Valuing Intangible Assets
Frequently, the values of intangibles are not separately identified in financial statements but, instead, a value may be ascribed to goodwill, which is really a conglomeration of all the components of intangible assets. However, goodwill most often it does not appear on the balance sheet unless there has been a purchase of net assets (assets less liabilities) of a business for a price in excess of the total of the values ascribed to each of the respective assets and less the values of the respective liabilities. If goodwill exists when a business is being valued for such purposes as a purchase or sale, a gift or for estate tax reporting, or in a divorce, then the value of the goodwill (if not segmented) will be inherent in the total value of the business enterprise. Without getting into a detailed discussion of the various valuation methodologies, an example of how the existence of goodwill value is determinable under the income approach is by applying an appropriate capitalization rate to the business’ cash flow i.e., dividing a representative cash flow amount by a capitalization rate, and comparing the result to the fair market value of the business’ net tangible assets (tangible assets minus liabilities). To the extent that the capitalized cash flow, i.e. the value of business, exceeds the fair market value of the respective net tangible assets, a goodwill value exists. Thus, the value of the business that was arrived at consists of the fair market value of the assets minus liabilities that appear on the balance sheet plus the intangible characterized as goodwill.
Examples of specific types of intangible property can be proprietary software, customer lists, customer loyalty, a business’ work force and/or its stability, a business’ particular location, and patented processes. It should be noted, however, that many of these types of intangibles, such as customer loyalty (as opposed to customer lists or contracts), stability of the work force or the location of a business, etc., are particularly qualitative in nature and are often extremely difficult, if not impossible, to meaningfully value separately. That is not to say that situations do not arise where these intangibles need to be valued. The point is that, collectively, the value of all intangibles is inherent in the value of goodwill, and that at least some intangibles cannot be specifically identified, let alone quantified. Furthermore, when valuing businesses, often there is no reason to attempt to separately quantify those components of goodwill, as the business’ earnings or cash flow which, under the income approach as previously mentioned, is capitalized to arrive at a total value for a business.
Some examples of intangible properties that are often valued are licenses, patents, trademarks, customer lists, proprietary software, franchise agreements, various other types of agreements and contracts, etc. Many of these kinds of intangibles are characterized as intellectual property. Valuation of these assets are performed for such purposes as when damages for infringement or contact breaches are litigated, when claiming losses covered by insurance, when liquidating of a business in bankruptcy, and for certain financial statement reporting requirements under generally accepted accounting principles.
There are the three approaches used in valuing intangibles (as there are in valuing businesses or real estate). Different methods exist under each approach. The use of any one method or a combination of methods depends on the nature of the intangible and the purpose for which it is being valued. Also, among many important factors to be ascertained when valuing intangible property are: the valuation date of the intangible, as the value could value materially as of different points in time, and the useful life of the intangible, which depends on its legal life, contractual life and/or some other condition that determines the end of its viability.
When a business enterprise is being valued as a whole, the valuator needs to decide which of the three approaches or combination of two or all three of the approaches to use, and which method or methods under the one or more of the respective approaches to apply.
Recognizing the existence of intangible property is necessary when performing valuations of business enterprises, but in many if not most situations, separate valuations of these intangibles is not fundamental to the valuation process or not even practical, let alone if even practicable. However, if intangible property needs to be valued either as a separate asset or as separates assets as components of the value of a business as a whole, then your valuation expert will need to decide which approaches and methods are appropriate under the circumstances. You should always be able to feel free to discuss with your business valuator the methodology being used by him or her.
