This article has been written by Maitree Tyagi pursuing a Diploma in Intellectual Property, Media and Entertainment Laws at LawSikho and has been edited by Shashwat Kaushik.
This article has been published by Sneha Mahawar.
Table of Contents
Introduction
Corporate restructuring activities have been on an uphill climb each year and have reached an all time high in 2022, with an increase of 139% in deal value in 2022. This paper aims to understand the concept of IP valuation and its effect and importance in M&A activities. The importance of due diligence is to get a proper and accurate value of the assets of a company, which helps a company determine whether to undergo any sort of corporate restructuring or not.
According to the Bains report, “Even if India’s economy changes course, executives feel optimistic about the prospects for deals, and they are not pausing M&A.” However, all mergers and acquisitions do not see the light of day and lead to their downfall due to poor valuation of both tangible and intangible assets, with the merger between Kingfisher and Deccan Airlines being one of the prime examples. Many corporate executives still weigh heavily on factors other than due diligence when viewing the advantages of a merger between two entities.
IP valuation has no fixed method to be used. Different methods, like the income method, the cost-based method, and the market approach, can be used according to the conditions and priorities of any corporation. IP valuation is nevertheless important to get the true value of a business and capitalise on its assets. With this, due diligence becomes an investigative yet voluntary requirement. It helps to classify the intangible assets as ones that can afford profits, like the registered intangible assets and the unregistered ones. It can also help identify assets that can be registered and potentially generate profit. Hence, IP valuation and due diligence can lead to a successful merger, generate greater synergy, and lead to the actual transfer of technology in order to gain a competitive edge over others.
In 1998, Rolls Royce was acquired by Volkswagen, wherein Volkswagen purchased all the assets of Rolls Royce; however, out of all the assets, the right over the logo was not transferred; that is, the transfer was restricted to the trademark of Rolls Royce. It was later found that, due to improper IP due diligence, the Rolls Royce logo was in fact bought by BMW, as they were producing engines for Rolls Royce according to an agreement. However, after a lengthy process of negotiations and agreements that were tripartite in nature, Volkswagen retained the Bentley trademark, and BMW became the owner of the Rolls-Royce brand.
This is one of the prime examples of improper valuation of assets, which leads to the buying of overpriced or under-priced assets. Any company needs to do a proper IP valuation as part of its due diligence on intangible assets, as there is a growing reliance on intangible assets around the world. One of the drawbacks of doing business in India is that you rely heavily on factors other than due diligence and the valuation of the target company. Let us look at mergers and IPR as separate concepts.
Role of mergers and intellectual property rights
Mergers are corporate restructuring or combining. When two companies of about the same size proceed to merge as a single entity, it is referred to as a merger of equals. However, mergers of equals do not usually take place. Mergers can take place either through absorption or consolidation. Scenarios include one company acquiring the other. Acquisition, on the other hand, takes place when one company buys more than half of the targeted company’s shares. By doing so, one company gains control over the other. The combination of two or more entities to form a separately owned and separate entity is known as a merger. A merger can take place for a number of reasons, like to attain diversification, increase economies of scale, or, in some cases, eliminate competition.
Indian and M&A
In contrast to world patterns, the merger and acquisition landscape, i.e., the deal value, has risen by 139% in 2022 due to various factors like the availability of assets and many conglomerates looking forward to diversifying their businesses. Another one of the major reasons for the rise in deal value is that it has become a global hotspot for Foreign Direct Investments. The deal value around the world has fallen sharply to a 10 year low of 36% in 2022 with respect to deal values.
2022 marked a boom in terms of mergers, with the biggest merger, HDFC-HDFC Bank, taking place. Companies, as per the reports, are buying online business-like Aditya Birla Fashion and Retail Limited (ABFRL), which bought online businesses like Bewakoof and Urbano Fashion. The initiatives of the Indian government’s very ambitious energy transition policies have led companies to invest more in renewable forms of energy, which has marked a paradigm shift in the investing scenario of the country.
However, according to the same report, one of the few challenges companies face is the retention of talent after deal competition. Many employees view such activity as a threat to their careers and start to look for other jobs. Further highlighted by the report, India needs to cover up the huge gaps left in due diligence. Due diligence becomes vital in knowing whether such a deal is beneficial for one’s business or not. As per the data, 30% of India-based executives say they heavily weigh assessing the cultural and strategic fit of the target company before initiating due diligence.
Intellectual Property Rights: Intellectual Property refers to incorporeal, intangible property, i.e., immaterial property. It refers to the creation of the human mind through skill and labour. The immaterial things that the law recognises as subject matter of rights are the products of human labour and skill, which are known as Intellectual Property Rights. Intellectual Property is everywhere around us, from advanced gadgets to literary and artistic creations like music composition, novels, and even symbols that differentiate one trade from the other.
As a justification for Intellectual Property Rights, John Locke rightly justified that a man uses his labour and skill on a resource that is generally held in common to invest, and that such a person should have a natural right to such a product produced and ensure that such rights are properly protected and enforced.
Various immaterial rights are vested by virtue of:
- Patents: Patents are known as exclusive rights, or popularly known as monopoly rights, which are granted to the inventor to exploit his invention and to prevent others from exploiting it according to the provisions of the respective Act for a specified period. Patents are granted for a limited duration, which is generally 20 years in most countries.
- Trademark: It is generally comprised of commercial names. Logos, signs, marks, lines, packaging combinations of colour, or any combination would be considered trademarks. A trademark is defined under Section 2(1)(zb) of the Trademarks Act of 1999 which states that a trademark should be one of the following:
- Which can be represented graphically, or
- one that can distinguish the goods and services of one person from those of another.
This serves two purposes- it helps the owner protect his business and does not create confusion in the minds of consumers.
- Copyright: It comprises musical, dramatic, artistic, and literal works, along with sound recordings and cinematograph films. It vests in the owner of the copyright the right to exploit the creation by performing the work in public, making copies of it, or cinematographing films.
- Trade secret: It contains confidential information. Such information is valuable in the sense that it can afford an economic advantage to a company, a firm, etc. Trade secrets include any method or process, any unpublished patent application, computer programmes, and many more.
- Other intangible properties include designs, know-how and integrated designs, which can constitute an important part of intangible assets and afford a competitive edge, as well as factorshat are important in the case of any sort of corporate restructuring.
Connecting the dots
Intellectual property contributes heavily to the assets of any company; hence, it becomes very important for the company to take into consideration the value of intangible assets while undergoing any corporate restructuring, as it helps to determine the true value of the business. Intellectual Property Rights have helped businesses in building a brand value for themselves in terms of design, invention, etc., which helps it to distinguish one’s business from that of the other. Moreover, IPR helps a company to attain a competitive edge by getting a technology which helps it in some function of the production or servicing line.
Mergers and acquisitions involve the transfer of assets from one company to another. Such assets can be both tangible and intangible, and IP valuation thus plays a vital role. It highlights the importance of targeting the company after checking the IP portfolio. The strategy of world class companies such as Volkswagen group and Tata group enunciates the IP valuation technique to adopt brands, Intangible assets now form 90% of its value.
IP mergers take place with the main objective of acquiring a new technology in a less complex and time taking manner, as inventing a product or a process of manufacture may take up a lot of time and the company’s resources. However, many companies tend to neglect such intangible assets for the sole purpose of eliminating competition. Acquiring IP after IP valuation can help a company
IP valuation
Intellectual property is an intangible asset, and hence it becomes difficult to value such assets, unlike tangible assets like property, which can be calculated on the basis of comparative methods. Nevertheless, they form an essential part of mergers and acquisitions. IP Valuation helps determine the monetary value of IP assets.
Intellectual property valuation is nevertheless important to get the true value of a business and capitalise on its assets. There is a growing dependence on intangible assets. According to the study conducted by Ocean Tomo, which is an intellectual property merchant bank, such intangible assets now form 90% of the business value as against 80% in 2005. A business places a high reliance on trademarks, which distinguish them from different trades and help establish goodwill.
| Year | Intangible assets | Tangible assets |
| 1995 | 68% | 32% |
| 2020 | 90% | 10% |
Businesses derive monetary incentives from intangible assets through the sale or licencing of the same. Many companies, prior to any corporate restructuring, check the intellectual property portfolio of the targeted company. Many companies, like Tata, focus on intellectual capital as a growth strategy. Many companies are encouraging the growth of a strong IP portfolio strategy to protect its intellectual property and attract management and investors
However, due to the nature of intellectual property, there is no best suited method for Intellectual Property (IP) Valuation. There are various methods that can be applied by any company according to the circumstances. The methods can be divided into quantitative and qualitative. The Quantitative method includes:
- Market approach: also known as the transactional method, this involves the price paid for transferring rights for similar corporeal assets under similar circumstances. The transactional method is known to be the most popular and reliable method for valuation, as it sets a fair price on the value of the intangible assets involved, moreover, it can determine fair royalty rates.
- Income method: the value is determined by the amount of wealth the intangible asset can generate. It is considered the most mathematical method because it considers the value of time. Due to its mathematical nature, it is usually considered the final stage after the cost method and the market method.
- Cost based method: This is further divided into historic and futuristic approaches.
- The historic approach normally includes the cost of making the intangible asset, like the cost of procuring raw materials, cost of manpower, cost of the patent grant application, and others.
- Futuristic, on the other hand, depends on the ability to reproduce the creation or replace the creation out there with another one. For example, We know LED televisions would constitute the replacement cost of LCD television technology.
One of the most important questions that surrounds intellectual property in corporate restructuring is how to maximise its value. The simple answer to this question will be utilisation of the intangible assets to create revenue. There can be no brand creation or capitalization from assets until and unless there is exploitation of the intellectual property. For example, there can be no ‘Cadbury’ brand without the use of its trademarks and goodwill. This part helps in attracting the management and the investors and, in many cases, leads to the acquisition of the same when one buys more than half of the stocks of the targeting company’s shares.
Due diligence
Due diligence, in literal terms, can be explained as taking the necessary steps and precautions in order to avoid any loss or harm. Due diligence in the context of mergers and acquisitions can be referred to as investigating the ownership of the business or assets of the business as well as the identification and valuation of the assets, which include both tangible and intangible assets.
IP due diligence, in particular, refers to ascertaining the valuation of the incorporeal assets of any company or business and determining whether any corporate restructuring with the target company yields any commercial benefits or not. It helps the company to acquaint themselves with both the advantages and disadvantages with respect to the nature and extent of the target company’s liabilities.
IP due diligence takes into account factors like domestic and foreign patents and steps taken to protect IPR, like whether the company has registered their creation, whether such an intangible asset is licensed to any third party, or if there are any encumbrances on the assets. Any wrong valuation may lead to either the buying of overpriced or under-priced assets or paying for invalidated IPR. IP nowadays constitutes the highlight of any company portfolio and due diligence in turn helps in building new strategies, like whether the company
Steps involved in the same:
- Identifying the intangible assets: Intangible assets can be in the form of innovations protected by patents, designs, any logo or symbol, databases, manuals, etc. According to the data, 10% of the SME’s have their own registered IPRs, out of which 93% have seen a positive impact because intangible assets help lift the reputation of a brand. By identifying the intangible assets properly, there are fewer chances of mistakes in the further process of due diligence.
- Existence of IPR-related IP assets: It is important to categorise whether the intangible assets are protected, registered, or unregistered as matter of fact. It is only when these assets are registered and protected that the inventor gets the right to prevent others from exploiting the invention.
It is also important to take into account the assets that are not protected by the company but can do so and eventually lead to the future profitability of the business.
- Valuation and the current situation of IPR: The valuation of IPR, as discussed in the paper, helps to ascertain the value of business. In addition, certain other factors, like ownership over the property, are to be considered. A corporation cannot be the first and true inventor; however, a corporation can be an assignee. Another factor in business is the employer-employee relationship. Generally, the employer has the right over the creations made by the employee in course of business; however, in the absence of any contract, the employee may be able to exercise the rights first. In addition, it is important to check whether an additional fee is paid for the invention or not. Further, any sort of opposition or objection may delay the process of granting a patent for an invention.
- It is almost essential to check the rights and liabilities that may arise due to ownership. For example, many contractual obligations may be attached to the IP rights, like the existence of a license and the duration attached to the same. Similarly, confidentiality by way of non-disclosure agreements related to information that is sufficient to provide commercial benefits is to be maintained. Certain non-contractual obligations are also included, like infringement claims, which can considerably impact the IPR value, and other non-judicial processes like ongoing arbitration and mediation.
Another case of improper valuation and due diligence
One of the prime examples of mergers without taking into consideration intangible assets happened with Kingfisher Airlines. The downhill for the Kingfisher airline started with the merger with Deccan Airline, which was a low-cost airline providing seats at an affordable rate. After the merger, neglecting the brand reputation both companies held with respect to their trademarks, Kingfisher changed it to Kingfisher Red, which created confusion in the minds of consumers as to the difference between Kingfisher and Kingfisher Red, as a result of which Kingfisher went into debt with heavy losses. Hence, it becomes all the more important to take into account the intangible assets and how much they contribute to the brand’s value.
Conclusion
I would like to highlight a quote by James Gleick that reads, “Patent battles have become a strong catalyst for mergers, reducing competition in various domains. The largest corporations, with gigantic patent portfolios, routinely enter into cross-licensing agreements with their largest competitors.”
Mergers have become a common affair due to the uncertain economic landscape. However, it becomes equally important to weigh the tangible and intangible assets, as both contribute to determining the true value of the assets and the makeup of the value of the company. It is important for any corporation to look into the history of the company, such as what technology it possesses, as well as whether acquiring such technology will benefit the firm’s business in any way. Moreover, the maximum utilization will generate the best IP value; for example, a brand can create goodwill attached to it through its maximum utilization. Giving more weight to initiating due diligence and relying on the same will leave a company with answers and increase the chances of the merger being a success. A robust IP Valuation infrastructure before any mergers is now a necessity to avoid another infamous Volkswagen-Rolls Royce case.
References
- https://www.mondaq.com/india/maprivate-equity/950464/ip-due-diligence-in-ma–4-points-to-consider
- https://www.iiprd.com/role-and-significance-of-ip-due-diligence-in-ma-transactions-in-india/
- https://ttconsultants.com/ma-due-diligence-ttconsultants/
- https://blog.ipleaders.in/ip-issues-in-ma/
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