Whether or not your company operates in one of the few states that tax intangible assets—those that have no physical form but do have value—understanding intangible asset valuation is important. 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 is something of intrinsic value to the owner, but without a physical nature (though it may be represented by something tangible such as a contract). Some typical examples of intangible assets are:
- Tenant leases in real estate property, which can have intangible value if they are struck 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 market value of the building 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.
- A wireless carrier’s FCC license to transmit a signal via cell towers. Wireless companies have paid billions of dollars for the right to send a 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 sold on the market as 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 valuable in a business acquisition scenario.
- Trademark/trade name (brand) reflects consumer perception of a particular brand and often adds value to the brand’s tangible assets. Marriott, for example, is able to 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 actual physical nature of the property but everything to do with the brand Marriott has created.
- Goodwill, usually factored in during an acquisition process, refers to things that enhance the value of a business beyond other identifiable assets. A company’s reputation, a loyal customer or client base, process efficiencies, workforce talent, and proprietary technology are some things that would be classified as goodwill. The presence of these intangibles will provide a greater rate of return on the transaction than if they were not present.
Intangible Asset Valuation: Why It Matters
But consider this: If you can replace that tangible asset for a much lower cost than what you’re valuing the entire entity together, then the intangible portion has value—it’s just a matter of separating it out. Until you’re able to measure and remove the intangible portion of that value, your assessments may not be fair.
When Intangible Values Come Into Play
Intangible asset valuation is particularly relevant if you’re using either the market and/or income approach for valuation; both may include intangible elements simply by the methodologies they use. (The income approach is based on an asset’s ability to generate income, and the market approach is based on the selling price of similar assets.) An example: Even though investors would pay more for a Marriott building because it will generate higher income, you shouldn’t attribute the intangible value of the Marriott brand to the tangible building, which is ultimately the taxable asset. Therefore, you’ll need to extract the value of intangible elements to take this into account.
The one approach that is not likely to include intangible assets is the cost approach, because it is based on tangible construction costs. Let’s say you’re valuing a cell tower site—using the cost approach you would factor in the costs of constructing the actual tower, purchasing, and installing the cell site equipment, but you would not include the cost of acquiring radio spectrum licenses. The nature of the cost approach in many cases means intangible assets are not part of the valuation, and therefore they don’t need to be separated out.
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Intangible Asset Valuation Models
So how do you actually separately value intangible assets? There are three methods: determine the contributory charges, determine a brand’s royalty rate, 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 the total value of an asset is attributable to the intangible portion. One method is to try to isolate the value of the intangible 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. If you’re making $100 million in profit, 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.
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. There are various services that provide average industry royalty rates, which you can use to isolate the value of that particular intangible. 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 but the fee to use the brand 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 impact of the branding increases the value of an enterprise greater than the cost, otherwise, the use of the brand 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 value of the entire business with everything in it, and then valuing the asset separately using the cost approach, which may not have any intangibles in it. Then compare the two amounts. The difference between the cost approach of tangible assets vs. the entire business enterprise value can be attributed to intangible assets. Beyond that, you can then begin to segment those intangibles and try to identify what they consist of—a brand name, above-market contracts, licenses, etc.