Tax, Exchange Control & Valuations Valuation procedure

Although IP assets have certain special qualities, being intangible and invisible, their value, like other property, is financially quantifiable; they can be traded and commercialised; and they can play a dominant role in establishing and enhancing shareholder value. In fact, the value of a company’s IP rights can exceed the value of its physical assets.

The purpose of valuation is to determine a fair value for the IP. The value is not necessarily equivalent to the price or cost of acquiring or creating the IP rights; it is generally accepted that a more realistic quantification is to equate the value to the sum total of all future benefits to be derived from the IP, valued at current rates and compressed into a single payment.

The criteria in determining valuation figures should be:

that of a willing buyer and a willing seller the market sector involved and the strength of the market the functional, technological, economic and legal life of the asset whether the asset is to be valued as part of a going concern or on a liquidation basis

Valuation methods

There are well-recognised and accepted methods for estimating the fair market value of intellectual property of all types. The cost, market, and income approaches are grounded on well-recognised financial principles and have reached sophisticated levels of application.

Of these methods, the cost approach has limited usefulness whereas the market approach can provide a fair indication of value within the context of an active IP market. At present the income approach is the best and most credible alternative for IP valuation in the South African market.

These different methods can be summarised as follows:

Cost/replacement approach: the estimated cost to replace the IP asset, or the historical cost for acquiring the IP is used to determine the value. This approach seeks to determine the future benefits of ownership by quantifying the amount of money that would be required to replace the IP. The basis underlying this approach in the principle of substitution, ie. the value of the IP is equated to the cost to recreate it.

Market approach: comparable transactions in the marketplace are used to determine the value. This method is rarely used in South Africa, since the country does not have an active IP market.

Income approach: the anticipated income derived from goods or services employing the IP, taken over a period and discounted to a present value, is used as a base figure representing total turnover. The income derived from the IP component of the goods and services is calculated on the basis of a reasonable royalty on the total turnover, the reasonable royalty being that payable by a third party licensed to use the IP.

This method of evaluation therefore entails three distinct steps:

  • determination of a total projected income stream. Turnover history may be relevant in this determination;
  • determination of a reasonable royalty rate;
  • determination of a suitable discount factor. Factors which should be taken into
  • account are inflation, liquidity, real interest rates and a risk premium (which measures

    the relative risk).

    Factors relevant to valuation

    The following factors are relevant to and should be taken into account in determining future income:

  • nature of the goods or services employing the IP
  • extent of the IP monopoly
  • technical and market trends
  • development speed and durability of the product
  • brand loyalty
  • ability to line-extend to meet market trends
  • period of marketing and goodwill created
  • extent and efficacy of competitive products
  • extent of counterfeiting and availability of grey goods
  • export/import restrictions/incentives
  • political factors and economic outlook
  • costs of exclusivity (including advertising, public relations, quality control, legal

    expenses, development costs).