A cautionary tale for trustees valuing intellectual property assets

A cautionary tale for trustees valuing intellectual property assets

Intellectual Property is everywhere and nowhere. While sometimes you might be able to see it and hold it, sometimes you can only hear it or observe it in operation.

The whole reason why intellectual property needs to be treated as a separate class of assets to which a unique set of rules apply is because it is “intangible” by its very nature. You may own a precious work of art but that does not necessarily mean you have the right to sell copies of it.  Why? Because ownership of the physical asset does not automatically give you exclusive rights to the intellectual property. You can use your computer or smartphone for work or leisure but you don’t own the copyright in the software programs that make it work.

More often than not, we don’t think, or even care, about the intellectual property that makes all these things happen but it does mean that you have to be very careful when valuing intellectual property assets. In fact HMRC has a separate “intangible assets” regime because of the complexity of this area of law and the need to treat intellectual property assets differently to physical assets.

In the case of Morgan Lloyd Trustees Ltd and others v Revenue and Customs Commissioners[1], the Tax Chamber of the First-tier Tribunal held that the Trustees had failed in their duty of care when accepting without challenge third party valuations of trading names and software used within the businesses to which pension schemes were related.  The case related to self‑administered pension funds (and their financial advisers) and the tax charges to be imposed when funds have been wrongfully transferred out.

Valuing intellectual property assets

It can be difficult to value intangible assets given that their value often depends on the use to which they are put. Take a trade mark such as Nike or Coca Cola; using these marks respectively for sporting goods and beverages adds value to the products which allows the brand owners to charge more. In cases such as these, given there is a ready consumer market for the products, the difference in price between non‑branded and branded goods can be readily assessed and a value ascribed to the trade marks.

However, in the Morgan case the intellectual property to be valued was the copyright in software used exclusively within the businesses with which the pensions were connected and the trade marks protecting the names of the businesses for which there was no real market outside the businesses using them.

Methodologies to value intellectual property

There are a number of accepted methodologies to value intellectual property.

A starting point is often to look at an arms’ length transaction between reasonable parties (the hypothetical seller and the hypothetical buyer) to purchase the asset. This method can work well when there is a history of equivalent transactions. This is known as the “Market Approach“.

In a software context, it can sometimes help to look at the man hours it would take to recreate the software and value the IP based on the cost of reproducing it. This is the “Cost Approach“.

Depending on the asset, it may be possible to look at the income the asset would generate by considering royalty rates, market comparables based on commercially available alternatives and affordability. This is the “Income Approach“.

There is also the concept of a “springboard” valuation; i.e. what advantage does the intellectual property give a business over one without the IP such that the latter would gain a “springboard” to its valuation if it had the IP.

No matter which method is used, there is always a degree of subjectivity given that there are so many variables.  Accordingly, there is always a discount to be applied. On the flip side, it is usual to consider if a “special purchaser” exists which could increase the valuation. Finally, it is usual to apply a “commercial reality” check to ensure that the valuation makes common sense.

The problem of using the market approach

In this case, a market approach was adopted and accepted by the Trustees/Administrators. However, the tribunal found that no one “stood back and considered realistically what the assets in question should be worth, preferring to apply accepted approaches and methodologies which assumed that a real market existed without asking whether the results were realistic“. It went on to find that “in these circumstances there was no real market for the IP assets at all and a costs rather than income approach would have been more appropriate.… we have to assume an open market [and] the very limited nature of that market suggests that the value of the IP assets is negligible.

Accordingly, the tribunal was not impressed that the trustees/administrators simply accepted third party valuations without in any way subjecting them to scrutiny or challenge. It could have been reasonable to rely on valuers if the trustees/administrators had ‘undertaken some steps to ensure that those on whom they relied had relevant expertise’ so as ‘to fulfil their role as trustee of the pension fund and to at least apply basic commercial acumen to test the valuations

As a result the valuations the relevant loans were not secured by a charge of adequate value and therefore the payments made from the pension funds were unauthorised.

Take aways

First, the benefit of a well‑managed portfolio of IP assets cannot be overstated. The case highlights that IP assets can, like physical assets, stand as collateral against loans and so offer businesses a way of raising (more) funds than might otherwise be available.

However, the valuation of the IP assets needs to be robust and capable of standing up to scrutiny in an open market. Get it wrong and there can be serious consequences.

[1] Neutral Citation: [2023] UKFTT 355 (TC)