In today’s marketplace, patents, copyrights, brands, customer lists and other intangible assets add significant value to many companies. However, because intangibles are often developed internally, they’re rarely included on a company’s balance sheet. The unique nature of these assets also makes them harder to value than hard assets, such as receivables or equipment. Here are some common reasons for businesses to identify and assign value to intangible assets.
Intangible asset values are important to know when managing a company’s day-to-day operations. For example, businesses need to know how much intangibles are worth when they:
Likewise, when companies buy or sell a business, the value of intangibles takes center stage. Sellers need to understand the types of unrecorded intangible assets they’ve accumulated over the years to set a realistic asking price. And buyers need to perform sufficient due diligence on the value of intangibles to make a reasonable purchase offer — and to avoid overpaying.
When one company acquires another, U.S. Generally Accepted Accounting Principles (GAAP) requires the purchase price to be allocated among the acquired tangible and intangible assets. These accounting rules now give private companies the option of electing to amortize goodwill over a period of ten years (or less, if the conditions warrant a shorter amortization period).
On an ongoing basis, public companies — and private companies that don’t elect the alternate accounting treatment — must test unamortized intangible assets at least annually for impairment. This occurs when the asset’s fair value falls below its carrying value on the balance sheet. Impairment testing also may be required when a triggering event happens, such as the loss of a major customer or introduction of new technology that makes the company’s offerings obsolete.
In most states, the local government collects property taxes on a business’s real estate and certain types of tangible property, such as equipment. But intangibles — such as brands, licenses, contractual rights and proprietary technology — may be specifically exempt from property taxes.
Companies can use an appraisal of these assets to petition for a lower assessed value. Separating tangible and intangible asset values can significantly lower a company’s property tax bill, particularly if it generates income from real property, as do luxury golf courses, recreation facilities and resorts.
Disputes over intangible asset rights — such as patent infringement or breach of contract — often require a valuation of intangible assets and/or lost profit analysis. The value of intangibles also comes into play in minority shareholder disputes that result in statutory appraisal actions and divorce cases. In theory, if a business owns intangible assets, they should be included in the value it awards to minority shareholders.
And the value of goodwill can be a major sticking point in states that specifically include (or exclude) portions of this intangible asset when splitting up a marital estate.
In general, the same valuation methods are used for tangible and intangible assets, including the cost, market and income approaches. When appraising intangibles, valuators often turn to the income approach, which derives value from expected future earnings and the associated risks of achieving those earnings. The cost and market approaches are more difficult to apply, because it can be challenging to accurately estimate the cost to replicate a unique intangible or find truly comparable sales (or royalty rates) for similar types of assets.
Regardless of the intangible asset or your reason for valuing it, be sure you work with a qualified appraiser. Every appraisal organization offers some type of continuing professional education courses on valuing intangibles. Before engaging a valuator for these hard-to-value assets, ask about their previous experience, published academic research and education in this specialized niche.
There’s a quick and easy trick to demonstrate how important intangible assets are to the average company’s value: Compare a few of your favorite public companies’ market capitalizations to their net book values. In general, the higher the price-to-book value ratio is, the more intangible assets add to the company’s value. High price-to-book ratios frequently are observed for manufacturers and homebuilders that rely on brands, investments in research and development, and the skills and reputations of their key owners and employees.
There may be other reasons for the price-to-book differential besides the presence of unrecorded intangible assets, such as the use of accelerated depreciation methods or temporary investor exuberance. Investors and other stakeholders usually want a more reliable estimate of value for intangible assets than this ratio provides. So, it’s important to hire a valuation professional to get a reliable estimate of fair market value.