Technology assessment – essential for industry 4.0

While technology solutions have always played an important role in M&A activities, the challenges associated with the COVID-19 pandemic as well as the disruption of business models have made technology an absolute necessity.

The tech sector's strong position during the pandemic has led to a surge in M&A activities, higher valuations, historic highs in venture capital funding and numerous tech IPOs since the second half of 2020.

The following article presents the possibilities for assessing technologies and describes the essential drivers of technology assessment.

What Are The Options For The Assessment Of Emerging Technologies?

The value of technology is derived from the benefit it provides to the owner or a potential buyer. The assessment can be carried out using three different methods:

discounting the expected future cash flows of the technology ("discounted cash flow (DCF) approach");
market prices of comparable technologies ("market approach");
replacement costs of the technology ("cost approach").

Especially for emerging and innovative technologies (e.g. development of COVID-19 vaccines), comparable market prices cannot be usually derived. Because there is a very fine line between non-targeted research and technology-specific development, replacement costs are typically difficult to quantify. Thus, when acquiring emerging and innovative technologies, the focus is always on uniqueness and the related future financial benefits.

How Does The Assessment Of Technologies Work?

The starting point for the assessment is the owner's or seller's business plan. This includes the technology’s expected future cash flows and should therefore be analysed in the first place. In addition to conducting market and competitive analyses, technical experts who are able to assess especially the areas of application as well as the existing protection through e.g. patents should also be consulted.

An important criterion of the business plan is also the expected useful life of the technology and thus the time horizon over which cash flows can be expected.

Considerations about the following cash flow development of technologies are always helpful in this respect:

In particular, the extent to which possible patent protection can positively or negatively influence the value of the technology should be assessed.

Thus, it must be weighed up to what extent public disclosure of the patent enables "copying" after the patent protection expires and whether, if applicable, a "trade secret" that is only documented internally offers a longer-term protection against competitors.

After these preliminary considerations are made, the next step is to select an assessment approach. In practice, one of the two following methods is used in most cases:

Here, an indicative royalty for the use of the technology is assumed. The royalty is derived from comparable licence models.

It is assumed that although the technology is owned by the company, its "true benefit" only unfolds in combination with other assets of a company (e.g. production facilities, working capital, customer base, etc.). This is taken into account by deducting indicative lease/licence fees for other assets.

In both valuation methods, the discounting of future cash flows is carried out in a manner analogous to a company valuation based on the weighted average cost of capital ("WACC"). The starting point for this consideration is that the risk of the technology's financial surpluses is oriented towards the operational and financial risk of the company that typically uses the tech¬nology and pursues a comparable business model in comparable markets.

How Is The Assessment Carried Out In Practice?

In practice, it can be observed that the licence price analogy method is the one most frequently used.

However, determining the royalties often resembles the famous "search for a needle in a haystack". The amount of the licence fee to be paid by the licensee for a technology is often a matter of individual negotiations carried out between licensor and licensee, and their result. Therefore, applying this method may be limited in practice by the availability and resilience of comparable licences granted on arm's length terms.

In particular, the comparability between the reference technology and the technology to be assessed requires a precise analysis in practice with regard to the following criteria:

4. subject matter of the licence agreement,

5. rights of the contracting parties,
6. amount of the royalty,
7. reference basis of the royalty,
8. payment modalities and
9. territory and exclusivity.

Conclusion

While technology solutions have always played an important role in M&A activities, the challenges associated with the COVID-19 pandemic as well as the disruption of business models have made technology an absolute necessity. Technology assessment always requires a detailed analysis of the expected future financial benefits of the application. A well-founded assessment of future application possibilities of the technology is therefore indispensable.