Intangible assets in the valuation process: a small business acquisition study.

Author:Thom, Randall R.
 
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  1. INTRODUCTION

    Many small business owners lack clear understanding of how specific intangible assets or a combination of these assets increase or decrease the market value of a business. Shaikh (2004) suggested that 50-90% of a company's value is derived from its management of intangible assets rather than from its management of traditional tangible assets. In today's business environment, a company can achieve high revenue, report a profit, have strong financial indicators, and still see a decrease in their corporate value through the inefficient or ineffective use of intangible assets (Pulic, 2004). For small, privately held businesses that lack the benefit of market valuation through publicly traded stock prices, research suggests that the failure of GAAP to adequately recognize intangible assets has created an outdated measurement system that distorts the actual business performance and, therefore, the value of these businesses (Blair & Wallman, 2001; Lev, 2001; Pulic, 2004).

  2. LITERATURE REVIEW

    2.1 Historic Perspective

    Today's emphasis on intangible assets began in the early 1980s as business leaders, academicians, and consultants world-wide began to notice that a firm's intellectual capital had become a major determinant of the corporation's profits and overall firm performance (Huselid et al., 2005; Stallworth & DiGregorio, 2004; Sullivan, 2000). There was also increasing importance of intangible assets to the valuation of a business (Banham, 2005). A study of non-financial companies over the 20-year period from 1978 to 1998 indicated a significant shift in composition of corporate value (Blair & Wallman, 2001). In 1978, nearly 80% of the market value of a corporation was due to tangible assets and only 20% was due to intangible assets. By 1998, the intangible asset portion of corporate value had increased to 80% of corporate value, and the tangible asset portion had fallen to 20% (Blair & Wallman, 2001; Sullivan & Sullivan, 2000).

    2.2 Market Value Impact

    The study of the relationship between tangible and intangible resources and firm performance suggests that intangible assets appear to have a greater impact on a firm's superior performance than do tangible assets (Galbreath, 2005). Other studies provided evidence that intangible assets are a fundamental source of competitive advantage for companies in most industries, and investing in intangibles consistently improved the financial performance of companies (Garcia-Ayuso, 2003). Research also validated a positive relationship between the investment in specific intangible assets and the future earnings of companies. This positive relationship suggested increased market value for companies that invest in intangible assets.

    2.3 Models for Market Valuation

    The accounting of intangible assets is of great significance in understanding the gap between a corporation's book value and its market value (Green, 2006). Investors seek forward-looking data focused on growth and continuity, and intangible assets assist in this business valuation process (Andriessen & Tissen, 2000). The visibility of intangibles also provides corporate stakeholders the necessary data to make cognizant decisions about the future performance and potential growth of a business (Green, 2006). Business leaders need to understand the value of their intangible assets in order to sustain competitive advantage (Green & Ryan, 2005). In order for investors, business owners, and business leaders to place a value on intangible assets, a method for measurement that can survive the scrutiny of academicians, accountants, and business leaders is required. A number of measurement methods have been proposed and tested by their authors; however, the industry still lacks a time-tested standard.

    2.4 Key Components of Intangible Assets

    There are a number of intangible assets in any company; not all of them are equally important. Intangible assets of value are intangible assets that are of strategic importance to the future success of a business (Andriessen, 2005). The process of determining the strategic importance of intangible assets requires a company to define its core competencies. Core competencies are the clusters of skills that a business utilizes to achieve competitive success and contribute to long-term corporate prosperity. The key components of the intangible-asset-based economy differ for each industry but also share a degree of commonality: the knowledge of their employees. For companies that invest in the knowledge of their employees, the expectation is that future earnings will result from this investment (Johnson et al., 2002).

    2.5 Small Business Differences and the Valuation Process

    Valuation difficulties are more significant for small businesses relative to larger corporations, and research indicates that the severity of these valuation difficulties is greater for small, privately held manufacturing businesses versus their publicly traded competitors (Shen & Reuer, 2005). A privately held firm's value is based its return on capital and the market's perception about its future (Leitner, 2005). For investors, the future prospects of a company are of far greater relevance in their valuation than historical performance since investors seek to determine if the company has the potential to continue performing well on a long-term basis.

    2.6 Increasing Value through Intangible Assets

    Numerous studies have suggested that corporate culture is a significant factor in the innovation process of an organization and that innovation is critical for long-term competitiveness of smaller firms (Gudmundson, Tower, & Hartman, 2003). The knowledge base within a company is a complex collection of individual talents and abilities that form the intellectual capital of an organization (Keogh, 1999). The intellectual capital of an organization is enhanced or decreased by the addition or loss of key individuals. Leadership style and the blending of technical talent with an organizational...

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