Valuation of In-Process R&D Can Stump Acquirers: For starters, many buyers fail to objectively forecast the probability of the technology’s success.

Buyers of product development-driven firms like high-tech and pharmaceutical companies often find that the value of the target is largely tied to intangible assets, such as copyrights, patents, and trademarks. Additionally, a significant portion of the target’s asset base probably includes products under development or in-process R&D (IPR&D). IPR&D can be in the form of a prototype, formulation, or even software code, to name a few. Despite the decline in technology dealmaking over the past few years, target companies still have IPR&D projects in progress and deals still are being done. Properly valuing this particular type of asset became even more crucial with the establishment several years ago of new accounting rules, which raised the bar on proper classification of intangibles. Current rules require the immediate expensing of the fair market value of acquired IPR&D in situations where the technology is “incomplete” and has no alternative use. The fair market value of an asset is the value established by an exchange between a willing buyer and a willing seller. In order to be considered IPR&D, the technology must not yet demonstrate technological feasibility and must have no alternative future use. Certainly IPR&D can lay the foundation for future products or services, but compliance with FAS 141 does not require a buyer to think generations ahead. “They [FASB] don’t want you to go too far down that road. They want you to look at what’s on your plate right now and see what you can reasonably foresee today,” notes Dave Dufendach, National Director of Fair Value Reporting at Grant Thornton. Valuing acquired IPR&D can be a challenging task. Several steps that can stump buyers, valuation experts say, include coming up with an objective estimate of the probability of technology’s success and identifying “contributing assets” in order to isolate the component of income related solely to the IPR&D. Colleague Neil Beaton, Partner in Charge of the Valuation Services Group at Grant Thornton, says, “I’ve never seen a forecast that says a technology is going to fail. I think most buyers become enamored with an asset and have trouble coming up with an objective, well-reasoned forecast for valuing it. If you assume that anything is successful if you throw enough dollars at it, you’re going to wind up overvaluing the IPR&D.” “You don’t want to overvalue something that you’re going to take an immediate hit on if instead it can wind up as developed technology or goodwill or something else,” Dufendach adds. Another tough task in IPR&D valuations is accounting for contributing assets, he adds. In order to accurately value any intangible asset, the buyer must isolate the portion of income related exclusively to the IPR&D. To do that properly, he says, the acquirer has to “charge the technology for the contribution that other company assets make to it.” In the case of a startup technology company, the contributory assets could include net working capital or a trained and assembled workforce, says Robert Reilly, a Managing Director at Willamette Management Associates. In a more mature technology firm, contributory assets may also include customer relationships, real estate, and patents, copyrights, and trademarks. Identifying contributing assets and deducting their contribution to revenue can be a painstaking process but is a necessary component to accurately valuing in-process R&D. Copyright 2004 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com