Family-Run Businesses Need to Think Out of the Box

Despite reports that the economy may be on the rebound, a recent Wall Street Journal article discusses how the economic downturn has caused many family businesses to shut their doors. Although the article says that it is difficult to quantify the number of family-owned businesses that have been forced to close, experts believe that these types of businesses have been particularly hard hit by current economic conditions.

The article reports the Small Business Administration estimates that somewhere around 90% of U.S. businesses are family owned or controlled, ranging from mom-and-pop shops to a third of Fortune 500 firms, and the Bureau of Labor Statistics estimates that approximately 4.3 million businesses with 19 or fewer employees closed during the fourth quarter of 2007 through the fourth quarter of 2008.

The vulnerability of family-run businesses is attributed to many factors, including the tightness of the credit markets and some of the family traditions and factors that have kept them in business for so many years, which have rendered them unable to adapt quickly enough to changing times and without necessary preparations for times of crisis.

The article highlights the importance for small, family-run businesses to think outside of the traditional box. This includes understanding how the business is valued in the market and the value of physical assets like machinery and equipment or intangible assets like customer base or intellectual property, all of which can help small business owners to think more strategically and plan accordingly for tough economic times.

By: Present Value

Posted in Business Valuation, Intellectual Property, Machinery & Equipment Appraisal, business appraisals | 1 Comment »

Valuing Intellectual Property: Income/Relief-From-Royalty Approach

This is the last in the series on Valuing Intellectual Property. This post will cover the Income/Relief-From-Royalty Approach. Click on the following to read the first in the series: Valuing Intellectual Property. And, click on the following to read the other two Valuing Intellectual Property break-out posts on Cost Approach and Market Approach.

The income method to valuing intellectual property (IP) assets is based on the income-producing capability of the IP. It is determined by the anticipated income that can be derived over the life of the piece of a business that is tied to the subject IP assets.

Through this methodology, factors used to determine the value of IP assets over their lifetime include size and factors influencing the potential and future market factors, risk factors, competitive landscape, and customer attractiveness.

The relief-from-royalty method is considered to be a subset of the income method. Through this approach the value of the IP asset is equal to the value of the after-tax royalties that the owner is “relieved” from paying by virtue of owning the assets. A royalty rate is used to establish the potential cash flow that can be associated with the IP. The royalty rate is determined by what a licensee would be willing to pay for use of the IP and based on a percentage of revenues.

Oftentimes, the “25-percent rule” will be used in such a case, which assumes a royalty equal to 25% of the operating profits of the business for which the licensed IP is used. The income stream calculated using the royalty becomes representative of the economic benefit attributable to the IP. A capitalization of that income stream becomes an indication of value. However, this may only represent a fraction of the economic benefit attributable to the IP assets.

As we mentioned in the first post in this series, there is overlap among all the approaches used to value intellectual property, and an appraiser should look at all of these methodologies before determining the value of IP assets.

By: Present Value

Tags: Add new tag, Income/Relief-From-Royalty, present value, Valuing Intellectual Property
Posted in Appraisal Terms, Intellectual Property | 1 Comment »

Valuing Intellectual Property: Market Approach

To continue our series on the ways to value intellectual property (IP), this third post covers the market approach. Read part one here and part two here.

Under the market approach, appraisers look at sales and licensing agreements of comparable, but unrelated intellectual property. To determine which IP is comparable, an appraiser would look at the description of the sold or licensed IP, its potential to generate income, the date of the sale or licensing agreement, and the IP’s age and remaining useful life. What can sometimes make the market approach to IP valuation difficult is that companies tend to guard the details of IP transactions because IP frequently is what gives one company a competitive advantage over another. To get information about IP transactions, an appraiser may have to conduct an in-depth review of SEC filings or gain access to proprietary transaction databases. 

When using the market approach for IP valuation, it is important that you work with a skilled appraiser who knows about the factors that can skew an IP valuation. For example, in a licensing agreement, the IP transactions may restrict the licensee’s rights to a specific geographic area. Because the licensee’s rights are limited, the market approach can underestimate the value of the IP. Or if one of the sale terms of the chosen comparable transaction is an installment payment, the IP may be overestimated. An experienced appraiser would be aware of these factors and adjust accordingly.

Stay tuned for our next post, which will be on the income approach to valuing IP.

By: Present Value    

Tags: Intellectual Property, IP Valuation, Market Approach
Posted in Appraisal Terms, Intellectual Property | No Comments »

Valuing Intellectual Property: Cost Approach

Following up on last week’s post, Valuing Intellectual Property, this post covers the first valuation methodology: cost approach.

Under the cost valuation method, the cost of creating an intellectual property (IP) asset is used to estimate the value of it, but not in the sense that the value of the IP asset is just the sum of the actual costs of creating it. The legitimate, actual cost, e.g., money spent in the process of creating the IP is taken into consideration, but that cost doesn’t necessarily represent what a buyer will pay for that IP asset. So the cost in this methodology is how much a buyer would be willing to pay for the asset, irrespective of the IP creator’s monetary investment.

Generally speaking, there are two types of cost: reproduction cost and replacement cost. Reproduction cost is the investment required to re-create an IP asset of identical quality. Replacement cost is the investment required to create an IP asset of similar quality to the original. Clearly, a reasonable investor would never pay more for an IP asset than it would cost him to create a duplicate IP asset or a comparable IP asset.

A valuation analysis can be based on reproduction cost or replacement cost. The resulting value should be similar regardless of the type of cost used. The components of cost approach analysis are material cost, labor cost, overhead cost, and return on investment. These are calculated based on the actual monetary investment of creating the original IP asset. Adjustments for inflation and other economic factors are taken into account.

Obsolescence factors, including physical deterioration, functional obsolescence, technological obsolescence, and economic obsolescence, are factored in to determine the value of the IP asset. The relevant obsolescence factors are subtracted from the cost to estimate the value of the IP asset.

Make sure to select a competent appraisal firm that follows recognized standards for the valuation of intellectual property.

By: Present Value

Tags: Intellectual Property, IP assets
Posted in Intellectual Property | No Comments »

Valuing Intellectual Property

For many businesses, intellectual property (IP) assets, such as patents, trademarks, copyrights, trade secrets, software, customer lists, and research, are an important part of their value. Because these assets are intangible, meaning that there is high degree of uncertainty regarding their future worth, it can be extremely difficult to determine their value. However, it is increasingly becoming more necessary for businesses to establish the value of IP assets, including mergers and acquisitions, for tax or litigation purposes, or for an ongoing business valuation, or liquidation.

An accurate valuation of IP assets requires that the appraiser look very carefully at the following factors:

• The nature and size of the market to be served
• The competitive advantages of your asset
• The price customers are willing to pay for your solution and related value proposition
• Costs of implementing the technology or products
• The impact of the technology on the processes used by the business to service its customers
• Length of time before new competition will enter the market

There are three methodologies that generally are used to value IP assets:

• Cost Approach
• Market Approach
• Income/Relief-From-Royalty Approach

There is overlap among these approaches, and an appraiser should use all three of these methodologies to determine the valuation of an IP asset. (We will cover these valuation methodologies in another post.)

Make sure to select a competent appraisal firm that follows recognized standards for the valuation of intellectual property.

By: Present Value

Tags: Intellectual Property, IP assets
Posted in Appraisal Terms, Business Valuation, Custom Appraisal, Intellectual Property, business appraisals | 1 Comment »