Intellectual Property (IP) assets, in today’s largely knowledge based economy; play a hefty role in a company’s overall asset valuation. Unglued from tangible assets and asserted into financial reports and balance sheets as intangible assets, IP assets are now contemplated to be a major driving force behind M&A activities especially when such activities encompass knowledge-based enterprises. As an anecdote, in 2006 when Google acquired YouTube, out of its total valuation for the acquisition, $0.2 billion was allocated to its intangible assets. IP assets contribute not only to large corporations but small or medium business enterprises could also benefit from the same.
Conventionally, ‘goodwill’ of a company, built over several years, dominated the notion of intangible assets. But growing contribution of intellectual properties in the global economy over the recent years, IP assets are now asserted separately in financial reports and balance sheets as intangible assets; hence, identifying and recognizing IP assets has become an important part in M&A activities. And to ease the process of identifying and recognizing IP assets for valuation, professionals have repeatedly embraced disclosure of intangible assets through financial statements as the optimal route.
This article will briefly highlight the importance of recognizing IP assets in M&A activities and the norms set globally as well as in Bangladesh concerning disclosure requirements through financial reporting standards.
Intellectual properties are considered as intangible assets irrespective of its type. Trademarks or Trade Names are marketing related intangible assets, Copyrights are artistic or literary work related intangible assets, Licensing, royalty etc. are contract based intangible assets, Patents are technology based intangible assets and Trade Secrets are knowledge based intangible assets. Failing to comprehend the role of IP assets in M&A activities may be compared with missing the Cherry placed on top of the cake. In M&A activities the onus lies on the lawyers, auditors and valuers involved to identify and recognize the IP assets accurately and ascertain the intrinsic value to reach a fair valuation. For instance, a company being acquired may have a number of patents or software under its belt, but not all will prove to be beneficial for the acquirer or a patent can virtually be worthless without its necessary trade secret. On the other hand the company being acquired needs to identify and recognize its intellectual properties and assert into its financial reports as intangible assets to drop a strong fist on the table of negotiation. A single error may cause a ruinous outcome. A classic illustration of such an outcome would be; in 1998 when Volkswagen purchased the assets of Rolls-Royce and Bentley automobiles, after the deal was closed, Volkswagen realized that though they have acquired all the assets and rights to manufacture the car but left to include the right to use the Rolls-Royce trademark. Therefore, lawyers and valuers involved in M&A activities need to dig deep to avoid any gaffes.
Despite all the hurdles and hindrances Bangladesh is facing due to political unrests and prevailing corruptions, a notable headway in our knowledge and technology oriented industries is observed in the recent times. Technology based developments in different sectors have allured the foreign business corporations to step into our markets. Some are merging with the local companies while many are acquiring entirely. Valuation of intangible assets can generate a fortune for an enterprise whether it’s being merged or acquired once its intellectual properties are identified and recognized for that matter. But it is observed that regarding intangible asset valuation in Bangladesh, people frequently possess a fallacy that other than goodwill a company’s intangible assets are comprised of trademark or the brand value of its products. Often the concerned parties fail to recognize that intangible assets are beyond trademarks or patents.
Intangible assets on the brink of being generated internally are frequently overlooked and seldom incorporated into financial statements. Lists of customer details, distribution rights, archives of newspapers, continuing projects of R&D wings etc. all are different forms of intangible assets. In recent years locally owned enterprises in Bangladesh are intensely inclined towards investing in research and developments especially in pharmaceutical and IT oriented industries. These enterprises often become subjects of M&A activities as larger corporations foresee the probable outcomes of their endeavors. If valuers fail to identify an enterprise’s IP assets for valuation, the acquiring entity inevitably is at liberty to become largely benefitted from intangible assets of the acquired enterprise without having to pay a single penny. It is evident that by having to identify and recognize these intangible assets, small enterprises if merged with bigger corporations, will have a larger portion on their plates to begin the negotiation with.
To ascertain fair value of intangible assets in an M&A activity, be it local or a cross-border one, disclosure of such assets is essential and much emphasized in order to identify the valuable ones. Disclosure requirements are met through a company’s financial and balance sheet reports where all intangible assets are listed separately from tangible assets. Several accounting standards were introduced and adopted worldwide to include intangible assets in financial reports. Although it is upon the accounting body of the respective country as to which accounting standard shall be followed, a harmonization between these standards is observed. These accounting standards stipulate a greater disclosure requirement in M&A activities concerning intangible asset valuation e.g. IAS 38 introduced by International Accounting Standard Board (IASB). However according to many renowned professionals, disclosures in M&A activities shall be made carefully or else it may jeopardize the confidentiality of a company. E.g. in an acquisition or business combination a continuing research project of the R&D wing when asserted as an intangible asset, is likely to demand a detailed report of that particular project and explanations for the investments made in connection with the project but potential value of such project may seem less attractive to the acquirer which consequently will leave the secrets of the company exposed if the deal crashes.
With a view of joining the league of harmonization, Bangladesh is gradually yet positively progressing towards adopting accounting standards that are leaning more towards disclosure requirements and recognizing IP assets as intangible assets. The Institute of Chartered Accountants of Bangladesh (ICAB) has adopted International Financial Reporting Standard (IFRS) for SMEs as the Bangladesh Financial Reporting Standard (BFRS) for Small and medium sized entities that will come into effect on 2013. But the setback persists in our legislations as the Companies Act of Bangladesh (1994) lays down only basic requirements for financial reporting by all companies and is silent concerning Bangladesh Accounting Standards or International Accounting Standards.
In the present date, IP accounts for a higher percentage for a company. Due to lack of recognition and stronger protection of intellectual properties, foreign corporations merging with or acquiring local enterprises often overlook to pay or pay significantly lesser value to our intangible assets compared to what they would have to pay in countries like USA or Singapore. For a meaningful contribution of IP assets to our economy, government agencies as well as private organizations need to step forward to raise and spread awareness and educate the people concerned by taking varied measures. And such events shall include lawyers, auditors and valuers since they are the ones responsible to ensure the cherry on the cake stays in its place. Fortunately the ball has started rolling and among my peer groups I see many standing up to secure their rights and taking initiatives to enlighten others of their rights. But understanding the role of intangible assets in valuation is not the only panacea. IP assets will become a noteworthy part of our economic growth if protection of IP rights is ensured exceedingly. It is about time that for the betterment of our own economy and individual’s benefits, the government starts enacting stricter laws and enforcing the existing ones. Once enforcement of our IP laws are at par with the global standards and there is a reconciliation between our laws regulating M&A activities and financial reporting standards, financial statements will indicate an unyielding image of an entity’s intangible assets and subsequently the trend to disregard intellectual properties for valuation will diminish.
The story was first published in INTELLECT Issue no.2, dated July 2012.