Page 5 - Asset Valuation

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Asset Valuation | MONDAY, MAY 19, 2014 | S5

is the remaining expected life of the subject and conidentiality agreements, and limiting be secrets any more. Therefore, the cost Second, the residual income method esti-

asset. Since a trade secret does not have access to only those with a “need to know.”
approach and the market approach will gener- mates the value attributable to the subject
a statutory life, the estimated expected life ally not be applicable to trade secret valuation.
trade secret by (1) estimating the entire
represents the period over which the trade Valuation of Trade Secrets
The income approach is therefore the most economic income of the company or the
secret is expected to have economic value. common trade secret valuation approach. reporting unit that utilizes the subject trade
Some trade secrets, such as the Coca-Cola The valuation of trade secrets begins with The income approach estimates trade secret secret and (2) subtracting the income attribut-
formula, can be reasonably expected to the same process as any business and/or value based on the expected future economic able to all other assets held by the company
have an ininite expected life. Other trade intangible asset valuation assignment. The income attributable to the trade secret.
or reporting unit. Every asset owned by a
secrets, perhaps those based on changing valuation analyst must irst select valuation A trade secret can impact the owner com- company is considered to contribute to the
technologies and/or tastes, might be expect- criteria, including (1) the valuation date, pany’s economic income in three ways: (1) company’s income. The residual income is

ed to have a shorter expected economic (2) the standard of value (e.g., fair market increased revenue, (2) decreased expenses, then attributed to the subject trade secret.
life. The expected life is a critical input into value, fair value), (3) the premise of value and (3) decreased investments. The goal of These other assets can include:
both valuation and infringement damages (e.g., as a going concern or in liquidation), the valuation analysis is to estimate these • Tangible assets such as working capital,
analyses.
and (4) the purpose of the valuation.1
incremental components of economic income machinery and equipment, and real estate
All else equal, a trade secret that is obvious A trade secret valuation should consider the attributable to the subject trade secret, and • Intangible assets such as customer rela-
might have less value than a trade secret that three generally accepted valuation approach- not to other assets (tangible and intangible) tionships, vendor relationships, and a trained
is not obvious. And, the infringement of an es. The cost approach estimates value based owned by the company.
and assembled workforce, and
obvious trade secret might lead to a lower on the cost to replicate the subject intan- Two income approach methodologies • Other intellectual property such as pat-
market approach
measure of damages. In some cases, a trade gible asset. The estimates that can be used to value trade secrets are ents, trade names, and copyrights.
secret might seem so obvious to the valuation value based on arm’s length transactions in described below.
The goal of each method under the income
analyst that one might wonder whether it’s intangible assets deemed to be suficiently First, the incremental income method is approach is to estimate the economic income
really a trade secret. The determination of similar to the subject intangible asset. The based on estimating the difference in eco- attributable speciically to the subject trade
whether an actual trade secret exists should income approach estimates value based on the nomic income resulting from ownership of secret. Once this determination is made,
be made by legal counsel. However, it is logi- expected future economic income generated the subject trade secret. The analyst must the next step is to estimate the period over
cal that the obviousness of a trade secret by the subject intangible asset, discounted to analyze each revenue, expense, and invest- which the trade secret is expected to gener-
could impact its value and/or infringement present value at a discount rate that considers ment item that might differ absent owner- ate economic income. As discussed above,
damages.
the risk of achieving the projected income.
ship of the trade secret. It is important to some trade secrets may be expected to have

Trade secret owners should take reason- A trade secret valuation will usually utilize work with company management in order to an indeinite life, while others might have an
able measures to protect secrecy. While trade only the income approach in estimating trade determine which revenue or expense items estimated life of only a few years.
secret validity is beyond the scope of this arti- secret value. The cost to create a great idea in would change as well as the amount of the For a trade secret with a inite expected life,
cle, valuation analysts should be aware of the the form of a trade secret will rarely relect its change. The analyst should independently the valuation analyst should project expected
efforts at maintaining the secrecy of a valua- true economic value—otherwise; the idea might analyze the reasonableness of the changes in economic income for the expected life of the
tion subject. Secrecy efforts can vary consid- not be so great. There is generally no ready mar- assumptions between the two scenarios (i.e., asset. For a trade secret with an indeinite life,
erably, and might include marking documents ket in which to observe arm’s length transac- with and without ownership of the subject the valuation analyst should project expected
as confidential, executing non-disclosure
tions in trade secrets; otherwise, they wouldn’t
trade secret).
economic income for the num- »
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