Using intangible assets to super charge business valuations
It is a tale as old as time: buyers are always looking for a bargain, while sellers are haunted by the suspicion that they could have squeezed more value out of a sale.
Whether the goal is to sell a lone hamburger or an entire hamburger business, arriving at an appropriate valuation is crucial for both parties to be happy.
Everyone wants a piece of a successful business. However, when price comes into play, it can be tough to know exactly what a company is worth. That gap is precisely what a buyer is hoping to exploit in their aim to find a bargain – they hope that the shareholders do not know their company's true market price, particularly with regard to its intangible assets.
That is why valuing a company’s intangible assets is vital. Getting it right could mean the difference between a nice payday and generational wealth for shareholders.
Understand the facts
To ensure the most accurate valuation, business owners looking to sell their company must know three key things:
- the types of intangible assets in the business;
- their quality; and
- how their presence – or absence – might affect the value of the business.
When a prospective buyer walks through the door and asks for a proper valuation of a business, there is no excuse for the owners to draw blank stares. Knowing what intangible assets are, where they fit into the company’s valuation and what they are worth should be considered business 101.
However, an alarmingly high number of business people – even experienced ones – still struggle to see past their tangible assets, which is anything you can drop on your foot: machinery, property, cash or inventories, among many others. While these are obviously key, the bulk of a modern company’s value is now in its intangible assets.
As the name implies, intangible assets cannot be touched – or dropped on your foot. Examples include data, supplier relationships, patents, expertise, confidential information, inventions, software, content, design, approvals and even plant varieties. They are occasionally referred to using an umbrella term: ‘goodwill’.
At least, goodwill is generally how accountants consider intangible assets. That term may have been useful in the past, but lumping intangible assets together into a single-line item risks missing an enormous chunk of a company’s worth (about 85 to 90%, according to a 2020 Ocean Tomo study).
The accounting world has thus struggled to keep up with what makes a business valuable. So, how can a modern company use the intangible asset framework to know its true worth?
Think outside the box
Consider Snowflake, a software-as-a-service (SaaS) provider with next-generation software that enables large dataset integration, manipulation and analysis on the cloud. What is the real value of a company if the entire business could fit on a hard drive? Can it truly be valued at millions of dollars?
It certainly could be. A SaaS company’s main intangible asset is likely its software, which represents thousands of hours of R&D written by teams of highly competent coders and programmers.
The resulting software might look simple on paper, but its underlying value is layered in its years of effort, millions of dollars of investment capital and fine-tuned market strategy. Each of these dynamics must be factored into the company’s final valuation. Yet Snowflake’s balance sheet is not enough to reflect the value of the software; it is necessary to dig deeper.
IT and SaaS companies also hold intangible asset value in their trademarks. Microsoft, for example, has an impressive trademark portfolio spanning multiple jurisdictions. A set of well-defended trademarks can be hugely valuable since they will provide a shield against rival companies trying to pass off copycat products or services.
Microsoft also benefits from scalability in its online subscriptions or licences, which gives the company access to a wider audience for little extra investment. This means that it can offer its services to customers at a lower monthly rate compared to its competitors. Done right, scalability creates a positive feedback loop that further energises a company’s recurring revenue while expanding its market share.
A ‘sticky’ customer base can also be an intangible asset. Customer stickiness is a marketing term describing the tendency to gain repeat business. Loyal customers mean that a company can easily reinforce its brand equity over time and these sticky users begin to create a network effect (an intangible asset), which attracts more users.
In the information age, intangible assets will continue to occupy a greater percentage of most businesses’ enterprise value than tangible ones. By including intangible assets in a potential valuation, a business owner has the metrics they need to appropriately price their company, likely at a higher multiple than by measuring just its tangible assets.
Not only are intangible assets critical for driving long-term business success, they are fundamental when it comes time for shareholders to capitalise on their success.
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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