COVID-19 has greatly impacted the global economy. More than two years since the health crisis began, many businesses are still grappling with the financial, regulatory, and operational challenges caused by the pandemic and adjusting to the changing needs of their customers, employees, and suppliers. Indeed, the coronavirus has brought about various issues that are shared by all businesses across industries.
Nearly all multinational businesses, particularly, are in a dilemma over whether to execute the internal intangible assets (IA) or intellectual property rights (IPR) transfers they planned out during pre-COVID-19 times. Their concerns are valid — the economy is still highly uncertain, and the market remains volatile to this day.
To help these businesses, this article tries to examine whether the current COVID-19 environment is indeed still too uncertain to allow intercompany IA transactions, assuming that valuations of intangible assets derived in the context remain too speculative.
Is developing a defendable IP value possible in the present COVID-19 environment?
The simple answer to this question is yes. Generally, intercompany IA or IPR transfers may need intangible assets valuations for tax or financial reporting purposes. Most of the time, valuation analysts base their projections of future performance on the facts and circumstances that are existent on the valuation date. However, even under normal conditions, the future is already hard enough to forecast. This difficulty is made even worse by COVID-19.
Nonetheless, valuation analysts often have numerous tools with which to cautiously develop a defendable IA or IPR value, especially when it comes to intercompany IA or IPR transactions that have a valuation date when the start of the COVID-19 was determined, or at least determinable.
Most Appropriate Framework to Use for Valuing IP
Valuing IA or IPR under the present COVID-19 environment does not necessarily require the development or use of new valuation approaches. However, more attention should be placed on the best practices for key variables. Although a cautious valuation analyst will naturally take into account all approaches, it may be necessary to focus on the most appropriate framework anchored on income approach.
Under the income approach, an asset or a business is valued as its future cash flows’ current value. Generally, in accordance with this method, future cash flows that are prompted by the asset are projected and adjusted for any changes in cost structure and growth, amongst others. The asset’s current value is calculated using a discount rate that reflects the valued asset’s relative risk and the money’s time value.
Even though the income approach does not depend on past or similar transactions, the estimated value it generates is quite sensitive to the inputs in the model. With that, it is necessary to carefully determine and vet these inputs, especially in the present environment.
For better IA or IPR valuation, performance risks and expectations need to be reflected in the valuation model’s cash flows to the furthest extent possible. Particularly, in the present circumstances, it may be smart to develop numerous scenarios and designate a probability to each. For example, a best-case scenario may illustrate the recovery of a business and its return to normal operations during the second quarter of 2022.
On the other hand, a worst-case scenario may show that a return to normal operations will be hindered by supply chain disruptions until the middle of 2024. Depending on the expectations of the management, these imagined scenarios can then be measured (e.g. 50% chance of early recovery and 50% likelihood of 2024 recovery) to identify a reasonable value estimate.
For any uncertainty or risk that cannot be modeled in the cash flow projections, the discount rate has several levers that may be utilised to catch risk. Since an overlap exists between the risks that can be considered in the discount rate and those that can be taken into account in financial projects, care and caution should be taken to prevent double discounting.
Overall, valuations of intangible assets (IA) or intellectual property rights (IPR) transfers need to carefully take into account how the current economic uncertainty should be incorporated into valuation model inputs. Moreover, detailed files and notes should clearly and cautiously document the basis for model assumptions. Given the available valuation tools, it may not be necessary, or even wise, to suspend intercompany IA or IPR transactions due to COVID-19.
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*The above represent our views and opinions and does not necessarily reflect the position of any entities mentioned.