In today’s global economy, technology is a significant catalyst for change and progress, which makes intellectual property (IP) a primary driver when it comes to the value of a company. IP is a unique and often non-physical asset that is the product of the company’s work or reputation and is often patented, trademarked, or copyrighted. These provisions provide legal protection from unauthorized use.
Because IP can be essentially intangible, it is more challenging to value fairly. But an accurate valuation is critical to getting fair market value in a sale. And around the world, regulations regarding the valuation of IP have been adapting to the circumstances of a globalized economy. IP is less tangible than it used to be in today’s tech-driven world, even in manufacturing.
A significant reason that IP valuation is so important is that companies typically invest heavily in creating IP. Suppose the value of the IP isn’t properly assessed. In that case, the balance sheet will only show the investment in the creation of the IP and not its actual worth, resulting in the business being ultimately undervalued.
Accurate IP valuation is critical for mergers and acquisitions, licensing, or transfer pricing. A company’s method to value its IP can vary based on whether it is being done for accounting, tax, or transfer-pricing purposes.
IP Valuation Methods
Two primary methods are used to value IP: the income method and the market method. Under the income method, IP valuation is derived from future projected cash flow stemming from the IP. Under the market method, IP valuation calculates a market price from observations of comparable IP third-party transactions.
Different valuation techniques can generate different results, so how do you know which way to go? When determining IP valuation methods, there are several factors to consider, such as the type of IP, data availability, and business structure. For example, there isn’t enough comparable data available to perform an accurate market method. Then the income method would be more reliable. In the same way, if there is no correct forecast of future IP-generated profits, the market method may be the better route. In a transaction, the most reliable route is not automatically the one that gets the most favorable financial outcome for the company. Typically, the valuation method should be the one that is fair to both parties. It should also be justifiable to tax authorities.
Changing Global IP Regulations
Ever-evolving regulatory guidelines and heightened scrutiny of transactions are essential to how cross-border companies structure their IP ownership. Many international companies transfer their IP to low-tax regions because revenue must be allocated to the region where the profits were earned. Under such regulations, sales in countries outside the company’s legal headquarters are considered transactions between jurisdictions.
In 2017, the United States passed the Tax Cuts and Jobs Act (TCJA). This major tax reform made it less beneficial for companies to move ownership and development of intangible assets outside the US. The act established the Global Intangible Low-Tax Income (GILTI) provision, designed to deter companies from moving IP profits to low-tax regions. Because the guidelines differ between jurisdictions, the best IP valuation model varies based on each region. For these reasons, many companies returned IP to the US to avoid conflicts.
How to Get a Reliable IP Valuation
First, be practical in your expectations of the outcome. If your IP value seems surprisingly high, the chances are that it is not accurate. The buyer and the seller should agree that the valuation results are fair to both parties. You can also conduct testing to gauge the outcomes to help determine the more reliable method.
Don’t forget that an IP valuation may face some dispute by tax authorities, so it is best to enter into the valuation process with this in mind. Then, choose the method that you feel you can make the best case.
It is also a good idea to enlist the help of an IP valuation expert. This can reduce your risk of being audited or penalized for your valuation is far off base. Getting a qualified expert goes a long way in showing good faith in your efforts and can help you avoid disputes and headaches.