Oct 17, 2024 | The Concrete Impact of Intellectual Property Value
1 It is often heard that Western countries proudly claim that certain well-known brand names are worth tens or even hundreds of billions of dollars. These astronomical figures have little significance in Hong Kong or even most Asian countries. One of the main reasons is that financial institutions (including banks) will not take into account the value of the company’s intellectual property (collectively referred to as “Brand”) when calculating the company’s “total” asset value, and thus will not consider it in their business considerations, including loaning.
2 Nevertheless, Brand value can sometimes seriously impact a company’s development. For example, when a shareholder who is about to leave the company (“Outgoing Shareholder”) is selling their shares in the company to the remaining shareholders (“Remaining Shareholders”), they will include the company’s Brand value in their valuation. If the shareholders do not have any prior agreement on how to determine the value of the company’s shares, it can easily lead to “troubles”.
Dispute on Share Prices
3 Without a prior agreement, the Outgoing Shareholder naturally wants a higher share price (which includes the Brand value). However, the Remaining Shareholders do not. Usually, the Remaining Shareholders are only willing to use the company’s “net” assets (i.e., excluding Brand value) to calculate the value of the shares of the Outgoing Shareholder. The divergence in share value could be tens of percentage points, and sometimes even several times (“Issue 1”).
Application for Company Winding Up
4 The worst-case scenario is when the Outgoing Shareholder has malicious intent, and they may use the following law to claim that their legal rights have been “prejudiced”, and thereby apply to the Court for a “winding up order”:
Section 117(1) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32)
5 Once a petition for winding up is filed, most of the company’s stakeholders (including banks) and customers will take immediate business actions upon learning of the petition for winding up (“Issue 2”):
The bank will freeze the company’s bank accounts – that is, the bank will refuse to allow money to be deposited into or withdrawn from the company’s accounts.
The company’s customers will no longer pay their debts – that is, if the customers pay the company’s invoices, they may incur potential liability and/or risks.
Drafting a Shareholders’ Agreement
6 To avoid the inevitable disputes and the above Issues 1 and 2 when Outgoing Shareholder and Remaining Shareholders part ways, the author (based on work experience) recommends that the company’s shareholders should draft and sign a shareholders’ agreement early on, containing the following clauses:
Any shareholder (or a specified minority shareholder) must first offer to sell their company shares to the other shareholders (or a major shareholder) when transferring their shares (i.e., pre-emption right);
The value of the shares is calculated based on the “net” asset value (i.e., NAV); and
To request the company’s accountant to estimate the company’s “net” asset value.
NAV Calculation
7 The NAV mentioned above is a technical accounting term, meaning that the company’s value is calculated based on its tangible assets, while intangible assets (such as Brand) are not included.
8 Given that the shareholders have signed a shareholders’ agreement and reached a consensus on the method of calculating the company’s assets, not only could Issues 1 and 2 mentioned above be avoided, but the relationship between the Outgoing Shareholder and the remaining company can also be maintained. As for the Outgoing Shareholder’s attempt to “mark up the price” to sell, this position will not be brutally manifested.
9 Based on experience, when the company is operating normally, shareholders generally do not object to accepting the NAV calculation. It is only when the environment changes later, and the Outgoing Shareholder is more concerned about its own interests and has more imaginations, that they wish to use a higher-value method to calculate the share value.
10 In summary, to prevent problems before they occur, the author advises that company shareholders should, as much as possible, set up a shareholders’ agreement between the shareholders during the harmonious stage, establish the basis for the company’s share value, and avoid unnecessary divergences in the future.