Patents 1. The most frequently used procedure for the valuation of patents is the “relief from royalty” approach. The underlying basis for this approach is the concept that if the patents were not owned, the manufacturers or marketers of devices protected by patents would pay royalties to the patent owner. Such royalties are most commonly based on the percentage of sales. The computed royalty payments are then capitalized over the legal or economic life of the patent as a measure of the value of the patent to the owner. 2. The process of capitalization of future income involves the use of risk rates (rates of interest) for the purpose of estimating the present worth (worth today) of income expected to be realized in the future. 3. The rates used in the capitalization process consist of two principle elements: 1) interest on the moneys invested and 2) the risk involved in the anticipation that future income will actually be realized. The most conservative investor would likely be content with investment in U.S. Government Securities (Treasury Bills, etc.), Triple-A Bonds, or the like, acknowledging that the return on the investment would be relatively low but also realizing that little risk accompanied the investment. In order to attract the investor to invest in a venture less predictable than a safe risk, the investor therefore must be compensated with a higher return which includes the element of risk that the venture might not be as favorable as was predicted. 4. Our procedure, therefore, will be to arrive at a reasonable royalty rate from which a stream of income will then be converted to its present worth using the capitalization process. 5. The time requirement obviously varies greatly. To make an estimate, we must know the number of active patents (using active in the sense of currently being employed) and the extent to which the patents are interrelated. For example, one may find a company has twenty patents, but fifteen of these may all relate to one basic concept and product and, therefore, these fifteen have to be considered as a group with a collective value, it being impractical and often impossible to assign individual values to each of the twenty specific patents. Trade Names and Trademarks 1. In valuing existing trade names, we follow the “relief from royalty” process outlined in the discussion of patents; however, our capitalization process will utilize a straight line procedure in that trade names do not have a determinable life because of their ability to be extended indefinitely. 2. In the development of the royalty estimate, consideration is given to the recognition accorded the product by reason of the trade name / trademark identification. This procedure involves a s study of product sales and profit margins, customer preference in the market-place and advertising support required to maintain the product identification. 3. Relationships between patent protection and trademark (trade name) identification are carefully studied to determine their individual contribution to product or process longevity. 4. Valued in accordance with their earning potential, this work effort involves a study of product sales and profit margins. The general principle is that the profit from the associated product must first produce a fair return on the necessary investment in working capital and facility property, all or part of the residual amount (as judgment may develop) being attributable to the trademarks and other assets which are intangible by nature. 5. Where appropriate, we may consider the amount spent on advertising in the recent past as some broad indication of the trademark value. License Agreements 1. Our analysis develops a stream of income which flows during the existence of these agreements. This income is capitalized to its present worth, using rates appropriate to the consideration and term of these specific agreements. 2. An important element of this analysis is a study of typical license agreements existing within the particular industry to develop a basis for comparability with the agreements being valued. Franchises The valuation of franchises can be treated similar to license agreements. Purchase Contracts 1. In the majority of instances, we have found that the value of ongoing or potential contracts will be reflected in the valuation of the business enterprise in total. This treatment recognizes that the potential in ongoing contracts will likely be representative of the performance of the company in the near term and the anticipation of the closing of potential contracts, together with the earnings these are likely to generate. Such an analysis should provide a good indication of long term potential. 2. When the above does not apply, the valuation of contracts can be treated similarly to license agreements. Leasehold Interests We analyze the prevailing market rentals for the property or properties under lease to isolate those instances where a client is leasing a property at less than market rent. Should such a rental advantage exist, and the remaining period of the lease is sufficient to accrue measurable value to the firm because of the cost saving involved, the value of the leasehold interest is developed by capitalizing this rental advantage over the remaining period of the lease, giving consideration to the effect of renewal options, should these exist. Joint Ventures and/or Subsidiary Operations An investment in these ventures and/or operations, whether as equity in the earnings or capital stock, ownership, could have measurable value, independent of a client’s direct operations. We examine these relationships to determine to what extent they improve the overall earnings outlook, provide penetration into other markets or market areas, or otherwise accrue identifiable and supportable advantages to the client. The process of valuation then follows that used in relation to the other intangible assets whereby this advantage is assigned value (worth) as of the date of the valuation. Non-Competition Covenants 1. A covenant not to compete typically solidifies the market position of a business enterprise and, in so doing, directly influences its profit picture. In valuing a covenant, therefore, we analyze this additional profit potential from two viewpoints. o The first is to consider the beneficial effect of the greater stability afforded present and future profits because the business has less exposure to the effect of possibly damaging competition. o The second consideration is to examine the likely cost of combating the influence of such competition in the absence of protection. 2. These two approaches serve as a check on one another. The direct effect of additional income, or costs avoided, is capitalized to value using an appropriate risk rate, applied over the legal or effective life of the covenant, to produce the present worth of the observed advantage as of the date of valuation. Going Concern Value The going concern value of a business may be approached from several directions. One of the most common is to reconstruct a likely developmental period for the business from the inception to the point at which it begins to produce a profit. The costs of development, measured in terms of profits deferred over the development period, giving consideration to the benefit of tax loss carry forward, are capitalized to their worth as of the date of valuation. Good Will 1. It is a commonly accepted appraisal concept that the value of goodwill of a business enterprise is measured by the earnings excess of the amount necessary to provide a reasonable return on the investment in other assets necessary to operate the business. The return must include provisions for recovery of the investment in depreciable and amortizable assets as well as a return on total invested capital including working capital. The remaining income is then capitalized to arrive at the value of goodwill. 2. The application of this technique proceeds as follows: o The first step is to arrive at an estimate of the income that will likely be produced by the operations of the enterprise over its predictable future. o This income is then converted to an annual amount before allowance for the historical components of depreciation and interest charges. The procedure of estimating both the annual income level and depreciation and interest charges must give consideration to the historical performance of the enterprise, the particular industry itself, together with any other events – past, present, or future – which are likely to exert an influence on the conduct of the business. o The next step in the procedure of estimating goodwill is to deduct from the estimated income amount, as adjusted, the anticipated requirement for depreciation, amortization, and return on total invested capital using as the basis for these computations the results of our appraisal of the various assets and reported values of other assets and a working capital sufficient to support the anticipated level of operations over the period the acquired goodwill will continue to reside with the company. o Any income remaining after making these deductions is considered to be excess to the normal requirement for return of and on invested capital and this is indicative of the goodwill element of the business. Our final step is to capitalize this excess or residual income to an indication of the value of such goodwill. The rate used in such capitalization gives appropriate recognition to the more speculative risk element associated with an asset of this type. Concluding Note “The fundamental concept in the valuation of intangible assets is that the actual value of the assets to the enterprise is the present value of future benefits of ownership. These benefits must be reduced to a stream of income that can be anticipated over a reasonable period of time and capitalized at a rate commensurate with the degree of uncertainty in forecasting the income.” In sum, the steps in appraising intangibles are: • Search out and identify. • Segregate the intangibles. • Assign the proper income segments to each intangible. • Capitalize this income to establish the present value.