This Article covers the valuation aspects of Intangible assets as below, which are not Physical but provide the owners with specific rights and privileges.
· 1 Goodwill
· 2. Trademarks
· 3. Patents and copyrights
· 4. Trade secrets
· 5. Franchise and licenses
· 6. Complying with Disclosure requirements for intangible assets
In addition to reading the article below, readers can also listen to my Youtube link given below on the same subject.
1 Goodwill
· Goodwill represents the reputation, customer loyalty, and brand value a company has built over time. It arises from exceptional customer service, a strong market presence, favourable supplier relationships, or skilled employees.
· It is reflected by the premium paid by a company for acquiring another company above its net assets ( such as property, plant & equipment, inventory, and liabilities) fair value.
· By definition, goodwill has an indefinite life.
· Once Goodwill is recorded in the balance sheet, it is not amortized. Instead, it is subject to an annual impairment test.
Valuation of Goodwill
· Valuing goodwill often involves the following methods:
A)The excess earnings method
B)The market approach (comparing the value of similar businesses in the market),
C)The relief-from-royalty method (based on estimating the hypothetical royalties saved by owning the goodwill).
A) Excess earning method
It is often used when significant intangible assets are considered, such as in mergers and acquisitions or when valuing a company with strong brand recognition and customer relationships.
The steps are as follows.
1. Estimating the value of the company's net tangible assets e.g ,The book value of the assets adjusted for depreciation and impairment)
2 Calculate earnings attributable to the company's tangible assets by Multiplying the value of the net tangible assets by a fair rate of return.
3. Estimating the company's total normalized earnings on an ongoing basis (excluding unusual or non-recurring items)
4. Compute Excess earning = Normalize earning less earning attributable to tangible assets
5 Value of goodwill & other intangible assets = Excess earning Divided by an appropriate capitalization rate
B) Market approach method
The market approach method to valuing goodwill is based on the principle that the value of an asset is equal to the price that a willing buyer would pay to a willing seller. It is normally used to value goodwill in mergers and acquisitions transactions.
The steps are as follows.
(Assuming Co B is the acquiring company and Co A is the target co)
1. Select companies comparable to A in terms of size, operations, market
2. Collect financial data like Earnings Before Interest, Taxes, Depreciation, and market multiples like price-to-earnings etc
3. Determine adjustments needed to size variation growth rate, risks, etc, between A and others
4. Estimating fair value of the target company A after adjustments
5. Value of total Intangible assets = Adjusted estimated fair value of A as above less tangible assets of Company A
6. Value of Goodwill = Total value of Intangible assets less estimated value of other intangibles like patents.
C) Relief from the Royalty method
This method calculates the value of goodwill by estimating the cost savings or economic benefit that a business enjoys by owning its intangible assets, such as trademarks, patents, or customer relationships, without having to pay royalties or licensing fees to a third party.
The steps are as follows.
1. Identify intangible assets for the company
2. Determine the hypothetical Royalty rate by the valuer if it did not own the intangible asset but licensed it from a third party.
3 Calculate the hypothetical Royalty costs based on the assumed Royalty rate and estimated revenue/profit generated by intangible assets
4 Determine the present value of hypothetical Royalty cost using the appropriate discounting rate (such as cost of Capital)
5 Value of Intangible assets= Fair market value of intangible assets Less present value of the royalty cost
The value of Goodwill can be computed by subtracting the value of other intangible assets like patents, trademarks, etc.
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2. Trademark
A company's brand value represents the recognition, reputation, and perception associated with a particular brand name or logo. It encompasses factors such as brand awareness, loyalty, and equity.
Trademarks safeguard brand names through distinctive signs such as logos .or symbols to identify and differentiate products or services.
Purchasing of Trademarks
Trademarks are important to the overall marketing and branding of products or services and must be protected. A company’s success can often be attributed to the existence and continued protection of these trademarks, patents, and licenses.
Trademarks, as intangible assets, are transferable.
The purchase price is capitalized if a trademark is purchased from another company.
However, the cost of internally developed trademarks is expensed as incurred.
For these reasons, many trademarks are not presented in the balance sheet.
The useful life of a trademark, as an intangible asset, is far enough into the future, and hence it is almost impractical for the management to estimate it.
Therefore, a trademark with an indefinite life should not be amortized.
Valuation of trademarks
Valuation of trademarks can be done by methods /approaches similar to the valuation of goodwill (mentioned earlier )and hence not being duplicated.
3. Patents and copyrights
Patents
Patents are exclusive rights granted by a government to protect inventions.
The purchase value of a Patent is reflected as an intangible asset in the balance sheet
Negotiating the value of Patents during M&A
Negotiating Parameters are :
· The market demand for patented technology and the potential to generate more revenue
· Commercial potential opportunities for future revenue streams
· Infringement implications on the business
Therefore, management & technical, and sales /marketing teams jointly make a well-informed decision while negotiating Patent value.
Valuation of Patent
· The valuation of patents can be challenging due to factors such as the uniqueness of the invention and its potential market value.
Copyrights
Copyrights provide exclusive rights for original works of authorship, such as software, literature, music, and films, thus protecting their original works.
Valuation of copyrights
Copyrights can be evaluated by methods /approaches similar to the valuation of goodwill mentioned earlier and, hence, not being duplicated.
4. Trade secrets
Trade secrets, such as formulas, processes, or customer lists, are confidential and valuable business information.
Valuation of trade secrets
· Valuation of trade secrets can be challenging due to their secretive nature.
· Valuation methods may include the following:
· The cost approach (based on the expenses to develop or safeguard the trade secret
· Income approach (based on the expected economic benefits derived from the trade secret).
· Market approach (comparing the value of similar trade secrets in the market).
5. Franchise and licenses
· A franchise is a contractual agreement that gives a company the right to operate a particular business in an area for a particular period.
· For example, a franchise may give the owner the right to operate several fast-food restaurants in a particular geographic region or sell and service End products like Vehicles (specific models) for, say twenty years.
Licenses are similar to franchise rights, except that government agencies typically grant them.
· Most franchise rights are purchased, so the purchase price should be capitalized and presented as an intangible asset in the balance sheet.
Valuation of Franchise and licenses
The most common methods are:
Income-based approaches: These approaches value the franchise or license based on the future cash flows that it is expected to generate
Market-based approaches: These approaches value the franchise or license based on the prices of similar franchises or licenses that have been sold recently..
Asset-based approaches: These approaches value the franchise or license based on the underlying assets that it includes, such as trademarks, patents, and trade secrets.
Additional factors
The exclusivity of the franchise or license
The growth potential in the franchise or license industry
The brand strength and reputation
The support provided by the franchisor or licensor
Economic scenario
6. Complying with Disclosure requirements for intangible assets
· Companies are generally required to disclose information about their significant intangible assets, including the following:
· The types of intangible assets
· Carrying amounts
· Useful lives as applicable
· Methods of amortization
· In the Indian context, the following provisions are applicable.
· Gross block: General note 8.7.1.2 to schedule 6 of the company’s Act as advised by the Institute of Chartered Accountants of India describing the classification of intangible assets
· Amortisation of intangibles: General note 9.5.6
· Accounting standard AS 26.
Potential activities (including unethical) that can adversely impact business.
Common Aspects for Goodwill, Trademarks, Patents
i)Overstating the value due to improper or exaggerated assessments resulting in misleading financial statements.
ii)Submitting financial reports and disclosures that are misleading
Trademarks
iii)Making false claims by misrepresenting the ownership rights to trademarks,
Misrepresenting trademark usage to enhance the perceived value of the asset.
Trade secrets
iv)Stealing and selling of secrets like customer lists or proprietary software, formulas or designs to competitors or 3rd parties and obtaining kickbacks.
Patents
v) Withholding information about patent infringement risks or disputes thus impacts the value or validity of the patent.
vi)Making false claims by misrepresenting the ownership rights to Patents and copyrights