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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:
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 are intangible Assets 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.
Not all three of these elements need to be present to create the value:
Also keep in mind that while 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.
When either Personal or Professional Goodwill 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.
*Disclaimer*: Harvard Business Services, Inc. is neither a law firm nor an accounting firm and, even in cases where the author is an attorney, or a tax professional, nothing in this article constitutes legal or tax advice. This article provides general commentary on, and analysis of, the subject addressed. We strongly advise that you consult an attorney or tax professional to receive legal or tax guidance tailored to your specific circumstances. Any action taken or not taken based on this article is at your own risk. If an article cites or provides a link to third-party sources or websites, Harvard Business Services, Inc. is not responsible for and makes no representations regarding such source’s content or accuracy. Opinions expressed in this article do not necessarily reflect those of Harvard Business Services, Inc.