Intellectual property can be a business’s most important asset. How do you measure its true value?

The value of intellectual property must be analyzed in terms of the future profitability it is likely to generate. Earnings and profits can come from:

• the direct use of intellectual property in the course of the business’s activities;
• the sale of an exclusive or non-exclusive right to use the intellectual property;
• the entry barrier the intellectual property creates for competitors.

What is intellectual property?

Let’s begin by reviewing what is meant by “intellectual property.” According to the World Intellectual Property Organization, the term refers to creations of the mind: inventions; literary and artistic works; designs; and symbols, names and images used in commerce.

These creations of the mind can be divided into two main categories:

• literary and artistic property, including copyright;
• industrial property, including patented and non-patented technologies, trademarks, industrial designs and trade secrets, application and software programming codes, and algorithms.

To be valuable, intellectual property must be:

• identifiable;
• proven to exist;
• proven to have evidence of ownership;
• legally protected;
• transferable;
• capable of generating profitability that is distinctive and can be distinguished from the business’s other assets.

How do you determine the value of intellectual property?

Many factors influence the value of intellectual property. To determine this value, you need to consider not only the profitability generated directly by its use, but also the business model that could maximize future profits from this property.

The following factors affect the value of intellectual property:

• its market size;
• its market recognition;
• its economic benefits to users;
• its useful life (consider the patent date or copyright creation date);
• the entry barriers it creates (the degree to which it reduces competition);
•  the added profitability it generates as compared with a generic product or brand;
• its degree of IP protection (e.g., patent strength);
• competitors’ ability to develop similar property without infringing the law;
• current product substitutes.

How do you calculate the value of intellectual property?

Intellectual property is typically valued based on the future profits it can generate for its owner, using two main methods:

• a discounting of future cash flows based on the royalty relief method, that is, by calculating an appropriate royalty percentage on future sales of the intellectual property;
• a discounting of future cash flows based on the excess earnings method, that is, earnings generated exclusively by the intellectual property.

Both methods involve estimating the profits that can be generated exclusively by the intellectual property, and applying a rate of return to those profits based on the likelihood of achieving that profitability (using mainly the valuation factors described above).

When making an acquisition or sale, obtaining financing or simply implementing a marketing strategy, a business’s intellectual property must be estimated at its fair value. Don’t hesitate to contact an advisor to help you through this complex yet crucial analysis.

The International Accounting Standards Board (IASB) has amended IAS 7 Cash flow Statements and IFRS 7 Financial Instruments: Disclosures through the increase of disclosure requirements to enhance the transparency of supplier finance arrangements and their effects on an entity’s liabilities, cash flows and exposure to liquidity.

Download the Adviser Alert.

After the pandemic crisis, other challenges are testing the mettle of some of our businesses. When should we start to worry and what solutions are available to us?

Different issues are delaying a return to pre-pandemic stability for organizations, including labour shortages, inflation and supply problems.

While the inflation rate has dropped in recent months, it remains higher than the pre-pandemic level (4.8% in September in Québec), and the current prime interest rate is the highest it’s been in 30 years (5%).

So, it’s important to know how to identify early warning signs that could lead to financial difficulties for your company, in order to prevent and better manage the consequences.

Clues you shouldn’t ignore

External environment

Some signs come from the company’s external environment, that is, the market and socio-economic context. These are elements over which the company has little control, but can generally anticipate. Many aspects must be assessed and monitored:

• Your business industry (positive and negative globalization effects, positioning compared to the competition, changing trends, life cycle of your industry);
• Technology (technological change can have an impact on your competitiveness and efficiency, thereby requiring constant adaptability);
• Availability of labour (intense competitiveness for workers can lead to high turnover and hinder retention of top talent if you’re not careful);
• Economic situation (risk of recession, exchange rates, interest rates, etc.).

It’s important to keep your eyes open for new developments. If you find that these elements are affecting your business, you’ll be in a better position to anticipate and adjust to them to minimize their impact.

Finances and cash

Your cash management is an invaluable key for monitoring the state of your finances and anticipating fluctuations. With the right tools on hand, you can plan targeted measures to turn things around if necessary.

• Your financial information needs to be reliable and updated on a timely basis, ideally monthly. Furthermore, it must be sufficiently detailed to allow for accurate data analysis.
• Your management information may include weekly dashboards, key performance indicators and product costing analysis.

You will be able to identify your vulnerabilities at the right time, make realistic financial forecasts and implement an action plan.

Internal environment

Several aspects of your company’s internal environment will also influence your financial vitality, such as:

• a drop in revenues, the source of which must be determined (loss of a major customer or supplier, outdated products, demographic or territorial change, increased competition, etc.);
• rapid revenue growth, which can have an impact on your need for material, human and financial resources;
• the acquisition of businesses and related risks;
• staff turnover rate;
• the implementation of a new computer system;
• a succession issue;
• a conflict between shareholders;
• disputes, legal proceedings or fraud.

So you need to know the environment in which your company operates, as well as general market trends. Also, you need to have effective monitoring tools at your disposal.

Solutions to consider

If your company is receiving warning signs in one or more of the categories listed above, you can consider various scenarios to try to save the day or turn your business around.

Analysis and financial forecast

An expert’s financial analysis consists of getting to know your company by drawing up an exhaustive statement of your assets, liabilities and shareholders’ equity. It allows you to:

• understand your history and your company’s financial situation;
• determine your company’s successes and failures;
• foresee your business’s future performance;
• react quickly to current or potential problems;
• communicate to your business partners the weaknesses identified and the action plan to remedy the situation.

Filing a notice of intent and proposal

This legal procedure enables you to restructure your operations in order to breathe new life into your business. When the financial situation makes this action possible, it gives managers the opportunity to:

• maintain the company afloat;
• manage cash for the company’s future needs;
• terminate commercial leases or contracts deemed non-essential;
• make necessary redundancies;
• reduce the company’s level of debt;
• obtain interim financing.

Bankruptcy

When a financial turnaround is not possible, and the company is unable to return to profitability despite the measures proposed, the last resort to consider is bankruptcy. This is a legal measure that can:

• suspend legal collection proceedings;
• protect the organization from legal proceedings by creditors;
• leave debt management to a trustee;
• limit potential losses to creditors and, by extension, guarantees.

To learn more about this topic, listen to our webinar (in French). You’ll hear specific examples and tips on how to avoid many pitfalls.