4 Oct 2018 02:09pm

Intellectual property: how to protect invisible assets

Businesses have a vast amount of worth bound up in their intellectual property

Caption: Companies' true worth consists not of tangible assets but intellectual property
Look at the world’s top five companies by market value – led by the “three As” of Apple, Amazon.com and Google owners Alphabet, and rounded off by Microsoft and Facebook – and one thing is immediately apparent. Their true worth consists not of tangible assets such as buildings, machinery and vehicles, but of intellectual property (IP) that has no physical manifestation, and has traditionally been almost invisible in business accounts.

It’s an asset class that includes everything from patents, trademarks and brands to industrial designs, copyrighted software, technical know-how and trade secrets. And while technological titans such as Apple make good figureheads for the value of ideas, figures show that IP is now the lifeblood of the economy in general. The Office for National Statistics estimates there was greater UK investment in intangible assets such as IP than in tangibles during every year between 2000 and 2014 (though in 2015, tangible investment was slightly greater – £141.7bn at current prices, compared with £134.2bn).

The picture is similar across other developed economies. A paper co-authored by Professor Jonathan Haskel of Imperial College – a recent appointee to the Monetary Policy Committee – suggested that by 2013, investment in intangibles was outstripping tangibles in both the US and the EU-14 nations.

Some researchers believe this has not just caused a quiet revolution in the way global commerce operates, but that it has profound implications for civil society. It’s an idea encapsulated in the title of Professor Haskel’s book Capitalism without Capital, written with Stian Westlake, which examines the rise of the intangible economy. (Somewhat gloomily, the authors conclude that it is helping to bring about low productivity, the dominance of a small number of giant corporations and an increase in social inequality.)

One of the book’s contentions is that it’s not just knowledge-intensive businesses that are heavily reliant on IP. Shaun Beaney, manager of ICAEW’s Corporate Finance Faculty, reviewed the book on its original release. He says: “There’s an amusing anecdote in there about how even your local gym is now an ‘IP-rich’ business. I was a bit sceptical when I started reading it, but they made a valid point
in a witty way. There are IP elements to consider in a gym’s brand, for example, and its training devices, electronic tools and data.”

Others make the point that while there has indeed been a shift in investment away from physical entities, IP has always been crucial as an asset class – although one that is poorly understood. John Rugman is partner and head of valuations, assurance and business services at Nexia Smith and Williamson. He says: “I remember the same points about intangibles being made back in 2006 when I contributed to the IP Valuation Handbook. They have always been important.

“But I think there is more awareness now that they are unlike fixed assets that can simply be liquidised, as with selling machinery. Intangible assets are more will-o’-the-wisp – here today, gone tomorrow, and easy to damage. People have become more interested in them because with all the advances in accounting, you can now put a number on them and bring them to life.”

For businesses and those advising them, two questions loom large. How should their IP be valued, and how can it be protected – not just domestically, but across international borders? Speak to valuation specialists, IP lawyers and others who operate in the sector, and one maxim quickly emerges: in itself, IP is not necessarily worth anything at all. It’s what can be done with it that counts.

Mark Anderson is managing partner of Anderson Law, and a former chair of the Law Society’s Intellectual Property Law Committee. He says: “While companies are increasingly trying to place a value on their IP assets in their accounts, the IP itself often has little stable value because it depends so much on the underlying products or business that it’s seeking to protect. So what one should really be applying value to is not the IP itself, but the business, or invention or brand that the IP rights are protecting.”

Anderson cites an example from his own first job, as an in-house lawyer at a company formed from the privatisation of a government research facility. He says: “It had a portfolio of around 30 patent families, all inherited from the time when it was a government laboratory. We did an analysis, and every one of them was abandoned as no longer having any commercial value.

“Having a large number of patents may impress the less sophisticated type of investor – the sort that count up the number of PhDs you have on staff. But sometimes the best business strategy
is to scrap IP because it’s a drain on money.”

Gaining an accurate valuation of IP may be necessary for a number of reasons: financial reporting, acquiring or selling the business, or securing finance. Companies with most of their value bound up in IP have traditionally found it relatively more difficult to borrow money, as they lack the tangible assets to serve as collateral. This has often meant turning to venture capital.

“I don’t think there’s going to be a fundamental change in this situation,” says Beaney. “The kinds of metrics used by credit committees at banks will remain the same. They’ll still primarily look at what the fixed-asset value is when they’re seeking to back their loans for security, or for cross-guarantees.

“But what’s important is there is a steady increase in forms of lending that may consider IP more centrally. There’s venture debt – a form of lending to high-growth, often technology-based businesses – that takes a little more risk in its lending and will consider IP specifically as part of the decision. We expect to see an incremental increase in this kind of lending, though probably not a transformative one.”

By their nature, IP assets are notoriously difficult to value. Patents can quickly degrade in value as competitor products emerge; software can be rendered obsolete by disruptive technology; and brands and trademarks may appreciate in worth over time, or have their equity wiped out by a single catastrophic event – as high street jewellery magnate Gerald Ratner famously discovered in 1991, when an ill-advised comment on the quality of his products effectively finished his company.

In the UK, the Intellectual Property Office (IPO) suggests three principal methodologies for valuing IP assets. There is a “cost method”, whereby the valuation is based on the costs incurred in creating an IP right, and how much would be necessary to develop it from scratch. The “market value” method looks at real-world figures from the sale or licensing of similar IP rights in the marketplace. It’s the simplest metric, but reliant on data that may be difficult to obtain (or impossible, in the case of new inventions that have not been brought to market before).

The “economic benefit” method is somewhat more complex, focusing on the revenue that an IP right can expect to realise in the future, and balancing this against the costs of generating that income. “There are various almost-theoretical ways you can value IP,” says Beaney, “but most will come back to its earnings potential. What are the revenues and profits that the IP is generating, or could potentially generate? It’s always about how it’s embedded in the business model.”

When it comes to securing IP assets against theft, making a comprehensive audit of the company’s assets – and doing a risk assessment on potential threats, such as overlapping third-party IP rights or any ongoing ownership disputes – is an essential first step. Beyond that, there’s no one-size-fits-all approach for all the various forms. “There’s no generic concept of IP,” says Anderson. “There are very different rules with patents compared with trademarks, compared with copyright. You always need to drill down to the detail of what you need to protect. Is it a name, a technical invention, or a business idea?”

Obvious weapons in the arsenal include the registration of trademarks, patents and domain names, the drafting of watertight non-disclosure agreements and licensing deals, and having robust policies in place to ensure trade secrets are disclosed only to those who need to know them. In the case of copyright, prevention of theft can mean employing digital means of protection: passwords, paywalls and digital rights management.

Very often, businesses will be dealing with more than one form of IP rights. Andrej Savin is director of the Law Unit at Copenhagen Business School, with specialisms that include international IT law. He says: “You may have a bundle of different things. In a smartphone, for example, you may have patents on it, copyright in the software, a trademark in the name, and industrial design. All these IP rights are very different, and they all have their own logic.”

In all cases, however, prevention is far better than cure – and particularly when operating across international boundaries. Brexit, and the withdrawal of the UK from the institutions that administer EU-wide IP laws, is likely to complicate dispute resolution even further in cases that involve Britain’s closest trading partners.

“Cross-border enforcement of IP rights is notoriously complicated and difficult,” says Savin. “It’s very expensive, even if you’re successful – you may not recover your costs in some jurisdictions – and it’s uncertain. The expense and preparation needed mean it’s effectively out of the reach of small companies.”

When disputes do occur, companies are well advised to be pragmatic. “There’s a strategic element here,” says Savin. “Does it make sense to litigate, or does it make better sense to negotiate? Let’s imagine China as an example: you’re a medium-sized company, you’ve licensed IP of some kind there, and suddenly you find it’s being leaked, or used in violation of the contract in some other market.

“If you’re heavy-handed and decide to go to court, you’ll lose their confidence even if you win the case. And will you even be able to enforce the judgement? It’s almost certainly better to try to negotiate a settlement.”

Digitisation has made the picture even murkier. Piracy of copyright material provides a classic example, as it can be near-impossible even to work out the appropriate jurisdiction in which to take action. Savin says: “Back in the old days, you might be able to get an injunction and have the infringing material removed from the street by 11 o’clock the next morning. These days, if you want to shut down a server that’s hosting pirated material, where’s it located? It may be in Russia, the Cayman Islands or anywhere. And if you shut it down, another one immediately pops up elsewhere.”

This is not to suggest that it’s only high-tech enterprises that need to have adequate safeguards in place. As the UK government states in its advice for SMEs, IP is “not only the currency of the knowledge economy, but also underpins the value of ‘old’ economy companies too”.

Shaun Beaney says: “It’s difficult to generalise across sectors. I do a lot of work on behalf of ICAEW in the creative industries and in digital and technological innovation. But in any business sector, people can be less or more sophisticated in their awareness of the issues. I think anyone who is setting up or developing a business, regardless of the sector, should be thinking about where their IP lies and ensuring it’s registered and legally protected.”