Fundamentals of Business Evaluation. Part 2.

Lecture 1-2 Intellectual Capital Evaluation

PhD in Economics Anna A. Bykova

Topics
? ? Intellectual Capital Evaluation Relative (Market Based) Approach

How we will cooperate and work?

4 Lectures & 6 Classes

Attendance at lectures or..

Casestudies

Quizzes (at the beginning/ end of lecture)

How You will contact me?

HSE-portal: http://www.hse.ru/org/persons/27040334
LMS-portal: http://www.lms.hse.ru/userpage.php Email: abykova@hse.ru Where? Room 310, 38, Studencheskaya str.

()

, , 2011

1. What is the main problem of SVA Model Implementation? 2. What does it mean Gross Investments in CVA Model? 3. What the main advantage of EVA Model?

Agenda

Intellectual Capital

Definition Structure Examples Fundamental Principles The three approaches to Intellectual Property (IP) Evaluation Patents Copyrights Trade secrets

The Basics
IP Value Brand Value

Brand Evaluation models

Intellectual Capital

An era in which the key economic resource is knowledge is startlingly different from an era in which the key resources were capital, raw materials, land, and labor. James Martin. CYBERCORP (1996)

Intellectual capital is intellectual material that can be put to use to create wealth. Thomas Stewart. Intellectual Capital (1997)

Intellectual Capital Components

Knowledge VS Intellectual Capital?

Intellectual capital includes both tangible, material (explicit knowledge) and intangible knowledge in the minds of individuals (tacit knowledge)

Why should I care about IP Evaluation?

Brand / Trade Names Value of Business Intangible Assets = = Intangible Assets Intellectual Properties

Present Value of Expected Future Benefit

Tangible Assets

Tangible Assets

Intellectual Property are the various types of rights given specific legal protection

Intangible Assets and Intellectual Property

Intangible Assets

Intellectual Property

PATENTS

TRADE MARKS

Data & Knowledge Bases

Customer & Vendor Relations

COPY RIGHTS

TRADE SECRETS

COPY RIGHTS Internet Assets

Proprietary Software

IP Property Types
Marketing Relationship (Customer / Supplier)

Marks, brands, names, domains Trade-dress, packaging, logos Non-competes, key-person

Customer / Supplier relationships Distribution networks

Order backlog
Technology Contract

Technologies, know-how, systems, methods Patents, software, recipes, content, databases

License / royalty, lease, franchise Permits, use rights, broadcast rights

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Several Reasons of Evaluation

Exploitation, as any other asset For Raising Funds and Securing Financing Taxation Assessing Damage Claims in a Dispute, Infringement of Contractual Rights

Profit Sharing in case of Multiple IP Owners

Restructuring or Bankruptcy procedure

Driver of Stock Price

Value Maximization Case Studies

Licensing Sale Collateralization Securitization Auction Holding Company

IBM, Kmart

Collins & Aikman, Jenny Craig

Polaroid, Delphi Dunkin Brands, Gloria Vanderbilt Circuit City, Tower Records Chiquita Brands
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Basics of IP Evaluation Approach

NB!!!! The nature of the asset doesnt changes the fundamental principle of valuation.

Identify asset(s) / understand rights

Determine basis/conte xt of valuation

Select and apply appropriate valuation methodologie s

But Valuing IP is a bit harder

IP doesnt comes alone: Intangibles are often composite assets Value may depend on form and scope of legal rights protecting the asset: Unclear how claims will be interpreted in practice

Values can vary hugely depending on circumstances: between use, between users, over time Availability of information/incomplete data: Novelty and Secrecy in the IP market

Patents
Protect all instances of a technical invention Right to exclude others
Technical solution to a technical problem

Exclusive rights against all commercial uses in exchange of mandatory publication

Application prosecution litigation Strict criteria:

Max. ??? years First to file, first to invent

Novelty, inventive step, industrial applicability Clarity, sufficiency of disclosure

Copyright

Protects the expression of idea, not idea itself

No registration required Fixation Originality Duration (+70 or 50yrs)

Trademarks

Protects the expression of idea, not idea itself

No registration required Fixation Originality Duration (+70 or 50yrs)

Trade secrets

Source code

Copies of object code can be sold Reverse engineering using decompiles No protection against piracy of object code

Evaluation Methodologies (Approaches)

Cost
Economic principal of substitution
Description

Income
Present value of future economic benefit Requires projections and a risk assessment Requires allocation of benefit specific to the asset

Market
Value based on price of similar assets Requires suitable comparable assets

Measures expense required to replace Neglects future benefit

Application

Replication / replacement feasible

Benchmarking

Excess Income method Relief from Royalty Premium Profit Valuation as Art and Science
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Comparable transactions

Benchmarking

Cost-based methods
Historic cost v. replacement cost

Relevant to intangibles which can be readily replicated

databases brands technologies know-how

Value

avoided cost of purchase / reconstruction obsolescence inflation/required return on original investment

Dont forget about

opportunity cost of delay (late to market?) risk of failure in attempting to replicate

Market-based methods
Frequency of transactions

evidence of an active market

Comparability of market transactions

licences, more often than sale/assignment of IP rights transferred circumstances of transaction (e.g. cross-licence, licence agreed in settlement of litigation) summary royalty terms, but what about the rights and obligations under the licence? summary transaction terms, but what about manufacturing and distribution contracts?

Headline data only

But still likely to provide some relevant data

Income-based methods

All IP is worthless if it cant create, maintain or increase future cash flows

What if the Context Changes?

What if we dont have a completed transaction between a wiling buyer and a willing seller?

IP Evaluation Methodologies
Comparable Transactions Relief from Royalty Discount Future Benefit Replacement Cost

All these approaches construct a hypothetical agreement between IP Owner and IP User

Crafting the Hypothetical Agreement Requires Art and Science

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Comparable Royalties Approach: Relief from Royalty Method

Comparable licence agreements need to be adjusted to reflect specific licence terms (duration, geographical coverage, exclusivity) lump sum and minimum royalty payments extent to which asset contributes to market demand for the final product the availability of substitutes licensors anticipated profitability from use of the IP (including collateral or ancillary sales/profits) state of development of the IP The circumstances in which a previous licence was agreed can be significant product of willing negotiations court-imposed solution cross-licensing uncertainty or validity of IP rights Interaction of royalty rate and royalty base the result- must reflect the underlying economic position

Comparable Royalties Approach: Relief from Royalty Method (cont.)

Range of royalty rates

Forecast revenues

Incremental cash flows

Other costs
Taxation and etc.

Value
Discount rate

Licensing Royalty Rates

There is no typical royalty rate The most frequent rate is 5% 39% of agreements are for less 42% of agreements are for more

Royalty Rate Distribution

20 18 16 14 12 10 8 6 4 2 0

% of agreements

1% 3 5 7 9 11 13 15 > Annual Rate

Source: RoyaltyStat.com

Reflecting Real-world Complexity

A Typical Relief From Royalty Calculation

Annual Sales of Brand X Industry Average Royalty Rate Estimated Annual Royalty Income Term (years) Annual Discount Rate Total Value / Damages

100,000 8.0% 8,000 10 15.0% 40,150

Did Consider . . . Forecast benefit (sales, term) Industry dynamics (rate) Risk assessment

Assumed . . . Constant sales Industry average royalty rate No changes during term
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Case: Alternative Royalty Rate Analyses

Royalty Rate Build-up Method: BVEq BVEQ= CBV + (IVE1 + IVE2 + . + IVEN)
Brand Value Components CBV Core Brand Value IVE 1 IVE 2 IVE 3 IVE 4 IVE 5 Total Sub-brands Global Brand Marketing Incremental Sales for Licensee New Product Development Other Brand Assets Range (%)

1.0 0.0 0.1 0.1 0.2 0.1

1.5

2.0 0.0 0.1 0.1 0.3 0.3

2.8

Surveys and Comparable Transactions are not The Only Tools Available

4 Models for Brand Evaluation

BRANDZ Brand Metrics

Brand Asset Valuator Interbrand

Interbrand method
Looks at the ongoing investment
Management of the brand as a business asset

Brand Value: three key aspects

The financial performance of the branded products or services (EVA Concept = EP)

The role of brand in the purchase decision process = Branded Earnings

The strength of the brand (from 0 to 100)

BRAND VALUE

www.interbrand.com