What are intangible assets and how do you value them?
You could likely sit back, look at your company's balance sheet, your financial statements, and your customer lists, and get an idea of your company's value. But, this would be selling your small business short. These sheets, lists, and statements only track your tangible assets. They flat out ignore your intangible assets.
Virtually every company has some kind of intangible assets, whether they know it or not. Understanding what intangible assets are and how to value them is a key part of valuing your business, so let's take a look.
What are intangible assets?
Tangible assets are any physical assets: equipment, real estate, products, and even customers. These are all things you can physically see and touch (although you maybe shouldn't).
Intangible assets are non-physical assets that play a role in your company's success, even if you can't see them. Oftentimes intangible assets play into your company's long-term growth. Tangible assets, on the other hand, are more often associated with short-term success, cash flow, and overall working capital. (You can sell a tangible asset.)
Intangible assets can be broken down into two categories: those with indefinite useful lives, and limited-life intangible assets.
An indefinite useful life intangible asset will be of value forever, barring any kind of catastrophe to your brand. These types of assets can generate income indefinitely. Some indefinite useful-life intangible assets include trademarks, goodwill, and brand recognition. For example, think of a popular franchise like McDonald's or Chick-fil-A. For franchises of this size, brand recognition is indefinitely useful.
A limited-life intangible asset is exactly as it sounds: an intangible asset that will only generate cash flow for a certain period of time. The most common type of limited-life intangible asset is a patent because patents have an agreed-upon term when they're created.
For example, if Coca Cola had a patent for a special flavor that lasted 10 years, that patent would have a life of 10 years. While limited-life intangibles only last a set amount of time, these are still long-term assets and are just as important as indefinitely useful ones.
Now, let's look at some common intangible asset examples to further solidify this invisible concept.
Examples of intangible assets
Intangible assets, while not physical, are actually quite common and likely all around you. Regardless of your industry or niche, the following examples of intangible assets are common for most business owners:
- Brand recognition: Any brand recognition you have is an intangible asset and plays a role in your company's success. For example, a big brand name alone can help a company sell far more than a company with little brand recognition.
- Licensing agreements: A licensing agreement between you and another party is an intangible asset because it allows your company to generate increased revenue but can't be labeled with a clear dollar amount.
- Copyrights and patents: Any kind of copyright, patent, trade name, trademark, or other kind of intellectual property is an intangible asset because it plays a role in your company's ability to generate revenue. Many of these elements, such as a trademark, are directly related to your brand recognition, as well.
- Computer software: If you're paying for any kind of computer software, that's an intangible asset. You can't sell your computer software license if you need some quick cash flow, but it does add value to your company because it would go to a buyer if they purchased your entire company.
- Trade secrets: Trade secrets are one of the most ethereal types of intangible assets because they're hard to value, but they most certainly add value to your company. If you're privy to any trade secrets, these are definitely an asset, but determining their value will be a challenge.
- Legal rights: Any kind of permit or legal right can be classified as an intangible asset. For example, if you have a specialized security permit that allows you to manufacture a chemical, that is an asset.
- Domain names: Every domain name your company has registered is an intangible asset because they likely act as a gateway for your business but can't be assigned a specific book value.
- Customer relationships: Technically, a customer relationship is an intangible asset. While customers and customer lists are tangible assets, the relationship itself is a grey area that leaves it in the intangible territory. You can sell a customer list with your business, but you can't sell the relationship.
From customer relationships to brand recognition, intangible assets are varied. And this list is by no means exhaustive. There are countless intangible assets, many of which are specific to certain industries. But, the above list can act as a starting point for determining what intangible assets you have. Next, let's look at how you can value intangible assets.
How to value intangible assets
Tangible assets are often easy to value: You look at the cost of the asset, depreciate it if necessary, and go from there. But, because intangible assets are so, well, intangible, they're a little harder to place value on. Fortunately, there are three methods that can help you determine the value of an intangible asset.
The income approach to valuation is suited for any intangible asset that's more closely linked with revenue. For example, you could use the income approach to determine what a patent could be worth.
To determine the patent's value, you would first examine what that patent has done for your company. If it enabled you to do something like create a unique product that you now sell, that's a clear indication that the patent is directly tied to income. From there, you could review your books to see how much revenue that product has generated since it was introduced.
It's important you look back as far as possible, as you want to see if the sales are trending up or down. If the product is past its prime you'll want to factor in any potential devaluation that might occur over the course of the product and patent's lifetime.
If you have to pay a costly licensing agreement to sell the patented product in stores you'll also want to factor that in. While the patent itself might result in the creation of a high-dollar product, expensive and necessary licensing agreements will eat into the patent's value.
Market value method
The market approach to determining intangible asset value isn't perfect, nor is it a science, but it's a solid way to estimate value.
To perform a market valuation of an intangible asset, take note of the asset you're trying to value. Then, look to your competitors and see if any of them have publicly traded or sold a similar intangible asset. This can be easier said than done, as many public transactions encompass numerous assets, not just a single intangible asset.
For example, you might find a report that a company just sold a licensing agreement to a retailer. But, what this sale doesn't tell you is how much of that licensing agreement's value came from the company's brand recognition alone.
Ultimately, you want to lean on any data you can find. If you’re trying to determine what your building space is worth, you can look at real estate in your area. But, if you’re trying to determine what your brand itself is worth, you likely need the income approach.
If you can't find any public information related to the intangible asset you want to value, try another method from this list.
The cost method or cost approach is commonly used for tangible assets but can also be used for some intangible assets like software.
The cost method uses substitution to determine an intangible asset's value. This is done by simply asking, "How much will it cost to replace this asset with a similar one?" In the case of computer software, for example, this can be easily done simply by comparison shopping.
This method isn't as useful for most intangible assets, but it's important to remember if you're wanting to determine how much your entire business is worth. Just keep in mind that those software subscriptions can be replaced and may not add as much value as you hoped.
None of the three common intangible asset valuation methods are perfect, but each one has a unique purpose that serves to provide a deeper understanding of your company's total value.
Intangible assets seem mysterious at first, and maybe some of them are. But, with a better understanding, these assets become understandably intangible: They're not necessarily something you can see or touch, but they're still vital to your business and its success.
If you're still feeling uncertain about how to value your intangible assets, consult with a financial advisor or speak with your bookkeeper. With some teamwork — and likely some documentation — you can arrive at a deeper, more holistic understanding of how much your company is worth. And that is a wonderfully intangible feeling.