Why is IP missing from “how investors evaluate your company” posts
LinkedIn is replete with “viral” posts (i.e., 900+ reactions) about how investors assess your company with catchy visuals, such as those posted by Eva Dobrzanska and Daniel Horak.
Though these visuals are representative of an investment process (or thesis), they do not consider the role intellectual property (IP) in the deal, or how companies can make themselves more “investment ready”, especially when IP can represent a significant portion of:
the company’s valuation (McKinsey, Visual Capitalist, etc.), which may be required to:
Determine the sale price of the company and particular intangible assets, or the sale of “all or substantially all” of the company’s assets, as the case may be;
obtain financing (see our post: The Flywheel Effect of IP-Backed Financing);
Address accounting and tax practices, in particular transfer pricing, which consists of the setting of “prices for goods and services between related entities” (CFI, OECD transfer pricing guidelines);
the legal documents, including disclosures schedules, which supplement the lengthy representations and warranties contained in the agreement that can take the form of an asset purchase agreement, a stock purchase agreement, amongst others.
Valuation of intangible assets, including IP, goodwill and reputation
Valuing intangible assets is challenging for a number of reasons:
Complexity and Subjectivity: Intangible assets are often complex and subjective. Unlike physical assets, they lack a clear, tangible form. Examples include intellectual property (IP), brand reputation, customer relationships, and software. Determining their value involves assessing factors like future cash flows, market position, and competitive advantage. These factors are difficult to quantify.
Uncertainty: The future benefits of intangibles are often uncertain. For instance, projecting the revenue generated by a brand or patented technology can be challenging. Some intangibles have an undefined lifespan, making it even more complicated to account for their value.
Changing Business Models: Modern business models increasingly rely on intangibles. Companies invest heavily in building brands, developing software, and creating innovative ideas. As a result, traditional valuation methods based on physical assets (like book value) are less informative. Intangibles are often missing from balance sheets.
Lack of Objective Metrics: Unlike physical assets, there are few objective metrics for valuing intangibles. Their worth is often tied to market perception, competitive positioning, and strategic importance. Valuation becomes especially challenging for new and unproven IP, or where the company is at a pre-revenue phase (see videos here and here, as well as Kohn, Golej, Mustafa, Koseoglu, Halt, amongst other references).
Overestimation Bias: Entrepreneurs and business owners tend to overestimate the value of their intangible assets. This bias can lead to inflated valuations and impact investment decisions. For more information on this issue, reference can be made to our book chapter, tilted: What’s the Big Idea? The Crossroads Between Investment and IP.
Valuing intangibles requires a blend of science and art, considering both financial models and qualitative assessments.
A primer on intangible asset (and IP) valuation
According to the World Intellectual Property Office (WIPO):
“To be able to value an IP asset, the asset should meet the following conditions:
It must be separately identifiable (subject to specific identification and with a recognizable description)
There should be tangible evidence of the existence of the asset (e.g. a contract, a license, a registration document, record in financial statements, etc.)
It should have been created at an identifiable point in time.
It should be capable of being legally enforced and transferred.
Its income stream should be separately identifiable and isolated from those of other business assets.
It should be able to be sold independently of other business assets.
It should be subject to destruction or termination at an identifiable point in time.”
Once the data has been aggregated, a qualified specialist will proceed in performing an intangible asset (or IP) valuation, applying at least one of the valuation approaches (see here) in compliance with standards, such as: (i) IFRS - IAS 38 Intangible Assets, (ii) FASB 141, 142 - Identifiable Intangible Assets and Subsequent Accounting for Goodwill, (iii) ASC 350, which is the U.S. standard for private, small companies, (iv) Royal Institution of Chartered Surveyors (RICS), and/or (v) International Valuation Standards Council (IVSC).
In closing and to borrow the words of the IVSC, a non-profit organization dedicated to establishing and promoting global valuation standards to serve the public interest, “as businesses continue to evolve, understanding and accurately valuing these intangible assets becomes increasingly crucial for investors and stakeholders”.
Have more questions about IP and IP valuation, contact us.
More general information regarding IP valuation can be found at WIPO, WIPO - Module 11: Valuation, the ICC Handbook on Valuation of Intellectual Property Assets.
