Valuing a Business in Volatile Markets
Editor: Jim Horvath
Book Review by:
Andrea Rush, Partner
Patent and Trade-mark Agent, Heenan Blaikie, Canada
ISBN: 978-0-7798-2286-7
No. of Pages: 900
Binding: Hardcover
Publication Date: June 2010
Visit http://www.carswell.com/ to
order
Valuing a Business in Volatile Markets1
Once again James Horvath has delivered a gift which will be appreciated by those in the
fields of business and securities valuations and related intellectual property.
Internationally renowned as a valuation expert, prolific author, speaker, editor, and
expert witness, Horvath’s text speaks masterfully in crisp clear terms which impose
coherence on the seemingly unexplainable. It is one of a series of six valuation texts
edited by the author. In no less than 800 pages of text, comprising some thirty
substantive chapters, the authors tackle methodologies from perspectives as diverse as
Canada, the US, Europe and China.
Topics Covered by the Co-Authors
The valuation methodologies discussed are consistent with traditional approaches such
as the income, market and cost approaches, or more specifically, discounted cash
flows, capitalized cash flow, capitalized earnings, trading multiples and transaction
multiples, and replacements cost among others. While the book explains the basics, its
focus is on the unconventional issues faced during capricious business environments.
The authors speak from experience gained as leading professionals in their fields.
During the recent stock market events of 2008 and 2009, these valuators were charged
with making sense and opining on value where value was no longer easily
determinable. The valuation methodologies discussed in the book cover areas in which
to focus, to adjust, and to increase time spent on due diligence time during volatile
markets.
Focus of the Review
This review considers how the book contributes to de-mystifying the value of intellectual
property. In a knowledge-based or brand-based business, like a software company, the
value of the intellectual property drives the value of the company. The measurement of
this transfer value and what is considered a market rate are a subset of the broader
exercise of valuing an entire company. Normalizations or market value adjustments are
central to any valuation exercise, be it transfer pricing, the allocation of corporate costs
or goodwill across subsidiary operations, or adjusting related-party financings.
A business valuation will seek to adjust the entity’s operations to reflect an
arm’s-length perspective from each individual transaction through to the
overall value of the corporate entity.
1
Meredith Bacal, 2011 HBA Candidate from the Richard Ivey School of Business: Andrea Rush, Partner, Patent
and Trade-mark Agent, Heenan Blaikie, Canada
Valuing a Business in Volatile Markets
Editor: Jim Horvath
Book Review by:
Andrea Rush, Partner
Patent and Trade-mark Agent, Heenan Blaikie, Canada
ISBN: 978-0-7798-2286-7
No. of Pages: 900
Binding: Hardcover
Publication Date: June 2010
Visit http://www.carswell.com/ to
order
The chapter by Robert F. Reilly entitled, “Valuation of Intellectual Property in a
Distressed Economy” summarizes three significant components regarding intellectual
property. It first summarizes procedures related to the identification of intellectual
property. It continues to summarize the procedures related to the valuation of
intellectual property as one an intangible asset. The chapter concludes with a summary
of the characteristics or elements that affect the valuation of intellectual property in a
distressed economy. This portion provides illustrative examples of the valuation of
intellectual property within the context of a distressed economic environment. These
topics are particularly meaningful to professionals who assist knowledge based
industries in commercializing their intellectual property and rely on the novelty of their
ideas and expression to attract financing.
Intellectual Property is more than “Goodwill”
But what is intellectual property? The drive to monetize rights in intangible property is
challenging because the scope of protection for subject matter is in a continuous state
of flux. The Copyright Act2 defines categories of protectable works/subject matter in
terms of what can be protected. The Patent Act3 also hints at what cannot be protected.
Section 2 of the Patent Act gives the following definition of what can be protected under
the classification of “invention:”
“Invention” means any new and useful art, process, machine, manufacture or
composition of matter, or any new and useful improvement in any art, process,
machine, manufacture or composition of matter.
Subsection 28(3) of the Patent Act clarifies what is not an invention:
“No patent shall be granted for any mere scientific principle or abstract theorem.”
Recent Canadian proceedings before the Patent Appeal Board suggest that business
methods are not patentable in Canada because they do not disclose an inventive
technological solution to a practical problem. Put simply, linking a business method to a
system may result in a commercial, potentially vendible product. That, however, has not
sufficed to confer patentability in Canada.
As patent holders appreciate, knowledge-based industries commercialize raw
information. The essence of life – that which cannot necessarily be seen, sounded,
smelled or touched. Intangible property-based industries thrive on generous valuations
2
3
R.S., 1985, c. C-42
R.S., 1985, c. P-4) (“Patent Act”)
Valuing a Business in Volatile Markets
Editor: Jim Horvath
Book Review by:
Andrea Rush, Partner
Patent and Trade-mark Agent, Heenan Blaikie, Canada
ISBN: 978-0-7798-2286-7
No. of Pages: 900
Binding: Hardcover
Publication Date: June 2010
Visit http://www.carswell.com/ to
order
of “expression,” and the vision of those optimists who see the potential to convert
information into tangible products which are resold or licensed. Information is not
property; however, tangible property may embody intellectual property of more than one
kind which can increase its value. Consider, for example, no name cosmetics,
beverages, pharmaceuticals, consumer goods and the like. Now add on a brand name
to provide an understanding of the value of trade-mark rights. These rights are
protected both under the Trade-marks Act 4 and operation of the common law.
The software sector exemplifies a sector in which continued repurposing of existing
code and content create enhancements which transmit ideas e.g. the form of code
annotated with programmer’s notes. It also exemplifies actual tangible applications
which can be licensed and sold but not developed while the code remains confidential
and in escrow. There is value at different levels- in the confidential code on the one
hand and in the application which is used on the other. Both are protected under
intellectual property laws- possibly even the same forms. The ownership rights may be
the same or divided. The valuations will likely differ in the same way that the sale of
painting generates one price while the right to reproduce the painting generates a
revenue stream which is subject to a different valuation formula. Given the short
commercial lifespan of a computer program in the retail market, transformative re-use of
code is more attractive than returning to the drawing board for pure clean room
development. The open source movement offers a preferred alternative to creation of
fresh code in a clean room environment. This gave rise to a new economic model, part
open source and part proprietary. Although this open source movement has made new
product development, it has increased the complexity of performing valuations (see for
example GNU licences).
Free, Fair and Proprietary
Such examples indicate that creators who are also users are well positioned to chart the
value of free use, fair use, and proprietary use of intellectual property. At one time, a
defence to infringement, fair dealing of works protected by copyright, such as software,
caught on as a counterbalance to the creator’s copyright and as such, a forceful
qualification. Hybrids, creators who are also users, have effectively morphed this onetime exception into a full-fledged standalone user’s “right.” The right is not limited to any
one sector and has already found application to both literary and musical works.
Fairness pre-supposes an accepted methodology of valuation of a work such that value
can be fairly apportioned between creators and users or buyers and sellers. Unlike
other commercial intangible assets, intellectual property is “consciously and creatively
produced.” The three generally accepted intellectual property valuation approaches are
4
R.S.,
(“Trade-marks Act”)
Valuing a Business in Volatile Markets
Editor: Jim Horvath
Book Review by:
Andrea Rush, Partner
Patent and Trade-mark Agent, Heenan Blaikie, Canada
ISBN: 978-0-7798-2286-7
No. of Pages: 900
Binding: Hardcover
Publication Date: June 2010
Visit http://www.carswell.com/ to
order
the cost approach, the market approach and the valuation approach.5 The gap between
what a seller is willing to accept and a user is willing to pay is an obstacle to assessing
value. If there is no accepted valuation methodology suitable for copyright, there can be
no splitting the value for compromise purposes. Second, “use” is an unwelcome word if
undefined in copyright assignments and licences.
“User rights” present a value driver (a negative) of significance to intellectual property
rightsholders. Such “user rights” are statutory and contractual exceptions which limit
protection. Left on the shelf, rights are of no value. They produce no new product
offerings nor do they generate a revenue stream. Transformative rights of “use” are
worth auditing when examining an intellectual property rights portfolio, particularly as set
out in licence agreements. These user/licensee rights would be expressed as grants to
create, sustain and enhance the value of knowledge – patents, trade-marks and
copyright.
A proposal to amend the Copyright Act6 purports to expand exceptions to copyright
protection, in fairness to both users and creators, Bill C-32 has brought renewed focus
by treating exceptions as user’s rights in relation to both copyright and moral rights. Bill
C-32 presents rights and qualifications as intertwined. Because the balance is not only
between creators and users but also between predictability and flexibility so as to
address the particular fact-specific context of a given dispute, consistency with other
forms of intellectual property is desirable. Other forms of protection provide a framework
for analysis which is steeped in market sensitivity to commercial norms derived from a
cohesive factual context.
Timing is Material
Valuation considerations are important at the outset and during litigation of intellectual
property rights, to provide a cost benefit analysis, which is helpful as a strategic reality
check. When is it preferable to settle rather than to litigate? The costs of pursuing a
“slam dunk” outcome - a presumptive fiction in any event- outweigh the potential for
recovery of damages. Valuation techniques to assess both the value of the intellectual
property and the costs of recovery are described by the authors.
The valuation techniques covered in the text are particularly applicable when intellectual
property rights are identifiable to both the infringer and the infringed, but identification is
not always feasible. The presumptions of ownership set out in the relevant laws show
the utility of registration – which is mandatory for procurement of patents, but not for
copyright and trade-mark rights which arise without the need to register. Even if
optional, registration of intellectual property rights is advantageous in establishing value
5
6
JAMES L. HORVATH, VALUING A BUSINESS IN VOLATILE MARKETS
Bill C-32, ( “Copyright Modernization Act”)
106-07 (2010).
Valuing a Business in Volatile Markets
Editor: Jim Horvath
Book Review by:
Andrea Rush, Partner
Patent and Trade-mark Agent, Heenan Blaikie, Canada
ISBN: 978-0-7798-2286-7
No. of Pages: 900
Binding: Hardcover
Publication Date: June 2010
Visit http://www.carswell.com/ to
order
to their rightsholders, by precluding the assertion of ignorance as a defence.
Registration creates presumptions of exclusivity, enforceability across Canada, and
precludes the infringer’s ability to assert no reason to suspect the existence of the right.
If, for example, this defence to copyright infringement succeeds, the only remedy is an
injunction to restrain further infringement: monetary damages are unavailable as a
consequence.
Damage awards made by the courts for infringement may purport to reflect the value of
intellectual property but do not necessarily correlate to market value include. Reasons
for this disconnect include the following: the prescribed amount for statutory damages
set out in the Copyright Act, a defendant may choose to render goods non-infringing in
some way and avoid payment in whole or in part, and the provincial court schedule of
tariff of costs. On the other hand, damages may be topped up, rather than limited by the
courts, if the defendant’s conduct so warrants. Where the conduct of the parties is
egregious the courts may impose punitive damages which exceeds market value so as
to set a precedent, e.g. to discourage the manufacture of counterfeit goods.
Recessionary times can lead to a wide range of business issues for corporations,
including impacting a company’s tax and treasury objectives. Chapters 19 through 21
are devoted to transfer-pricing issues. The chapter entitled “Transfer Pricing in Times of
Volatility” discusses several transfer pricing issues facing companies in uncertain
economic environments. Transfer pricing is by definition a non-arm’s-length transaction
that assigns value to the goods and/or services being transferred within the same
corporation. In the global marketplace, an increasing number of multinational entities
maintain operations in multiple jurisdictions.
In practice, the various operations or functions of the larger corporate entity are often
segregated and assigned to a specific country. Intra-company transfers between
various functions of a larger corporate entity highlight the need to determine the nonarm’s-length “value” to be assigned to these goods and services that are classified as
transfer pricing. Inconsistent measurements of risks and value creates questions for
various third-party interests, such as tax regimes from any of the company’s governing
jurisdictions, current bond holders, investors with claims to specific operations or assets
and arm’s-length parties considering a possible acquisition of all or part of the
operations. Any analysis of the variables that drive the value of the business must be
internally consistent if they are to be considered well-reasoned and accurate.
The book will be welcomed by buyers and sellers of intellectual property who see too
many dispositions of patents, trade-marks and copyright for “good and valuable
consideration.” This guide for the perplexed from an eminent editor and a select group
of authors is concise but complete, analytical and practical, timely and indispensable for
all who treasure intellectual property.