In 1975, intangible assets accounted for barely 17% of corporate value; today this has increased to more than 87%. They are the primary drivers of a company’s competitive edge and financial performance and include items such as data, brands, content, code, trade secrets and industrial know-how, internet assets, design rights, regulatory approvals, patents and plant variety rights.
Research has consistently shown that companies that focus on intangible assets consistently outperform their peers and industry benchmarks. By understanding what your intangible assets are you can identify how they drive your business growth, what they are worth, the risks around them and how to monetize them.
Given how critical intangible assets are – especially within the tech sector and with start-ups – companies wanting to raise capital or sell their business should ensure that these critical assets are included in any valuation process.
Unfortunately, accounting standards like GAAP and IFRS were essentially designed for an industrial age economy and consequently largely ignore intangible assets, leaving them either off-balance sheet, lumped under the amorphous term “good will” or recorded solely at cost. None of these approaches correctly or accurately capture the value of these critical assets.
Take, for example, a recent report from the UK Treasury, which highlighted that while the world’s five most valuable companies are together worth £3.5 trillion yet their balance sheets report just £172 billion of tangible assets. The other £3.3 trillion of value is missing in action due to these company’s intangible assets not being reflected on their balance sheets.
Valuing intangible assets
With so much value now being driven by intangible assets, while any valuation exercise needs to be grounded in some form of numerical analysis, it is also critical that new qualitative methods are adopted in order to more accurately capture the value of a business’ intangible assets. Traditional income (DCF) and cost approaches risk becoming lost in the numbers and producing results that bear little resemblance to the reality of value, which means that any valuation of intangible assets that draws primarily on conventional (tangible or fixed asset) valuation methodologies should be treated with extreme caution. There is a high probability that a valuation utilizing these methodologies could be out by several orders of magnitude (10x > 1000x).
Predicting future value
While complex, there are methods of valuing intangible assets that can reliably and accurately predict future value. These methodologies work off the general principle that a strong intangible asset position delivers a sustainable competitive advantage that translates into market share or margin premiums that significantly increase the value of the business.
An intangible asset valuation will involve the assessment of a much broader range of factors than are generally included in traditional valuations. Things like the underlying quality of the intangible assets (for example, the nature of software code; how current and relevant the data is; the breadth of a patent etc), as well contextual factors such as the leverage or benefit those intangible assets will deliver to different potential buyers, investors or partners.
An intangible asset valuation will also take into account that, when it comes to intangible assets, the whole is typically worth more than the sum of its parts, which means that an analysis of the interaction of how all these assets are grouped together is essential. Additionally, an intangible asset valuation will typically review a much broader range of factors leading to a report that will tend to be more discursive and featuring a lot more prose and analysis, with fewer numbers in order to help build a solid interlocking framework of multiple, well researched factors that together produce a numerical value that can be relied on.
Understanding where the value lies
By way of example: we were recently asked by a start-up to complete a valuation for its new technology and business model around a major infrastructure play. The founders needed to raise $100M. A traditional valuation from a major accounting firm generated a number around $40M, which made the raise non-viable. The CEO approached us for a critique. It rapidly became clear that the initial valuation created using traditional methodologies hadn’t captured anywhere near the value of the venture, so we prepared a new comprehensive valuation, which valued the company at $200M.
It would be fair to say the reaction from the accounting firm was incredulity – no venture could be worth this much they argued. However, entrepreneurs don’t typically take no for an answer and this founder was no different. He took our valuation to a major investment bank, who enthusiastically adopted the valuation as the centerpiece of the investment memorandum. The result: the company raised $400M at a $200M pre-money valuation in record time.
In another example, we worked for a company owner who was selling his financial services firm after 30 years. The investment bank provided a valuation of 4X EBITDA, which the owner did not feel fairly reflected the value of his company so asked us to also prepare a new valuation.
As part of this process, we identified a highly valuable intangible asset (data) that was not listed on the balance sheet and had not been recognized in the sale process to date. We prepared an Intangible Asset Story that highlighted the value of the data and identified and targeted buyers who we believed would pay significantly more for the data than what the operating company had been valued at. The result: the company was purchased for 32X EBITDA by a strategic buyer who saw the value in the data that had been identified.
Moving beyond enterprise value
What these examples help to highlight is that intangible assets are really the only lever that can move enterprise value beyond cash flow multiples. While any valuation exercise needs to be grounded in some form of numerical analysis, it is critical that new qualitative methods are also adopted if you are looking to ensure that you don’t undersell the value of your assets.