Valuation of Intangible Assets
As a follow-up to our posts “Profit from Intangible Assets in a Business Sale” and “Understanding the Value of Intangible Assets”, this post offers answers to the question, “How do you value intangible assets?”
In one of these posts, we looked at a simple example for valuing the Bayer tradename associated with its sale of aspirin using a simple capitalized earnings approach to a likely royalty stream. While the valuation of intangible assets is the subject of a dedicated course of study and professional certification, I will try to simplify these methodologies and offer other approaches to give you a general idea on how these assets are valued.
Approaches
The same approaches to estimate the value of a business are applied to intangible assets. These are: i) the income approach; ii) the market approach; and ii) the cost approach. Selection of an approach depends on the situation and the characteristics of the intangible asset. The most common approach when valuing intangible assets is the income approach, while the less common applied is the market approach.
The income approach is a general way of determining a value indication of a business, business ownership interest, security, or intangible asset by using one or more methods through which anticipated benefits are converted into value. A method within the income approach is the discounted cash flows (DCF) method, based on the present value of the forecasted cash flows during the expected life of the asset.
The market approach determines a value indication of a business, business ownership interest, security or intangible asset by using one or more methods that compare the subject to similar businesses, business ownership interests, securities or intangible assets that have been sold.
The cost approach estimates a value indication of an individual asset by quantifying the amount of money required to replace the future service capability of that asset. [1]
[1] American Society of Appraisers – ASA Business Valuation Standards.
Illustration
There is one technique that it is especially useful within the income approach. It is called the “with” and “without” method, since the objective is to extract the value of the intangible asset that it is in the company by determining the value of the business with and without the intangible asset. The difference between the two values is the value of the intangible assets.
Let me illustrate this technique with a simple example. Assume that you own a business and the buyer wants you to sign a non-compete agreement that says that you can’t compete within the industry (or geographic area) for three years. You agree. Therefore the value of the business is the value “with” the non-compete. The “without” scenario has you not sign the agreement with the expectation of competing day one after the deal closes. This competition will impact the buyer in many ways from a decline in revenues, the possibility of losing other staff, and the need to go out and replace you with someone else, likely through a recruiter. All of these costs add up and the buyer, in the “without” scenario suggests that the impact to the value of the business is $500,000 in lost profits and increased costs over the three year period they hoped to have you not competing. Therefore, the value of the non-compete intangible asset is the difference in value between the “with” and “without” scenarios. That is exactly how it works when dealing with an intangible asset.
Other applications of this technique are applied to estimate the value of employment agreements, franchise agreements, and key knowhow (formulas and other intellectual property) and processes and technologies developed internally.
In many ways, this approach highlights the overall theory of intangible asset value as a subset of the enterprise value. This concept is true in identifying specific income streams associated with certain intangible assets like technology and customer relationships. In thinking of your business as a portfolio of these tangible and intangible assets, some have low risk (real estate or fixed assets) while others have significant risk (technology, drug development; i.e intangible assets).
Other methodologies using the income approach include the Relief from Royalty (see our Bayer tradename example in our prior post), and the Excess Earnings (see above in terms of carving off income streams to an asset). Understanding these methodologies and the fact that every intangible asset has a “charge” that you need to apply to the other intangible assets, including the estimation of a discount rate that considers additional risk are fundamental when valuing intangibles. These concepts may be the subject of another blog.
Exit Strategies values intangible assets as well as control and minority ownership interests of private businesses for tax, financial reporting, strategic purposes. If you’d like help in this regard or have any related questions, you can reach Victor Vazquez, ASA, MRICS at victor@exitstrategiesgroup.com.