Intangible assets have continually grown in their importance as a driver of value in businesses, in particular over the past thirty years.
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2 Intangible assets have continually grown in their importance as a driver of value in businesses, in particular over the past thirty years. In the 1980s large, publicly-traded company values were generally not much greater than the value of their tangible assets while today, the portion of such companies value attributable to tangible assets is much lower. The difference is in the intangible assets. Intangible assets are typically described as assets that are non-physical in nature, give their owner certain rights and privileges (or the potential for such rights and privileges) and have the potential to provide their owner with economic benefits. Specific qualifications of intangible assets include that they can be identified with specificity and described in addition to being subject to legal protection.
3 Intangible assets are commonly categorized as follows: It should be noted that a particular type of intangible asset is not necessarily exclusive to a particular category of intangible asset. For example, patents may be correctly categorized as an engineering-related intangible asset, or as a technology-related intangible asset.
4 Intellectual Property Intellectual property is a specialized class, or subset, of intangible assets that are distinct from other intangible assets. Unlike other intangible assets that are created in the normal course of business activity/operations, intellectual property is the result of conscious creative, or inventive activity that is attributable to the activity, or efforts, of specific individuals. Intellectual property is typically classified as either creative or innovative and divided into five categories as follows: Appraisal of Intangible Assets The appraisal/valuation of intangible assets is based on the same three approaches that are used in appraising businesses, real estate, or any other asset. These are: The Income Approach The Market Approach The Asset (Cost) Approach
5 Income Approach The Income Approach takes the perspective that the value of an intangible asset is defined by the benefit one gains from owning the asset a stream of prospective economic income, usually after-tax cash flow, that can be generated through use of the asset. As such, the Income Approach is based upon the economic principle of anticipation (sometimes called the principle of expectation) by which the investor anticipates an expected economic income. Application of the Income Approach is a two-step process using one of two methods: the discounted cash flow ( DCF ) method or the capitalization method. Under the DCF method one must (i) project the future cash flow associated with the subject asset and (ii) discount the projected cash flow stream to a present value, at a discount rate appropriate for the expected risk inherent in the subject asset. Under the capitalization method one must (i) determine a level of cash flow that is representative of the future cash flow associated with the subject asset and (ii) capitalize the representative cash flow to a present value, at a capitalization rate equal to a discount rate appropriate for the expected risk inherent in the subject asset, less the expected long-term cash flow rate of growth.
6 Market Approach The theory underlying the Market Approach holds that a recent sale of a similar asset is the best indication of the subject asset s value. In practice, the market value of an asset is assumed to bear a close relationship to the prices at which similar assets have recently changed hands. Therefore, a major component in applying the Market Approach is to collect market data on the sale of assets sufficiently similar to the subject asset, often called comparables. Comparable sales are analyzed and adjusted to reflect differences between the comparable and the subject asset. Consideration is given to such factors as time of sale, asset characteristics, and terms or conditions of sale. Cost Approach The Cost Approach is based on the principle that a willing buyer will pay no more to a willing seller than the cost associated with replacing the subject asset either by purchase or production with one of comparable functional utility. There are two principle Cost Approach methods that appraisers use as a starting point related to intangible assets - the depreciated replacement cost method and the depreciated reproduction cost method. As in the appraisal of fixed assets, replacement cost, as applied to intangible assets, is the present cost of replacing the asset with another asset of roughly equal utility while reproduction cost is the current cost of reproducing the asset with the same or highly similar characteristics.
7 Use of the Three Approaches The Market Approach is often inapplicable in the valuation of an intangible asset due to the lack of comparable asset transactions or the lack of sufficient publicly available information regarding such transactions. However, some intangible assets (or the rights to use such assets) are bought and sold through licensing agreements for which public information may be available. Such data may be utilized as the basis for developing an indication as to the value of the underlying asset. Intangible assets to which the Market Approach is often applied include tradenames, trademarks, technology and patents. The Cost Approach is typically utilized in the appraisal of intangible assets (i) for which there is no active market involving sufficiently similar assets that would allow for use of the Market Approach, (ii) which are not utilized directly to generate economic income, and/or (iii) for which the cost to reproduce the asset is reasonably determinable. Such assets would include drawings/designs, formulas and internaluse software. Use of the Income Approach is common in the appraisal of intangible assets in large part the result of (i) the inability to apply the Market Approach due to the lack of readily available data on transactions involving sufficiently similar assets, (ii) the inapplicability of the Cost Approach due to the nature of the intangible asset resulting in an economic income generating capacity that commands a value significantly greater than the cost of reproducing the asset, and (iii) the nature of the asset and its expected use allowing for the reasonable forecasting of economic income generated through the use of the asset. The application of multiple approaches is fairly common in the appraisal of businesses and real estate; however, this is not nearly as common in appraising intangible assets. Although the development of intangible asset value indications from multiple approaches may be feasible in light of the available data, it is often the case from a logic standpoint that one approach provides a much more reliable indication of value than the other approaches. As such, the determination as to which approach is most appropriate/reliable depends on the expertise of the appraiser in assessing the facts and circumstances regarding the subject intangible asset.
8 About Hill Schwartz Spilker Keller LLC (HSSK) HSSK is a professional services firm devoted to Business Valuation, Litigation Consulting and Financial Restructuring. The principals have been serving the corporate, legal and professional communities for over thirty years. HSSK assists clients in quantifying and articulating value for financial reporting, taxation, transaction, and corporate planning purposes. We also work with clients involved in filed and pending litigation and disputes by providing valuation services, financial forensics, financial damage determination, and bankruptcy related services, including serving as financial advisors to parties, as trustees, and as examiners Hill Schwartz Spilker Keller LLC. All rights reserved. All referenced product names are the trademarks of their respective companies.
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