How Much Are Intangible Assets Worth?
When I receive a call asking how much my brand or customers are worth, or the value of my trade name, the caller usually doesn’t understand what is really needed to answer that question. Many times the owner simply wants to know how much the business is worth. This always leads to the question; how much are intangible assets worth?
Measuring Your Business’s Value
Perhaps the owner is thinking that each individual asset of the business needs to be appraised to determine the total value of the business. Since the owner often takes on the task of getting real estate appraisals and estimating the value of equipment, the owner figures he just needs to know the value of the intangibles and then put the pieces together to determine business value.
However, this approach is, in fact, the direct opposite of how healthy businesses are valued by appraisers or brokers. The total value of the business is determined in aggregate first and is typically based on an income and market approach.
If someone really wants to know what the goodwill and intangible assets are worth, the value of equipment and all of the other tangible assets are deducted from the aggregate value of assets, resulting in a residual value for goodwill and intangible assets.
This residual value is not bought directly since a buyer normally wants the entire business. In fact, goodwill and intangible assets often have very little value if they are separate and apart from the entire business.
What about brand value?
Many consider “branding” to be part of the sales and marketing function, specifically related to building a presence in the marketplace.
For many businesses, most of the value lies with the goodwill and intangible assets, which include the brand as well as customer relationships, proprietary processes, and human capital. In fact, as we continue to leverage technology, this is probably truer today more than ever before.
You need both the tangible assets (think Net Asset Value) and the goodwill and intangible assets (think blue sky) to run a business. Owners rarely sell just their brand, customers, employees (yikes, is that legal?), or goodwill. It would be like selling the frosting off the cake.
Measuring Customer & Employee Value
How much are your customers or employees worth? A better question is how do your customers and employees contribute to the overall value of your business? And how do your proprietary processes, equipment, accounts receivables, business strategy, and competitive advantages contribute to the overall value of your business?
In many cases, owners fixate on the individual values of each of these asset components and many more. But adding up the value of each of these assets is rarely the approach taken to estimate business value. In fact, how these assets work together determines the cash flow, growth potential, risk, and value of your business, which is what really interests investors.
It is true that if a public company makes an acquisition or a private company complies with “Big GAAP,” the purchase price must be allocated among different asset classes including certain intangible assets based on very specific accounting rules. However, this allocation process doesn’t mean that each intangible asset could be sold independently based on that value and some intangible assets might not receive a value allocation based on accounting rules.
Unless a business acquires another business, the net book value (owners’ equity) from the balance sheet consists of tangible assets such as inventory, A/R, and fixed assets less liabilities. Few if any intangible assets are booked on the balance sheet otherwise.
Simply put, the existing owners’ investment in the intangible assets of the business rarely lands on the balance sheet, until the business is sold, and the assets are recorded on the balance sheet of the new owner.
When the public trading price (or private selling price) exceeds net book value, the difference is often associated with the intangible assets (including brand) and goodwill of the business that are not on the balance sheet. Basically, the invisible stuff that makes a business operate successfully. Now there are a few exceptions, a company can book proprietary software development costs on the balance sheet as the costs are incurred, but this is more of an exception than a rule.
Since public companies are traded every day but aren’t being sold in their entirety (hence the intangibles are not booked on the balance sheet), the public market is a great playground to find data that supports this claim about most of the value being attributable to intangible assets and goodwill. This is expressed as a Price/Book multiple. For public companies that trade on U.S. stock exchanges with a positive book value, approximately 70% have a price/book multiple above 1x based on recent research (source Capital IQ).
If you liquidate a business (remember those going out of business sales, selling at below cost), chances are you will receive something less than book value (total assets minus total liabilities), unless you own appreciating assets such as real estate. Any discounts applied to tangible assets under a liquidation scenario can quickly result in a price/book multiple below 1x.
There are plenty of public companies that trade for below 1x book value, yet they don’t go out of business since their price is still above liquidation value, but still below book value (think ham sandwich). For public companies that trade on U.S. stock exchanges with a positive book value, approximately 30% have a price/book multiple below 1x. Of course, this could be abnormally high due to the COVID-19 recession.
As the value of a business increases, the improvement is often more attributable to increases in the value of goodwill and intangible assets rather than tangible assets. The spread between liquidation value and fair market value as a going concern (income approach and market approach) represents the value of all of the goodwill and intangible assets.
Book Value vs Fair Market Value
When I find business owners believing that book value is the fair market value of their businesses or the price they should be asking, I point them to the Price/Book multiples of public companies. Very few public companies actually trade at 1.0x book value.
While liquidation establishes a floor value for a business that is often below 1x book value, healthy businesses are frequently worth more than book value due to goodwill and intangible assets contributing to strong cash flow and growth potential. Ironically, there are still buy-sell agreements between shareholders of private businesses that use book value as the agreed-upon transaction price. I have found this to be erroneously used as fair market value, and if book value is used as the agreed-upon transaction price for a healthy business, the buyer could be getting a fantastic deal!