It’s a tale as old as time. Buyers are always looking for a bargain while sellers are haunted by the suspicion that they could have squeezed more value out of a sale.
Whether the goal is to sell a hamburger or a hamburger business, arriving at an appropriate valuation is crucial if both parties are to be happy.
Everyone wants a piece of a successful business. But when the issue of price comes up, it can be tough to know exactly what a company is worth. That gap in knowledge is precisely what a savvy buyer is hoping to exploit in their goal to find a bargain. They hope the shareholders don’t know their company’s true market price.
That’s why valuing a company’s intangible assets is becoming so important. Getting this right could mean the difference between a nice payday and generational wealth for the shareholders.
To ensure the most accurate valuation, business owners looking to sell their company must know three key things:
- The types of intangible assets in the business;
- The quality of those intangible assets;
- How the presence or absence of these intangible assets might affect the value of the business.
When a prospective buyer walks in the door and asks for a proper valuation of a business, there really is no excuse for the owners to draw blank stares. Knowing what intangible assets are, where they fit into the company’s valuation and what they are worth should be considered Business 101.
However, an alarmingly high number of even experienced businesspeople still struggle to see past their tangible assets – which is anything you can drop on your foot. This includes machinery, property, cash, inventories, etc. While these are surely important, the bulk of a modern company’s value is now in its intangible assets and owners need to wrap their heads around this concept.
As the name implies, intangible assets can’t be touched or dropped on your foot. Examples of these assets include data, supplier relationships, patents, expertise, confidential information, inventions, software, content, design, approvals and even plant varieties. You might know them better by the umbrella term “goodwill.”
Or at least, “goodwill” is generally how accountants think about intangible assets. That term may have been useful in the past but lumping intangible assets into a single line-item risks missing an enormous chunk of a company’s worth (about 85-90%, according to a 2020 Ocean Tomo study).
Simply put, the accounting world has not kept up with what makes a business valuable. So, how can a modern company use the framework of intangible assets to know its true worth?
Consider Snowflake, a software-as-a-service (SaaS) provider with next-generation software that enables large dataset integration, manipulation and analysis on the cloud. What’s the real value of a company like this if the entire business could fit on a hard drive? Could it really be valued at millions of dollars?
It certainly could be. After all, a SaaS company’s main intangible asset will likely be its software which represents thousands of hours of R&D written by teams of highly competent coders and programmers.
The resulting software might look small and simple on paper, but its underlying value is layered in its years of effort, millions of dollars of investment capital and the fine-tuned market strategy. Each of these dynamics must be factored into the final valuation of the company. Snowflake’s balance sheet isn’t enough to reflect the value of the software. It is necessary to dig deeper.
IT/SaaS companies also hold intangible asset value in their trademarks. Microsoft, for example, has an impressive portfolio of trademarks held in different jurisdictions. A set of well-defended trademarks can be hugely valuable since they will provide a “shield” against rival companies trying to pass off copycat products or services.
Microsoft also benefits from scalability in its online subscriptions or licenses. Scalability gives the company access to a wider audience for little extra investment which means it can offer its services to customers at a lower monthly rate compared with competitors. Done right, scalability creates a positive feedback loop that further energises a company’s recurring revenue while expanding its market share.
A “sticky” customer base can also be an intangible asset. Customer stickiness is a marketing term describing the tendency to gain repeat business. Loyal customers mean a company can more easily reinforce its brand equity over time and these “sticky” users begin to create the intangible asset of a network effect which attracts more users, and so on.
In the “Information Age,” intangible assets will continue to account for a greater percentage of the enterprise value for most businesses than tangible assets.
By including intangible assets in a potential valuation, a business owner will have all the metrics they need to accurately price their company for potential buyers, likely at a much higher multiple than by just measuring its tangible assets.
Not only are intangible assets critical for driving long-term business success, they are fundamental if shareholders hope to capitalise on their hard-won efforts.
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