Whether or not your company operates in one of the few states that tax intangible assets—those with no physical form but do have value—understanding intangible asset valuation is essential. Why? Because it’s part and parcel of ensuring a fair assessment for both real estate and personal property.
In this article, we’ll take a closer look at what constitutes an intangible asset, as well as various intangible asset valuation methods you can use.
What is an intangible asset?
An intangible asset has intrinsic value to its owner, but without a physical nature (though it may be represented by something tangible such as a contract). An intangible asset has several generally agreed-upon attributes that give it form and structure:
- It has a legal existence and is subject to legal protections.
- Intangible assets have transferable ownership. The right can be separated in three ways: by itself, with other intangible assets, or with tangible assets.
- It can be destroyed or terminated at a specified time or as a result of an identifiable event.
Examples Of Intangible Assets
Below we walk through several typical examples of intangible assets across the five categories defined by ASC 805, an accounting treatment set by the Financial Accounting Standards Board (FASB).
1. Contract-Related Intangible Assets
Tenant leases in real estate property can have intangible value if lease rates are set at rates higher than market rates. For example, a couple of years ago, it may have made sense to lease out a commercial office building at $30/foot over a five- or 10-year term, but today, the building’s market value would only warrant $20/foot. That additional value is not related to the underlying tangible assets, which could today only achieve a $20/foot lease rate—it’s solely related to the fact that you contracted a lease arrangement that’s currently above market value.
An FCC license, where a wireless carrier owns the right to transmit a signal (spectrum) via cell towers, is intangible. Historically, wireless companies have paid billions of dollars for the legal authority to send a radio signal across the airwaves.
Orbital slots are valuable for satellite companies, who have to pay for the right to “park” their satellites at a particular set of coordinates in outer space. Those locations are considered intangible assets and transact on the market.
2. Marketing-Related Intangible Assets
Trademarks/trade names reflect consumer perception of a particular brand and often add value to the brand’s tangible assets. For example, Marriott can attract more occupants to its hotel rooms simply because its brand name is associated with a certain quality of service. Those attributes have nothing to do with the property’s actual physical nature, but everything to do with the brand Marriott has created.
3. Customer-Related Intangible Assets
Customer relationships, whether they’re established via contract or simply forged over time, can be valuable. A long-term relationship with a customer, client, or vendor, for example, usually costs money to create and can be invaluable in a business acquisition scenario.
4. Technology-Related Intangible Assets
Software is often tied to hardware and used in a physical capacity. The software can be “bundled” as a transaction with the hardware, or its purchase can occur separately. It includes source code, program specifications, procedures, and associated documentation, which are all codified items. Despite such physical attributes related to software, it is still an intangible asset because it has no physical nature and is subject to legal protections.
The software asset can be purchased or internally developed. Purchased software (or “off the shelf”) generally requires minimal modification. In contrast, internally developed software originates from the design and development of an application internally, or in combination with third-party contractors on behalf of the organization.
5. Artistic-Related Intangible Assets
Theatrical creations such as plays and operas fall under the artistic category.
Literary works are also considered artistic and fall under this category. These include items such as books, magazines, and newspapers.
Goodwill is a mixed bag for intangible assets; therefore, it deserves a separate discussion. Goodwill as a booked asset is known as accounting goodwill and is only factored in during an acquisition process. Accounting goodwill captures the synergies that can be expected from the merger or acquisition of another business. The second form, economic goodwill, refers to things that enhance a business’s value beyond other identifiable assets. A company’s reputation, a loyal customer or client base, process efficiencies, workforce talent, and proprietary technology are goodwill examples. The presence of these intangibles will provide a greater return rate on the transaction than if they were not present.
Intangible Asset Valuation Models
So how do you separately value intangible assets? There are three methods: determine the contributory charges, select a brand’s royalty rate from a comparable company study, and compare full value vs. cost approach value.
1. Determine the contributory charges.
If you’re using the income approach, you need to determine how much of an asset’s total value is attributable to the intangible portion. One method is to isolate the value of the intangible asset itself by asking: Could I license this intangible by itself via a royalty agreement? If so, what fees would I be able to charge? That amount is called contributory charges. Suppose you’re making $100 million in profit. In that case, various comparability analysis may show that a portion of that—about $30 million—is attributable to an intangible asset, thereby increasing its value by that amount.
You often see contributory charges in scenarios involving software. In valuing software, you need to consider how much you’re paying for the equipment. For example, assume you’re an airline looking to purchase a new plane. The plane is selling for $100 million. In looking at the line-item costs, all physical aspects of the plane amount to $80 million, leaving only the software as the sole non-physical aspect. The implication here is the software is contributing $20 million toward the cost of the plane.
2. Determine a royalty rate for the use of a trademark or trade name (or brand).
Brands with a broad awareness in the marketplace may charge a fixed percentage rate of sales for the use of their brand, an amount you can then assign as the value of that particular intangible. Various services provide average industry royalty rates, which you can use to isolate that specific intangible value. Another element of brand value occasionally missed by appraisers is the value creation of using the brand—that is, the economic value of the brand license. For example, if revenues increase by 10 percent with branding, the fee to use is 6 percent of the revenue. Then the additional 4 percent is attributed to the economic value of the brand or trade name. It’s natural to assume the branding’s impact increases an enterprise’s value is more than its cost; otherwise, the brand’s use is pointless.
3. Compare full value vs. cost approach value.
Another way to calculate the value of an intangible asset is by first determining the entire business enterprise value with everything in it and then valuing the asset separately using the cost approach, which may not have any intangibles. Then compare the two amounts. The intangible value is the difference between the cost approach of tangible assets and business enterprise value. Beyond that, you can then begin to segment those intangibles and identify what they consist of—a brand name, above-market contracts, licenses, etc.
For an example of the cost approach in practice, assume you’re an airline again. You decide to develop a billing system that you don’t intend to sell on the market. If there is no open market for these billing systems, it would be difficult to quantify the software’s value. Still, you can look at the labor costs associated with developing the software. If your development team’s hourly rate is $120 and they spent 500 hours total on the project, then the software cost $60,000 (500 hours x $120), which is its value—other factors withstanding.