As per Indian Accounting Standard (IAS) 38, assets are identifiable, measurable, controllable and generate future economic benefits for an enterprise. Assets are further classified into tangible and intangible assets. Intangible assets are non-monetary assets without any physical substance. There are various intangible assets, i.e., brand, goodwill, intellectual property, etc. that may or may not be recorded in the books of accounts of an enterprise. Intangible assets are assets which can neither be felt nor seen but still manage to generate significant amount of value to an enterprise. Per a Forbes article: “Intangibles have grown from filling 20% of corporate balance sheets to 80%.” And this trend is expected to continue in the coming years which will include one of the highest valued intangible assets. Therefore, it is imperative to understand how such assets are to be valued.

Valuation of intangibles can be done for various purposes, some of them have been listed below:

• Purchase price allocation (IAS 103) 
• Impairment testing (IAS 36), 
• For transfer or sale of intangible assets, for obtaining financing from banks or financial institutions, for licensing and franchising, etc. 

Intangible assets should possess the following characteristics:

• Capability of generating additional resources/ cash flows/ profits over and above those which the business would otherwise make if it did not own the rights in question.
• They are often capable of legal enforcement and of legal transfer of ownership.
• They are often separable from the underlying business.
• The asset can be regarded as a capital asset rather than a carry-over of recent expenditure.

Following assets that fulfil the criteria to be classified as intangible assets:

• Brand;
• Customer list;
• Intellectual Property rights;
• Internet domain names;
• Database;
• Royalty agreements; and
• Customer contracts.

The value of any asset depends on its revenue-generating capacity or the incremental future economic benefits attained or the cost savings achievable by using that particular asset. Like any other asset, there are predominantly 3 approaches practiced in order to value intangible assets and are explained as follows:

1. Market Approach: This approach is based on the availability of the market data of the trading multiples or transactions of identical or substantially similar intangible assets. Data on transactions in similar assets is generally difficult to obtain due to the lack of data. Publicly traded data usually represents a market capitalization of the enterprise, not singular intangible assets.
   
   
2. Income Approach:
   1. This approach is based on the future income/ cash flows generated by the use of the intangible asset. Future cash flows are discounted to the present value using appropriate discounting factor. Future cash flows are based on management projections for 5-10 years along with appropriate assumptions for terminal cash flows. This approach commonly uses the following methods to value the assets:
      1. Excess earnings method
      2. Relief from royalty method
      3. With or without method
         

         Excess earnings method This method is a mix of income and cost approach. Using the income approach, we calculate the present value of the cash flows of the Enterprise. From the total cash flows appropriate deductions are made for earnings attributable to contributory assets (various tangible and intangible assets), which are computed considering the appropriate return on such assets. The resultant earnings/ cash flows pertain to the intangible assets being valued, which are then discounted using the relevant discount rate to arrive at the value of the intangible asset. Relief from royalty method (‘RRM’):This method considers present value of after-tax royalty savings achieved by owning the asset instead of licensing the asset from a third party. This method is mostly used for valuing licensed intellectual properties, brands, know-how, computer software, domain names, trademarks, etc. Key inputs that are necessary for valuing an intangible asset using RRM are as follows:

   • The revenue to be generated from the intangible asset being valued
   • Expected lifespan of an intangible asset in which it can provide economic benefits to the company
   • Appropriate royalty rate of the asset
   • Discount rate including appropriate risk premium and tax rate applicable to the company

     With or without method:

     This method as the name suggests calculates the value of the asset based on the cash flows to the company with and without the asset in the business i.e., the valuer calculates the present value of the future cash flows of the business with the asset and present value of the future cash flows without the asset and the resultant difference between the two will give us the value of the intangible asset. This approach is often used to value non-compete agreements, franchises, processes and technologies, etc.

3. Cost Approach:
   

   This approach is based on the cost required to acquire or reacquire an asset. Per International Valuation Standard, cost approach is defined as “the value of an intangible asset is determined based on the replacement cost of a similar asset or an asset providing similar service potential or utility.” And is commonly used for valuing acquired third-party software, internally generated non-marketable software or assembled workforce. This approach is generally used when the income or market approach cannot be used. Commonly used methods under the cost approach include:

   • Replacement cost (cost to recreate)
   • Development cost (cost to create)

Almost every organization is faced with the need to know the value of its assets be it traditional assets, intellectual property, customer and supplier relationships, know-how, technology etc. Regulatory compliance requires both public and private companies to assess the fair value of recorded goodwill and identifiable intangible assets from time to time. Our endeavor at Acumen M&A Advisors is to assist enterprises in making well informed business and investment decisions.