Intangible Asset Valuation – Complete Guide
Many businesses are unaware that their trademarks, designs, and other intangible property rights and assets are frequently more valuable than their inventories.
Intangible assets are nearly always more difficult to evaluate than tangible assets for a variety of reasons. In the case of intellectual property (IP), intangible assets have no specific equivalents by definition; IP’s distinctive attribute is this uniqueness. Because it’s commonly acknowledged that comparables can be difficult to define—and because intangible assets are, well, intangible—active markets are less precise in evaluating value when they do exist.
Intangible assets in business
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. Intangible assets are considered critical resources and drivers of performance and value development for the firm.
What are intangible assets?
Intangible assets are assets that are not physical in nature. 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).
Importance of intangible assets
While most people have a strong notion of how to value their concrete assets in their firm, they are often unsure about how to value their intangible assets. If entrepreneurs, investors, and managers can assess the value of their intangible assets, they can more quickly and precisely measure and manage their company’s competitive position, investment portfolios, and overall IA/IP strategic roadmap, making strategic decisions easier.
Intangible assets can be commercialized and used in a variety of ways to produce revenue and growth. They can give you a competitive advantage and add value to your customers while also allowing you to differentiate your brand and offering. Here are some instances of how they can offer value:
- The company’s technical advancements are patented and protected.
- Internal proprietary procedures and trade secrets can help a brand and business stand out from the competition.
- The cornerstone of a company’s brand is its name, logo, motto, and other unique qualities; these are the identifiers that make a startup identifiable.
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) – A form of discounted cash-flow analysis is the MPEEM. The MPEEM isolates the cash flows connected with a single intangible asset and determines fair value by discounting them to present value rather than focusing on the entire entity. 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.
- 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.
- 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.
- Real Option Pricing – Competition must be limited in the event of a contingency for a genuine choice to have considerable economic value. Patents, for example, grant the owner the right but not the obligation to prevent others from creating, using, selling, offering for sale, or importing the protected innovation. If the net present value of the underlying project is assessed to be zero or negative at the measurement date, an undeveloped patent may have no “intrinsic” value. Nonetheless, the patent may have a significant “time” value based on the likelihood that the project’s net present value will turn out to be positive at some point during the patent’s life.
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.
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.
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.
How do intangible assets affect business valuation?
This means that even if every tangible feature of a business is similar, two enterprises can have wildly different values to potential buyers. These intangible assets are the things that provide your firm with its distinct selling qualities and influence your company’s value in a way that they wouldn’t for a competitor. As valuable as these assets are, most business owners are unaware of how their brands and client bases influence the value of their companies. In some businesses, rule-of-thumb formulas exist, but a more thorough examination yields a more accurate value assessment.
Intangible asset valuation services Eqvista provides
Eqvista provides intangible asset valuation services for trademarks, patents, licenses and permits, websites, goodwill, and customer-related assets). These services help you to identify the main differences between various business prospects, how to identify and value the intangible assets which are crucial and how to spot the difference between them.
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. We promise a custom valuation report for your software when you work with Eqvista. Getting a valuation for your software might be advantageous whether you’re selling it or looking for finance for your project. You may find out more about our software valuation and other valuation services or contacting us.