What Is the Core Tech of a Company Worth? It Depends Who Is Asking!

Abstract: 

Patents and brand names are only two examples of a broad category of disembodied assets from which firms derive revenue, referred to as “intangible assets.” Intangible assets pose a challenge for traditional financial valuation models for many reasons. Because intangible assets lack physicality, companies can easily transfer them internally from one subsidiary to another and among different countries. Aside from this difficulty in precisely determining their financial value, companies can use intangible assets as a profit-shifting tool in tax-planning schemes. In the course of their daily business, companies do not need to quantify the precise contribution of intangible assets to their business success. However, transfers of intangibles to other tax jurisdictions or to other companies force the question of the financial valuation of intangible assets. Likewise, when companies fail, the damage can be limited if they own intangible assets that can be 2 sold in the market.

As for the financial valuation of intangible assets, two categories of actors are distinguished by the difference in their approach. The first is market observers, who take action and advise decision-making by market players. Among such market observers are regulators, courts, financial consultants, tax advisors, and policy makers. The second is market players, who take part in transactions involving transfers of intangible assets. Market players buy or license patents from other players. They can also acquire financial exposure to intangible assets indirectly by investing their funds in companies and start-ups that are focused on intellectual property (IP).

The approach to valuation by market observers frequently relies on the cash-flow discount model, a financial model commonly used to value securities traded on a stock exchange. However, market players either ignore the cash-flow discount model or resort to it reluctantly; rather, they tend to rely on a holistic approach. In a holistic approach, patents can be worth more because of their right to exclude competitors than because of the future cash flows they are expected to generate. Strategic competition considerations dominate the market in intangible assets, based on which market players attribute value to these assets. In this approach, one estimate of the value assigned to intangible assets can be derived from the valuation of companies as a whole when investors hold a financial stake in them.

The discounted cash-flow approach favored by market observers seemingly based on a rigorous methodology. The holistic approach, by contrast, depends on the insight of specialists, including their assessment of a firm’s corporate strategy as a whole. This approach has the advantage of capturing the consensus expectations of the entire 3 financial investor community. To illustrate the implications of these different approaches, we contrast their results through the examples of Microsoft’s and Facebook’s tax-related transfers of intangible assets.

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Author: 
Helena Malikova
Publication date: 
August 1, 2017
Publication type: 
Working Paper