Valuation of Intangibles

As an accountant I have often met with the frustration of clients over the fact that their financial
statements do not reflect the "true value" of their companies. As a business owner myself, I share
this frustration but there is just nothing within the practice of accounting that allows for this
recognition. This frustration is magnified when financial statements are presented to third parties
for purposes of raising additional capital or at a time when you want to put the company on the
market for sale. Just as owners are interested in the extras a company has, investors and buyers are
also interested.

Essentially the balance sheet represents the original assets and liabilities at the time of formation
plus all increases in tangibles (buildings, equipments, receivables, debts etc.) accumulated since that
time. These statements do not include the value of a solid customer list, franchise contracts, brand
name and general goodwill developed. These intangible assets often can reflect more value than the
tangible assets within the company. Most companies have two or more types of intangibles and it is
important not to forget about these when looking at any company.

The gross value of the intangibles can be simply calculated by determining an overall value
(multiple of sales, earnings, current replacement value etc.) and then subtracting this total from the
net value of the assets. Once you have calculated the total value of the intangibles the real work
begins.

Examine the company from the prospective of what rights it owns. Example of this are trademarks,
franchise contracts and exclusive distribution rights. If there are any proprietary products these
should also be included. What we have here are real strengths that cash flows can be determined
from. In franchise contracts for instance determine the average royalty from each contract and
develop a net present value for the cash flows based on a cost of capital and the remaining life of
the agreement. For a trademark, consider the costs of duplicating this effort from a legal and
marketing point of view. Proprietary products can be examined on the basis of market share
achieved and the value of the longevity of the nature of the product. There are no hard and fast rules
here, but with some imagination you should be able to come up with two or more ways to value
each of the major classes of intangibles within the company.

I suggest two or more methods of valuation of these items as you want to ensure that both methods
deliver a value close to each other. In this area you can often miss the key issues that deliver (or
subtracts) substantially from the total. When two methods deliver vastly different values, find out
why.

Work through each of these off balance sheet assets and determine a collective value. Compare this
amount to the total derived from the total value less net tangible assets. Once again you are looking
for ways to validate each amount in reference to different standards. In all likelihood there will be a
difference. Usually this has simply been called the most intangible of intangibles - goodwill.

In the past it was critically important to separate out the types of intangibles as the tax treatment
differs. When my company was purchased we were able to assign a major portion of the purchase
price to the contracts we purchased and as a result we were able to write off the value over a
significantly faster schedule than if we had identified the difference in purchase price and net assets
as goodwill. The IRS, probably tired of fighting the classification battle of intangibles, has since
changed the rules. If it is not tangible, then it is intangible and must be written off over 15 years.

While the tax treatment has changed, the importance of properly valuing your intangibles has not.
Over the years we have invested heavily in brand name, training and development of new products.
While some of these items might have been capitalized, we chose to keep a cleaner balance sheet
and wrote them off in the year incurred. Nevertheless, we are positive of the ongoing benefit of
these investments.

Your opinion of the intangible values is almost worthless without some solid working papers. Be
prepared to demonstrate the calculations and the underlying assumptions. Generally I have found
that when these steps are taken, a higher value is often realized. Even if you are not looking to sell,
buy or raise capital, these periodic reviews of the intangibles help you better invest in the strength
of your business, even if accountants refuse to put it onto the balance sheet.

Valuation of "Intangible" Assets

"Intangibles" such as customer goodwill, name recognition, and customer lists are valuable non-
material assets that can be appraised just like physical equipment, real estate, accounts receivable,
and securities. Below are some of the most important intangible assets, and some ways they are
valued.

Brand Names or Trademarks. Brand names and trademarks can be extremely valuable. Some,
such as "jello," "xerox," and "kleenex" have nearly become generic terms. A common valuation
method is based on how much more a company can charge for its products than relatively unknown
competitors.

Contracts. Certain contracts, such as employment, affiliation, advertising, or sales contracts, can be
treated as intangible assets because they add value to a company. For example, a long-term lease at
below-market rates can represent a huge overhead savings. Or, when a business is sold, the
president of the selling company may contract to remain for a certain period. This contract is valuable
because it saves the cost to replace the president with a new executive who would have to learn the
business and take time to become as effective. Other types of valuable contracts might be
subscription contracts (for example, a cable company's revenue is based largely on subscriptions) or
long-term service contracts sold by the company.

Franchises and Other Licenses. Franchises that are well-recognized and have a long track record
are valuable. One common way to value franchises is based on profit advantage over similar
businesses by virtue of the franchise.

Goodwill. Goodwill is based on your company's reputation and relationships with customers, vendors
and the community, and its participation in trade-related activities. In broad terms, goodwill is a
measure of your company's reputation, and of how willing these individuals would be to continue
doing business with your company. Goodwill is often lumped with other intangibles in valuation
because it can be difficult to separate the value of each intangible. At a base level, goodwill can be
considered the value of having an established business, so that a buyer would not have to assemble
the business and seek customers from the ground up.

Patents and Patent Applications. The value of a patent depends on its economic and legal
lifespan. The value of a patent application depends on the strength of its claims.

Proprietary Lists. Many types of lists, such as customer or subscription lists, are often compiled for
internal use, bought, or sold. Lists are especially valuable if they represent ongoing business
relationships. For example, if a newspaper gets 80 percent of its advertising revenue from companies
on a customer list, that list is a critical business tool. Values may be based on the cost to replace a
list, or the repeat sales generated.

Secret Processes, Methods, and Formulas. Often these assets are not patented, and valuation
must be made based on profit advantage or cost savings provided by the asset. Because these assets
are volatile-secrets are precarious-an appraiser's judgment often plays heavily in these valuations.

Tax Credits For Past Losses. The IRS allows certain losses to be carried back or carried forward. If
a company has losses, they may be carried forward for a certain number of years to offset profits,
resulting in a tax saving. The anticipated tax saving can often be estimated, providing a value for this
asset.

Technical Libraries and Other Specialized Information Repositories. Many libraries contain
nearly irreplaceable material, and can be extraordinarily difficult to recreate. These assets are often
valued by the cost of recreating them, minus losses for obsolescence.
 VALUING INTANGIBLE ASSETS & INTELLECTUAL PROPERTIES
By Stephen J. Kerr
One of the more vexing problems in business valuation is the issue of valuing intangible
assets. Intangible assets come in many forms and probably do not appear anywhere on the
company's balance sheet. These intangibles may include, patents and trademarks, copyrights,
mailing lists, exclusive contracts, royalty agreements, work-in-progress, proprietary designs
and many others.
These assets and intellectual properties have a real value that can be estimated through
investigation and objective calculation. The actual value of anything, tangible or not, is
based on what someone else is willing to pay for it. The price paid for an asset has a great
deal to do with who can put it to its highest and best use. If you are holding a license or
copyright on a film or book that is not presently being distributed because you cannot afford
to do so, that right may still have great value to a larger company with the resources to
market the book or production.
In the mind of the purchaser of intangible assets you can bet that he or she will be trying to
calculate whether it is better to purchase the complete asset (take a mailing list for example)
or is it less costly to simply duplicate the work that went into making the asset themselves.
Therefore, Replacement Cost is one method in which you can estimate the hours and
expense of replicating the intangible asset yourself Once you have been able to estimate the
replacement cost as new, (often the highest price you could pay) you may then seek to offer
the current owner a fair price for their asset to spare you from having to go through the
process of recreating it from scratch.
However, there is no equivalent replacement value on many assets such as copyrights and
trademarks, and no open market to draw comparisons from. Thus, we are left with a second
and more accurate tool for valuing intangible assets:
THE DISCOUNT METHOD OF VALUATION
In the Discount Method of Valuation, the goal is to determine for a specific assets, what the
future cash flow would be over its projected economic life, and thereby derive what the net
present value of the asset is today.
HYPOTHETICAL EXAMPLE:
"Healthy Body Publishing"
Healthy Body Publishing in our example is a multi-faceted publishing and direct mail
company that wants to spin off its direct mail business to someone else. The management
has kept internal records on the direct mail business, and now they want to know how much
the direct mail business is worth if it were to be sold off. It is easy to imagine that the direct
mail business is basically a mailing list of 50,000 names - the company keeps no inventory
or other tangible assets on its books specifically relating to the direct mail business -orders
are drop shipped by other publishers directly to the customer and that Healthy Body
Publishers just does the ordering and invoicing.
The first item that you will need is to confirm how much of the income and profits of the
entire company are derived from the intangible asset (mailing list) and its surrounding
business (direct mail marketing).
We're going to suppose, for the sake of our sanity, that the owners of Healthy Body
Publishers have run the direct mail business as a profit center for the company and have
internal profit and loss statements that they can refer to when reviewing the unit's perform
ance against that of the whole company.
What they determine through investigation, because they kept careful records, is that the
mailing list is responsible for $300,000 in annual revenue and approximately $80,000 of the
company's net profits (before taxes).
Every asset tangible or intangible has a given Economic Life over which it provides the vast
majority of its income to the owner. For some patents and copyrights the remaining
Economic Life can be as long as 20 years. For others it may be as short as six months. In our
hypothetical example, Healthy Body Publishers has estimated that the remaining Economic
Life of their present mailing list, and the business that is built upon it, is about 4 years
before it is substantially worn out and would have to have been almost totally replaced.
If we depreciate the value of the present cash flow ($80,000) over the 4 year given
Economic Life of the mailing list we get the following schedule:
Year 1 $80,000
Year 2 $60,000
Year 3 $40,000
Year 4 $20,000
Total $200,000 / 4 years = $50,000 average cash flow
The next step is to divide the projected average $50,000 annual cash flow by the return on
investment the next owner will have to make to justify the business risk inherent in
purchasing someone else's depreciating intangible asset. Since we are saying that this is a
secure business with a consistent track record of profits, let's suppose that the buyer will be
satisfied with a return on investment of about 20% over the next four years. This model of
valuation is also known as the Capitalization Method and the percentage return on
investment is referred to as the "Cap Rate".
Capitalization Method
Average Cash
Flow
= Present Value
Return on
Investment

$50,000
= $250,000
20%
To achieve the Net Present Value of the investment in today's dollars, you will need to
discount the $250,000 for the cost of money (if borrowed) and for inflation. What you will
end with will probably be a negotiated price between $200,000 and $250,000.
An intangible asset can be valued in this way if you can accurately project the Economic
Life of the asset and isolate the net profit the company earns off of that specific asset.
 Royalties for example may be easy to calculate net earnings from, but you may not be able
to determine how fast those royalty agreements are depreciating.
For the purpose of capitalizing on intangible assets sometime in the future, it is a good idea
for entrepreneurs to keep track of the bottom line net profit they receive from the use and
application of their intangible assets. And, in the case of companies with multiple income
streams from separate but commingled operations, you must keep internal profit and loss
statements on these operations if you ever wish to sell one of these ventures off separately.
WHAT IS THE VALUE OF NEW INTANGIBLE ASSETS, NOT YET RELEASED?
To value productions or new works not net produced and marketed, you may follow
basically the same rules as presented above, but with some notable exceptions.
First, you must investigate with great care what the projected Economic Life will be on your
new asset. That means asking the competition, if you must, how much use they have
realized out of similar rights, licenses, lists or other assets. Whatever you do, your estimate
of a usable economic life should not just be some "wild guess". If your asset is to have a
long Economic Life, be sure to factor in costs to update the asset to keep it valuable.
Since you do not have a track record on this asset, you must make sales projections and cost
projections to forecast, as best you can, a conservative net operating income for the asset (or
company). This is called a "proforma" in financial circles. Once you have completed a
proforma on the new asset, divide the forecasted net income by its proposed economic life
and divide by the anticipated capitalization rate -- and you will have the estimated Present
Value of that intangible asset.
Again I must stress, any accurate valuation of a single asset or a whole company must
include some discussion as to terms under which it might be sold and the market it is being
sold to. Supply and demand still rule pricing in our free market and it is a good idea to study
the overall market in your industry to find out if your asset is in great supply, high demand
or neither.

Article: The valuation of intangible assets.

(accounting methods)
The analysis and appraisal of intangible assets is becoming a progressively more
common component of the corporate bankruptcy and reorganization process.
Companies in many industries - from manufacturing to retailing to transportation to
financial services - are using their established intangible assets as secured debt
collateral and as a cash flow resource as part of a plan of reorganization. Intangible
assets provide a source of cash flow both From the operational use of the
intangibles in the subject business and from licensing the intangibles to third
parties for use in "extension" businesses.

The topic of intangible asset valuation within a bankruptcy environment is broad,

and we only have space available for an introductory treatment of the topic in this
article. Of course, accountants are intimately involved in the bankruptcy and
reorganization process, as it involves their clients and corporate employers.
Accountants are involved in the selection of appraisers and economists, in the
development of historical and prospective financial data, and in the review of the
analyses and conclusions of the appraisers and economists. Accordingly, this article
is written from the perspective of the accountant involved in the bankruptcy and
reorganization valuation process.

Reasons to Appraise Intangible Assets

There are numerous reasons to conduct a comprehensive analysis and rigorous

valuation of a corporate debtor's intangible assets within the context of a
bankruptcy and reorganization. Some of these reasons include:

* Some forms of secured debt include various (or all) of the debtor's intangible
assets as collateral; obviously, the creditors are interested in the value of their
collateral interests.

* For companies considering reorganization and restructuring alternatives,

established intangible assets may present cash generation and spin-off
opportunities; under-utilized intangible assets may be sold for valuable
consideration; currently-utilized intangible assets may be licensed to generate
incremental royalty income.

* Both debtors in possession and creditors should be interested in the effects of a

proposed plan of reorganization on the value of the established and long-lived
intangible assets of the corporate debtor.

* An appraisal of the company's intangible assets is often an essential element of

the overall business enterprise valuation of the corporate debtor on a going concern
basis versus on a liquidation basis; these alternative analyses are generally quite
useful to the assessment of a proposed plan of reorganization.

Clearly, the informational benefits of such formal intangible asset valuation

analyses may accrue to both the debtor and the creditors and to other parties-in-
interest.
How to Identify Intangible Assets

In identifying the elements that contribute to the valuation and legal existence of
an intangible asset, two related questions are relevant: what economic
phenomenon qualifies as an intangible asset? and what economic phenomenon
does not qualify as an intangible asset?

For an intangible asset to exist from a valuation, economic and legal perspective, it
must possess certain attributes. Some of these requisite attributes include the
following:

* It must be subject to specific identification and recognizable description.

* It must be subject to legal existence and protection.

* It must be subject to the right of private ownership, and this private ownership
must be legally transferable.

* There must be some tangible evidence or manifestation of the existence of the

intangible asset (e.g., a contract or a license or a registration document).

* It must have been created or have come into existence at an identifiable time or
as the result of an identifiable event.

* It must be subject to being destroyed or to a termination of existence at an

identifiable time or as the result of an identifiable event.

In other words, there must be a specific bundle of legal rights (and other natural
properties) associated with the existence of any intangible asset.

For an intangible asset to have a quantifiable value from an economic perspective,

it must possess certain additional attributes. Some of these additional requisite
attributes include the following:

* It must generate some measurable amount of economic benefit to its owner; this
economic benefit could be in the form of an increment or of a cost decrement; this
economic …