Frequently Asked Questions Making the intangible, tangible

 

Intangible Asset Type

If a company owns an intangible it must be 'identifiable' and 'separable' from other business assets before it can be described as an asset and ownership can be transferred to a third party.

Here's a very simple definition of an intangible asset in a business context:

‘All the components of a firm that are codified and exist separately from monetary and tangible assets - tacit elements belong to individuals.’

 There are several classes of intangibles such as:

  1. Rights – usually codified in a firms contracts
  2. Undefined intangibles
    • Goodwill
    • Relationships
    • Going concern value
  3. Intellectual Property
  4. Structural capital – assets owned by a firm that support employees to create, codify and commercialise their tacit knowledge
Here's a short description of each intangible asset type:
  • Bundle or Portfolio - a collection of related intangible assets often with the same owner
  • IP - Copyright expression of an idea, economic and moral rights
  • IP - Database a valuable collection information 
  • IP - Design (registered) the way things look (new / individual character)
  • IP - Design (unregistered) the way things look (new / individual character)
  • IP - Mask works (electronic chips) semiconductor or chip topography
  • IP - Patent (application) exclusive rights pending grant by a sovereign state to an inventor or their assignee for a limited period of time, in exchange for the public disclosure of the invention
  • IP - Patent (granted) exclusive rights granted by a sovereign state to an inventor or their assignee for a limited period of time, in exchange for the public disclosure of the invention
  • IP - Plant variety legal recognition of a cultivated plant as a 'variety' in this particular sense provides its breeder with some legal protection
  • IP - Software copyright used by proprietary software companies to prevent the unauthorized copying of their software.
  • IP - Trade secret or Know-how know-how is valuable and walks out of the door at the end of the day & a trade secret is information that is confidentially derived and held and has value
  • Relationships - Internal - Assembled workforce a skilled knowledgeable workforce
  • Relationships - External - Customer relationships a data rich list of established customer relationships
  • Relationships - External - Distributer relationship a data rich list of established distributer relationships
  • Rights - Contract to provide goods and services
  • Rights - Contract to receive goods and services
  • Rights - Franchise contract with another entity to distribute products or services supported by intangible assets 
  • Rights - Publicity or Media right of a person to control and benefit from commercial exploitation of his or her identity
  • Undefined - Going concern value a business that functions without the threat of liquidation for the next 12 months
  • Undefined - Goodwill patronage, excess earnings and residual

 

Intended Use

What is the exact purpose for the valuation and what standards, regulations or laws apply?

  1. management (Portfolio management)
  2. strategic planning (Exploitation and commercialisation potential, R&D investment)
  3. value reporting
  4. accounting
  5. liquidation
  6. legal transaction
  7. licensing
  8. litigation support
  9. dispute resolution
  10. taxation planning and compliance
  11. fundraising
  12. initial estimate
  13. in-kind contribution
  14. intracompany transfers
  15. joint ventures
  16. mergers or acquisitions

 

Valuation Start Year

What year will the valuation begin?  This is simply a label for the first year but is important to contextualise the valuation.

 

Number of years for valuation

The period over which the asset is expected to contribute directly or indirectly to the future cash flows of that entity.  Legal, regulatory, or contractual provisions may limit or enable renewal or extension of the valuation period.  IPCalc only allows you to enter input data for years 1 to 10.  Year 11 onwards is extrapolated using year 10 data.

 

Separating the Intangible from the tangible

The following inputs are needed to value your intangible asset.  If you can’t enter any of these inputs and you simply want to input a forecast for sales in year 1 (units sold multipled by price per unit) then click override and enter a figure in the Unsecured income box (unsecured income is income that is not guaranteed, contracted or recurring).  This does mean you will be valuing both the intangible and the tangible elements combined.  It is useful to separate the intangible and tangible elements by separating the intellectual property from the physical product.

Here is an example: A TV without any intellectual property contained within it has a market value of $500.  The Cost of Sale for each TV without a proprietary WiFi component is $250.  If you integrate your intellectual property (a patent for a WiFi device) into a physical component and then integrate this component into the TV, the TV now has a market value of $1000. The Cost of Sale for each TV with the WiFi component is now $250 for the TV +  $10 for the WiFi component – total Cost of Sale is now $260. The value of the intellectual property (Price Premium Per Unit) can be calculated as follows where:

   Price Premium Per Unit = (x – y) – (p-q)

   x = Market value of TV with WiFi component: $1000
   y = Cost of Sale for TV and WiFi component: $260
   p = Market value of TV without WiFi component: $500
   q = Cost of Sale for TV without WiFi component: $250
   Price Premium Per Unit = ($1000 - $260) – ($500 - $250) = $490

 

Price per Unit of product with IP

Market value of product (per Unit) with integrated Intellectual Property

 

Cost per Unit of product with IP

Cost of sale of product (per Unit) with integrated Intellectual Property

 

Price per Unit of product without IP

Market value of product (per Unit) without integrated Intellectual Property

 

Cost per Unit of product without IP

Cost of sale of product (per Unit) without integrated Intellectual Property

 

Units of product sold with IP

 Forecast number of product Unit sales (with integrated Intellectual Property)

 

Royalty Rate

The royalty rate paid by the licensee using the IP to the licensor holding the IP.  The royalty rate must have some economic basis and have arm’s length characteristics.

 

Secured Income

Guaranteed or recurring income.  This income will not be subject to risk adjustment i.e. 100% chance (gauaranteed) that the income will be realised.

 

Unsecured Income

Income that is not guaranteed or recurring.  This income will be subject to risk adjustment.

 

Base annual income

The value you enter in this box should take into account the Base annual income figure on the card, the territory multiplier and any doubling bonuses acheived.  

 

Unsecured income by third party licencee(s) in first year

This value will determine the unsecured royalty income by the licensor in the first year.

 

Sales growth or decline per year

Positive and negative values can be entered.  Enter 1.06 for 1.06% growth per year or enter -7.86 for -7.86% decrease per year.  This is commonly known as the compound annual growth rate (CAGR).  IPCalc measures growth between years 1-5, 6-10 and 10+.

 

Extra variable costs as a percentage (%) of sales

This simplifies variable costs by attributing a percentage of costs based on the value of sales made in each year.  If sales increase or decrease then the associated variable costs do too.  Positive and negative values can be entered.  Enter 5 for 5% additional variable costs as a percentage of sales per year or enter -7.5 for -7.5% decrease in variable costs as a percentage of sales per year (may occur if economies of scale in production are achieved).

 

Tax rate payable as a percentage (%) on profits after tax

This is the tax rate that is payable by the company on the income derived from the intangible asset for the period of the valuation taking into consideration any tax losses that could be utilised against future forecast profits.

 

Tax lagged by one year (Yes or No)

Tax is usually not payable until 1 year after it is incurred and would normally be paid in the following year.  If your busines has made losses in previous years you may be able to bring forward these losses and reduce your effective tax rate in future years.  Please contact us if you would like to build this into a model.

 

Working capital as a percentage (%) of sales

A percentage should only be entered when the override box has been ticked when you're valuing the intangible and tangible elements combined. Additional working capital is sometimes needed to ensure operations can continue.  

 

Discount rate as a percentage (%)

It is simply the cost of borrowing money (equity or debt) or using company savings (retained earnings) and the risk that the forecasted income or expenditure from this asset will not be accurate.  Low (4%) and high (16%) discount rates can have significant effects on valuations.  The weighted average cost of capital (WACC) is a simple way to calculate the Discount rate in a company.  This is the average cost of obtaining capital (cash) from both lenders (debt) and shareholders (equity). Contact us for more advice on how to calculate an appropriate Discount rate.  The discount rate is the interest rate used in discounted cash flow analysis to determine the present value of future cash flows. The discount rate takes into account the time value of money (the idea that money available now is worth more than the same amount of money available in the future because it could be earning interest from the next best alternative investment) and the risk or uncertainty of the forecasted future cash flows (income minus expenditure).

 

Other Expenses

These expenditure will have a direct impact on profit and cash flows.

 

Capital Expenditure

This expenditure will have an impact on cash flows.

 

Risk adjustment

Risk adjustment is directly linked to the unsecured income.  The percentage risk adjustment relates to the probability that the income will be realised.  100% means the probability is 1, whereas 50% means the probability is 0.5.