Storage Wars: the price of overlooking hidden intangible assets
The popular reality show Storage Wars, in which bidders compete to guess the value of a repossessed storage container’s contents based only on what they can see (with the help of a torch), acts as an apt visual metaphor for our broken modern accounting system. While the treasure hunters on the show probably know what to look for as they peer into the gloom, the same cannot be said for those involved in a typical due diligence process. Valuers often lack the right tools to assess a company’s intangible assets, which is where the real value lies.
One cannot simply shine a torch into a company; doing so would only highlight objects that cast the biggest shadows – things like fixed assets and cash holdings. Correctly valuing a company requires pulling on the rubber gloves, peeling away the dusty covers and systematically picking up every piece on the pile.
Of course, that is easier said than done. Like the abandoned lockers on Storage Wars, many corporations have been cooking in the sun for so long that few even remember how the whole puzzle fits together. Companies get split into different units, knowledgeable people leave, documents are mislabelled and crucial customer data remains unwashed for years.
Unpacking a company’s intangible assets is the only way to apply a fair value that represents all the time, effort and imagination. It is vital to get this right, because roughly 90% of the average company’s total value is wrapped up in its intangible assets.
The Storage Wars problem
The typical process of due diligence focuses on locating and describing a company's tangible assets as a starting point. Then, valuers calculate how much revenue the business might reasonably be expected to earn during a given time window. But that is about it. After this process, a sale price is then presented to the business owner and, generally, the sale is made.
This process is akin to shining a flashlight into the storage locker from the outside. Intangible assets cannot be felt or touched in the same way as cash and fixed assets, so they are easily overlooked in a valuation. Not counting the intangible assets is like refusing to put price tags on each box inside the container and instead selling the entire thing as a bundle – just like on Storage Wars.
This discrepancy is magnified when considering the purchase price allocation, a process used to assign a fair value to all of a company’s assets and liabilities. Even if valuers include intangible assets such as patents or trademarks in their estimation, most of the time these figures only land on the tally sheet at cost. The remainder end up in a big bucket called ‘goodwill’, which must be evaluated every year and checked for impairment.
Of course, every company thinks it is special. That hunch might well be true, but a company will only know the exact level of its specialness after picking apart the storage locker with annual audits of its intangible assets and then writing strategies to maximise value and minimise the risk of those assets.
If it performs this daunting valuation process correctly, identifying intangible assets can be highly lucrative for both the buyer and the seller.
The process in practice
An Australian software provider asked us to value their assets during negotiations with a California-based buyer. The Californian firm was hoping to acquire the target company for three to four times its annual revenue. After performing a full audit and valuation of the company’s intangible assets, we estimated there was enough evidence to increase the asking price. The buyer ultimately agreed to a final price of 7.4 times revenue.
All it required was ditching the torches and getting stuck into the dusty contents of the company’s storage boxes to identify all its intangibles, including patents, trademarks, copyright, data, software, trade secrets and know-how, among many others.
Whether you have a fantastic piece of technology or are hoping to pull the trigger on that long-awaited exit, performing a proper due diligence assessment that considers intangible assets could be the difference between setting off a bidding war or selling your storage locker for well under its true value.
This is an Insight article, written by a selected partner as part of IAM's co-published content. Read more on Insight
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