One of the key challenges our clients face when acquiring a technology company or asset, especially one with a significant IP component, is how much to pay for that asset. Typically price is determined by reviewing and revising the acquisition target's valuation. The problem with this approach is that it allows the target to paint the landscape of the value of the asset across its total market potential, which may not align with your intended use. As a result, although the target's valuation may make sense, you may pay too much if you can't realize a compelling return on investment.
Companies are most likely to pay a fair value - that is, a price that delivers a reasonable return in the future -- if they invest in more sophisticated diligence on the value of the acquisition. A Triangulation Approach to valuation looks at value in three ways: 1) modeling the value that the technology and IP provides for your company's intended use; 2) reviewing, risk-adjusting and use-adjusting the target's valuation, and 3) understanding market comparables. By triangulating from these three methods, you can develop a reasonable offer that will deliver a sufficient return on your investment while taking into account the inherent and market value of the asset.
Method One: Determine the value of the technology toyourcompany.By modeling your current and future business opportunity that would arise through the acquisition target's technology and IP assets, you can assess its financial value. The first step is to determine the markets and applications to which you will apply the asset. First determine the total size of the market - that is, what is the potential revenue if you capture 100% of the market? Then project a reasonable market penetration to determine the portion of value you can extract in that market. The model should include the total revenue, COGS, and business expenses associated with launching and supporting the R&D, Sales and Marketing, and G&A expenses associated with the new products or services. Using these inputs, estimate a profit for the business.
Next, determine what portion of the profits of that business can be attributed to the technology and IP, and what can be attributed to the assets your company provides (marketing, brand, distribution, customer lists, etc.). Make sure you are only paying for the incremental profits provided by the target's technology and IP.
You will want to do a 3-5 year projection and determine the discount rate to apply - that is, what is the minimum return you need for the investment over that period. From there, you can apply a net present value to the asset to determine its current value to your company.
For more information about how to model this value, read my article in the February 2011 issue of Intellectual Property Magazine entitled, "Considering intellectual property in acquisition pricing."
Method 2: Review and adjust the target's valuation.The valuation presented by a target is one that will put the technology and IP assets in the best light. This means that you must vet every key assumption (such as pricing, market share, market growth).
Most target company valuations do not take into account risk factors, such as time to market, competition, or technology fit and fitness. To adequately assess an asset's value you need to determine areas of risk and risk-adjust the target's model in those areas.
Once you have done that, you may also want to apply a use factor to the model that reflects the portion of the value your company will utilize based upon your intended use. You may be able to identify assets within the portfolio that would not achieve their potential value if brought within your company.
Method 3: Evaluate comparable market transactions.A thorough understanding of comparable market transactions will tell you whether the price is reasonable based on the value the target company could expect to get in the general market. This process involves identifying acquisitions in a similar technology space, and between similarly sized companies in similar market positions. It is difficult to find good comparables. You can find related transactions through Google searches and then, if one of the companies involved is public and the transaction is material, uncover details of the transaction through reading the companies' annual reports, SEC filings, or press releases. If you can't find similar comparables, you may need to skillfully adjust found comparables to provide a fair value range. For example, you would identify key attributes of the found deals (e.g. revenues, number of patents, and size of industry) and then provide multipliers based on the differences between these found deals and the one you are valuing.
Comparables provide insights into your target's price expectations and the price expectations of other prospective buyers. They may also provide clues about the circumstances under which the target would likely receive a more favorable offer (such as types of acquirers, specific industries of acquirers, etc.).
When you approach valuation from these three perspectives, you gain key insights into the value of the company or technology assets to you and to other prospective buyers. This information makes it possible for you to determine a fair price for the company or asset, and also sets the ceiling on the price you're willing to pay to achieve a desired return. This process may also provide critical insights to identify creative ways to carve up the target's assets so that you only buy those assets your company needs to achieve maximum ROI, or specify limited fields of use when acquiring IP. Finally, it may provide your executive team with the information it needs to gain internal alignment and deal approval.
For an in-depth look at how to value IP for an acquisition, read Rachael Schwartz' article on the subject published in the February, 2011 issue of IPM Magazine.
ipCapital Group, Inc. (ipCG) specializes in working with companies around the strategic use of Intellectual Property and technology innovations. Our valuation experts combine their expert knowledge in IP and technology and financial valuation acumen to quickly develop valuations and business modeling to guide business decisions. If you'd like to learn more about valuing IP in an acquisition, click here or contact Adam Bulakowski at 802-859-7800 x261 or firstname.lastname@example.org.