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As briefly mentioned in a previous blog, an intangible asset is an asset that is not physical in nature (i.e., cannot be physically seen or touched). They may be specifically identifiable assets, such as customer lists, patented technology, trademarks and copyrights. Or they may include assets that are not specifically identifiable, such as general business reputation, a well-trained workforce or business systems in place. When intangible assets are not specifically identifiable, but still contribute to a businesses’ earnings, they are referred to as Goodwill.
Unlike the tangible assets of a business (which may be identified upon a review of the Company’s balance sheet), intangible assets are often more elusive. They are only included on the Company’s balance sheet if they were actually purchased as part of an acquisition transaction. In contrast, if these assets were created internally, they will not be reflected on the balance sheet at all. Even if a business has spent millions of dollars building the value of its product brands (through expensive advertising campaigns) or its proprietary technologies (through R&D spending), these assets will not be captured on the balance sheet. This is why using an asset based valuation approach may result in an under-valuation of the business.
In fact, the value of some businesses may be comprised almost entirely of their intangible assets. For example, nobody will dispute that a reputable and well-known brand such as Coca-Cola can have significant value. Consumers around the globe may choose their next soft drink purchase simply based on this brand name, even though there are numerous comparable soft drinks from which to choose. In fact, the Coca-Cola brand name itself may be worth more than all of the Company’s manufacturing equipment and other tangible assets combined!
It may be useful for a business owner to understand the value of their intangible assets and how they have changed over time. Importantly, understanding the key valuation drivers will help the owner to maximize his exit price if a sale is contemplated at some point in the future.
The value of intangible assets lies in their ability to generate future incremental cash flows for the business. There are a number of methodologies that exist in the valuation profession to value such intangible assets, depending on their nature. In our next blog, we will discuss the principal valuation methodology used to estimate the value of a product brand name.