In today’s market, buyers are increasingly setting their sights on businesses with intangible assets that will drive their corporate growth strategy. As a result, business owners, in search of growth and ultimate divestiture, need to understand the nature of intangible assets and how they may increase the value of their businesses.

What is an Intangible Asset?

An intangible asset is often defined as a non-monetary asset that lacks physical substance. Loosely defined, the term includes general business goodwill and identifiable intangible assets that are capable of being separated from the business.

As valuators, we group identifiable intangible assets into the following categories:

• Marketing-related intangible assets, including trademarks, trade or banner names, advertising slogans and marketing campaigns.
• Customer-related intangible assets, including customer lists, customer contracts, customer relationships and order backlog.
• Technology-based intangible assets, including patented and non-patented technology, computer software, databases, business processes, recipes, trade secrets and know-how.
• Contract-based intangible assets, including lease agreements, licensing agreements, franchise agreements, distribution agreements (including exclusivity arrangements) and regulatory permits or licenses.
• Artistic-based intangible assets, including literary or musical works, books and magazines.

Included in intangible assets is “Intellectual property.” These are intangible assets for which legal protection is available, including patents, trademarks, copyrights, industrial designs and trade secrets, among others. You should discuss the benefits of such protection with your legal counsel.

Non-identifiable intangible assets are collectively referred to as goodwill. Examples of non-identifiable intangible assets included in goodwill are workforce, location and reputation.

Components of Business Value

In order to understand intangible assets in the context of your business, it is useful to understand the components that make up your business’ value.

This diagram illustrates the relationship between the various components of your business’ value and the relative risk associated with each component:

You can see that the least risky component of value is monetary assets, closely followed by tangible assets. Because monetary assets are liquid (can quickly be converted to cash) they carry the lowest risk. At the upper end of the risk scale are your identifiable intangible assets and general business goodwill. You would likely have more difficulty converting identifiable intangible assets to cash than tangible assets, so naturally they carry more risk. General business goodwill cannot be separated from the business, so therefore it’s the riskiest component of value.

Benefits of Intangible Assets that Drive Business Value

Owning and using intangible assets can increase your business’ value by delivering a variety of benefits:

• Cost advantage: Intangible assets can create a cost advantage. For example, a trade secret that enables you to produce a product in half the time as a competitor would create a cost savings for your company.
• Premium pricing: Intangible assets allow your business to command premium prices, which in turn increase profits. Coca-Cola can command a higher price for its cola than a generic brand.
• Exclusive rights: Intangible assets can provide your business with exclusive rights. If your business holds a patent, your business holds the exclusive rights to exploit that technology in the specified jurisdiction for the remaining life of the patent.
• Barriers to entry: Intangible assets can overcome or create barriers to entry. A superior product can unseat the competition or create significant barriers to entry for would-be competitors.
• Market share: Intangible assets can expand market share. The customer recognition of a strong brand can facilitate the introduction of new products and product lines.

Understanding your intangible assets –- including their related benefits and risks -– better positions you to achieve your business’s growth objectives and command an attractive price when you are ready to sell or transfer ownership of your business.

This article was originally published by Canadian Capital on September 13, 2011. Read the original article here.

Steven Hacker, CA, CBV and Amanda Salvatori, CA, CBV are chartered business valuators with MNP LLP and have valued multiple intangible assets including brands, trademarks, customer relationships and technology for the purpose of financial reporting, income tax planning/compliance and acquisitions and divestitures.