Valuing Intangible Assets Within a Business

It’s usually quite straightforward to value the assets of a business, such as buildings, vehicles, plant and equipment. But what about the things you can’t see? The intangible assets, like brand names, bespoke software and goodwill that a business may have developed, which lack physical substance but add to its value and prestige. Luke Morris, Corporate Finance Partner examines the concept of an intangible asset, and how it can be valued.

22 September 2023 - Luke Morris

Sargent’s Ice Cream. How that name stays with me. A small, family-run business founded back in 1922 by the late Bill Sargent. It was based near Brigg in North Lincolnshire, and continued operating from that location until around 2006.

It’s not there anymore.

I haven’t tasted ice cream like it since. Four decades on and I can hardly describe the childhood excitement of a visit to Sargent’s on a Sunday afternoon.

I don’t know the full story, but I like to believe that Mr Sargent took his “intangible asset” – which was a magical and secret recipe – to the grave with him.

What is an intangible asset?

It’s very easy to define an intangible asset in technical accounting and valuation language: “a non-monetary asset that manifests itself by its economic properties. It does not have physical substance but grants rights and/or economic benefits to its owner”.

It’s much harder to define intangible assets in everyday language. I think the easiest way to think of them in layman’s terms is rather like any amorphous quality: hard to define what it actually is but you “know it when you see it”.

Take the amorphous quality of “excellence” as an example. What is excellence? I am not sure I can do that justice using words. But Luciano Pavarotti singing an aria, Sachin Tendulkar batting at the crease, or Marlon Brando as The Godfather, all raise the hair on the back of my neck. They’re clearly excellent (to me at least).

If they are hard to define, intangible assets are even harder to value. There is an active market for my most troublesome tangible asset, my ten-year-old Volvo: I can get you a precise valuation in minutes. However, as for intangibles, implicit in my excellence analogy is the assumption that (a) there is collective consensus on what in fact comprises “excellence”, and then that (b) such a thing can be measured. But is there? And can it?

Perhaps I am (a) more of an arm-chair-cricket-watching, occasional tenor-listening, mafia-movie fan than average, and (b) the premium that I would pay for such pleasures is surely challenging to measure.

There is certainly no “webuyanycar.com” to check for intangibles.

First: what are we valuing and who owns it?

It’s easy to understand how intangible assets are fundamental to any successful business, big or small.

“I’m giving Bill a ring to do the plumbing because I used him last time, his price was fair, and he did a decent job.”

“Coke or Pepsi? I’ll take the Coke, please.”

The “what”, in more formal terms, is a whole gamut of trademarks, trade names, technology, trade secrets, contracts, customer relationships… Intellectual property (“IP”) is a special subset of intangible asset that has legal protections and includes “creations of the mind” such as copyrights, patents, trademarks, and trade secrets.

Such intangible assets can create sustainable competitive advantages and protect businesses from competitive forces. These advantages can significantly enhance long-term profitability and value. The sorts of benefits conferred may be product differentiation (Apple iPhone), exclusivity (holding an exclusive product distribution agreement for the UK, thus eliminating competition), technological capability (the trade secret of the chemical composition of Mr Sargent’s ice-cream recipe), or economies of scale (the virtually limitless IP of Google). The benefits are usually a combination of them all.

On top of that we have the challenge of understanding that most ethereal of intangible assets: goodwill. Goodwill represents the value of future economic benefits that arise from the assemblage of a business’ assets, but which cannot directly be ascribed to a specific asset. There are numerous factors that influence goodwill: a business’ ability to adjust to changing markets, to develop new products, its going concern, the skills and expertise (and age) of its specific workforce, interpersonal relationships between specific employees and customers, location benefits… As goodwill comprises so many elements, its value can intuitively be thought of as a residual calculation, often arising in deals as a premium a buyer is prepared to pay.

Furthermore, a common valuation complexity is the added concept of “personal goodwill”. Does the goodwill being considered belong to the company being valued, or does it really belong to an individual person in the business? If my plumber Bill leaves his company, will I use the company again, or will I find out where trusted Bill is now plying his trade? To be honest I would call Bill’s mobile. How would the value of Tesla change without Elon Musk? (note: goodwill can be positive or negative).

So before we even get to our valuation calculations, we need to figure out what the intangible asset we are valuing is, how it is being used, and who owns it.

Second: how do we value it?

International Valuation Standards help us here as they set out three principal valuation approaches: “Market”, “Income”, and “Cost”.

Each valuation approach includes different, detailed and technical methods of application.

  • The Market approach provides an indication of value by comparing the intangible asset with identical or comparably similar assets for which price information is readily available.
  • The Income approach provides an indication of value by converting future cash flows to a single current value.
  • The Cost approach provides an indication of value using the economic principle that a buyer will pay no more for intangible asset than the cost to obtain such an asset of equal utility, whether by purchase or by creation.

Because intangible assets are by nature (if not unique) at least heterogeneous and because they seldom transact separately from other assets, it’s rarely possible to find Market approach evidence of transactions involving identical assets. In certain cases (e.g. internet domain names or broadcast spectrum rights) it is possible to obtain market evidence. But it is rare.

The Cost approach only tends to be relevant where the intangible asset in question is not in itself directly income generating (or cost saving). Again, there are only limited scenarios where you can imagine this might be applicable to a specific asset. Acquired third party software, or trying to determine the value of an assembled workforce may be relevant cases.

The Income approach is the most common method applied to the valuation of intangible assets, and there are many income approach methods. The exact scenario determines the correct method, and that is where the valuation professional comes in. Typically, the work includes some sophisticated future financial modelling comparing scenarios: one in which the business uses the subject intangible asset and one in which the business does not use the subject intangible asset, with all other factors being kept constant.

Last word

Although the intangible asset concept is as old as business itself, valuation of intangible assets is highly complex and is becoming increasingly so. This has been accelerated by a wide variety of intangible assets emerging and the ever-increasing impact of technology and data on all businesses and society at large.

We have seen increasing demand from our clients wanting to better understand this increasing proportion of value in their companies, and wanting to understand how these intangible value drivers may be protected and enhanced.

It all makes me feel like having an ice cream, and I assure you I would pay more for one from Mr Sargent than one from Mr Whippy.

Luke Morris oversees and leads Scrutton Bland’s valuation work. He has a vast amount of practical valuation experience, particularly with owner-managed and private family businesses, in both fiscal and non-fiscal cases (including dealing with the Courts). Get in touch with Luke or one of his team at hello@scruttonbland.co.uk or by calling 0330 058 6559.

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