Licensing agreements grant one party the right to use another party's intellectual property — technology, brand, content, or know-how — under specified terms. Under IFRS 3, licensing agreements are classified as contract-based intangible assets because they arise from contractual rights that are clearly identifiable and separable.
In a business combination, licensing agreements on both sides of the transaction may require recognition. An in-licence (the right to use someone else's IP) creates value for the licensee when the terms are favourable. An out-licence (the right granted to others to use the acquiree's IP) creates a receivable stream of royalty income.
The Relief-from-Royalty (RFR) method is the natural valuation approach for both, though the application differs depending on which side of the agreement is being valued.
The valuation perspective depends entirely on which side of the agreement the acquired entity holds:
An in-licence at market terms has no incremental intangible value — the licensee pays exactly what the right is worth. Value arises only when the licence terms are favourable relative to current market rates. Conversely, an out-licence always has positive value equal to the present value of the future royalty income stream.
An in-licence creates a recognisable intangible asset when the contractual royalty rate is below the current market rate for an equivalent licence. The value equals the present value of the royalty savings over the remaining licence term.
A pharmaceutical company is acquired with an in-licence for a patented drug delivery technology. The licence terms: 3% royalty on net sales, with 8 years remaining. Current market royalty rates for equivalent technology: 5%.
| Year | Net Sales (£M) | Contractual Rate | Market Rate | Annual Saving (£M) |
|---|---|---|---|---|
| 1 | 50 | 3% | 5% | 1.0 |
| 2 | 55 | 3% | 5% | 1.1 |
| 3 | 58 | 3% | 5% | 1.16 |
| ... | ... | ... | ... | ... |
Discounting 8 years of savings at 13% produces a fair value of approximately £5.8 million for the favourable in-licence.
An in-licence at above-market rates represents an unfavourable contract — a liability, not an asset. Under IFRS 3, this must be recognised as an assumed liability at the present value of the above-market payments. This is the mirror image of the favourable terms asset.
An out-licence is valued as the present value of the future royalty income stream. This is conceptually straightforward but requires careful attention to:
Revenue base growth: The licensee's revenue — which drives the royalty calculation — must be projected using reasonable assumptions about market growth, product lifecycle, and competitive dynamics.
Minimum guarantees: Many licences include minimum annual royalty payments, which provide a floor for the valuation regardless of the licensee's actual performance.
Termination provisions: The licensor's right to terminate for cause, or the licensee's right to terminate for convenience, affects the expected duration and therefore the value.
Renewal expectations: As with franchise agreements, the inclusion of renewal periods depends on historical practice, contractual terms, and stated intentions.
Document the royalty rate, revenue base, payment schedule, minimum guarantees, exclusivity provisions, territory, and term including renewals.
Estimate the licensee's revenue that forms the royalty base, using management projections, market data, and historical growth rates.
Apply the contractual royalty rate to projected revenue. Include step-ups, caps, and minimum guarantees as specified in the agreement.
Apply a risk-adjusted discount rate reflecting the certainty of the royalty stream. Contracted minimum guarantees warrant a lower rate than performance-dependent royalties.
Cross-licences — where two parties each licence IP to the other — present particular valuation challenges. Neither party pays cash royalties; instead, the exchange of rights constitutes the consideration. Valuation requires:
Two technology companies enter a cross-licence agreement where Company A licences its patents to Company B, and Company B licences its software to Company A. In a business combination involving Company A, the acquired cross-licence must be assessed: the right to use Company B's software (in-licence) may have a different value from the obligation to allow Company B to use Company A's patents (out-licence). The net position determines recognition.
Businesses with many licensing agreements — technology companies with patent licensing programmes, franchisors with hundreds of franchise licences, publishers with translation licences across dozens of territories — should group agreements into categories and value them as portfolios. Individual valuation is reserved for material, non-standard agreements.
Not all licence agreements create material intangible value. Short-term, at-market software licences (like annual SaaS subscriptions) are typically immaterial. Long-term, exclusive licences for core IP used in the business's primary revenue-generating activity are material and require separate recognition.
Licensing agreements are among the first items reviewed in M&A due diligence because they reveal both opportunities and risks. Favourable in-licences create hidden value. Unfavourable out-licences constrain future monetisation. Change-of-control provisions may allow counterparties to terminate on acquisition. A thorough licence audit is essential before attempting valuation.
Licensing agreements are one of eight contract-based intangible assets under IFRS 3. For the full classification, see 35 types of intangible assets. To understand the RFR method, read our guide to intangible asset valuation methods.
Tony Hillier is an Advisor at Opagio with over 30 years of experience in structured finance, M&A advisory, and intangible asset valuation. Meet the team.
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