Valuing intangible assets
One of the most significant challenges in evaluating companies is the correct identification and evaluation of intangible assets. In the information and knowledge age, intangible assets are becoming increasingly relevant in the valuation process of a company.
Conceptually, intangible assets are assets that have no physical existence but are identifiable. Key examples of intangible assets include brands, patents, client portfolio, goodwill, exploration rights, concessions, intellectual property and market knowledge. Although they are not tangible, that is, something that we can touch, there are methods where it is possible to estimate the value of intangibles for the company. It is worth mentioning that intangible assets can be bought and sold independently of the business itself.
In many cases, the intangible assets are the real value drivers of the company, responsible for defining the success of the business. A large percentage of the market value of the most significant companies in the world are derived from the value of intangibles.
Intangible assets represent an intellectual and competitive advantage for the business, allowing the company to operate with higher profit margins and also act as a driving force for increased sales.
There is some confusion in understanding the concepts of Intangible Assets and Goodwill, making many people consider it to be the same thing. It is essential to clarify and differentiate concepts. Goodwill is harder assets to measure value directly. Some examples of Goodwill are customer loyalty, brand value, recognition and reputation of the company name, plus all the assets that make a company worth more than its historical value recorded in the accounting books. Here also enter the records of innovation, research, and development. Unlike intangible assets, Goodwill cannot exist independently of the business, nor can it be purchased or transferred separately. In this way, Goodwill has a useful life that is undefined (while the company is operating), unlike most other intangible assets. In fact, Goodwill is calculated at the time of purchase of a company and is accounted for as the premium amount paid on the fair value of the assets during the negotiation of purchase.
There are three primary methods for evaluating intangible assets:
- Income Approach
- Market Approach
- Cost Approach
Income Approach takes into account the future cash flows generated by the intangible asset to be valued. This approach uses the discounted cash flow method to assign the asset value. The value of the intangible asset will be the present value of the future cash flows discounted at an interest rate that represents the specific risk of the business. We work under the assumption of continuity of the company’s operations and the benefits of intangible assets.
Market Approach is based on the comparison of identical or similar transactions of the intangible asset to be valued in the market. Not always the data of these transactions are available, in this way, it is essential to seek data from market participants, as well as the use of multiples for comparisons, such as the multiplying factor on sales and the multiplying factor on the cash generated, among others.
Cost Approach is cost-based to create or recreate a similar intangible asset. The costs involved are Development (create) and Replacement (re-create) costs. This method is typically used to evaluate businesses that no longer generate positive cash flow, and which may be either extinct (settled) or transferred. When an investor intends to acquire a company in this situation, the central objective is to know the value to be invested in the productive assets so that the business, or one of its assets (tangible or intangible), returns to produce wealth satisfactorily.
Due to the relevance and weight in the final result of a valuation of a company, the evaluation of intangible assets are very complex and should be performed by professional appraisers with extensive market experience and in-depth technical knowledge.
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