Valuing Intellectual Property for Use as Collateral

The recent economic climate has compelled managers to come up with creative solutions in order to keep their companies liquid. One such solution is to use their intangible assets as a non-monetary form of collateral, thus freeing their tangible asset portfolio for eventual deals. Regulations in Brazil allow the use of intellectual property (IP) such as patents, trademarks or copyrighted works, as collateral in a wide range of applications. The problem often encountered by managers is how to value these assets.

The traditional approaches for valuing IP consider their cost, market comparables, or expected revenue stream. This is tricky in the best of times, requiring a good understanding of the asset and the context that surrounds it, as well as some educated guesswork as to what the future may hold.

Consider patent valuations, a relatively new field in Brazil, but one that is steadily maturing in developed economies, as illustrated by deals such as Ocean Tomo’s auction of US 6,618,593 (a patent related to matching telecommunication devices) for US$ 2.6 million. Most new patents are not radical innovations but rather incremental inventions, effecting improvements on existing products; and patents, as is well known, grant its owner the right to exclude others from using his particular improvement, but not necessarily the right to build the product itself – for that he would need consent from all other stakeholders on that product. Thus patent valuations are usually a three-part exercise, where one needs first to determine the
extent to which the inventor has the right to build the underlying product, then analyze alternate known implementations, and finally value the underlying product with and without the use of the invention in order to gage the potential value of the patent.

The challenge in valuing IP for use as collateral is disassociating it from its owner, thus, should that collateral be called upon, the Lender – or equivalent counterpart – would be able to recover the expected value by selling the asset. This unfortunately is not as simple as it sounds.

Consider for instance Millward Brown’s recent US$ 100 billion valuation of Google’s brand. What would happen if Google actually sold its brand to an unknown "Joe’s search engine"? After a certain time, Google would have to offer its services under a new name. Joe’s search engine would now use the brand Google, and Google itself would, for example, operate under the brand "NewSearch". What then? That is up to "Joe’s" performance. At first, people would unknowingly continue to type www.google.com into their browsers, but now instead of getting Google’s results they’d get Joe’s. If "Joe’s" does a good job, people will continue to use the page, but eventually all would catch on to the fact that "Google" is not the same as it used to be, whereas "NewSearch" is. The "Google" brand value would gradually change to reflect "Joe’s" performance, just as the "NewSearch" value would adjust. Put differently, mere fact that Joe bought the "Google" brand changes the asset’s expected value.

When considering IP for use as collateral it is important first to identify what value generating characteristics the asset holds in its own – such as whether it produces licensing revenues or is of particular interest to certain sector of industry – and only then begin the valuation exercise. A good valuation will also take into account the effect that having been offered as collateral will have on the IP, as well as characteristics of the Lender that might impact the value of the asset should it end up on his hands.

Ultimately, as with any real asset, the value at which the IP will be accepted for collateral is subject to negotiation between both parties. Having a good valuation report will provide a basis for these discussions, and hopefully streamline the process of reaching a consensus.