Intellectual Property

[mstaples]

My company, Multi Axis Games, currently has two investor groups interested in participating in a syndicated investment with us once a lead investor comes forward. This is both encouraging and problematic. It leaves us trying to hunt up additional investors to join the syndicate and for a good lead investor candidate.

Currently we are looking into getting our intellectual property valued so as to be in a better bargaining position and to help investors understand the worth of the company without having to understand the massively multi-player online video game market.

Does anyone have any expertise in the area of valuing and protecting intellectual property which might assist us?

Thank you,

[BusinessAdviser]

I know a bit about it, but would have to defer to someone like E&Y or Deloitte.

[pentupentropy]

Have you checked around to any other places that deal specifically in the market? Companies that were already developed and sold? try emailing someone over at inet-interactive (iNET Interactive : A social media company operating online communities for technology professionals and technology enthusiasts.). You can actually fill out a mail form there with one of their depts being acquisitions. They're not going to take your kind of idea on because it differs from what they do and they can probably tell you in some detail how they go about giving their acquisitions value before the get them. They're old hand at it.

[jasaunders]

I don't understand why getting a "value" for your IP is important? Unless you have the investment all set and are working on a deal and disagree greatly on a valuation and need this as evidence to back yoru side, how will having a value on IP convince other investors to join in? The potential investors will probably not give a shit about a random value on IP, because it is worthless until monetized. It's not a tangible asset that can be liquidated if the company were to fail (at least not in most cases).

In your situation, it should be very easy to get another investor on board. Most investors don't want to be the first on board, but if there are already two others, man, you should be able to close quickly. I can understand if you were looking for a value before you had any investors, but you are on the easy part now.

[akula]

i've got a bit of experience with IP valuation..using the DCF method
try going through LegalForce IP Marketplace
they'll be able to put a value on your IP portfolio

[BusinessAdviser]

I don't understand why getting a "value" for your IP is important? Unless you have the investment all set and are working on a deal and disagree greatly on a valuation and need this as evidence to back yoru side, how will having a value on IP convince other investors to join in? The potential investors will probably not give a shit about a random value on IP, because it is worthless until monetized. It's not a tangible asset that can be liquidated if the company were to fail (at least not in most cases).

In your situation, it should be very easy to get another investor on board. Most investors don't want to be the first on board, but if there are already two others, man, you should be able to close quickly. I can understand if you were looking for a value before you had any investors, but you are on the easy part now.

I disagree.

I don't think that the valuation of the IP is for the purpose of enticing investors to come on board, but rather to determine the appropriate share of the company to allot them based on their investments. Thus, it is in both parties' interest to have the IP valued, if it is a significant part of the business.

IP is not "worthless until monetized.," unless of course it has no opportunity for monetization. If I invent a drug that cures breast cancer, is it worthless until I actually get my first sale? And IP CAN be liquidated upon sale, just as any other asset of the company.

Again, I would defer to a valuation company that has experience in IP valuation. I know for a fact that Deloitte does this, and I'm sure that many other larger firms have experience in IT valuation.

[jasaunders]

The value of IP is almost as meaningless as putting a value on a company, unless someone is actually willing to buy it right now for that price. I can tell an investor my company is worth $2mm right now, but no one is going to buy it for $2mm, and an investor understands it is just a made up number.

IP is worthless unless it is monetized, otherwise you are just assigning a faux value to it (this is what caused the first internet bubble). You can't say it has the potential to be monetized. Everyone in the world who ever filed a patent thinks their idea is the best one on the planet and should make them a billionaire. The reality is a huge number of patents are worthless. Just because it has potential, doesn't mean it is worth something.

To get a figure that says your IP is worth X dollars, therefore my company is worth X+Y dollars, is just phony, if no one is going to buy your company for X+Y dollars today. IP does provide value to a company by providing barriers to entry, but even putting a figure on that would be a shot in the dark.

[jasaunders]

I guess my argument is that, yes, you can put a value on IP. But the value you assign to the IP is a random number pulled out of thin air, much like the valuation of a company. It's based on projections and a million what-ifs. Unless someone offers you an actual amount for your IP, it is still a made up number.

[richrf]

My company, Multi Axis Games, currently has two investor groups interested in participating in a syndicated investment with us once a lead investor comes forward. This is both encouraging and problematic. It leaves us trying to hunt up additional investors to join the syndicate and for a good lead investor candidate.

Currently we are looking into getting our intellectual property valued so as to be in a better bargaining position and to help investors understand the worth of the company without having to understand the massively multi-player online video game market.

Does anyone have any expertise in the area of valuing and protecting intellectual property which might assist us?

Thank you,

Hi,

Do you already have any seed capital from family and friends that would help begin determining the current value of a company?

From my experience in VC, it is very difficult to get a lead investor in the game market. Beginning with family and friends and then trying to get an angel to latch on may be the best path. Are you talking to angels? Are there angels that specialize in your niche and get help set some value? These are good resources, but they usually want a good amount of your own money in there before they risk anything.

Rich

[BusinessAdviser]

I guess my argument is that, yes, you can put a value on IP. But the value you assign to the IP is a random number pulled out of thin air, much like the valuation of a company. It's based on projections and a million what-ifs. Unless someone offers you an actual amount for your IP, it is still a made up number.

If you've ever done IP valuation, then you know that it is not pulled out of thin air. Yes, like my father always used to tell me, something is only ever worth what someone else is willing to pay for it. Sure, IP valuation is based on assumptions and projections, but isn't this the case when valuing anything? IP valuation is very important and does NOT require monetization to have value. I would encourage you into reading up on IP valuation a bit before continuing to argue that it is nonsense.

[BusinessAdviser]

"[T]he increasing importance of IP valuation is underlined by recent PricewaterhouseCoopers research showing that intangible assets and goodwill constituted up to 74 per cent of the average purchase price of companies in 2003. And the requirement to apportion the purchase price of acquisitions in terms of intangibles and other assets is leading to much more thinking in this area. In their drive for increased transparency and comparability, standard setters are pushing companies to report on the value of acquired intangibles under IFRS 3 and FASB Standards 141 and 142. At the same time, the investment community is now alert to the importance of intangible assets and the need for companies to manage value in this area and communicate their efforts to the market."

[BusinessAdviser]

Understanding IP valuation

In order to make progress regarding the correct cost of capital to apply in the context of IP valuation, it is necessary to understand the different valuation methods that exist. And, in any case, given the increasing importance attached to the valuation of intangibles and the drive towards reporting on this value by accounting bodies around the world, organisations need to be aware of the various methodologies in use for IP valuation – as well as understanding which of these methodologies best suit their own intangible assets. There is no one size fits all solution here – not all methods make sense for all assets, and misleading results can be obtained if inappropriate methods are chosen. In selecting the appropriate methodology, valuation expertise and a clear understanding of the role of intangibles within the business, as well as their impact on business value, are essential prerequisites.

Valuation methods

Most intangible assets generate incremental returns for the business that owns them, either through an increase in revenues or through a reduction in costs. All valuation methods focus on capturing the value of these additional returns. The principal methods of valuation which are deemed acceptable for financial statement purposes are as follows:

• Excess operating profits or premium profits method.

• Premium pricing method.

• Cost savings method.

• Royalty savings method.

• Market approach.

• Cost approach.

Each of these methods, together with their limitations, is discussed briefly below.

Excess operating profit method

The excess operating profit method determines the value of the IP by capitalising the additional profits generated by the business owning the property over and above those generated by similar businesses, which do not have the benefit of the property. There are various ways in which the additional profits may be calculated, for example by reference to a margin differential or comparing the return on capital employed earned by the business owning the property with that earned by companies without such benefit. The calculated additional operating profits expected to be earned over the life of the asset in question are then discounted to the present day to arrive at a value for the asset.

It is important, if using this method, to ensure that the additional profits identified are specifically attributable to the intangible asset in question and not to some other factor such as a relatively more efficient production facility or distribution network that relates to the business as a whole.

A further drawback of this method is that the business with which you seek to compare the subject’s margins or return on assets is likely to have some intangible assets of its own which generate an additional return. It may even have a more efficient production facility. These factors will make it more difficult to calculate the additional profits that the subject business is earning and should be taken into account in the valuation.

Premium pricing method

A variation on the excess profits method, this is often used to value brands in the consumer products sector where it is common for a branded product to be more expensive than an unbranded equivalent. The value of this additional revenue projected over the life of the brand, net of the marketing and other brand support costs incurred to achieve this revenue, and discounted to the present day, provides a value for the brand.

A drawback of this method is that it is often very difficult to find a truly unbranded product. In the food sector, where stores can sell both branded and own-label products, the store’s own brand itself has a certain value.

Cost savings method

This is fairly self-explanatory and values the asset by calculating the present value of the cost savings that the business expects to make as a result of owning the asset. This is usually as a result of an efficient process or secret technology. While a business can usually calculate the costs it has saved since it introduced the new process, it can be more difficult to estimate whether a third party would save more or less costs if they introduced the same technology to their own business.

Royalty savings method

This is based on the principle that, if the business did not own the asset, it would have to in-license it in order to earn the returns that it is earning. Alternatively, the business could out-license the asset if it did not wish to use it. The value of the asset is calculated based on the present value of the royalty stream that the business is saving/foregoing by owning the asset. Determining an appropriate royalty rate (reflecting a hypothetical licensing agreement) is therefore a key part of a valuation using this approach. While this method is popular, its major drawback is the difficulty in identifying truly comparable licensing agreements in the market, as details of licensing agreements, including royalty rates, are rarely made public. An appropriate rate can, however, be estimated by considering the effective additional profits that are earned by exploiting the asset in question and remembering that each party to a licensing agreement needs to earn a commercial return on their investment.

Market approach

This values the asset based on comparison with sales of similar assets. This is by far the preferred approach of the accounting standard setters. Market multiples are derived using the price at which a similar asset has been sold and attributes of this similar asset (eg, sales). These are then applied to the attribute of the asset being valued to indicate the value of the subject asset. As many multiples as possible should be derived – for example: sales, EBITDA, EBIT. In an ideal world this is the best method, as it gives an estimate based on a true market value.

In practice, however, the world is not ideal and it is very rare to find sufficiently detailed publicly available information on sales of truly similar intangible assets.

Cost approach

This values an intangible asset by accumulating the costs that would currently be required to replace the asset. The premise of the cost approach is that an investor would pay no more to purchase the asset than would be paid to reproduce the asset.

While this approach is suitable for some assets, particularly those which are not directly generating income, care should be exercised in choosing this approach as cost is not always a reliable guide to value – think of the vast amounts of money spent on pharmaceutical research projects which come to nothing.

Dealing with risk

One of the reasons why some people are cautious about placing a value on IP is that there is usually a greater commercial risk associated with the potential revenues from the exploitation of an intangible asset than from a business or tangible asset. This adds to the difficulties involved in reconciling IP valuation methodologies to cost of capital theory, because standard cost of capital theory distinguishes between commercial risks that are specific (and can be diversified away by investors), and commercial risks that are systematic and cannot be diversified. One therefore needs to be clear that these greater commercial risks associated with intangible assets are greater systematic risks if higher discount rates are to be deployed in the valuation.

A typical company operates with a portfolio of assets, each of which carries different systematic and specific risks. The convention is that both the systematic and specific risks should be captured in the cash flows associated with the asset (so that these become truly expected cash flows), but only systematic risks (that cannot be diversified) are captured in the weighted average cost of capital (discount rate). The difficulty with IP valuation is therefore that the judgements required in arriving a discount rate are twofold: in addition to making judgements about the distinction between specific and systematic risks, it is also necessary to form judgements about the risk profile of disaggregated cash and income streams of the asset relative to the overall aggregate cash generation of the business. For example, costs are likely to be far more systematically stable than overall aggregate cash flows and should therefore be discounted at a relatively low discount rate. Revenues might be expected to be more systemically risky and should be discounted at a higher figure. But without capital market benchmarks to benchmark the risk of individual intangible assets, it is often difficult to be precise about the right discount rate to adopt.

In arriving at appropriate discount rates for intangible assets, one therefore needs to consider a range of factors including the relative systematic risk of each asset and the particular circumstances surrounding the use of that asset in the underlying business. Riskier assets (eg, new technologies in economically sensitive markets) may require higher discount rates – while less systematically risky assets may need to be discounted at a lower rate. When undertaking this process, it is important to keep the business’s overall WACC in mind. The various discount rates arrived at for each asset should be such that the overall discount rate can be reconciled to the WACC.

In addition, as a cross-check, it is important that the reasonableness of the value derived for an intangible asset is assessed in light of the values of other assets within the same business and their relative importance to the business and, importantly, the value derived for the entire business (which is primarily based on the established method of discounting the overall operating cash flows of the business at the WACC).

Valuing IP and determining the cost of capital

[richrf]

Hi jmenq2,

I agree with what you have written, and it certainly is a good place to start in order to understand ways of valuing a business. However, I am not sure a start-up can utilize these methodologies, unless I am missing something.

In this case, finding some way of pricing a new enterprise that is building a game, is very specialized and I think requires specialized experience. I would recommend seeking out angels or similar who have experience in the industry and looking for some offer. This would create some floor to work with. Of course, family and friends stepping up to the plate is always a requirement.

Rich

[jasaunders]

Yes, I am familiar with valuation methods of intangible assets from an accrual accounting perspective. The fact is however, that this company is not even operating. The only method you could possibly use for projections is to base it off similiar IP sales.
Furthermore, it's important to note that a firm has incentives to inflate their intangible assets and goodwill to appear to have a stronger position to shareholders (except in the context of an acquisition when shareholders may be worried about excessive goodwill).

[Cole Taylor]

Let me ask the OP a question:

What IP do you have that hasnt been accounted for in your present valuation?

Also, as someone who has had "issues" with investors in WA state I hope you have, at minimum, an opinion from a securities attorney in regards to what you are advertising on your web site.

Have you filed a registration statement? Is there a particular exemption you are relying on? Here in CA we have a beautiful exemption [25102(n)] which allows company's 210 days to "test the waters." Anyway...

I would suggest that you make users submit thier information to you before being able to download any investment proposal.

I've been advised by our securities attorney to remove anything from our website which could be contrued as a solicitation.