Pricing intellectual assets at exit

Pricing intellectual assets for high-growth tech exits depends on three elements, says Juergen Graner at Globalator: the offer, the holdback and the earn-out

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Juergen Graner

Owners of high-growth tech businesses should decide at an early stage whether they are developing their company for continuation as an independent organization (build to grow) or for an exit (build to sell). They are two fundamentally different strategies. The ultimate goal of a build-to-grow strategy is to continue the business in perpetuity. On the other hand, a build-to-sell strategy has the clear goal of selling the business at a certain point in the future. Key strategic decisions are made with this goal in mind and differ if the time horizon is one to three years, three to five years, or five to ten years. Anything significantly below a twelve-month time horizon tends to be a patch-to-sell approach with limited options for creating value. In high-growth tech businesses, the capital requirements are often so significant that bootstrapping (building a company without external equity financing) is not an option. Moreover, since debt funding is limited by the collateral that a business owner can put up, most high-growth businesses require equity finance, which requires a build-to-sell strategy and a time frame dictated by the remaining life of the fund. The purchase price, is what the buyer is willing to pay overall to acquire a business. As a rule, however, the purchase price is not the amount that the seller will receive once the deal is closed. In most cases, the buyer will require the seller to provide binding promises that certain assumptions about the business are correct. To secure these promises, the buyer will ask that a certain portion of the purchase price be deposited in an escrow account as a holdback. This escrow holdback is subsequently released either to the seller or to the buyer, based on contractually defined terms and timelines. Companies that have been set up for high performance under new ownership through a solid build-to-sell process and supported by a strong portfolio of intellectual assets have the potential to benefit from an additional earn-out, which provides supplementary payments over and above the agreed purchase price for achieving defined performance criteria. While the escrow holdback has the potential to reduce the agreed purchase price, the earn-out can add to it. The secret to the success of an optimized exit is an understanding that different assets have a different impact on these three pricing elements of an exit deal:

• General assets have the highest impact on the purchase price and escrow holdback ,but little impact on an earn-out.

• Technology and brand intellectual assets generally have a high impact on the purchase price and limited impact on the escrow holdback, but both are the key drivers for an earn-out.

• Operational excellence is an inconsequential outlier within intellectual assets, as its impact on the purchase price is more intrinsic with low impact on the escrow holdback. On the other hand, it is usually the most important driver for earn-outs.

  
  

From an early stage, a proactive build-to-sell process will develop a solid portfolio of intellectual assets to secure the value of the business. The following example from life sciences illustrates the possible impact of escrow holdback and earn-out on the actual amount received by the seller. With a purchase price of $50 million plus a 20 percent escrow holdback and a $20 million earn-out, the difference between a worst-case scenario (all the escrow holdback is kept by the buyer and no earn-out is paid = $40 million exit deal value) and a best-case scenario (the entire escrow holdback is released to the seller and the full earn-out is achieved = $70 million) would be $30 million.

This translates to a 75 percent higher overall exit price if the business was well prepared in a build-to-sell process and the implementation phase went according to plan. Intellectual assets are major contributors and increase the likelihood of a higher purchase price in the first place and a higher overall exit deal.

• Juergen Graner is founder and chief executive of Globalator, a specialist in creating value through strategic transactions with a focus on build-to-sell engagements. The full version of his article on how intellectual assets impact exit value appears in ‘Winning with IP: Managing intellectual property today’, third edition, Novaro Publishing, October 2022.  See here for details.