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How To Value Intangible Assets?

07 April, 2010
One of the reasons why deal prices involve premium over book value of assets of the target company is the existence of intangible assets such as brands, technical know-how, licenses, copyrights, patents, customer contracts and relationships, distribution network, lease agreements, non-compete, computer software and skilled workforce. But how does one estimate value of these items?
 
While there are several globally acceptable valuation methods, the International Valuation Standards Council (IVSC) has recently released a revised guidance note 4 on valuation of intangible assets. According to Mr. Sanjiv Agrawal, Director, Ernst & Young India Merchant Banking Services, although intangible assets have been valued since many years, there is a need for consistency in application of methods due to increasing convergence of accounting standards across the globe.  Hence, the new guidance note is expected to benefit all – companies, advisors and investors.
 
As per the guidance note, an identified intangible asset is either separable i.e. capable of being divided from the entity and sold, transferred, licensed, rented or exchanged (either individually or together with a related asset or liability), or arises from contractual or other legal rights.  Difference between business value and values of identified tangible and intangible assets is goodwill, which would include value attributable to growth opportunities and synergies.
 
Amish Mehta, Associate Director, Ernst & Young, believes that analysis of the nature and attributes of the each intangible is critical for determining the appropriate valuation approach. More than one approach can be considered and within an approach there could be different methods.
 
The 3 most common approaches in valuing intangible assets are comparison approach, income approach and cost approach.
 
In the comparison approach, on determines the value of an intangible asset by reference to market activity like transaction prices, bids or offers involving identical or similar assets. Since all relevant information is seldom available in public domain, this method becomes less relevant. Also, given that intangible assets by their very nature are unique, market data for comparison approach, if available at all, is generally for similar but not identical assets and thereby requires certain adjustments.
 
Valuation methods under the income approach determine the value of an intangible asset, by reference to the present value of income, cash flows or cost savings that could actually or hypothetically be achieved by a market participant owning the asset. The methods generally used under the Income approach are royalty relief, premium profit and excess earnings.
 
The royalty relief method considers a hypothetical royalty payment saved through ownership as compared to licensing the asset from third party. Royalty rates are generally based on observed data in the same industry and typically applied as a percentage of revenues expected to be generated from the use of assets.
 
The premium profit method involves comparison of future profit streams/cash flows that would be earned by a business using the intangible asset with those that would be earned by a business that does not use the asset.
 
The excess earnings method determines cash flows attributable to the subject intangible asset after excluding the proportion of the cash flows that are attributable to other assets (say working capital, fixed assets) and is generally used in practice for those intangibles which have the biggest impact on the cash flows (i.e. where other assets are effectively only secondary assets in the business). The contribution to cash flows made by assets other than the subject intangible asset is known as the ‘contributory asset charge’ or ‘economic rent’ and requires determining value of those assets first.
 
Broadly speaking, royalty relief method is popular for valuation of brands/technical know-how while excess earnings method is generally used to value customer related assets.  
 
In the cost approach, the value of an intangible asset is arrived at by calculating the cost of replacing it with an asset with similar or identical service capacity. It is generally used for valuation of workforce, computer software, websites, etc. 
 
While importance of intangible assets may differ between industries and also amongst companies within a particular industry, one can make some broad conclusions. For example, consumer products or retail businesses have higher level of marketing related intangible assets like brand as against industrial products where technology may play a more important role. Telecom deal prices would get impacted by availability of license and spectrum, which is a key intangible asset for this industry, while content library could be key intangible for transactions involving media companies.
 
Intangible asset valuation is relevant not only in M&As but also for financial and tax reporting. Whether entity specific factors are considered in valuation depends upon the purpose of valuation. For purchase price allocations, scenario based on a typical market participant is considered.  
 
(Courtesy: Ernst & Young Merchant Banking Services Private Limited. The views expressed in this article are of the individuals and appropriate expert advice should be sought for each case.)

 


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1 Comment
Akash Bhalotia . 6 years ago

Nice article.. Thanks to Mr Amish and Team VCC for bringing more clarity to the subject… I would suggest the readers to read the following article for further clarifications. http://www.wipo.int/sme/en/documents/value_ip_intangible_assets.htm

How To Value Intangible Assets?

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