When preparing to sell a business, it's crucial to obtain an accurate valuation to secure a fair price that reflects the effort and dedication invested in building the company over the years. This encompasses the assessment of tangible assets like equipment, inventory, and real estate, alongside intangible assets such as goodwill and intellectual property. Learn how to value intangible assets during a business sale.
What Are Intangible Assets?
Intangible assets are things a company owns that you can't touch, like contracts or a famous brand. Even though you won't see them listed on a balance sheet with a specific value, these assets play a big part in making the company successful. Some intangible assets, like contracts, last for a limited time, while others, like well-known brand names, stick around for as long as the business is running.
Types of Intangible Assets
Let's explore some of the most common types of intangible assets, including brands, goodwill, and intellectual property.
Brands
A brand serves as a distinguishing factor between businesses and can manifest as a logo, symbol, or brand name. Businesses often utilize marketing, design strategies, and advertising to establish their brands, enabling consumers to identify a specific company. For instance, most people can easily recognize Apple (AAPL) by observing its logo. Brands are critical as they contribute to a company's brand equity and foster customer loyalty. Some consumers may prioritize a company's product over a competitor's, even if it is priced higher, due to their loyalty to the brand. This is evident in scenarios where athletes choose Nike over Adidas and vice versa.
Goodwill
When a company acquires another, it classifies the intangible assets associated with the transaction as goodwill. If the amount surpasses the fair value of the target's net assets, it represents the acquiring company's goodwill. Positive goodwill arises when the amount exceeds the target's book value, while negative goodwill occurs when it falls below the book value.
Intellectual Property
Intellectual property encompasses legally protected intangible assets that another entity cannot utilize without the owner's authorization. Common forms of intellectual property include digital assets, copyrights, franchises, patents, trade secrets, and trademarks. Any unauthorized use of another person's intellectual property involves using or copying another entity's brand name, logo, or other assets.
How to Value Intangible Assets
A company such as Coca-Cola (KO) owes a significant portion of its success to brand recognition, which, despite being intangible, profoundly influences sales. But how does a company go about valuing intangible assets?
The American Institute of Certified Public Accountants (AICPA) outlines three primary methods for valuing intangible assets:
Market Approach
This method assesses the expected value through a relative analysis, focusing on assigning a value to comparable intangible assets. However, it may prove challenging due to limited available details about similar assets other companies hold.
Income Approach
Companies can utilize this approach when their intangible assets generate a cash flow stream. Examples include:
The relief from royalty method.
Estimating potential royalty payments derived from asset usage.
The avoided loss of income.
Cost Approach
This method hinges on the principle of substitution and does not consider any future benefits based on time or amount.
Although companies expense all costs associated with creating intangible assets, these assets do not show on the balance sheet and have no recorded book value. Consequently, when a company is acquired, the purchase price often exceeds the book value of assets on the balance sheet. The acquiring company records the premium paid as an intangible asset on its balance sheet.
Intangible Assets That Contribute to the Assessment of Company Goodwill
Brand Recognition
When we consider brand recognition, we often think of multibillion-dollar corporations like Apple and Coca-Cola, where the influence of their brand alone generates hundreds of millions in annual sales. However, every established business, regardless of size, possesses a positive or negative brand.
Your brand plays a significant role in setting you apart in the marketplace. This encompasses your name, logo, symbol, mark, or slogan and the perception held by customers and the broader community regarding what you represent. A positive brand, built on customer trust and the belief in the quality of your products or services, adds substantial value to your business.
Intellectual Property
Intellectual property examples encompass copyrights, trademarks, patents, trade names, proprietary software, sales processes, recipes, and trade secrets. For instance, the closely guarded Coke Classic recipe is a prime example of a precious industry trade secret.
Digital Assets
Intangible assets such as websites and social media accounts can enhance the value of your business. Pages and posts on your website with high search engine rankings facilitate digital consumers' discovery of your business. Additionally, positive reviews on platforms like Facebook, Better Business Bureau (BBB), and Google Reviews contribute to increased web traffic and enhance your company's value.
Human Capital
Often, a business's most crucial intangible asset is its personnel. Talented management and staff committed to delivering exceptional service distinguish your business from others. Established relationships with clients or customers that yield consistent revenue also contribute significantly to the overall value.
Contracts and Agreements
The contracts and agreements with building owners, suppliers, vendors, and other associates can substantially impact the viability of your business. For instance, being locked into a long-term lease at a favorable rate that provides a strong competitive advantage can significantly enhance the value of your business.
Tangible Vs. Intangible Assets
Learn and explore the difference between tangible and intangible assets.
Tangible Assets
Tangible assets possess a physical form, making them tangible and manipulable. These assets form a core part of a company's portfolio. The value of tangible assets is often easier to determine. Achieving this involves hiring an appraiser to determine the fair market value (FMV) or comparing the asset to the replacement cost.
Common forms of tangible assets include furniture, equipment, inventory, land, property, vehicles, and even financial securities like stocks and bonds, which, despite being intangible, derive their value from contractual claims. Tangible assets are categorized as current (easily used and converted to cash, e.g., inventory) or fixed (with one year or more lifespan, e.g., plant, property, and equipment).
Example of Intangible Assets
The balance sheet includes intangible assets only when the company has acquired them. For instance, if Business ABC purchases a patent from Business XYZ for $1 billion, this transaction leads to Business ABC recording $1 billion in intangible assets under long-term assets.
The company writes off the $1 billion asset over a number of years through amortization. Indefinite-life intangible assets, like goodwill, are not amortized but are assessed annually for impairment when the carrying value exceeds the asset's fair value.
The Importance of Business Intermediary in Assessing Intangible Assets
Evaluating the value of intangible assets can be difficult, as owners often overvalue them due to personal investment. Hiring a business intermediary, like a Sunbelt Texas business broker, brings expertise to the sales process, ensuring an accurate business valuation.
FAQs About How To Value Intangible Assets
How does a company show intangible assets on its balance sheet?
Intangible assets typically appear on corporate balance sheets as long-term assets, with their value determined by purchase/acquisition price and amortization schedules.
However, companies may not include goodwill on balance sheets because they cannot amortize its value over time.
What is the impact of valuing intangible assets on financial statements?
The valuation of intangible assets can affect a company's balance sheet, income statement, and overall financial health, influencing metrics such as asset values, amortization expenses, and goodwill impairment.
What challenges are involved in valuing intangible assets?
Challenges include:
The lack of market data for comparison.
The subjective nature of valuation.
The rapidly evolving nature of certain intangible assets, such as technology and intellectual property.
How do companies account for internally generated intangible assets?
Internally generated intangible assets are typically not recognized on the balance sheet unless certain criteria are met, such as demonstrating that the asset has a determinable useful life and its costs can be reliably measured.
Why is it important to value intangible assets?
Valuing intangible assets is crucial for financial reporting, investment decisions, mergers and acquisitions, and determining the overall worth of a business.