Autumn 2021 Insights

Intellectual property includes several specific types of intangible personal property. These types of intellectual property are patents, trademarks, copyrights, and trade secrets. Valuation analysts may be asked to value an owner/operator’s intellectual property for various transaction, taxation, accounting, planning, and controversy purposes. The cost approach is applicable to the valuation of intellectual property in many instances and for many purposes. Damages analysts may be asked to value an owner/operator’s intellectual property as part of a cost to cure damages measurement method analysis. This method is sometimes applied with regard to the measurement of damages related to intellectual property breach of contract and tort claims. Transfer price analysts may be asked to conclude an arm’s-length price (“ALP”) related to the intercompany transfer of a multinational owner/operator’s intellectual property. The application of the cost approach to conclude an ALP is an example of an “other method” of transfer pricing, as allowed by the Regulations related to Internal Revenue Code Section 482. This discussion summarizes the conceptual principles and the practical applications of the cost approach to estimate value, measure damages, or determine an ALP for intellectual property—and related intangible personal property.

Fair value measurements are rules-based analyses. Fair market value valuations are judgment-based analyses. This discussion focuses on the fair value measurement of intellectual property for various purposes related to U.S. generally accepted accounting principles (“GAAP”). In particular, this discussion considers the application of the cost approach in the development of intellectual property fair value measurements prepared in order to comply with various GAAP financial accounting provisions.

Valuation analysts (“analysts”) may be retained to value an owner/operator’s intellectual property for various accounting, taxation, financing, controversy, planning, and other purposes. This discussion summarizes the generally accepted intellectual property valuation approaches and methods. This discussion primarily focuses on the conceptual development for—and the practical application of—the cost approach in the development of an intellectual property valuation. In addition, this discussion considers the professional standards and other professional guidance available to analysts related to developing the intellectual property valuation.

The cost approach is particularly applicable to the valuation of certain types of intellectual property—and of related general intangible property. And, the cost approach is particularly applicable in the development of intellectual property valuations—and damages measurement analyses and transfer price analyses—performed for certain purposes. This discussion describes—and illustrates—the individual cost approach methods and procedures that analysts generally consider in an intellectual property valuation, damages measurement, or transfer price analysis.

There is some diversity of professional practice among valuation analysts (“analysts”) regarding the application of the so-called tax amortization benefit (“TAB”) adjustment in the development of the intellectual property cost approach valuation. For the numerous reasons presented in this discussion, the analyst’s application of such a TAB adjustment is typically not supportable in a cost approach valuation of intellectual property. However, TAB adjustments are sometimes applied in an intellectual property fair value measurement (“FVM”) developed for financial accounting purposes. Therefore, this discussion presents an illustrative example of the calculation of a TAB adjustment in an intellectual property FVM developed for financial accounting guidance compliance purposes.

Valuation analysts may apply the cost approach in the development of an intellectual property valuation. Damages analysts may apply the cost approach in the development of an intellectual property damages measurement—particularly in the application of the cost to cure (or lost intellectual property value) damages measurement method. In either case, there are methods and procedures that such analysts can apply to confirm (or to otherwise support) the intellectual property cost approach value conclusion or damages measurement.

One objective of the valuation analyst is to prepare an intellectual property valuation report that is clear, convincing, and cogent. One objective of the damages analyst is to prepare an intellectual property damages measurement report that is clear, convincing, and cogent. Regardless of which valuation approaches (including the cost approach) the analyst applied, the analyst should prepare a valuation report that supports a credible value conclusion. Regardless of which damages measurement methods the analyst applied (including the cost approach and the intellectual property lost value method), the analyst should prepare a damages report that supports a credible damages measurement.

Analysts are often retained to develop a valuation conclusion, a damages measurement, or a transfer price determination related to an owner/operator’s intellectual property. There are generally accepted approaches and methods related to each of these three types of intellectual property analyses. One procedure that is typically performed in each of these three types of analyses is a functional analysis. This discussion describes what a functional analysis is and how a functional analysis is applied to reach the intellectual property valuation, damages, or transfer price conclusion.

Valuation analysts—and other financial advisers—are often retained to advise acquisitive clients with regard to proposed merger and acquisition (“M&A”) transactions. While such valuation analysts typically focus on the pricing and structuring of the proposed M&A transaction, these analysts are expected to work with the acquirer’s accounting, taxation, legal, and other professional advisers. Accordingly, such valuation analysts should at least be generally aware of some of the taxation considerations with regard to the proposed M&A transaction. When one of the transaction participants involves a loss corporation (or a target company with certain other tax attributes), the Internal Revenue Service (the “Service”) may allege that the principal purpose of the proposed transaction is to evade or avoid income taxes. Of course, the target entity’s tax attributes cannot be ignored in the consideration of the proposed M&A transaction. However, the target entity’s tax attributes should not be the principal reason for the transaction. The valuation analyst can assist the acquirer to defend against any Service challenge of the tax motivations for the proposed transaction. That is, the valuation analyst can assist the acquirer to understand—and to document—the non-taxation-related economic benefits that are the primary reasons for— and the primary value drivers of—the proposed M&A transaction.