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Business owners are often not aware of the nuances of intangible asset value. Intangible Assets are comprised of two principal groups both of which can add value: Discrete and Non-Discrete Intangible Assets.
Discrete Intangible Assets: are assets which have a legal existence in and of themselves and which may be transferred independently of the business. Examples are intellectual properties such as patents or copyrights, franchise agreements, licenses, proprietary processes and trade secrets, administrative policies and procedures, etc.
What distinguishes Discrete Intangibles from Non-Discrete Intangibles is that they meet the following criteria:
• are subject to specific identification and recognizable description.
• are subject to legal existence and protection.
• are subject to the right of private ownership, and the private ownership should be legally transferable.
• have some tangible evidence of the existence of the asset.
• have been created or have come into existence at an identifiable time or as the result of an identifiable event.
• are subject to being destroyed or to a termination of existence at an identifiable time or as the result of an identifiable event.
Unless Non-discrete intangible assets have a stream of profits that is separable and identifiable, such as a stream of royalty payments, they are otherwise analyzed as if they are part of the going-concern value and not valued separately from it. However, their presence can significantly influence the appraiser’s analysis and judgment as regards an appropriate capitalization rate and can result in a premium on value.
Non-Discrete Intangible Assets: Intangible Assets which are not discrete, but which have an economic value are usually classified as “Goodwill Intangible Assets” or “Going Concern Value”. The value of these assets lies in the principle that when all of the elements of a business system (capital, labor, management) are combined in a going-concern (or able to be going-concern), the value of the whole exceeds the sum of the value of the parts. It is important to recognize that it is a quantifiable number, and not just a “feeling” about the business.
There are three elements that create Going-Concern or Goodwill Value. Not all three need to be present to create the value.
• Assets in place and ready to use as a going-concern (capital, labor and management)
• Excess economic income over that justifiably allocated to other assets.
• Expectation of a valuable future event, such as gains on a sale.
Book Value Intangible Asset Values: Where intangible assets of any sort are shown on the balance sheet as part of an allocation of purchase price resulting from an acquisition, they do not necessarily reflect market value. The appraiser must determine the current market value of these assets, and adjust the balance sheet by removing the “book values” and replacing them with appraised intangible asset values which are determined in the course of the appraisal process.
Personal or Professional Goodwill: When either of these exist (they are functionally identical) they are normally included in the total goodwill value shown for a business unless there is a specific reason not to. When included in the total value, the underlying assumption is that any buyer of the business will insist upon mitigation measures to preserve the personal or professional goodwill values for the business. This is normally done by non-competition agreements, employment contracts, and a period of time specified for continued involvement in the business by the holders of these assets. In divorce cases an exception arises. When a business is being valued for a marital dissolution it is necessary to further analyze whether or not mitigation measures are feasible, because the divorcing spouse who holds the personal or professional goodwill may not be willing to enter into a mitigation agreement. It is further necessary to review the prevailing court cases pertaining in the particular state. Some states count personal or professional goodwill as a marital asset, others do not. It takes coordination between the respective divorce attorneys and the appraiser to determine the proper way to handle personal or professional goodwill in these cases.
THE AUTHOR OF THIS BLOG ARTICLE IS NOT A LAWYER AND HARVARD BUSINESS SERVICES, INC. IS NOT A LAW FIRM. THE ARTICLE ABOVE IS NOT INTENDED AS LEGAL ADVICE AND SHOULD NOT BE TAKEN AS LEGAL ADVICE. THIS SHORT ARTICLE IS STRICTLY TO MENTION SOME ASPECTS OF DELAWARE’S CORPORATION LAWS AND/OR LAWS RELATING TO OTHER FORMS OF ENTITIES WHICH YOU MAY NOT BE FAMILIAR WITH. WE RECOMMEND THAT YOU CONSULT WITH A LAWYER BEFORE FORMULATING A STRATEGY WHICH WILL BE SUITABLE FOR YOUR SPECIFIC CASE.