Valuation Consulting49-50 The Hop Exchange,

24 Southwark Street, London, SE1 1TY Tel: 020 7403 3344 Fax: 0207 499 2266e-mail: valconsult@valconsulting.co.uk

www.valuation-consulting.co.uk

VALUATION CONSULTING

STARTING AT THE TOP AND TRYING STARTING AT THE TOP AND TRYING TO BUILD DOWN.TO BUILD DOWN.

THE LAWS OF PHYSICS THE LAWS OF PHYSICS AND VALUATIONAND VALUATION

SUGGEST THAT THIS IS NOT SUGGEST THAT THIS IS NOT POSSIBLE.POSSIBLE.

VALUATION CONSULTING

OCCASIONS FOR VALUING OCCASIONS FOR VALUING INTELLECTUAL PROPERTYINTELLECTUAL PROPERTY

• Mergers & AcquisitionsMergers & Acquisitions• Portfolio Review and risk assessmentsPortfolio Review and risk assessments• Arrange a loan - securitisationArrange a loan - securitisation• Tax purposesTax purposes• LicensingLicensing• Balance Sheet purposesBalance Sheet purposes • Joint VenturesJoint Ventures• Selling your CompanySelling your Company• Selling your IPSelling your IP• InsuranceInsurance

VALUATION CONSULTING

METHODS OF VALUATIONMETHODS OF VALUATION

Market BasedMarket Based

• Comparable market transactionsComparable market transactions

VALUATION CONSULTING

COMPARABLE MARKET TRANSACTIONSCOMPARABLE MARKET TRANSACTIONS

• Few SalesFew Sales

• Lack of InformationLack of Information

• Separate ValuesSeparate Values

• Special PurchasersSpecial Purchasers

• Different Negotiating SkillsDifferent Negotiating Skills

• Distorting Effects of Varying ValuesDistorting Effects of Varying Values

• Assets Not Always ComparableAssets Not Always Comparable

VALUATION CONSULTING

METHODS OF VALUATIONMETHODS OF VALUATION

Cost BasedCost Based

• Historical or replacement costHistorical or replacement cost

VALUATION CONSULTING

HISTORICAL OR REPLACEMENT COSTHISTORICAL OR REPLACEMENT COST

CaveatsCaveats

• Economic Benefits ExcludedEconomic Benefits Excluded

• Duration of benefit-economic lifeDuration of benefit-economic life

• Obsolescence difficult to quantifyObsolescence difficult to quantify

• MaintenanceMaintenance

• Time value of moneyTime value of money

VALUATION CONSULTING

METHODS OF VALUATIONMETHODS OF VALUATION

Income ApproachIncome Approach

• Capitalisation of historical profitsCapitalisation of historical profits

• Future economic benefitsFuture economic benefits

VALUATION CONSULTING

CAPITALISATION OF HISTORICAL PROFITSCAPITALISATION OF HISTORICAL PROFITS

DRAWBACKSDRAWBACKS

ProfitabilityProfitability

• Problems of averagingProblems of averaging• Problems of extrapolating from past performanceProblems of extrapolating from past performance• Decline & other key variablesDecline & other key variables• Net tangible assets not separately assessedNet tangible assets not separately assessed

MultipleMultiple

• No reference point for price earnings multipleNo reference point for price earnings multiple• Often no regard to established marketplaceOften no regard to established marketplace• Often no reconciliation with market capitalisationOften no reconciliation with market capitalisation

VALUATION CONSULTING

MODERN VALUATION ANALYSIS IS EFFECTIVELY DCF MODERN VALUATION ANALYSIS IS EFFECTIVELY DCF APPLIED TO THE BUSINESS ENTERPRISE UNDER APPLIED TO THE BUSINESS ENTERPRISE UNDER

CONSIDERATIONCONSIDERATION

• The Net Present Value (NPV) of a strategy or business is the sum of itsThe Net Present Value (NPV) of a strategy or business is the sum of its expected free cash flows to a horizon (H) discounted by its cost of expected free cash flows to a horizon (H) discounted by its cost of capital (r) capital (r)

NPV = NPV = Year 1 Cash FlowYear 1 Cash Flow + + Year 2 Cash FlowYear 2 Cash Flow ... to ... to say Year 5 Cash Flowsay Year 5 Cash Flow (1 + r) (1 + r) ² (1 + r)H(1 + r) (1 + r) ² (1 + r)H

PLUSPLUS

The terminal value which is the value of the business at a horizon (HV)The terminal value which is the value of the business at a horizon (HV)HV = HV = Cash FlowCash Flow (r - growth)(r - growth)Also discounted back to present valueAlso discounted back to present value

VALUATION CONSULTING

HOW MUCH?HOW MUCH?

(CASHFLOWS)(CASHFLOWS)

VALUATION CONSULTING

GROSS PROFIT DIFFERENTIAL METHODGROSS PROFIT DIFFERENTIAL METHOD

Assessment of marginsAssessment of margins

• Generic or unbrandedGeneric or unbranded

• BrandedBranded

• PricesPrices

• VolumesVolumes

• MaintenanceMaintenance

VALUATION CONSULTING

GROSS PROFIT DIFFERENTIAL METHODGROSS PROFIT DIFFERENTIAL METHOD

LimitationsLimitations

• Net Tangible Assets and Rate of Return ignoredNet Tangible Assets and Rate of Return ignored• Cost & production efficiencies not isolatedCost & production efficiencies not isolated• Economies of scale not consideredEconomies of scale not considered• Information about other product’s cost, volumes, etc notInformation about other product’s cost, volumes, etc not available available• No generic brand name for comparisonNo generic brand name for comparison• If so differences in quantity, quality, availabilityIf so differences in quantity, quality, availability• Market trends over timeMarket trends over time• Bias towards industries with lower variable costs to total costsBias towards industries with lower variable costs to total costs

VALUATION CONSULTING

EXCESS PROFITS METHODEXCESS PROFITS METHOD

FeaturesFeatures

• Calculate current market value of Net Tangible AssetsCalculate current market value of Net Tangible Assets

• Estimate Rate of Return to calculate required profitsEstimate Rate of Return to calculate required profits

• Excess above required level to induce investmentExcess above required level to induce investment

• Attribute excess to intangiblesAttribute excess to intangibles

• Capitalise this returnCapitalise this return

• Ensure careful segregation to identifiable productsEnsure careful segregation to identifiable products

• Those unidentifiable must be goodwillThose unidentifiable must be goodwill

VALUATION CONSULTING

EXCESS PROFITS METHODEXCESS PROFITS METHOD

LimitationsLimitations• Rate of Return can be a reflection of other factorsRate of Return can be a reflection of other factors• Does not allocate between partsDoes not allocate between parts• Tangible assets often incorporate intangible value ie value in Tangible assets often incorporate intangible value ie value in use basis use basis• Information about technological developments often notInformation about technological developments often not available available• Assets being valued not employed in best mannerAssets being valued not employed in best manner• Asset values & reported profits often calculated on a differentAsset values & reported profits often calculated on a different basis basis• Erosion of margin over time by competitive pressuresErosion of margin over time by competitive pressures• Benefit of lower depreciation of branded productsBenefit of lower depreciation of branded products• Required Rate of Return often an ingredient in sale priceRequired Rate of Return often an ingredient in sale price• Method ignores potential profit from extensionsMethod ignores potential profit from extensions

VALUATION CONSULTING

ROYALTIES FOREGONE/RELIEF FROM ROYALTYROYALTIES FOREGONE/RELIEF FROM ROYALTY

FeaturesFeatures

• Estimate future royalty streamEstimate future royalty stream• Basic premise sale & lease-backBasic premise sale & lease-back• Usually maximum basis with acceptable Rate ofUsually maximum basis with acceptable Rate of Return Return• Alternatively payment for your useAlternatively payment for your use• Royalty equivalent to excess profit componentRoyalty equivalent to excess profit component• Greater availability of independent economic & trade Greater availability of independent economic & trade association forecasts association forecasts• Facilitates comparison with Royalty Rates of Facilitates comparison with Royalty Rates of similar intellectual property in marketplacesimilar intellectual property in marketplace

VALUATION CONSULTING

ROYALTIES FOREGONE/RELIEF ROYALTIES FOREGONE/RELIEF FROM ROYALTYFROM ROYALTY

ProblemsProblems• Separation of intangible componentsSeparation of intangible components

• Other factors often an ingredient in determiningOther factors often an ingredient in determining current Royalty Rate current Royalty Rate

egeg geographical goodwill geographical goodwill or monopolyor monopoly

• ComparableComparable may be out of date may be out of date lack of detailed information lack of detailed information arrangements may preclude extensions arrangements may preclude extensions

VALUATION CONSULTING

HOW LONG FOR?HOW LONG FOR?

(TIME PERIODS)(TIME PERIODS)

VALUATION CONSULTING

AT WHAT RISK?AT WHAT RISK?

(COST OF CAPITAL)(COST OF CAPITAL)

VALUATION CONSULTING

MONTE CARLOMONTE CARLO

• Effectively a DCF multiplierEffectively a DCF multiplier

• Numerous DCF calculations accounting for Numerous DCF calculations accounting for various scenarios, say of revenue, market various scenarios, say of revenue, market share, costs, internationality and other share, costs, internationality and other risksrisks

• With just 4 scenario changes of the stated With just 4 scenario changes of the stated assumptions above this means 256 models!assumptions above this means 256 models!

• That is 4 values for each of income, different That is 4 values for each of income, different market share, costs, international penetration market share, costs, international penetration i.e. 4 x 4 x 4 x 4 = 256i.e. 4 x 4 x 4 x 4 = 256

VALUATION CONSULTING

1-10 – 100 RULE1-10 – 100 RULE

• Often scarce capital resourcesOften scarce capital resources

• Each stage in a technical development Each stage in a technical development costs 10 times as much as the previous costs 10 times as much as the previous oneone

• Assumption of success – the probability of failure Assumption of success – the probability of failure at each stage could be 90% +at each stage could be 90% +

• Even with 50% probability an inventor needs two Even with 50% probability an inventor needs two ‘ ‘up his sleeve’, at each stageup his sleeve’, at each stage

• Multiplier effectMultiplier effect