Updated: Jan 27
By Jigar Desai
Due to the Covid-19 pandemic, many businesses have been forced to close, forcing owners to sell their business. Selling a business is always a difficult decision for a business owner to make as they have poured their time and effort into the business. Unfortunately, there are times when selling a business can save the business owner greater loss. So, how does a sale occur? A sale of a business or company can occur through a sale of stock or a sale of assets. A sale of stock occurs only for corporations where the purchaser buys all the outstanding stock. A sale of assets is where the purchaser buys all the assets that a business has, essentially buying the entire business. This article will focus on small businesses and the sale of assets.
The sale of a business’s assets includes all the tangible assets and intangible assets, meaning all the physical assets and assets that a buyer cannot see. One important intangible asset is intellectual property, which is an intangible asset and can be the sole reason a purchaser is looking to buy the business. We have provided more information on intangible assets in a previous article here. Intellectual property (IP) includes all trademarks, copyrights, patents and trade secrets. A business’s IP can hold incredible value if it contains an innovative idea that is revolutionizing the industry. An example of this would be a secret manufacturing process that cuts down cost of manufacturing by 15%. This secret would help a purchaser save money in the long run and can only be used if they purchase it. This IP would add great value to the purchase price of the business.
How do I get IP?
If businesses are unsure if they own any IP and are seeking to increase the value of their business, we have provided a short list of how to obtain IP rights. The most common IP among small businesses is trade secrets. The Uniform Trade Secrets Act defines a trade secret as any formula, pattern, program or method that derives independent economic value, actual or potential. Fortunately, for business owners, that is a broad definition that covers almost anything that makes them money. A trade secret does not need to filed with a government agency or any state government, saving the business owner some hassle and money. The key to trade secrets is in the name; it has to be a secret. A business owner must keep this IP a secret, only allowing a limited number of people to know about it and they must take reasonable steps to keep the information a secret. This can be difficult, but is not an overly daunting standard, as this can satisfied by simply telling someone that a trade secret is under the protection of an NDA. Investopedia provides more information of how to form an NDA. Unfortunately, if a business owner does not take these steps to protect the trade secret and provides its information, they have destroyed the trade secret protection. Thus, it is important for a business owner to maintain reasonable secrecy in order to experience the monetary benefits of a trade secret. A business owner can show the trade secret to a potential buyer and explain why they are seeking that price if they protect themselves with an NDA.
A copyright is the business owner’s right to sell and reproduce their artistic work. These artistic works include architectural drawings, sound recording and any graphic or audiovisual work. While important artistic work may not jump out at the business owner right away, a business may have some copyrightable work that could be valuable to protect. Anything similar to a theme song or pictorial work, but not a logo, done by a business can be protected. This is important because these artistic works are a part of an overall brand that customers look for. For example, a theme song can invoke a specific thought in a customer’s head that assures them that they are receiving a high-quality product or service from the business. For modern technology companies, the programming code used in software may be filed as copyrightable work. In recent technology company sales, the copyrighted programming code is the sole reason why the company was purchased. Chron provides more examples of copyrightable work and their importance. To gain copyright protection, a business owner will have to file a registration with the US Copyright Office. For more information on registration fees, click here. The process is fairly quick as a business owner will get a response within three to four months of applying. To obtain protection, a business owner will need to demonstrate that they have created an artistic work, that is original, and on some artistic medium.
Business owners have stated that the protection is easy to obtain. It is common understanding among business owners that an owner has copyright protection even before they apply through the US Copyright Office. However, these protections are limited and a business owner should seek the maximum protection through their application, especially when they are selling their business. This grants the business owner protection when showing a potential buyer their work and makes their business more marketable.
A patent is an exclusive right granted to an invention created by the owner. This invention can be a product or process. The process to acquire a patent is the most difficult out of all the other IP, but that makes it the most lucrative when selling a business. The product or process has to be patentable, original and filed within the United States through the USPTO. A business owner should first develop their idea and decide what the ultimate product or process will be that they are trying to create because the patent process requires great detail. A business owner should then go to USPTO.gov and search through the patents to see if their idea has not been taken already. Discovering if your patent idea has already been filed can save a business owner a considerable amount of time and money. Then, a business owner should decide within the four type of patents (design, utility, software or plant) their invention falls under. The USPTO provides more information about the different types of patents. Then, the business owner should apply for a patent using an application from the USPTO. A business owner can apply themselves to save costs, but it is highly recommended to consult a lawyer before applying. As the patent process requires great detail, the lack thereof can get an application denied; thus it is recommended to hire a lawyer to write the specific application the owner is seeking. The last thing an owner would want is to get denied or receive a patent for something they did not intend to patent. The patent process takes one to five years, so we recommend a business owner to start immediately if they want to have a marketable patent. A business owner can apply for a provisional patent while they are working on their patent. This grants the patent protection and requires that a full application be filled within one year. A provisional patent is an easier process and does not require the assistance of a lawyer. Investopedia provides more information on provisional patents.
Lastly, a business owner should file and acquire a trademark registration before selling their business. A trademark is a word, phrase, symbol or design that distinguishes a source of goods from another. The logos of the business and products, the packaging of the products and even the name of the business can be trademarked. This essentially allows a business owner to protect their business’s brand and reputation, which is a large portion of what they are selling to a potential buyer. A potential buyer is not just buying the physical property that the business owns but also the goodwill the business has created amongst their customers. The protection granted from a trademark can be indefinite, but it requires the owner to provide a detailed description of the trademark, a drawing of what is being trademarked and proof of actual use or intent to use the trademark. In order to maintain a trademark, a business owner is required to use the mark and the mark has to be distinctive. This means that the mark cannot be generic and cannot be a concept commonly used by others. For example, a pizza restaurant cannot trademark just a logo of a slice of pizza; they also have to provide more detail to earn the trademark. There is a sliding scale of distinctiveness that the USPTO uses to award a trademark, generic being on one end and fanciful being on the other end. The best trademarks evoke a thought of the business solely on their products without any suggestion from the name. An example of a fanciful trademark would be “Chevron” as the name does not suggest that they are a gas station company. A generic mark that would likely be denied is “Mike’s pizza shop,” since the name is generic and lets the consumer know exactly what they are without knowing the business. For small business owners who are looking to save money in the application process, they can apply for a trademark with their respective state rather than with the federal government. Filing a trademark with the state is cheaper and provides some protection for the business owner. This could be beneficial for small business because they do not conduct business across the country and will not need the broad protection.
Ways to sell IP
When a business owner is selling their business and their IP, they must consider a few issues. First, since IP is an intangible asset, how would they value it in the sale? There are a few options for the business owner. The simplest is to value the IP by the cost they incurred to acquire them. These costs would be the filing fees, the costs for lawyers, or any other third-parties that assisted. However, this does not account for the value the IP has gained over time in the industry. This does not provide any profit for the owner; it simply allows for them to break even. Another option would be to value the IP to similar IP that have been sold in similar industries in recent histories. This requires the business owner to conduct research on transactions that have occurred in their industry, which can be difficult if they operate in a niche industry. There are many factors for why a business obtained a certain price for their IP; this means there can be a lot of negotiation between the business owner and the buyer as to which comparable factors should be used to find a price. Lastly, a business owner can use past and future estimates to value their IP. This means that the business owner uses the past profits attributed to the IP and predicts the future profits that will derive from the IP. Using the past and future profits, the business owner can create a price.
Suppose the business owner does not want to give up the IP all together and possibly plans to use the IP for a future business endeavor, they can license the rights to use the IP rather than outright sell it. This means the purchaser will pay a reoccurring fee to use the IP for a stated amount of time for specified uses. Then, after the licensing agreement has expired, the IP rights belong back to the owner. Alternatively, a business owner can also assign the IP rights to the buyer. Assigning means that the business owner has provided the rights to use the IP for a stated amount of time and then the rights revert back to the original owner. When using an assignment agreement, the owner will factor the assignment into the business purchase price rather than collect a reoccurring licensing fee.
IP makes up one of the largest assets sold during the sale of a business; thus the ownership of IP increases the value of the business and protects the owner during the initial business sale period. The valuation of IP can provide an accurate value of your business that physical assets may not be able to, for example, the amount of goodwill encompassed within a business’s trademarks. It is key that the business owner takes the time to look around their business and start to protect the intangible assets that they have.
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