IP Management for start-ups: Tax and valuation

IP management provides the basis for ensuring that software, technical solutions, brands and know-how are allocated to a company in an economically appropriate and tax-efficient manner. For start-ups and innovative mid-sized companies, tax, accounting, valuation and robust documentation are particularly important alongside the protection of intellectual property.

Record IP early and assess its economic significance

Intellectual property, or IP for short, encompasses more than patents. The intellectual property of an innovative company may include technical inventions, software code, brands, designs, databases, domains, trade secrets and contractual rights of use. Unregistered assets can also be crucial for the business model, financing and exit.

For effective economic management, it is advisable to begin with an inventory: What IP assets exist? Who created them? Who owns them? What rights of use exist, and in which markets are they needed? These questions should not be left until a financing round or sale.

Legal questions concerning protectability, ownership, employee inventions, licences or potential infringements of third-party rights should be handled by appropriately specialised lawyers and patent attorneys.

From IP inventory to tax and accounting

Once the relevant IP assets and their allocation have been established, tax and accounting questions arise. The commercial balance sheet and the tax balance sheet may treat intangible assets differently. Under certain conditions, internally generated intangible assets may be recognised in the commercial balance sheet; restrictions apply to internally generated brands and comparable assets. The accounting treatment under German commercial law is determined in particular by Section 248 HGB.

For tax purposes, the acquisition for consideration is generally decisive for intangible assets held as fixed assets. This is why the economic value of IP often cannot be identified from the balance sheet.

Particular attention should be paid to the transfer of IP between founders, companies, a holding company or an IP company. The tax transfer value is not necessarily based on the carrying amount; it may instead be linked to the market value or an arm’s-length value. Particularly where IP is growing rapidly or is technologically significant, this value may be substantially higher than the carrying amount.

Dry Income: When IP triggers tax without generating a cash inflow

The difference between the carrying amount and the tax transfer value can reveal hidden reserves. If these are taxed without the company receiving a corresponding cash inflow in the same context, a typical dry-income risk arises: liquidity must be made available for tax payments even though no, or only very little, liquidity has previously flowed in.

The risk is compounded by the fact that IP is not always recognised on the balance sheet. Self-developed software, know-how, data holdings and other intangible assets may exist economically without being visible in the balance sheet. If such assets are implicitly transferred as part of a restructuring or transfer, this may have tax consequences. The absence of a balance-sheet item therefore does not automatically mean that no value exists for tax purposes that can be transferred.

Before a transfer, at a minimum, the reason for the transfer, the scope of the assets transferred, the valuation method, the tax treatment and the financing of any potential tax liability should be reviewed. The distinction between a transfer, licensing and the mere granting of rights of use may also be decisive. In the case of associated companies, arm’s-length terms and robust documentation are also required.

Valuing IP from an economic perspective

The economic value of IP does not automatically correspond to either the development costs or the amount recognised in the balance sheet. The purpose of the valuation and the valuation date should be established first. Typical purposes include financing, licensing, contribution, restructuring, a transaction or an exit.

Depending on the purpose, different valuation approaches may be appropriate:

• The cost approach considers reproduction or replacement costs. It captures future market potential only to a limited extent.
• The market approach is based on comparable licences or transactions. For start-ups, however, reliable comparable data is often lacking.
• The income approach values expected financial benefits. The result depends heavily on forecasts, risks and discounting.

For brands, patents or software, a relief-from-royalty approach may be used, for example. This estimates the royalty fee that would have to be paid without owning the IP. For start-ups, scenarios are often more informative than a single point forecast. Valuation assumptions, data sources and uncertainties should be documented in a comprehensible manner.

IP Due Diligence for financing and exit

An IP due diligence examines whether the key IP assets have been recorded, can be used economically and are reliably allocated to the company. It is not an isolated legal review, but an interface between the business model, contracts, tax, accounting and valuation. The legal review itself should be carried out by specialised lawyers and patent attorneys.

Typical areas of review include:

• IP register containing intellectual property rights, domains, key licences and other intangible assets;
• Contracts with founders, employees, freelancers, agencies and co-operation partners;
• Open-source components, third-party software and the resulting obligations;
• Terms, scope of use, territorial scope, encumbrances and potential dependencies;
• Consistency between economic use, legal ownership, accounting treatment, tax structure and business planning;
• Valuation assumptions and potential tax liabilities, particularly in the case of transfers or restructurings.

In a share deal, IP rights generally remain with the company and are transferred with it. In an asset deal, by contrast, the relevant rights and contracts must be transferred individually. For the economic assessment, the number of intellectual property rights alone is not decisive; their quality, allocation, enforceability and significance for the business model are more important.

Checklist: Ten steps for robust IP management

1. Record technical, creative and commercial IP assets.
2. Document their creation, authors, inventors, owners and rights of use.
3. Consider balance-sheet visibility and economic significance separately.
4. Determine the purpose and date of the valuation at an early stage.
5. Distinguish between transfers, licences and the granting of rights of use for tax purposes.
6. Analyse potential hidden reserves and dry-income risks before a transfer.
7. Document development expenditure, contracts and tax allocation in a comprehensible manner.
8. Select the valuation method, scenarios and assumptions to suit the purpose.
9. Keep the IP register, contracts and data room up to date.
10. Coordinate legal, patent-law, tax and accounting reviews.

Our contribution: Tax, accounting and economic IP matters

Conclusion: IP as part of corporate management

IP should not be viewed solely as a legal protection issue. For financing, growth, restructuring and exit, its tax and accounting treatment, economic valuation and robust documentation are equally important. The dry-income risk should be assessed at an early stage, particularly in the case of transfers, because IP assets not recognised in the balance sheet may also be relevant for tax purposes.

A compact IP and structure check helps prioritise the need for action. ACCONSIS provides support in the areas of tax and accounting, economic IP valuation and IP due diligence. The relevant specialised advisers should also be involved for legal and patent matters.

Note: This article provides general initial guidance and does not replace individual legal, patent, tax or valuation advice.

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