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Analytical Background

From an analytical perspective, the liquidation value of IP as the low-end of the range of value of a firm’s IP can be modeled as such firm applying an IP Asset Portfolio (“IPAP”) which generates a net cash flow from operations. Moreover, these firms typically still have proprietary information, specific expertise in the marketing, sales, and distribution of the products manufactured with the aid of the IPAP, as well as a certain reputation in the marketplace, which support the concept that such firms are the first-best operator of the assets, in the sense that the IPAP generates the highest cash flow under control of the Company until a default event. Due to credit constraints (e.g.-when the liquidation upon a default event affects the whole industry) and government regulation (e.g.- antitrust, geographic limitations of protection) of strategic (industry) buyers, the IPAP in liquidation would have to be sold to industry outsiders who do not have the necessary skills and experience to operate at the same level, or must incur higher costs to acquire/retain specialists to operate the assets optimally, IP Assets in liquidation fetch prices much below their value in best use (i.e., their value when managed by specialists). Over time, the new owners will gradually attain the proprietary (private) information, develop the expertise, and rebuild the reputation of the technology by managing the assets. As time passes by, the cash flows will tend to return to pre-default/liquidation levels.

The IP value in liquidation, as a proportion of the annual cash flow optimally generated by the portfolio will therefore depend on the amount of the initial shortfall from optimal, the speed of recovery to optimal levels, the estimated economic life remaining for the assets, and the time-value of money.

Empirical Studies

Liquidation values, as a proportion of the pre-default revenue levels, vary significantly from industry to industry and types of IP. The market for patents, in particular, is still characterized as illiquid. For instance, well known observers have noted that

“…IP is still a highly-illiquid asset class with a very inefficient marketplace.  That is, potential sellers of IP rights historically have been unable to access a large quantity of buyers who are willing to pay a predictable price under an agreed-upon set of conditions.  Furthermore, IP transactions are characterized by difficult acquirer identification, long periods of negotiations and endless due diligence activities.  Such transactions are also hampered by the lack of widely-accepted valuation models and independent valuation organizations.” (R. Millien )

We have studied the impact of liquidation on IP asset prices in various contexts (see e.g. yesterday’s post) and found the most likely range to be from 81.5% to 91.2%, with a median of 86.4%. These discounts are typically deeper than the normal discounts seen in real estate markets, which are much more liquid than IP markets; traditionally fluctuating in the 15% to 30% range. The median value is compatible with the following parameters of the conceptual model described above: A likelihood of default of 10%, a three year delay in recovering cash-flows to pre-default levels, and a 4% risk free rate (long-term).

Typical IP Value Loss in Liquidation

Future Research

Based on practical experience, the modeling of the liquidation value of IP for going concern valuation appears to be a clear possibility. The securitization of intellectual property and intangible assets in the past few years may provide empirical data to test the conceptual model outlined here.