Valuation of intellectual property (hereafter the broader term, intangible assets) is one of the most important and vexed issues in finance, investment and commercialisation today.
It’s important (and will only become more important) because intangible assets now account for over 87% of all company value – in technology orientated companies and start-ups that proportion is higher still. Intangible assets are everywhere: data, software code, content, confidential information, brands, regulatory approvals, product designs, inventions and industrial know how. These assets are not just the largest repository of value today but they are also the primary drivers of future company performance – which is fundamentally what drives today’s share price. It’s also extremely important for tax as virtually all transfer pricing schemes are based on intangible rather than tangible assets. Likewise purchase price allocation exercises.
It’s vexed for several reasons:
§ the area is extremely poorly understood, even among the most reputable accounting firms – there is very little agreement about how to value intangible assets.
§ It requires an in-depth understanding of intangible assets – the ability to analyse and accurately comment on complex interactions between multiple assets as diverse as data, plant variety rights, patents, brands and software code (as in one recent example we faced). This kind of deep technical and intellectual property skill set is almost entirely absent from most accounting firms.
§ International accounting standards aren’t particularly useful when it comes to valuing intangible assets. Under IFRS and GAAP these assets typically don’t make the balance sheet and when they do they are either simply put under “good will” or on at cost.
§ The assets themselves are not physical – you can’t perform a stocktake or inventory.
§ By definition intangible assets are more or less unique and differentiated – meaning establishing a benchmark or comparator is challenging and there is often no liquid market to price seek against…
§ Cost Basis: First, capital providers (internal or external) generally don’t care much about your sunk cost for a non-revenue producing asset. The money is gone and just because it was been spent doesn’t mean it was spent wisely. Second, there is zero relationship (either positive or negatively) between the cost to build these assets and their actual value.
§ Cash Flow Basis: new intangible asset rich projects usually have no cash-flow to conduct an NPV analysis on. The general response is to forecast (imagine) them. In other words, project future revenues and bring them forward for valuation purposes. This is why zero revenue companies can be worth billions (on paper) – the valuation represents the expectation of tens of billions in the next 20-30 years…
We are uncomfortable with the NPV reasoning that dominates much valuation methodology for new intangible asset rich projects (in isolation of other triangulating factors) for one simple reason: the one thing we know with absolute certainty is that the future is guaranteed to be unlike the present.
That was from a nice post at EverEdge called The Price Isn’t Right: Valuing Intellectual Property and Intangible Assets. The author gives some nice examples of accountants undervaluing technology firms because of their focus on tangible assets.
EverEdge apparently helps companies identify and monetize their intangible assets, the latter presumably through Information Rules tactics. Not clear to the extent that they will invest in the companies, but this is likely along the path where accounting and finance will walk in the future.
I think the problems of valuing businesses with high intangibles is along the same lines as weapon systems choice. In both cases, you are dealing with highly uncertain technical and market/military feasibility. You are also dealing in highly specific ventures which are difficult for third-parties to evaluate objectively. Often a great deal of cash must be put up front without much clarity as to when it will get paid back, if ever.
But there is a chance that you can revolutionize outcomes and reap large rewards. In markets, generating cash flow from intangibles will itself require more and more creativity. In defense, platform designs are intangible. The physical costs of bending and cutting metal might be large in dollars, but it is the ingenuity of design that puts high dollar procedures to useful ends. The design constrains production techniques, operating costs, reliability, and so forth.
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