Putting Value to Intellectual Property
31 December 2015
Lee Quin examines the landscape of intellectual property valuation in Malaysia.
At the turn of the century, major companies began to change the way they viewed assets. Preceding the dotcom era in the late 1990s, a company’s assets largely comprised of tangible property such as land, buildings, machinery and raw materials. Although such assets are still a factor, the most valuable assets today are often intangible: intellectual property (“IP”).
In the last decade or so there has been a significant increase in the number of companies which have become market leaders through the effective creation, extraction and leveraging of their IP through efficient IP management. Nevertheless, small and medium enterprises, or SMEs, which are the building blocks of many developed economies, have been slow to realise the potential of IP management in increasing their competitiveness due to a lack of understanding of the role of a strong IP portfolio in their business operations.
Traditionally, corporations would use their tangible assets as collateral to obtain financing from financial institutions. Currently, there are over 1,000 SMEs in Malaysia with MSC Malaysia status that own Intellectual Property Rights (“IPRs”) in the form of patents, trademarks, copyrights, industrial designs and geographical indications. As with any other savvy business, these SMEs would ideally want to capitalise on their IPRs.
However, in the absence of an officially recognised IP valuation framework to rely upon, financial institutions are reluctant to accept IP assets as collateral for loans. To satisfy the needs of the SMEs and the requirements of the financial sector, the Prime Minister Datuk Seri Najib Tun Razak had suggested at the 22nd MSC Malaysia Implementation Council Meeting (ICM) in October 2010 that an IP valuation model be established.
As a result, the Multimedia Development Corporation (MDeC) and the Intellectual Property Corporation of Malaysia (“MyIPO”) jointly formulated an IP valuation model and the same was introduced to the market in November 2013 to pave the way for IPRs to be valued, recognised and accepted as collateral by financial institutions. This IP valuation model is to serve as a guide for financial institutions as well as stakeholders in conducting IP valuation, in addition to being used as a basis for third parties to undertake the valuation process.
WHAT IS IP VALUATION?
IP valuation is a process of determining the monetary value of a particular IP, whether in the form of a trademark, patent, copyrighted work, or otherwise. IP valuation is relevant for a myriad of reasons, e.g. for purposes of mergers and acquisitions, joint ventures, IP portfolio rationalisation and assessments, tax planning, the monetisation of IP including licensing and franchising, sale and purchase of business or IP asset, technology transfer, collateral in financing or IP-backed securitisation, litigation or in the case of a liquidation.
The main purpose of having an IP valuation exercise is to determine how much an IP or a combination of IPs is worth. This estimated value will then form the basis for accepting the IP asset as collateral for a financing facility provided by a financial institution or for other transactions or purposes, such as a sale of the IPRs or the assets or shares of the owner of the IP.
HOW IS VALUATION PERFORMED?
Valuation of an IP right is not a straightforward task as it is not a matter of putting a fixed number on it. For a variety of reasons, IPRs fluctuate in value. For example, a patent may begin its life as a unique solution to a problem, but with time, newer and better solutions may be found which may reduce its worth. Alternatively, successful marketing of the product can result in the patent becoming more valuable. A trademark generally gains value with the passing of time, as more goodwill becomes attached to it.
There are a number of methods used to value IPRs. Identifying and selecting the most appropriate approach to IP valuation would depend on a number of factors, including the context and purposes of transactions, the timing, and the perspective of the valuation (be it from the perspective of a seller, buyer or financier).
However, each method has its limitations and no method is appropriate in every case. Generally, these methods are divided into two categories: the quantitative and qualitative valuation.
While the quantitative approach relies on numerical and measurable data to calculate the economic value of the intellectual property, the qualitative approach focuses on the analysis of the characteristics (such as the legal strength of the patent) and the uses of the IP.
SELECTING THE RIGHT METHOD
The three commonly used IP valuation methodologies are: the cost approach, the market approach, and the income approach.
By adopting this approach, value is determined by calculating the cost of developing a similar or exact IP asset. Its advantage is that it is a useful indicator when an income stream does not exist or when there are no economic benefits. However, this approach does not incorporate expected economic benefits or income generating potential.
With the market approach, value is determined by comparing the IP asset with the actual price paid for a similar IP asset under comparable circumstances. This approach is simple and accurate if comparable data is available, as it is useful as a cross-check. Its drawback, however, is that it does not consider the uniqueness of the IP, the fact that there are limited formal markets, and that there may be a lack of comparable data.
The main concept of this approach is to determine value based on economic income that the IP asset is expected to generate, adjusted to its present day value. This is a useful method when IP assets generate stable or predictable cash flows. However, it may be subject to many assumptions and distant cash flows and discount rates have to be estimated.
THE MALAYSIAN IP VALUATION MODEL
The Malaysian IP Valuation Model (“IPVM”) is said to be consistent with the recommendations of internationally accepted standards, including the International Financial Reporting Standards (IFRS), International Valuation Standards (IVS) and International Organisation for Standardisation (ISO). Additionally, the IPVM generally follows a relatively cautious approach to provide a conservative view of IP value, which is better aligned with the needs of the financial sector.
The generally accepted method and the one that has been selected for the IPVM is the income method, or specifically, the valuation on a relief-from-royalty (“RFR”) basis. The mechanics of the RFR approach operates by calculating how much an IP owner is relieved from paying royalties by virtue of owning its IP, assuming a traditional licence agreement is in place. Future IP earnings (sales x royalty rate) are discounted to reflect the time value and risk attached to those future cash flows and tax is deducted. However, as the RFR approach utilises discounted cash flow methodology, it requires an understanding of the future cash projections, comparative applicable royalty rates, hurdle rates (that are normally expressed via rates calculated from the weighted average cost of capital), terminal growth values and the prevailing taxation rate.
As a result, MyIPO has acknowledged that by nature, the RFR approach is conservative (although it provides a reasonable view on IP value), as the royalty rate on which it is based does not necessarily incorporate full value transfer to the licensor. It can be shown that as a result of the negotiation process, in reality the licensee regularly retains a percentage of the economic benefit resulting from use of the asset.
It is also noteworthy that the IPVM comes with a proposed, standardised reporting format that outlines not only the valuation approach and method but also detailed descriptions of the business, in order to provide a complete picture of the valuation undertaken.
IP VALUATION TRAINING
To ensure that IPR owners get fair value for their IP assets, the government has allocated a budget of RM19 million for IP valuation training programmes to local intellectual property valuers. Towards this end, MyIPO successfully conducted Malaysia’s first ever IP Valuation Training Programme in May 2013, in collaboration with IP valuation experts from Switzerland’s University of Bern’s World Trade Institute.
In line with this, MyIPO in cooperation with the Ministry of Finance and the Ministry of Domestic Trade, Cooperatives and Consumerism has also been hosting the biennial Global IP Valuation Conference in Kuala Lumpur. The purpose of the global event is to bring together key industry players, influencers, stakeholders and policymakers to share their best practices and experience in creating and extracting value from IP assets, as well as to discuss the growing interest in transforming IP assets into an alternative form of collateral.
MyIPO has indicated that the key for acceptance of IP as collateral boils down to its acceptance by financial institutions. It has suggested that it is useful to have in place an established and agreed IPVM in order to achieve this. It must be noted that the agreed approaches or techniques of valuation will depend on the financier’s assessment criteria. When both the assessment criteria and approaches are reviewed hand-in-hand, more credible IP valuations can be obtained. The success of the Malaysian IPVM will require a shift in the mindset and outlook as well as the support and commitment from the financial sector and the IP community.