of past
and future economic benefits. In an ideal situation, an independent expert will always prefer to determine a market
value by reference to comparable market transactions. This is difficult enough when valuing assets such as bricks and
mortar because it is never possible to find a transaction that is exactly comparable. In valuing an item of intellectual
property, the search for a comparable market transaction becomes almost futile. This is not only due to lack of
compatibility, but also because intellectual property is generally not developed to be sold and many sales are usually only
a small part of a larger transaction and details are kept extremely confidential. There are other impediments that limit
the usefulness of this method, namely, special purchasers, different negotiating skills, and the distorting effects of the
peaks and troughs of economic cycles. In a nutshell, this summarizes my objection to such statements as ‘this is rule of
thumb in the sector’.
Cost-based methodologies, such as the “cost to create” or the “cost to replace” a given asset, assume that there is some
relationship between cost and value and the approach has very little to commend itself other than ease of use. The
method ignores changes in the time value of money and ignores maintenance. The methods of valuation flowing from
an estimate of past and future economic benefits (also referred to as the income methods) can be broken down in to
four limbs; 1) capitalization of historic profits, 2) gross profit differential methods, 3) excess profits methods, and 4) the
relief from royalty method. 1. The capitalization of historic profits arrives at the value of IPR’s by multiplying the
maintainable historic profitability of the asset by a multiple that has been assessed after scoring the relative strength of
the IPR. For example, a multiple is arrived at after assessing a brand in the light of factors such as leadership, stability,
market share, internationality, trend of profitability, marketing and advertising support and protection. While
this capitalization process recognizes some of the factors which should be considered, it has major shortcomings, mostly
associated with historic earning capability. The method pays little regard to the future. 2. Gross profit differential
methods are often associated with trade mark and brand valuation. These methods look at the differences in sale prices,
adjusted for differences in marketing costs. That is the difference between the margin of the branded and/or patented
product and an unbranded or generic product. This formula is used to drive out cashflows and calculate value. Finding
generic equivalents for a patent and identifiable price differences is far more difficult than for a retail brand. 3.
The excess profits method looks at the current value of the net tangible assets employed as the benchmark for an
estimated rate of return. This is used to calculate the profits that are required in order to induce investors to invest into
those net tangible assets. Any return over and above those profits required in order to induce investment is considered
to be the excess return attributable to the IPRs. While theoretically relying upon future economic benefits from the use of
the asset, the method has difficulty in adjusting to alternative uses of the asset.
4. Relief from royalty considers what the purchaser could afford, or would be willing to pay, for a licence of similar IPR.
The royalty stream is then capitalized reflecting the risk and return relationship of investing in the asset.
Discounted cash flow (“DCF”) analysis sits across the last three methodologies and is probably the most comprehensive
of appraisal techniques. Potential profits and cash flows need to be assessed carefully and then restated to present value
through use of a discount rate, or rates. DCF mathematical modelling allows for the fact that 1 Euro in your pocket today
is worth more than 1 Euro next year or 1 Euro the year after. The time value of money is calculated by adjusting expected
future returns to today’s monetary values using a discount rate. The discount rate is used to calculate economic value
and includes compensation for risk and for expected rates of inflation. With the asset you are considering, the valuer will
need to consider the operating environment of the asset to determine the potential for market revenue growth. The
projection of market revenues will be a critical step in the valuation. The potential will need to be assessed by reference
to the enduring nature of the asset, and its marketability, and this must subsume consideration of expenses together
with an estimate of residual value or terminal value, if any. This method recognizes market conditions, likely performance
and potential, and the time value of money. It is illustrative, demonstrating the cash flow potential, or not, of the
property and is highly regarded and widely used in the financial community.
The discount rate to be applied to the cashflows can be derived from a number of different models, including common
sense, build-up method, dividend growth models and the Capital Asset Pricing Model utilising a weighted average cost of
capital. The latter will probably be the preferred option. These processes lead one nowhere unless due diligence and the
valuation process quantifies remaining useful life and decay rates. This will quantify the shortest of the following lives:
physical, functional, technological, economic and legal. This process is necessary because, just like any other asset, IPRs
have a varying ability to generate economic returns dependant upon these main lives. For example, in the discounted
cashflow model, it would not be correct to drive out cashflows for the entire legal length of copyright protection, which
may be 70 plus years, when a valuation concerns computer software with only a short economic life span of 1 to 2 years.
However, the fact that the legal life of a patent is 20 years may be very important for valuation purposes, as often
illustrated in the pharmaceutical sector with generic competitors entering the marketplace at speed to dilute a monopoly
position when protection ceases. The message is that when undertaking a valuation using the discounted cashflow
modelling, the valuer should never project longer than what is realistic by testing against these major lives. It must also
be acknowledged that in many situations after examining these lives carefully, to produce cashflow forecasts, it is often
not credible to forecast beyond say 4 to 5 years. The mathematical modelling allows for this in that at the end of the
period when forecasting becomes futile, but clearly the cashflows will not fall ‘off of a cliff’, by a terminal value that is
calculated using a modest growth rate, (say inflation) at the steady state year but also discounting this forecast to the
valuation date. While some of the above methods are widely used by the financial community, it is important to note
that valuation is an art more than a science and is an interdisciplinary study drawing upon law, economics, finance,
accounting, and investment. It is rash to attempt any valuation adopting so-called industry/sector norms in ignorance of
the fundamental theoretical framework of valuation. When undertaking an IPR valuation, the context is all-important,
and the valuer will need to take it into consideration to assign a realistic value to the asset.
Intangible Asset & Intellectual Property Valuation: A Multidisciplinary Perspective. When you measure what you are
speaking about and express it in numbers, you know something about it, but when you cannot (or do not) measure it,
when you cannot (or do not) express it in numbers, then your knowledge is of a meager and unsatisfactory kind.Sir
William Thompson, Lord Kelvin (1824-1907). Intellectual property (IP) and intangible asset (IA) issues abound throughout
the business world, touching nearly all aspects of a company, from product development to human capital, and staff
functions such as legal, accounting, finance to line operations such as R&D, marketing and general management. This
wide diversity of IP applications and stakeholders is a leading contributor to the complexity of managing IP, as each field
has its own legal, regulatory and practitioner history. One aspect all these disciplines have in common is the need for
valuation. Valuation, as noted by Lord Kelvin, provides the potential to enhance our knowledge of intellectual property
and to bridge the gap between these disciplines by providing a common set of methods to capture and describe the
business, legal and financial aspects of the intangible asset in question. While the applications and even the vocabulary of
these field can differ, the underlying valuation methods bear striking similarities, which in turn reduces complexity and
helps shed light on key management issues. In particular, this paper highlights the importance of valuation context – why
do we need a valuation? - and the importance of premise – what do we assume about the use of the intangible asset? –
in determining the valuation game plan. We demonstrate how a small number of methods can be used to value IP across
the range of issue areas and assess strengths, weakness, critical assumptions and practical applications of each. This
paper is an overview of some of the critical elements of intellectual property and intangible asset valuation and is
intended for two audiences: the person with an interest but relatively little direct experience with intellectual property
valuation and the person with deep knowledge of one application but an interest to learn about the implication of
valuation across IP issue areas. It combines both academic perspective on IP management issues and a practitioner’s
experience in valuing these assets for a number of different business purposes. The first section of the paper presents the
Valuation Pyramid as a device to structure the valuation game plan. The second section describes briefly the legal
attributes of each type of asset under consideration and their implication for valuation. The third section presents the
four valuation method families – transaction, cost, income and option/binomial. Case studies will be presented
throughout the article to illustrate key concepts.
The Valuation Pyramid: The Basics. Any valuation exercise can be viewed as a ‘pyramid,’ where each level supports the
analysis generated on the level above (see Figure 1). The first level of the pyramid is the ‘Foundation’ level – the
underlying rationale for and key assumptions of the IP valuation. The second level is the ‘IP profile’ level, where the
business, legal and economic attributes of the IP asset are defined. The third level is the ‘Methodology’ level, where the
specific quantification and financial analysis is performed to generate a financial result. The top level is the ‘Solution’
level. IP is never valued for curiosity, it is always valued to resolve a specific business issue. This highest level of the
pyramid addresses the important issue of how the valuation analysis solves a business problem or generates a
recommendation to a specific business question.
The Valuation Pyramid: The Foundation
The Foundation of IP valuation analysis consists of four building blocks, each with an associated question: Purpose – Why
are we valuing the asset? Description – What is the asset? Premise – How will the asset be used? Standard – Who is the
assumed buyer of the asset? These foundation questions frame the context of the valuation and define the focus, depth,
completeness and general working parameters of the analysis. For instance, a litigation matter requires complete and
thorough documentation whereas for a technology transfer valuation, a lower level of documentation will suffice,
generally. Moreover, understanding these foundational questions will ensure the valuation is performed within the
context of acceptable standards of the field associated with the issue area and that the valuation will address all relevant
considerations.
Valuation Purpose. The Valuation Purpose refers to the primary usage of the valuation analysis. The purpose of the
valuation defines the legal or regulatory statutes, jurisdictional court of resolution, acceptable methodologies and
‘rules of thumb’ that have developed in that particular field. There are dozens of reasons why an IP asset may be
valued -- six key reasons are presented inFigure 2.
Transaction Strategy: A strategic purpose for valuing IP is when one is considering buying, selling, or transferring the
asset in a licensing arrangement or acquisition. Usually, the transaction strategy end-purpose is a ‘go versus no go’
recommendation. That is, at what price am I willing to enter into this proposed transaction?
Financial Reporting: Valuing IP and other prescribed intangible assets for reporting on public financial statements. In
2001 the Financial Accounting Standards Board (FASB) established detailed new regulations for the reporting of certain
intangible assets acquired through acquisitions and business combinations. These regulations specify the valuation,
amortization and reporting of goodwill and other intangible assets. The end deliverable is usually a report specifying the
value and change in value of the subject assets.
Litigation: A high-profile purpose of intellectual property valuation is to compute damage awards in an infringement
lawsuit. The court history for determining IP valuation for infringement is rather lengthy, and a separate court system,
the Court of Appeals for the Federal Circuit, is dedicated to resolving IP disputes.
Bankruptcy: During a corporate bankruptcy and reorganization, often the most valuable assets remaining are IP-related.
Valuation is required by the Bankruptcy Court to properly dispose of the assets and reorganize the company, if necessary.
Figure 2: Valuation Purposes & Standards Financing/Securitization: An increasing area of activity is the securitization
and financing of IP assets. This can be achieved through a number of ways, including borrowing against the license stream
(similar to factoring) or securitization of IP. Tax: The U.S. tax code has several provisions that require IP and intangible
asset valuation for tax planning and compliance. These include charitable donations of IP, the sale or license of IP across
tax jurisdictions (inter-company pricing), taxable reorganizations, goodwill allocations, built-in gains, among other areas.
Disputes in these areas are resolved in the U.S. Tax Court.
Valuation Description.The description states the general characteristics of the intangible asset. Intellectual property
refers to patents, trade secrets, copyrights, trademarks/trade dress. See Table 1 for an overview of the IP regimes.
Intangible assets refer to the broader class of intangibles that are specified in a contract between the contracting parties.
Intellectual property in contrast gives the IP owner rights against anyone, regardless of the presence of a contract, as in
the case of patent infringement where a non-contracting party has made a patented product. Examples of intangibles
assets that are not IP include relationship capital and supply agreements.
The intellectual property regimes have several unique business attributes. As a general advantage, they can offer high
margins due to low variable costs in licensing. Each resource has distinct differentiating capabilities as well. In the domain
of brands, the trademark offers the ability to leverage existing brand equity within the firm, e.g. through brand
extensions, or with partners in the case of franchising where the mark’s goodwill is licensed to franchisees. Patents, if
broad enough, can be powerful elements of competitive advantage. This is especially true in new technology markets
where early entrants rely on differentiated functionality more than brand recognition. Before the new technology
“crosses the chasm”, patents will be of paramount importance for sustaining competitive advantage.1 Copyrights
encompass additional offerings called derivatives. For example, a powerful core media asset like the Harry Potter novels
can, by virtue of the initial copyright, generate significant downstream revenues through the exclusivity rights associated
with films, apparel, video games, board games, and merchandizing.
Valuation Premise. Valuation premise refers to the underlying assumption on how the asset in question will be exploited
in the future. Will the use of the asset remain as it? (Valued under continued use) Alternatively, the asset may be valued
under a specific use that differs from the historical usage, such as an acquisition. A common premise is the ‘best use’
concept, which values the asset at the highest value under foreseeable circumstances, regardless of current usage. An
area where premise is of crucial importance is in bankruptcy, where the distinction between an orderly disposition and a
distressed disposition can have a significant impact on valuation.
Valuation Standard. The valuation standard refers to the definition of value tied back to the valuation purpose. The most
common valuation standard is the ‘fair market value’ standard, which is commonly defined as the price at which a willing
buyer and a willing seller would transact, with each party having access to all relevant information and with neither party
under the compulsion to transact. Alternative standards include ‘fair value,’ which is often used in court cases to
compensate a party for the involuntary use of an asset, such as eminent domain, where there is no reasonable
assumption of a fair market value transaction.
The Valuation Pyramid: The Profile. The Profile refers to the legal, business/strategic and financial characteristics of the
asset in question. The profile level of the pyramid articulates the business and legal issues that dictate the opportunities
and limitations of the asset, and ultimately its ability to generate income and create value. Much of the hard work and
creative energy of a valuation analysis takes place at this level.
Legal Profile. All assets, tangible, intangible or IP-related, have legal ownership aspects.2 The majority of non-IP intangible
assets such as customer relationships, water or air rights, and workforce intangibles, are given substance by some form of
legal contract. For IP, which has no physical form and for which the marginal cost to replicate is often close to zero, the
legal protection provides an important component of value. However, because each IP form has unique characteristics
each must be examined within the larger business question at hand.
Business Profile. The value of an intangible asset is ultimately captured through commercial exploitation (either directly
or indirectly through infringement damages). Exploitation, in turn, is determined by the strategic and business
environment that enables or hinders commercialization. Factors that comprise the business profile include the barriers to
exploitation, market lifecycle of the offering3, bundled services or other assets, competitor products and services,
customer and supplier dynamics, government regulation, and new technologies. There are many useful frameworks for
analyzing the business profile of an intangible asset. Since valuation is in many ways simply the quantification of business
strategy, strategic planning frameworks such as Michael Porter’s ‘Five Forces Analysis’ are a good starting point for
assessing the business dynamics of the asset.4 Additionally, any thorough analysis will consider the entire value chain that
is required to exploit the intangible and will consider the competitive dynamics of each level of the value chain and its
effect on the asset in question. An important factor to consider is that most IP is exploited in conjunction with other IP
(e.g., technologies are often bundled with trademarks and/or trade secrets), and a careful consideration of the inter-
relationships among all IP in the value chain and market life cycle is often important. The business profile will generally
differ by IP or IA class. With technology patents, the question of economic useful life is typically important. The useful life
(or economic life) of an asset represents the period of time that the asset will generate income or enable cost savings.
The useful life of an asset may be longer or shorter than the legal life of the asset, depending on the competitive factors
that are identified in the Business Profile analysis. An important element of the business profile is the economic
characterization of the intangible asset. Economic characterization refers to the ability of function or asset to command
the residual income of the value chain.5 Value chains are composed of functions and assets which can be characterized as
either routine or entrepreneurial. A routine function or asset, in principle, can be obtained from an alternative provider in
an arm’s length transaction. Therefore, any excess profit (above and beyond a ‘routine’ amount) can be retained by the
contracting party and does not accrue to the owner or performer of the asset or function. In contrast, an entrepreneurial
function or asset is one which is critical to the value chain and is unavailable from alternative suppliers. Therefore,
entrepreneurial functions and assets are in a much stronger bargaining position than other members of the value chain
and claim a larger share of the total profits.
Legally protected IP, which has an exclusive monopoly on exploitation of a given asset, can be either routine or
entrepreneurial. Routine IP is one whose benefits can be obtained from a non-infringing alternative. In the
pharmaceutical industry, the patents of the compound tend to be entrepreneurial, as the patent is unique and is a critical
factor in the success of the drug while other elements such as manufacturing, sales and distribution tend to be obtainable
from a multiple of sources. Conversely, in manufacturing industries, manufacturing IP tends to be routine as the benefits
of the technology are likely available from other sources and can provide an ‘upper bound’ on the value of the asset.9 In
complex industries, such as the automotive industry, there can be several entrepreneurial assets, including platform
technology and trade names / trademarks.
Financial Profile; The financial profile quantifies the impact of the intangible asset on the value chain of the product or
service. This includes typical accounting data, such as revenues, costs and capital investment, but also can include
strategic information such as price premiums, cost savings, excess (of saved) capital, or any other financial result of usage
of the subject intangible for directly or indirectly creating value. Indirect benefits include the impact of the intangible on
revenue streams outside the direct value chain (also known as ‘convoyed sales’ or ‘bundled sales’) that include
aftermarket sales, potential brand extensions, etc. The financial profile is usually performed iteratively with the valuation
methodology described below. Usual questions associated with the financial profile include: Projected revenues, costs
and capital requirements associated with commercializing the intangible Estimated time to commercialize the asset
Estimated cost of non-infringing alternatives Time value of money (cost of capital) associated with the intangible. Impact
of the commercialization on working capital (accounts receivables and account payables) The financial profile should
typically cover the entire useful life of the asset.10
The Valuation Pyramid: Methodology. An understanding of the foundational questions: Why is the valuation required?
Who is the presumed purchaser? What are the conditions of the transaction? What are we valuing? Combined with an
understanding of the legal, business, and financial attributes of the asset help ensure the proper selection and
computation of the valuation methodology. While they each have several names and a myriad of permutations, all
valuation methodologies boil down to four methods: Transactional; Cost; Income; Binomial/Option.
Transactional Method A transactional method is in many ways the most simple method to understand. It is actual price
paid for a similar intangible under similar circumstances. This can be used either for direct acquisition or purchase or for
the right to use, a license. The transactional method also goes by the name of the ‘market approach.’ The transactional
approach is appealing because it is a direct measure of the value of the intangible asset. As such, it is often considered to
be the most reliable of methods when it can be performed credibly. The intuitive appeal of the transaction method lies at
the heart of many standards of valuation, as described above. ‘Fair market value,’ and ‘arm’s length standard’ two of the
most common valuation standards derive from the transaction method. Therefore, as a general rule transaction data can
never be ignored in a valuation exercise – it either must be incorporated or affirmatively rejected as part of the analysis.
The key to performing a successful transactional approach is to ensure comparability between the outside evidence and
the subject asset. Comparability factors to consider are based on the factors discussed in the Profile level of the Valuation
Pyramid. Due to the depth of the required information to ensure comparability, often the only good transactional data is
from a transaction where there is complete access to the legal agreement. As these are generally private documents and
difficult to obtain, often only transactional data where one party of the subject transaction is a member is useful under
this approach. Also, transactional methods are more difficult to apply in contexts where objectivity is critical such as
financial reporting, tax, and litigation support and easier to apply in a consulting context where the deliverable is more
dependent on the subjective experience of the valuation specialist. Typically, there are two steps to a transactional
method valuation – screening and adjustments. Screening refers to the selection process of identifying candidate third
party transactions with sufficient information on pricing, scope and terms and conditions to be deemed comparable to
the intangible asset in question. Adjustments refer to an explicit quantifiable change in the valuation due a specific
rationale. Adjustments are typically grounded in a baseline transaction (or transactions) that are sufficiently close to the
subject intangible asset, and for which sufficient information is available to analyze the technical, legal, business and
financial terms. Adjustments are then based on either ‘hard,’ quantifiable data where there is an explicit difference
between the subject intangible asset and the outside evidence or subjective estimates by the analyst.11 Adjustments must
be used with care, as too many may limit the comparability of the outside evidence and can compromise the credibility of
the transactional method. It is also noteworthy that the economic characterization described above is important to
determine the applicability of the transactional approach. Entrepreneurial IP, by nature of their uniqueness, will have a
great deal of difficulty in identifying similar transactions for use in this method -- This is analogous to valuing a Van Gogh
masterpiece based on the price of a Rembrandt. Both are fine art, but likely have very different market values.
Transactional Case Study: Trademark. Foundation: This is a fair market valuation to properly assess royalty rates of
trademarks between a U.S. cosmetic company and several overseas affiliates for tax purposes. Profile: At issue are the
value of a series of trademarks for mid-range women’s cosmetics sold through department stores, drug stores and other
retail outlets. The trademarks will be licensed for three years to a series of companies in Latin America for exclusive use in
their territories. The company will also provide marketing services to the licensees on an as-needed basis. Some of the
licensees will manufacture the cosmetic directly while others will outsource to third party manufacturers. The company
has undisputed ownership of the relevant trademarks and manages them actively in all relevant countries. In this
industry, the trademarks are characterized as
entrepreneurial’ in that they are a

critical element of the success of
the revenue stream and have no
close substitutes in the market.
The financial projections of the
product lines are stable, with
moderate growth and constant
margins.
Transaction Method Application:A baseline transaction is identified: an exclusive license of the same
trademarks/tradenames with no upfront fee and a running royalty rate of 7% of net sales to a Western European
company. The license agreement is for 5 years. Adjustments were made for the following elements: Location: Trademark
valuation can differ significantly by geography, depending on the demographics and competitive factors of the territories.
It this instance it was concluded that the underlying value of trademarks in the cosmetic industries in Europe and Latin
American were comparable, and no explicit adjustment for geography is required. Advertising support: To help launch
the brands in the new territories, the licensor has agreed to provide market development support of up to $1 million in
the first year. The royalty rate was adjusted upward to compensate the licensor for this added expense. The adjustment
was computed by reimbursing the licensor for the $1m plus a one-year cost of capital to compensate for the time value
of money. When capitalized over the projected sales of the three year license agreement, the net effect was to increase
the royalty rate by 0.2%. IP Strength: Trademark protection and ability to manage the use of the marks is determined to
be lower in Latin America than in Europe. The subjective estimate was a decrease in the royalty rate of 0.5% of net sales.
Length: The length of the license agreement is an important factor in determining value. Longer licensing agreements
tend to have lower royalty rates. However, in this instance the expectation is that the agreement would likely be
renewed at the end of the three year period, so no adjustment was performed.
Income Method. The income method in many ways is the most fundamental of the valuation methods. The most basic
definition of ‘value’ is based on the ability of the asset to somehow generate future income. This underlying characteristic
is often referred to as the ‘intrinsic’ value of the asset, and is captured by the ability to directly or indirectly generate a
positive cash flow. This cash flow, when appropriately discounted, is the underlying premise of the income method.12
When the period cash flows (typically annual) are ‘discounted,’ or adjusted by some factor that accounts for the differing
value or money from one period to the next, it is called the present value of the asset. Cash flows are generally
forecasted explicitly throughout the expected economic life of the IP. Beyond the economic life of the asset an estimate
of remaining value, or terminal value may be appropriate.13
The income method has three components – projected cash flows, the economic life of the IP, and the discount rate.
Projected cash flows are the future income attributable to the intangible asset. It is important that the analysis should
capture all direct and indirect costs associated with the IP in question, including lost sales of bundled products or
services, incremental overhead costs, necessary investment and the likely effects of competition on the price premium or
costs savings derived from the asset. The economic life refers the to length of time that the IP will be able to command
the price or cost premium. The economic life is generally bounded by the legal life of the asset but is often much shorter.
For instance, it is common in the electronics field for the technology to become obsolete in as little as 3 years, often well
before the patent expires. The discount rate refers to the expected cost of financing the asset in question. For IP assets,
the discount rates are generally quite a bit higher than the cost of capital of a company and should be thought of as more
similar to venture capital types of investments, with a corresponding discount rate from anywhere from 20% - 50% per
year. The income method, while highly analytic, is also quite subjective. Subjectivity is employed throughout the
methodology, with particular care required to assess all the business and financial dynamics that impact the expected
incremental cash flows. The use of a terminal value, which captures value beyond the years, can often represent a
significant percentage of the total asset value. The income method has been well analyzed and published, with texts and
software readily available. While care is required for all valuation methods, the subjectivity involved in the income
method can be especially tricky.
Income Method Case Study: Gasoline Trademark Valuation. Foundation: This is a fair market valuation of the value of
the trademark of a retail gasoline brand name for tax planning purposes. Profile: The subject IP was the retail gasoline
trademark of a major oil company. Gasoline price is determined primarily by the underlying price of crude oil, refining,
and local regulatory factors, and secondarily by location and brand. To account for the primary factors, an industry
database providing price by region and brand was employed. This data enabled the determination of a price premium for
the trademark in question vs. the price of a similar grade unbranded gasoline.14 This price premium is then adjusted
downwards for the incremental costs in supporting the brand, including advertising, costs associated with the credit card
program, and certain identifiable selling and admin costs estimated to be above those required for an unbranded
product. The price premium is multiplied by the annual expected sales of branded gasoline. As trademarks have infinite
life employed, and as the economic life of the trademark is also infinite if the brand is maintained properly, an infinite life
was used, and no terminal value is required. A discount rate of 20% was employed, based on typical rates of return on
brand-related assets.
Replacement Cost Method. The replacement cost of an IP asset is the cost to develop similar functionality to the subject
IP outside the scope of the legal protection. A common usage of the replacement cost method is the cost to design
around a patent or set of patents. This method is based on the principle of substitution – an investor would not pay more
for an asset than the cost to obtain similar benefits from another asset. This method is particularly useful when the legal
protection is weak or the technology is relatively well-known, and the IP does not produce income currently.
The replacement cost method is a forward-looking perspective on how to create an asset with similar functionality to the
asset in question – it should not be confused with historical cost or accounting cost. It must be based on the cost of
resources to create the new asset today, using today’s costs and including the indirect cost related to the time required
to build the replacement asset. In addition, to reflect properly the value of the IP, the replacement cost analysis should
incorporate the obsolescence, or the current useful state of the asset.15 Many commentators and practitioners believe
that the replacement cost method has little role in IP valuation because a) the legal protection of IP makes replacement
difficult; and b) without the legal protection the replacement cost for many IP assets is effectively zero. 16 However, the
replacement cost method is a valuable tool to establishing a ‘floor’ or ‘ceiling’ price. As such, it is particularly useful in
negotiating the sale or license of an IP asset.
Replacement Cost Method Case Study: Auto Dealer Network.Foundation: This is a fair market valuation of the dealer
network of an automotive distribution company for negotiation purposes.
Profile: The intangible asset in question is the network of relationships between the auto distributor and the independent
franchise dealerships. Importantly, the analysis does not value the dealership directly but rather the distribution channel
relationship that the automotive company has established with the independent dealers. The automotive company incurs
cost to establish, monitor, and train the dealers. These costs form the basis of the replacement cost analysis. Here, the
replacement cost is the only viable method to value the network, as there is no income stream directly associated with
the intangible and this type of intangible is rarely sold in third party transactions for use under the transaction method.
Replacement Cost Methodology:The dealer network valuation method is based on establishment and support costs. The
establishment costs include the effort analysis to identify site, dealer-owner, environmental impact assessment, etc. This
represents the cost to create a new dealer network. This ‘new network’ must be lowered to reflect the changing
demographics and desirability of the locations due to time, or the obsolescence of the network. These costs are
supplemented by the ongoing support costs in training, monitoring, etc. This sum is the total Dealer Network Investment.
To harmonize the time value of money across the different points in time used to derive the cost estimate, a return on
capital is applied to the investment total to derive the dealer network value.
Binomial and Other Non-Traditional Methods. The three traditional valuation methods, transaction, income,
replacement cost, are appropriate for nearly all valuation analyses. However, over the past decade or so we have seen
the growth of a new family of valuation methods based on future contingent events. This family of methods includes real
options, binomial models, and Monte Carlo simulations. They are all based on decision tree models where the conditional
events required for the IP to generate value is modeled explicitly. At the core of each of these methods is a two step
process: first, compute the probability of the favorable event occurring that will make the IP valuable (or ‘in the money’),
and second, compute the payoff if the favorable event occurs (usually using one of the traditional three methods
described above). The real option method is based on the successful Fischer-Black valuation model for pricing options
(calls and puts) of financial stocks. The basic premise behind the real option method is that an investment with an
asymmetric payoff (i.e., a potentially large payoff and only limited losses) will have an increased value as the level of
uncertainty, known as volatility, increases. Consequently, real option methods have been most useful where large capital
investments are required with a highly uncertain and far away payoff, such as the pharmaceutical and oil exploration
industries. Monte Carlo simulations, named for the gambling games popularized at the Mediterranean resort models a
low probability payoff over multiple iterations. Monte Carlo simulations are used to estimate the spread of diseases,
engineering tolerances and even the probability of the Chicago Cubs winning the World Series! The binomial expansion
method, or decision tree, is the most intuitive of these methods. In the binomial expansion the required events and
decisions are modeled explicitly, each with their own probabilities. An important aspect of building a binomial expansion
is to ensure all potential alternatives and scenarios. Each of these alternative methods should be used with care. The
intuition behind each of these is often difficult for the reader of the valuation analysis to follow, and clarity in the purpose
and approach of the valuation is always a prime objective of any analysis. Indeed, the intuition behind these methods can
be so confusing that often the analyst can become absorbed with the model parameters and lose sight of the original
valuation purpose.17 Despite (or because) or the technical complexity of these methods, they require extreme care in
building models that are a highly sensitive to changes in underlying assumptions and parameters. For instance, when
using a real option or Monte Carlo model, it is always best to create a detailed binomial decision tree to ensure that all
potential outcomes have been incorporated into the analysis. With the increased importance of IP in the business world
and the increasing sophistication of valuation techniques, these alternative methods will become increasing useful tools
to value IP in the future. However, we offer caution in their use and application and suggest the reader acquaint
themselves with one of several resources on these methods before application.18
Binomial Method Case Study: Non-commercialized Agricultural Patent. Foundation: This is a fair market valuation of a
non-commercialized patent for purposes of negotiated sale. The European corn borer caterpillar (“ECB”) is a ravenous
pest, destroying millions of dollars of U.S. corn each year. For years a bacterium, Bacillus thuringiensis (“Bt”), has proved
an effective insecticide for the ECB. A transgenic corn was developed that maps the effective genes from the Bt bacteria
into the seed corn, creating what is referred to as ‘Bt corn.’
Event Probability
1) ECB larvae resistance development 5% per year
2) EPA ultimatum to seed companies to develop solution to ECB resistance 67%
3) Seed companies unable to modify seed effectively to manage ECB resistance33%
4) Patent insurance regime is successful 33%
5) No effective work around of the patent is developed 33%
One of the primary environmental and farm policy concerns raised by use of any transgenic seed such as Bt corn is the
development of resistance by the target pest. Here, the concern is that extensive use of Bt corn will lead to the
development of a resistant strain of ECB to the Bt bacterium, making both the modified corn as well as conventional
insecticides ineffective. To combat this potential, the Environmental Protection Agency (“EPA”) has mandated use of a
‘refuge’ planting policy. A refuge policy mandates that a certain percentage of the acreage be planted with conventional
hybrid corn that excludes the Bt genetic enhancement. Planting 20-40% of the acreage with hybrid corn creates a refuge
where non-resistant strains of ECB can develop and mate with the resistant strain, creating offspring that will most
likely not carry the resistant gene to the Bt bacterium. A main obstacle in implementing the high-dose refuge strategy is
the dependence on the voluntary compliance of the individual farmer. Compliance efforts have been hampered by the
difficulty in monitoring seed and crop management practices, especially among smaller farmers. If compliance does not
increase, the EPA may pull the approval for Bt corn, and prohibit the sale of a profitable line for several seed companies.
To help ensure compliance with the refuge policy, a business method patent was obtained to bundle an insurance policy
with Bt bacteria in the transgenic seed. The patent has 6 years of remaining life. A binomial model is appropriate here
because the patent is of no value unless the resistant gene within the ECB mutates and spreads. Here a decision tree is
employed to derive all the conceivable scenarios, with the associated probabilities. The value of the patent is then the
probability of resistance developing and the patent becoming valuable times the payoff (license value) of the payoff if the
favorable scenario develops. With an expected licensing fee or $1.5M per year if the above scenario comes true, the
expected income is still quite small due to the low probability. The cumulative value, expressed as a net present value
using the income method, is just under $25,000.
The Valuation Pyramid: Solution. As with any well-planned exercise, IP valuation should always be performed with the
end in mind. The final step of the valuation process is to express the analysis in a way that meaningfully helps resolve a
business issue. The general forms of deliverable solutions general fall into 3 categories that derive from the issue areas
described in the Valuation Purpose section above: planning recommendation, compliance, or dispute resolution.
Planning Recommendation is generally related to a new use of the IP, and typically revolves around the question of
whether to enter into a IP sale or license transaction. The deliverable it generally a management report on the feasibility
of the proposed transaction and the likely financial costs and benefits. Planning could be to support a license strategy, a
tax management issue or bankruptcy dissolution.
Compliance refers to the financial reporting of IP or IA value to comply with a regulatory requirement. The most common
compliance issue today concerns the business combination reporting requirement of FASB, but significant reporting
requirement exist in the tax code as well. In addition, compliance reporting may also be required for non-governmental
purposes including fairness and solvency opinions of business enterprises or financing and lending.
Dispute resolution refers to the settlement of infringement claims of IP or contractual violations for IA. The deliverable
here is often expert testimony to compliment the expert’s report. The specific standards are determined by the relevant
court and jurisdiction.
Selecting and Prioritizing Valuation Methods Selection of the most appropriate IP valuation method depends on a
number of factors developed in the Valuation Pyramid. In the Foundation level, the context and issue area of the
valuation purpose may have a relevant statute or court history suggesting one method over another. Critically, proper
execution of the Profile level will identify the availability, reliability, and suitability of data to employ the methods. Given
that each method requires extensive knowledge of data, this is typically the determining point on method selection. If the
IP is not commercialized, then one of the alternative methods may be most appropriate. As a general rule, the reliability
of a valuation method decreases as the number of adjustments and assumptions increases, therefore the best method is
usually the simplest and most straightforward one given the facts and circumstances. For most IP valuation applications
there is no hierarchy of methods, and all methods are in principle applicable equally. In addition, most practitioners
would concur that all valuation methods, if applied properly, should converge near a similar valuation estimate. As a
consequence, many practitioners suggest employing multiple valuation methods for a given IP asset to demonstrate
robustness and completeness of the analysis. In practice this is often difficult as data for multiple methods is often
unavailable or the economic characterization of the asset precludes use of a method (i.e., an entrepreneurial IP asset by
definition will not have a meaningful replacement cost method application). The field of IP valuation has been evolving as
rapidly as the explosion of IP in the economy and the complexity of IP in the legal field. However, while the methods will
certainly change over time, the requirements to ground the analysis in the key Foundation issues and to Profile the
business, legal and financial issues will remain critical to IP valuation.
We hear a lot about mergers and acquisitions these days. We have seen big companies acquiring small companies or
even acquiring big companies. We have seen companies merging together to form an alliance. So I will take up mergers &
acquisitions as two different cases.
Mergers.1.There is a proverb. “If you can’t defeat them, join them”. So, when your competitor is too powerful and you
don’t stand a chance when you play alone, then it is better to join hands rather than being kicked out.2.Many a times two
weak companies join hands to fight against the strong competitor. This is the major reason why companies go for
merger.3.Sometimes two companies has expertise in two different but relative fields. So they join hands to form a
complete package of the offering.4.If any company wants to expand to other countries, it has an option of merging with
another company which is local to that country.
Acquisitions.1.Killing the competition. Many a times big and powerful companies acquire small companies to kill the
competition.2.Diversification. If any company wants to enter into a new market, it has an option of acquiring already
established companies.3.Entering into a new country. Companies have option of acquiring local companies to set their
first foot in that country.4.To increase their competencies. Like I said above that two companies may have expertise in
different but relative fields. So the powerful company can acquire the other company to offer a complete package of
service or products.5.Reduce cost of manufacturing. Sometimes big companies specially in automobile sectors acquire
their supplier companies to reduce the cost of production.
10 Important Reasons for Merger; Reason # 1. Economies of Scale: An amalgamated company will have more resources
at its command than the individual companies. This will help in increasing the scale of operations and the economies of
large scale will be availed. These economies will occur because of more intensive utilisation of production facilities,
distribution network, research and development facilities, etc. These economies will be available in horizontal mergers
(companies dealing in same line of products) where scope of more intensive use of resources is greater. The economies
will occur only upto a certain point of operations known as optimal point. It is a point where average costs are minimum.
When production increases from this point, the cost per unit will go up.
The optimal point of production is shown with the help of a diagram also:
Reason # 2. Operating Economies: A number of operating economies will be available with the merger of two or more
companies. Duplicating facilities in accounting, purchasing, marketing, etc. will be eliminated. Operating inefficiencies of
small concerns will be controlled by the superior management emerging from the amalgamation. The amalgamated
companies will be in a better position to operate than the amalgamating companies individually.
Reason # 3. Synergy: Synergy refers to the greater combined value of merged firms than the sum of the values of
individual units. It is something like one plus one more than two. It results from benefits other than those related to
economies of scale. Operating economies are one of the various synergy benefits of merger or consolidation. The other
instances which may result into synergy benefits include, strong R &D facilities of one firm merged with better organised
production facilities of another unit, enhanced managerial capabilities, the substantial financial resources of one being
combined with profitable investment opportunities of the other, etc.
Reason # 4. Growth: A company may not grow rapidly through internal expansion. Merger or amalgamation enables
satisfactory and balanced growth of a company. It can cross many stages of growth at one time through amalgamation.
Growth through merger or amalgamation is also cheaper and less risky. A number of costs and risks of expansion and
taking on new product lines are avoided by the acquisition of a going concern. By acquiring other companies a desired
level of growth can be maintained by an enterprise.
Reason # 5. Diversification: Two or more companies operating in different lines can diversify their activities through
amalgamation. Since different companies are already dealing in their respective lines there will be less risk in
diversification. When a company tries to enter new lines of activities then it may face a number of problems in
production, marketing etc. When some concerns are already operating in different lines, they must have crossed many
obstacles and difficulties. Amalgamation will bring together the experiences of different persons in varied activities. So
amalgamation will be the best way of diversification.
Reason # 6. Utilisation of Tax Shields: When a company with accumulated losses merges with a profit making company it
is able to utilise tax shields. A company having losses will not be able to set off losses against future profits, because it is
not a profit earning unit.
On the other hand if it merges with a concern earning profits then the accumulated losses of one unit will be set off
against the future profits of the other unit. In this way the merger or amalgamation will enable the concern to avail tax
benefits.
Reason # 7. Increase in Value: One of the main reasons of merger or amalgamation is the increase in value of the merged
company. The value of the merged company is greater than the sum of the independent values of the merged
companies. For example, if X Ld. and Y Ltd. merge and form Z Ltd., the value of Z Ltd. is expected to be greater than the
sum of the independent values of X Ltd. and Y Ltd.
Reason # 8. Eliminations of Competition: The merger or amalgamation of two or more companies will eliminate
competition among them. The companies will be able to save their advertising expenses thus enabling them to reduce
their prices. The consumers will also benefit in the form of cheap or goods being made available to them.
Reason # 9. Better Financial Planning: The merged companies will be able to plan their resources in a better way. The
collective finances of merged companies will be more and their utilisation may be better than in the separate concerns. It
may happen that one of the merging companies has short gestation period while the other has longer gestation period.
The profits of the company with short gestation period will be utilised to finance the other company. When the company
with longer gestation period starts earning profits then it will improve financial position as a whole.
Reason # 10. Economic Necessity: Economic necessity may force the merger of some units. If there are two sick units,
government may force their merger to improve their financial position and overall working. A sick unit may be required
to merge with a healthy unit to ensure better utilisation of resources, improve returns and better management.
Rehabilitation of si.ck units is a social necessity because their closure may result in unemployment etc.

FS Mo Iii

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

FS Mo Iii

Uploaded by

Copyright:

Available Formats

Module 3 ; Business Valuations;

1. Define the meaning of business valuation.

Year $1000 up-front PV $100 per year PV

See example: Business Value = Assets + Business Goodwill

Income Discounted Cash Flow $1,200,000 25% $300,000

Asset Asset Accumulation $950,000 20% $190,000

Market Approach; In market approach, value of a business is determined by identifying comparable

M&A Examples:● Microsoft and Skype● TransCanada and

A carve-out is a sale of a minority interest to other companies. Typically the seller

Copyright infringement[edit] Copyright infringement is reproducing, distributing, displaying or performing a work, or to

The Valuation Pyramid: The Foundation

entrepreneurial’ in that they are a

1) ECB larvae resistance development 5% per year

2) EPA ultimatum to seed companies to develop solution to ECB resistance 67%

3) Seed companies unable to modify seed effectively to manage ECB resistance33%

4) Patent insurance regime is successful 33%

5) No effective work around of the patent is developed 33%

You might also like