The Invisible Path: Valuing Technology

• Author: James L. Horvath & Richard Ellsworth
• Pages: 533-575

533

Chapter 20

The Invisible Path: Valuing Technology

james l. horvath & richard ellsworth*

Practice Tip

“Do not go where the path may lead, go instead where there is no path and leave a trail.”

Ralph Waldo Emerson

A. INTRODUCTION

In one way or another, the success of any business depends on technology.

Def‌ined as “the practical application of knowledge,”1 technology contributes

to the success and, ultimately, the overall value of a company. To appreciate

this contribution, one must understand the strategic, operational, f‌inancial,

and tax-related contexts in which technology plays an important role. Ana-

lyzing this contr ibution requires both an u nderstanding of the fac tors that

drive technology’s value as well as those methods used commonly to assess

and quantify that value.

As technology develops continuously and at an ever-increasing pace, the

valuator has to analyze reams of data to assess its value. In the process, the

valuator has to determine whether the technology will succeed or fail. With

more than f‌ift y years of experience bet ween us as valuators, we have seen far

* The authors wish to t hank their colleague C arl Leung, C.A ., C.M.A., C.F.A., C .B.V. for his

review and sugges tions for this paper.

1 Merr iam-Webster dictionary, online: w ww.m-w.com/dictionary/technology.

534 james l. horvath & richard ellsw orth

more examples of failure tha n success. We have valued many different tech-

nologies and revie wed many more tech nology-related valuation rep orts pre -

pared by ot hers. In some cases, we concluded that the technology could not

deliver its intended benef‌its. In other cases, we concluded that the technology

was merely a pretentious modif‌ication of an existing tec hnology designed

to cash in on an overzealous marketplace. In only a very few cases, we con-

f‌irmed that the technology was a truly innovative, game-changing advance.

The development of new technology generally costs more money and re-

quires more time than its inventors anticipate. In addition, most inventors

do not possess all of the technological, f‌inancial, management, and market-

ing talents required to bring a new technology to market. Even the most

innovative and desirable technology, developed by competent and talented

inventors, may not make it in the marketplace without a number of factors

working together in its favour. These may include

adequate f‌inancial resources to complete a prototype and develop a •

market;

sound strategic planning;•

competitors who can readily imitate or duplicate the technology;•

adequate feasibility evaluations;•

a convincing business plan;•

adequate patent protection;•

suff‌icient production facilities; and•

the ability to overcome unexpected obstacles in a timely fashion.•

In the rare case when a ll these factors work together, the valuator will

recognize a tru ly innovative technological advance. In this chapter we look

at some of the considerations and methods employed in valuing technology

and technology-based companies.

Practice Tip

“Superior technology alone is rarely enough upon which to build competitive advantage.”

David J. Teece2

B. TECHNOLOGY ASSET VALUATION CONTEXTS

The valuation of technology is examined w ithin the following contexts:

strategic and operational,•

f‌inancial reportin g, and•

2 David J. Teece, Managing Intel lectual Capital (O xford: Oxford University Press, 200 0) at 8.

The Invisible Pa th 535

tax planning.•

1) Strategic and Operational

Mergers and ac quisitions, divestitures: Many companies derive a signif‌icant

component of their value from technology, therefore, a valuator must under-

stand the value of a company’s tec hnology and any other signif‌icant in-

tangible assets to make a n informed determination of the company’s most

likely selling price; that is, its value to the market place.

Licensing : A fair licensing royalty rate depends on a technology’s intrinsic

value. This value is often determined before the technology developer en-

gages in licensing negotiations.

Portfolio mining: Companies make signif‌icant investments in intangibles

such as technology and other related assets. To protect these most valuable

assets — often through the legal measure of patents — and to fully e xploit

all potential benef‌its, companies must continually monitor their portfolio of

intangible assets and track any chan ges in value.

Revenue enhancement: Many bu sin es ses dep en d on int an gi ble tec hn olo gy ass et s

for their success. A valuator must understand how t hese cruc ial intang ible

assets drive a business’s value (discussed in greater deta il below). With this

understanding, a company can enhance net cash f‌lows by making additional

investments in similar assets or by improving the util ity of existing assets.

Resource allocation: A company can allocate its resources most effectively i f

it identif‌ies its intangible technology assets and estimates their contribu-

tions to the company’s cash f‌low. It can then direct its capital resources

toward those investments offering the greatest returns.

2) Financial Reporting

Many businesses acquire signif‌icant intangible assets in the process of mer-

ging with or acquiring ot her businesses. As a result, f‌inancial repor ting

requirements have focused increasingly on determining t he value of these

acquired intangible assets and the post-acquisition allocation of the pu r-

chase price among them.

According to section 1581 of the Canadian Institute of Chartered Ac-

countants (CICA) Handbook, an intangible asset should be recognized

apart from goodwill, at estimated or appraised value, when

a) the asset results from contractual or other legal rights (regardless of

whether those rights are transferable or separable from the acquired en-

terprise or from other rights and obligations), or