Valuation of Intangibles
Given their intangible and unique nature, the question of how to value intangible assets essentially comes down to choosing the right method for valuation—and the application of good judgement.
The five primary intangible asset valuation methods are based on the three classic approaches to valuation—the market, income, and cost approaches—and incorporate principles and elements of these approaches. For the value of specific intangible assets, one method will likely be more appropriate than the others. These are the five methods used in the valuation of intangible assets:
- Relief from Royalty Method (RRM): In the RRM, value is calculated based on hypothetical royalty rates that would be saved by owning the asset. Ownership of an intangible means that the business doesn’t have to pay for the use of the asset. The RRM is often used to value trademarks and computer software, and it incorporates elements of both the market (royalty rates for comparable assets) and income (estimates of revenue, growth, and tax rates) approaches.
With and Without Method (WWM): Using the WWM, the intangible asset’s value is determined by calculating the difference between a discounted cash flow model for the enterprise with the asset and a discounted cash flow model without the asset.
Multi-Period Excess Earnings Method (MPEEM): A variation of discounted cash-flow analysis, the MPEEM isolates cash flows associated with a specific intangible asset, then discounts them to present value. It is most often applied when a single asset is the primary basis of a company’s value—and cash flows associated with the asset can be isolated from overall cash flows. Software and customer relationships are examples of assets that may be valued using the MPEEM.
Real Option Pricing: Assets that are not presently generating cash flows but have the potential to do so in the future are candidates for valuation using option pricing models. Undeveloped patent options are one example. Option pricing models can capture the “time value” of these types of assets.
Replacement Cost Method Less Obsolescence: As with the cost approach, replacement cost method less obsolescence relies on establishing a replacement cost new for the intangible asset—what it would cost to create “from scratch”—and is then adjusted for obsolescence, the equivalent of applying depreciation in the cost approach.
Valuing intangibles is usually more difficult than valuing tangible assets and often requires significant application of judgement. But by using these methods, a seasoned valuation expert can calculate a defensible fair market value.
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