In-process research and development (IPR&D) refers to R&D projects that are underway but not yet completed at the acquisition date. Under both IFRS 3 and ASC 805, IPR&D acquired in a business combination must be recognised as a separate intangible asset at fair value — even if it would not have been capitalised on the target's balance sheet under normal accounting rules.
This creates a distinctive valuation challenge. Unlike completed technology, which is already generating revenue, IPR&D represents potential future value that is contingent on successful completion. The project might succeed and generate significant returns, or it might fail and be abandoned. The fair value must capture both possibilities.
IPR&D valuation is unique because it must account for completion risk — the probability that the project will never generate any revenue at all. This risk fundamentally shapes the valuation approach and produces values that can vary enormously depending on the probability of success assumptions.
The two standards agree that IPR&D must be recognised separately at fair value, but they diverge significantly in post-acquisition treatment:
The post-acquisition treatment is now largely aligned between IFRS and US GAAP. The historic difference — US GAAP required immediate write-off of acquired IPR&D before ASC 805 — was eliminated in 2007. Both standards now capitalise IPR&D and test it for impairment rather than expensing it immediately.
IPR&D is typically valued using a probability-adjusted income approach — either MPEEM (if the IPR&D is the primary intangible asset) or a standalone income approach. The key feature that distinguishes IPR&D valuation from other intangible valuations is the explicit incorporation of completion probability.
Document the stage of development, technical milestones remaining, regulatory approvals needed, and expected timeline to completion.
Assess the likelihood that the project will be completed and commercialised. This is the most critical assumption in the valuation.
Model the revenue and earnings that the completed project would generate if successfully brought to market. Include the costs to complete the project.
Multiply the success-scenario cash flows by the probability of completion. The failure scenario generates zero value (costs already sunk are not relevant to fair value).
The remaining development costs must be deducted from the projected cash flows. Only the net value after completion costs represents the fair value of the IPR&D at the acquisition date.
Apply a discount rate that reflects the risk of the project, including a premium for development-stage uncertainty over the rate used for completed technology.
Estimating completion probability is the most judgemental aspect of IPR&D valuation. The approach varies by industry:
The pharmaceutical industry has well-established success rates by development phase, based on large-sample studies:
| Development Phase | Probability of Reaching Market |
|---|---|
| Pre-clinical | 5-10% |
| Phase I | 10-15% |
| Phase II | 15-25% |
| Phase III | 50-70% |
| Regulatory review | 80-95% |
These industry statistics provide a useful starting point, but should be adjusted for the specific compound, therapeutic area, and company's track record.
Technology IPR&D lacks the structured phase gates of pharmaceutical development, making probability assessment more judgemental. Relevant factors include:
| Factor | Higher Probability | Lower Probability |
|---|---|---|
| Technical feasibility demonstrated | Prototype working | Concept only |
| Market validation | Customer commitments | Unproven demand |
| Team expertise | Domain experts in place | New area for the team |
| Dependency on external factors | Self-contained | Relies on third-party APIs or standards |
| Competitive environment | First mover advantage | Multiple competitors |
A common error is to assign overly optimistic completion probabilities because the acquirer has already decided to purchase the company. The fair value assessment must reflect a market participant's view, not the specific acquirer's optimism. An arm's-length buyer would discount for completion risk even if they intended to prioritise the project.
IPR&D discount rates should be higher than those applied to completed technology because of the additional development risk. The premium over the completed technology rate typically ranges from 2-5%, depending on the stage of completion:
| Stage | Premium Over Completed Technology Rate |
|---|---|
| Early stage (concept/feasibility) | +4-5% |
| Mid-development (working prototype) | +2-4% |
| Late stage (near completion) | +1-2% |
Some practitioners embed the completion risk in the probability weighting rather than the discount rate, which is also acceptable provided the approach is consistent and disclosed. What is not acceptable is to embed completion risk in both the probability weighting and the discount rate, which would double-count the risk.
The deduction for costs to complete must include all remaining development expenditures necessary to bring the project to commercial readiness:
The costs to complete should be probability-weighted consistently with the revenue projections. If the revenue is weighted at 60% probability of success, the costs to complete should also be weighted at 60% (since if the project fails, the remaining costs will not be incurred — though some costs may be sunk before failure is determined).
Once recognised, IPR&D requires ongoing management attention:
Annual impairment testing. Like goodwill, IPR&D with an indefinite useful life must be tested for impairment annually. If the project falls behind schedule, the technology landscape changes, or the market opportunity diminishes, impairment may be indicated.
Reclassification on completion. When the project is completed, the IPR&D is reclassified as a finite-life intangible asset and amortised over its useful life. The amortisation period should reflect the expected period of economic benefit from the completed technology.
Abandonment. If the project is abandoned, the entire carrying amount is written off as an impairment loss. This can result in significant earnings charges for companies that acquired businesses with large IPR&D portfolios.
IPR&D valuation requires careful balancing of potential value against completion risk. The probability-adjusted income approach provides the most defensible framework, but the result is only as good as the probability of success assumptions. Always document the basis for probability estimates, cross-check against industry benchmarks, and ensure the discount rate and probability weighting are not double-counting the same risk. The Opagio Calculator supports probability-weighted IPR&D valuations with stage-gate modelling.
Tony Hillier is an Advisor at Opagio with 30 years of experience in structured finance, M&A advisory, and asset valuation. He has valued IPR&D portfolios across technology, pharmaceutical, and industrial acquisitions. Meet the team.
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