Intangible Asset Valuation – Complete Guide

The increasing significance of non-physical assets in determining a company’s overall value shows the importance of intangible asset valuation in corporate finance. The valuation landscape for intangible assets is evolving rapidly by the influence of technology and changing market conditions.

In 2023, aggregate investment in intangible assets reached $6.9 trillion, doubling from $2.9 trillion in 1995. Further to this Covid-19 pandemic has accelerated this trend, emphasizing the importance of intellectual capital as businesses adapt to new economic realities.

As intangible assets continue to dominate corporate valuations, understanding and effectively applying various valuation methods will be crucial for businesses aiming to maximize their value and appeal to investors. This article serves as a guide for valuing intangible assets.

What are intangible assets?

Intangible assets are a fundamental driver of corporate value and innovation. Organizations must make crucial strategic decisions regarding the allocation and deployment of intangible resources. These are considered critical resources and drivers of performance and value development for the firm.

Patents, trademarks, copyrights, trade secrets, registered designs, brands, computer software, contracts, and databases all fall under the category of intangible property.

Individual experience, organizational procedures, relational resources such as reputation, client loyalty, and business relationships all contribute to intangible resources. Human capital, process capital, and innovation capital are three types of intangible assets.

Types of intangible assets

There are various types of intangible assets that are used in the organization and are extremely important and valuable. Here are the different types of intangible assets:

• Trademarks – Any word, phrase, symbol, design, or combination of these things that distinguishes your goods or services can be used as a trademark. It’s how clients recognize you and tell you apart from your competition in the marketplace. Both trademarks and service marks are referred to as “trademarks”. For commodities, a trademark is utilized, whereas, for services, a service mark is used.
• Patents – A patent is a property right granted to an inventor by a sovereign body. In exchange for a complete disclosure of the innovation, the inventor receives exclusive rights to the patented process, design, or invention for a set length of time. For a limited time, a patent gives the patent holder the exclusive right to prevent anyone from creating, using, importing, or selling the protected idea.
• Licenses – Licenses are formal permissions to do something from a governmental or other constituted authority, such as carry on a business or profession. A certificate, tag, plate, or other document proving such authority; an official permit, such as a driver’s license.
• Copyrights – The term “copyright” (or “author’s right”) refers to the legal rights that creators hold over their literary and artistic works. Books, music, paintings, sculpture, and films are all covered by copyright, as are computer programs, databases, ads, maps, and technical drawings.
• Customer List – Customer lists are a list of the Borrower’s customers that includes each customer’s name, mailing address, and phone number. A customer list is unquestionably an intangible asset because it is an identified non-monetary item with no physical existence. A client is the recipient of a good, service, product, or idea gained from a seller, vendor, or supplier via a financial transaction or exchange for money or some other valuable consideration in sales, commerce, and economics.
• Website – A website is a collection of web pages and related material that has been published on at least one web server and is identified by a shared domain name. Wikipedia.org, Google.com, and Amazon.com are all good examples. The World Wide Web is made up of all publicly accessible websites.
• Franchise Agreement/Special Agreements – A franchise agreement is a contract between a franchisor and a franchisee that is legally binding. The franchisee’s responsibilities and the franchisor’s expectations are outlined in the contract. It’s a contract in which the franchisor (business) agrees to let the franchisee utilize the company’s name or system (individual or entity).

Why do businesses need to value their intangible assets?

In industrialized countries, intangible assets have long been the source of value creation. Intangible asset investment, both internally created and acquired, is crucial to an organization’s capital allocation process. Similarly, investors’ ability to pick those businesses that can best convert such capital into long-term profits is crucial.

• Improve financial communication– Despite their importance to the financial markets, only a limited percentage of intangible assets are recorded on balance sheets, usually as a result of a third-party transaction. Many current business models have developed over decades, particularly a greater reliance on intangible assets at the expense of tangible assets, but the reporting standards have not. As a result, economics and reporting requirements are no longer in sync. So it is extremely important for a business to value its intangible assets.
• Diversify access to finance – Diversification is a method for reducing your exposure to a single asset class by spreading your investments across different asset classes. This strategy is designed to help you reduce the volatility of your portfolio over time. Intangible assets have realizable value; hence access to finance is critical for SMEs’ development, growth, and productivity. When funding intangibles, consider brokering, selling patents, or licensing agreements on IP that offer revenue streams.
• Determine the FMV of intangible assets – Liquidity in the financial markets can be fickle. It is not a guarantee that you will be able to trade in assets of any size at any time and find a willing buyer. The price at which an asset would sell in the current market is known as fair market value. A fair market value analysis tells buyers and sellers how much an asset is worth in the present market. You remove the value of the net assets on the balance sheet from the overall business valuation to find the value of your intangible assets.
• Increase liquidity and market opportunities – This illiquidity risk is significantly greater in many advanced economy corporate bond markets and in developing market bond markets that are seeing big inflows of investment capital. Fortunately, such liquidity shortages have yet to have a long-term negative impact. However, today’s dwindling market liquidity could lead to increased market stress, potentially negatively impacting the global economy and financial stability.

How to value intangible assets

Intangible assets must provide a demonstrable economic benefit to the owner, such as higher market share or visibility, cost savings (process economies and marketing cost reductions), and increased turnover or revenues (price, volume, and better delivery, among others other things).

Intangible assets valuation methods

Many businesses are unaware that their trademarks, designs, and other intangible property rights and assets are frequently more valuable than their inventories, for example. It’s not unusual for a company’s intangible assets to be its most valuable asset, and they can be leveraged to secure finance. The following are the approaches for valuing intangible assets:

1. Income Approach

The income approach is a process used by appraisers to determine the market value of a property based on its income. The income approach is a type of discounted cash flow analysis in finance.

The property’s current worth under the income method is the present value of the future cash flows that the owner can expect to receive. This method is most prevalent for commercial properties with tenants because it relies on rental income.

Multi-Period Excess Earnings Method (MPEEM)

The MPEEM is employed when one asset is the primary driver of a firm’s value, and the relevant cash flows can be segregated from the total cash flows. This method is best suited for early-stage businesses and technological firms. Computer software and customer relationships are examples of assets that commonly generate such cash flows and can be analyzed using the MPEEM’s fair value measurement.

In the below example, we have derived the total present value for a Software company using the Multi-Period Excess Earnings Method under the Income Approach:

Particulars	Amount ($)
Normalized Earnings	1,200,000
Cash flows attributable to other assets through a contributory asset charge (CAC)	850,000
Cash flows associated with Intangible Assets	350,000

Assuming the above cash flow is expected for the next 3 years, at a discount rate of 10%, the Present Value would be calculated as follows:

Year 1: $350,000 / (1+0.1)^1	$3,18,181.82
Year 2: $350,000 / (1+0.1)^2	$2,89,256.2
Year 3: $350,000 / (1+0.1)^3	$2,62,960.18
Total Present Value	$8,70,398.2

With or Without Method

The WWM calculates the difference between two discounted cash-flow models: one that depicts the commercial enterprise’s status quo with the asset in place and another that does not. Noncompete agreements are frequently valued using the WWM.

If a company is expected to earn a net profit of $ 500,000 in profit with the help of a non compete agreement, and $ 400,000 without it. Using the With or Without Method (WWM), we will calculate the difference in cash flows with and without the asset, assuming a term of 3 years and a discount rate of 8%.

Year	Cash Flow with Asset	Discount Factor (8%)	Discounted Cash Flow with Asset	Cash Flow without Asset	Discount Factor (8%)	Discounted Cash Flow without Asset
1	$500,000	0.926	4,63,000	$400,000	0.926	3,70,400
2	$500,000	0.857	4,28,500	$400,000	0.857	3,42,800
3	$500,000	0.794	3,97,000	$400,000	0.794	3,17,600
Total			$12,88,500			$10,30,800
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The value of the Intangible Asset using the With or Without Method is $2,57,700

Distributor Method

The Distributor Method, a version of the MPEEM, values customer relationships using market-based distributor data or other applicable market inputs. It’s also known as a profit split method because it allocates function-specific earnings to the identified assets.

For example, if we’re valuing customer relationships for a software distributor. The company has a 3-year projected revenue of $800,000, and a cost of capital is 10%.

In order to do this, the method requires revenue and ancillary costs of revenue including cost of goods sold (COGS), distribution expenses, and general administrative expenses to be estimated.

Year	Revenue	COGS (40%)	Selling Expenses (20%)	G&A Expenses (10%)	Net Income	Discount Factor (10%)	Discounted Net Income
1	$800,000	$320,000	$160,000	$80,000	$240,000	0.909	$218,160
2	$800,000	$320,000	$160,000	$80,000	$240,000	0.826	$198,240
3	$800,000	$320,000	$160,000	$80,000	$240,000	0.751	$180,240

Total Present Value of Net Income: $909,600

Real Option Pricing

The real option pricing is a sophisticated approach to valuing investment opportunities that incorporates the flexibility and choices available to management. This method is different from traditional valuation techniques and it has better adaptability that leads to better decision making .

Using the Real Option Pricing method, we will determine the value of Patent which is not currently generating cash flows as below:

	Year 1	Year 2	Year 3
Expected Profit from Patent	$20,000	$60,000	$90,000
Tax	20%	20%	20%
Profit after tax	$16,000	$48,000	$72,000
Discount Factor (10%)	0.909	0.826	0.751
Discounted Profit after tax	$14,544	$39,648	$54,072

The value of the patent after summing up the expected cash flows for next 3 years is: $108,264

2. Market Approach

The market approach is a valuation method that considers the market values of comparable assets or enterprises that have recently sold or are still available when determining the appraisal value of a business, intangible asset, business ownership interest, or security. Sales, book values, and price-to-earnings ratios are commonly used as price-related indicators.

For instance, during the last year, a company’s trademark brought in revenue of $700k.

To estimate its value, we will use the Market data related to similar trademarks:

• Comparable Trademarks: Three similar trademarks were sold recently, details are as follows:
• Trademark A: Sold for $1 million with $500k revenue (Multiple: 2x)
• Trademark B: Sold for $1.8 million with $600k revenue (Multiple: 3x)
• Trademark C: Sold for $2.4 million with $800k revenue (Multiple: 3x)

Average Multiple = (2+3+3) / 3 = 2.67

Thus, the value of the trademark owned by the company = $700K x 2.67 = $1.87 million

3. Cost Approach

The cost approach to real estate valuation assumes that the property’s worth is equal to the total cost of constructing a comparable structure. The cost approach takes into account the cost of land + construction costs, less depreciation. The cost technique is less dependable than other real estate valuation approaches, although it can be beneficial in some situations, such as evaluating new construction or a one-of-a-kind home with few comparable.

Replacement Cost Method Less Obsolescence

This method necessitates determining the new replacement cost for the intangible asset, which is defined as “the cost of creating an intangible asset with a similar utility to the subject intangible, employing modern materials, production standards, design, layout, and quality workmanship, at current costs as of the date of the analysis”.

After that, an obsolescence factor is applied to the replacement cost in relation to the intangible asset. Below is a simplified replacement cost model for purchased software that accounts for obsolescence and the tax implications of the asset’s amortization.

For example, using the following assumptions: Cost of replacement of Intangible Asset $400,000, Obsolete factor 40%, and Tax rate 25%, the calculation for the Valuation of intangible assets would be as follows:

Replacement Cost (Including research and development cost, legal fees, indirect and opportunity costs)	$400,000
Obsolescence Factor	40%
Adjusted Replacement	$240,000
Tax Rate	25%
Post-Tax Value	$180,000

4. Relief from Royalty Method (RRM)

The RRM determines the value of an asset based on the hypothetical royalty payments that would be avoided if the asset were owned rather than licensed. The RRM’s logic is simple: owning an intangible asset eliminates the need for the underlying company to pay for the right of deploying that asset.

The RRM is frequently used to evaluate domain names, trademarks, licensed computer software, and in-progress research and development that may be linked to a specific revenue stream and when data on royalty and license fees from other market transactions is available.

For example, a company projected a revenue of $1,000,000 and estimated a royalty rate of 5%. The discount rate is 8 percent and the useful life of the domain name is 3 years.

Year	Projected Revenue	Royalty Rate	Royalty Savings	Discount Factor (8%)	Discounted Savings
1	$1,000,000	5%	$50,000	0.926	$46,300
2	$1,000,000	5%	$50,000	0.857	$42,850
3	$1,000,000	5%	$50,000	0.794	$39,700

Value your intangible assets with Eqvista!

Intangible assets must provide a demonstrable quantity of economic benefit to the owner, such as higher market share or visibility, cost savings (process economies and marketing cost reductions), and increased turnover or revenues (price, volume, and better delivery, among other things). Now get the valuation of intangible assets with Eqvista.

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