As we explored in last month's column about the importance of including intangible assets (patents, copyrights, trademarks, etc.) in any comprehensive plan, valuing those assets requires an approach similar to a business valuation. The relevant experts, such as intellectual property professionals, patent attorneys, and valuation analysts can help the advanced planning team with this task.
Although each type of intangible asset is different, a handful of factors help determine a credible estimate of value. Typically the greater the breakthrough, the more valuable the intangible asset. The breakthrough can come in the form of a valuable invention that solves a problem or an asset that can create a whole market that didn't exist before. A smudged carbon copy of an unpublished novel by an unknown author may appear inconsequential at first, but then it could follow a similar fate of the highly successful A Confederacy of Dunces, mentioned in last month's column.
If a client who is an engineer/entrepreneur and trailbike enthusiast, invents a different type of bicycle chain, the patent may not prove that valuable if it's just a variation of others available.
One of the preliminary barometers of value is the price a company would pay to use or distribute a protected creation. Other factors include uniqueness, size of the market, relative strength within the market, and term of rights (such as remaining years on a patent or copyright).
Valuation as Preventative
In creating a comprehensive financial plan for a client with complex wealth, an advanced planning group may need a valuation expert for gift, estate, and income tax planning. The expert appraisal serves another purpose beyond planning. It helps prevent the IRS from poking into the client's affairs and challenging the valuation. The IRS evaluates a case against a taxpayer by looking at its costs and potential return. "A good [expert valuation] report makes it more likely that the Service will have to expend more resources to assert its case, and will have a more difficult time trying to show that the taxpayer's position is somehow wrong," state Curtis R. Kimball and Timothy J. Meinhart, in Valuation Theory and Practice: Family Business Planning, an American Bar Association publication.
Hiring an expert after the IRS has come calling with a challenge makes the task that much more difficult since the required valuation may refer to a transfer several years earlier, for example. "The IRS has, also, made significant strides over the past few years in improving the level of business valuation expertise within its valuation engineering staff," note Kimball and Meinhart. "Although there can be no guarantee that the appraisal will withstand the scrutiny of a court, it puts the family in a better position to defend a challenge against discounts for lack of control and lack of marketability." A valuation report would also provide the substantiation for a valuation discount claimed for generation-skipping transfer.
Approaches to Valuation
Whatever intangible assets the client owns, a valuation will address these goals, which may have more or less significance depending on the nature of the asset:
