Tyler Capson is managing director at intangible asset advisory, valuation and corporate finance advisory firm EverEdge Global. Views are the author's own.
While capital has been flowing freely to startups, 2022 could be the year when investors start applying more scrutiny. Executive teams could find themselves under more pressure to justify their valuations, something they can do more effectively by giving their company’s intangible assets the attention they deserve. A rigorous examination of their intangibles would allow them to credibly defend a higher valuation and explain to investors the difference between reality and fluff.
The rise of intangible assets
What are intangible assets? In short, they’re assets you can’t touch and probably don’t show up on a balance sheet. Yet for almost every company today outside of pure real estate investments, these assets are the primary driver of company performance.
Think about the data and algorithms that power the operations at Google and Facebook, the secret formula for Coca-Cola, the brands of Apple and Nike, the patents owned by IBM and Intel, and the employee culture at Southwest Airlines. These assets are unlikely to be recorded on the P&L or balance sheet, yet they drive strategic decision-making.
The rising importance of intangible assets represents a major — but still underappreciated — shift in the economy. Because capital is so cheap today, physical assets are less of a differentiator than they used to be. Buying or investing in a factory won’t by itself distinguish a company from a competitor. What will separate the two are intangible assets. Which has the best supplier relationships? Who can leverage their customer data to predict buying trends and insights? Which has the better pricing strategies, the better systems and processes to operate safely and efficiently, the better workplace culture and the better software code?
These are the assets that increasingly matter most. According to an analysis, in 1975, intangible assets accounted for 17% of corporate value among companies in the S&P 500. Today that figure is 90%.
Why haven’t they found their way into mainstream accounting if intangible assets are so important? Well, for one, our financial reporting system was developed during the industrial age, when physical assets — inventory, property, plants, and equipment — drove the most value and when capital was scarcer. Reporting standards on intangibles has yet to catch up to their importance.
Intangibles are also hard to value, and they represent such a large and varied group of assets that treating them as one class can seem unwieldy and unworkable. Depending on the context, they are called different things by different people. Lawyers might see them as intellectual property, or “IP,” accountants as “goodwill,” and CEOs and entrepreneurs as a “competitive edge.” Warren Buffet famously referred to them as “moats.”
Identify, valuate and defend
Whatever they’re called, it’s a mistake to gloss over them, even for early-stage companies. Too often, startups focus too much on getting a product or service to market and growing it. They don’t take the time to pinpoint the intangible assets that are the most critical to their growth.
By failing to go through that process to understand where true value lies, startups often fail to protect those assets, leaving their companies more vulnerable to competitive threats that can slow or halt growth. We’ve seen tech companies outsource software development to third parties to meet a deadline without any protections or safeguards in place. They left their most valuable intangible asset — their software code — vulnerable to theft, with devastating impacts on their market share and margins.
We’ve also seen companies invest hundreds of thousands of dollars in a brand before securing trademarks, effectively pouring money down the drain by promoting a brand they do not own. Sometimes executives mistake their competitive edge. A low-cost eyewear provider might think that their competitive advantage is price. But what’s really driving that lower cost? Is it an efficient manufacturing process? Is it a special relationship with suppliers? Knowing the answer is crucial.
One way to find out is to assign a value to all intangible assets. Intangible asset valuation should use traditional quantitative methods but also analyze contextual and qualitative factors. These factors are primary drivers of intangible asset value.
There is a big difference between believing an asset has value and proving it. Executives that do it can attract more capital. It’s one thing to demonstrate to potential investors the value of an established relationship with a partner who is willing to provide access to their networks to sell your product and service. It’s another for a founder to say, “Google will love our technology.”
Companies that invest in developing their intangible assets and put a framework around them to minimize risk are more likely to achieve a higher valuation in the mid- to long term. This could include investing in company culture, resulting in a more profitable workforce that experiences less turnover and requires less recruiting and training costs.
This process also allows executives to consider options. If the assets a startup develops are the key to another company’s success, these could potentially be of enormous value. It may mean that the startup can leverage its intangible assets into an entirely new market at a vastly different scale by licensing or selling to a third party who has access to that at-scale market.
Valuing intangible assets also helps companies prepare for the unexpected. If a suitor comes seeking a partnership or making an offer for the whole company, understanding and being able to articulate the value of the intangible assets can help command – and defend – a higher valuation. The absence of such a valuation can give buyers and others an unfair advantage.
Here are some of the questions we advise executives to ask themselves:
- What are our intangible assets?
- How do these assets drive economic and strategic value for our business?
- How much are these assets worth?
- Is our company valuation capturing and articulating the full value of our intangible assets?
- How can we unlock additional value from our intangible assets – are they worth more in our hands or someone else’s?
- What is our intangible strategy – are we actively managing these assets?
- Does our team understand how important these assets are?
- What are our primary intangible asset risks?
- What is our strategy to manage and mitigate these risks?
- What systems and processes do we have to manage and mitigate these risks?
I’ve met a lot of spreadsheet billionaires in my career. With a stroke of the keyboard, some convince themselves that their companies’ sales will grow exponentially. My advice is always the same: apply a rigorous accounting of your company’s assets and create a plan to protect them. Otherwise, you’ll stay stuck in fantasy land.