Feature
Article
Grasping
the Value of an Intangible Asset
As a
CPA who performs business valuations, it is not uncommon
when explaining business valuations to people in other fields
to be told, Valuation is for you finance guys.Its not my
cup of tea.
Many
people restrain themselves from understanding basic concepts
of valuation. Todays world is technology driven. The Internet
has ensured that the world is truly a small place in which
to live. It has provided us with multiple options including
running online businesses and becoming successful entrepreneurs.
Now, what if we start a business tomorrow (online or otherwise)
and become successful? We develop a unique concept with
such high demand that a company like Microsoft, Yahoo, or
Google offers to pay us cash and buy our business. Wow!
Thats a big and an aspiring thought. How do we decide how
much the buyer should pay us? All of us want to make money,
but how would we know if we are being paid our companys
worth or not? Thus, understanding simple and basic concepts
of valuation would help us better answer these questions.
Lets
start with the concept of going concern. Every business
is assumed to be a going concern. What does this mean? It
simply means that a business goes on to a perpetual timeframe
in the future and not just a short determinable immediate
future. One may ask why this is important. It is not just
important but imperative that we understand the concept
of going concern to ensure we dont end up selling our business
for a value much less than the return that it may have provided
if we had not sold it. Where does this take us? It takes
us to a concept in valuation called Useful Economic Life.
Estimating the useful economic life of an asset/business
is an important aspect of valuation. The first step in understanding
useful economic life of an asset involves understanding
the average expected life for a new asset in the same category.
Experience has revealed that the average life of an intangible
asset will invariably be less than its legal life or its
economic life or both.
The
legal life of an intangible asset indicates the maximum
or the ceiling limit on the expected life of the asset.
The economic life of an intangible asset may be understood
as the life term over which the asset generates an income
or alternatively a savings in cost (indirect revenue). Of
course, both internal and external factors play a vital
role in determining the economic life of an intangible asset.
While most profitable businesses are assumed to be running
for a perpetual lifetime, the economic lifetime of the asset
(under the income model) is defined as the period over which
the cash flow of the business/asset is discounted. Though
this sounds simple, quantifying the useful economic life
of an asset is not an easy job. This is because valuation
of an asset or a business is governed, influenced, and impacted
by external factors. These include, but are not limited
to
-
The usefulness of the asset,
-
Life of the asset,
-
Legal issues including license to use the asset, pricing,
etc.,
-
Obsolescence of technology associated with the asset,
-
Demand in the market for the asset or the product that
the business sells,
-
Competing technologies that are substitutes for the asset,
and
-
The recurrence and cost of maintenance on the asset over
its lifetime.
Even
with an understanding of the above concepts, valuation specialists
have to better understand the asset class or category by
itself to ensure justice to the valuation. This, coupled
with the ability of the valuator to extrapolate historical
and projected cash flow of the asset, is extremely important.
Though there are multiple sophisticated analytical techniques
available to estimate the value of an intangible asset,
identifying the appropriate methodology for the valuation
is a job by itself.
Ultimately,
the use of a valuation specialist will help to estimate
a fair value of a great idea.
For
more information on HA&W's business valuation services
contact:
Richard
Millman, CPA/CFF/ABV, CVA
richard.millman@hawcpa.com
>>
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