Valuation of Intellectual Property for Blockchain and Cryptocurrency Companies

The Evolving Landscape of IP Valuation

Intellectual property (IP) valuations play a pivotal role across various critical business functions.  They are essential for the transfer of IP to newly developed entities, allowing companies to strategically allocate resources, focus on core business activities, and optimize the overall tax position.  IP valuations are used to secure capital financing by using IP as collateral and also to strategically assess IP values prior to M&A transactions.  They also serve a crucial function in legal proceedings by providing an objective assessment of damages in cases of infringement. Additionally, these valuations are integral for accurate financial reporting, aiding in the precise representation of assets on balance sheets.

It is increasingly common practice for blockchain and cryptocurrency companies to transfer, donate, or license intellectual property to newly formed foundations, associations, decentralized autonomous organizations (DAOs), and other entities.  Changes in the global tax landscape have brought increased scrutiny of intercompany transactions as technology, cryptocurrency, and blockchain companies have engaged in transferring their IP to low tax jurisdictions.

The consequences of mispricing (undervaluing) intercompany transfers can be devastating.  Under IRC §482, the IRS is authorized to adjust the results of certain related-party transactions and can impose penalties as high as 40% of the amount of underpayment and charge interest on the tax deficiency under IRC §6662.  The US Department of the Treasury and the Internal Revenue Service (IRS) have jointly issued proposed regulations aimed at enhancing transparency and compliance in the digital asset sector.  Therefore, a reliable valuation of IP is essential for cryptocurrency and blockchain companies.

Intellectual Property of Blockchain Companies and Valuation Methods

Intellectual property for blockchain companies is often comprised of software protocols and source code, patents and applications, trademarks, copyrights, web domain names and developed websites, non-fungible tokens (NFTs), exchange listing agreements, social media accounts, legal documents, and token minting rights.

The three generally accepted approaches to asset valuation are as follows:

  • Income Approach: This valuation method assesses an asset’s worth based on the present value of expected future income or cash flows it is projected to generate. It is commonly used for income-generating assets and relies on financial projections and discount rates to determine value.
  • Market Approach: This approach determines an asset’s value by comparing it to similar assets that have been recently bought or sold in the market. It is effective when there is a robust market for comparable assets, providing a clear benchmark for valuation.
  • Cost Approach: This method evaluates an asset’s value based on the cost to replace or reproduce it. It is particularly applicable for assets that may not have a strong market presence or are in the early stages of development, where their reproduction or replacement cost is a reliable indicator of value.

The selected valuation method or methods used to value intellectual property is based on a number of factors related to the subject IP, the transferring company, and the receiving company.  The majority of IP transfers within the blockchain sector involve companies and IP that are at such an early stage that development of income projections over the useful life of the IP is not a reasonable or supportable endeavor, which eliminates the use of the Income Approach.  In addition, the use of the Market Approach is generally not applicable to IP valuation, as the availability of market transaction data for similar assets is not available.

The Value of Experience

After eliminating the use of the Income and Market Approaches, valuation specialists often default to using the Cost Approach to value subject IP.  However, in our experience, a large portion of these IP-owning companies have received arm’s length capital financing, indicating that the value of the Company’s total assets (including IP) have progressed well beyond their replacement cost values.  As a reminder, the consequences of undervaluing intercompany transfers can be devastating.  Accordingly, the use of hybrid valuation approaches based on a combination of existing generally accepted methods is needed in these circumstances in order to avoid undervaluing intellectual property.  Teknos Associates has been at the forefront of providing supportable IP and token valuations for blockchain and cryptocurrency companies since 2016.

Teknos Associates: With a deep understanding of the financial landscape in both traditional finance and digital assets, Teknos Associates is uniquely qualified to provide valuation and fairness opinion services.  Our team proficiently navigates complex regulatory frameworks no matter how difficult the situation. With a strong understanding of digital asset dynamics, we offer unparalleled insights into both valuation and fairness opinions, ensuring informed financial decision-making. Teknos’ authoritative expertise, commitment to client-centric solutions, and unwavering ethical standards ensure your transactions reflect true market values while upholding highest transparency levels. Selecting Teknos Associates as your valuation advisor guarantees informed, transparent transactions safeguarding your interests.

Special Note:  From time to time, Teknos Associates has been retained by the Internal Revenue Service to perform valuation services.  However, nothing in this communication may be taken to represent the official position or policy of the IRS.  The opinions expressed herein are those only of Teknos Associates.

IRS Circular 230 Disclaimer:  Pursuant to regulations governing the practice of attorneys, certified public accountants, enrolled agents, enrolled actuaries, and appraisers before the Internal Revenue Service, unless otherwise expressly stated, any U.S. federal or state tax advice in this communication (including attachments) is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of (i) avoiding penalties that may be imposed under federal or state law or (ii) promoting, marketing, or recommending to another party any transaction or tax-related matter(s) addressed herein.

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