Maximizing Value in Private Equity Transactions

EverEdge Head of Transactions, Craig Margolius shares how intangible assets provide leverage for companies looking to maximize value through the transation process.  

Private equity transaction values have increased over the past few years driven both by competition for quality assets and increased liquidity created by strong capital flows within many sectors and more recently by extremely loose central bank monetary policy.

However, while ample capital is available and conditions are favourable, many (though not all) of today’s buyers are showing more discipline than they were five years ago (and certainly pre GFC) and are more rigorous in their due diligence especially with respect to their assessment of the quality of company assets and associated risks. Likewise, slowly but surely the focus of this rigour is now shifting to a target’s intangible assets. Investors increasingly have an expectation that a company being acquired will be able to demonstrate that it has, among other characteristics, a strong intangible asset position.

Sell Side: Where value lies

There is an abundance of data showing that intangible assets (largely contained in the post-acquisition goodwill), make up most of M&A deal value both for listed and unlisted companies. More generally, items such as data, content, software code, brands, confidential information, inventions, industrial know-how, and design rights, today account for more than 90% of enterprise value of companies in the S&P 500.

For any company entering a sell-side transaction (especially with cross border acquirers), understanding and articulating what intangible assets it holds, the associated risks and the true value of these assets is essential to extract value.

Unfortunately, accounting standards were developed in an age where value almost entirely resided in a company’s tangible assets hence intangible assets are largely absent from or effectively ignored within companies’ financial reports. Couple this with the fact that valuation methodologies that correctly consider intangible assets remain poorly understood and many sellers unconsciously find themselves in a situation where they aren’t able to maximize value within the transaction because the value of critical intangible assets hasn’t been articulated during the transaction process.

In short, years spent optimising accounts and normalising earnings at sale will not necessarily lead to the best outcome in an M&A transaction if 90% of the value of the company are in assets that are otherwise ignored in the transaction process. To maximise value, it is critical to go beyond the balance sheet when assessing value.

This applies even if the business seems prima facie to rely on tangible assets such as plant and equipment, inventory, or even physical resources. The presence of these physical assets does not imply that the business has no intangible assets.

Instead, it is more likely that the business’ intangible assets (due to the aforementioned issues with accounting standards) have not been listed within traditional financial reports and therefore their value is poorly understood or articulated.

There is a very simple thought experiment you can do to test this theory. Imagine I was to give you a steel mill – for free. However, the catch is I only give you the mill itself – the tangible assets. I hold back any information about the mills systems and processes, supplier and customer relationships or operational data. You can’t make use of the company brand, the mill’s proprietary software, the regulatory approvals to run the mill or any of its other intangible assets. Very quickly it becomes apparent that the true value of the mill is not in its tangible assets, but in its intangible assets.

Intangible Asset Position

“Intangible Asset Position” is a term EverEdge coined to describe the combined strength or weakness of the intangible assets that a company owns or controls surrounding a product, a service, a technology, or an entire business. An intangible asset position influences two key things. Firstly, opportunity size, which is the amount of money that can be derived from that position, and secondly, the options that are available to generate that money from that asset position. By understanding the intangible asset position of the company, investors are materially better placed to articulate the value of those intangible assets to potential purchasers.

Preparation of the correct intangible asset narrative can drive value

Articulation of intangible assets should start before any transaction to save time and start from a position of strength when negotiating. The process includes identifying and articulating the value of these intangible assets throughout the transaction process from data room preparation and collateral development through to strategic bidder selection and final term negotiations.

The broad steps to follow include:

1. Identify the key intangible assets that the company possesses via a structured, proven, and defendable process.
2. Identify and mitigate the risk associated with these intangible assets.
3. Maximise returns by articulating the value of your intangible assets and monetisation opportunities to potential buyers throughout the transaction process through your sale collateral, the sale process, and engagement.

The goal when selling a business is to capture the highest value possible. While many factors drive deal valuation (such as company prospects, competitive landscape, economic conditions, deal structure and tax considerations), well-prepared sellers that understand their intangible asset position are materially better positioned to answer questions posed by potential buyers and extract maximum value through the transaction process.

In summary intangible assets are one of the most important valuation levers that if narrated correctly in a sales process, can achieve above normal market valuations.