What Are Intangible Assets?
What Are Intangible Assets?
Wrapping your head around such an easily confused topic
By Nathan Smith
A good place to start for any giant topic is a quick 101. So, let’s dig into the weird and wonderful world of intangible assets.
Intangible assets are any non-physical assets that nevertheless have significant value for businesses.
Essentially, they are everything a company “owns” that you can’t drop on your foot. I put “owns” in scare quotes because the intangible asset of industry knowledge, for example, might exist in an employee’s brain. While that knowledge may be crucial for the operation of the company, unless the employment contract is extremely comprehensive, then a company can’t directly own that knowledge. But it can use it.
That’s a great framing for appreciating the complexity of intangible assets.
Definition of Intangible Assets
Intangible assets are assets that cannot be touched, seen or felt, but still hold significant value for businesses. These assets are generally created through a company's normal, everyday intellectual and creative processes and are a key driver of a company's growth and profitability.
Intangible assets can be protected with patents, copyrights and trademarks, making them difficult to replicate by rivals.
Valuation of Intangible Assets
Intangible assets can be difficult to value because they do not have a physical presence. Unlike tangible assets, such as buildings and machinery, which can be easily appraised by auditors and accountants, intangible assets require a more complex valuation process.
Because intangible assets can be hard to quantify using normal accounting standards, they are often overlooked during M&As, business exits and negotiations for things like royalty rates. Without proper valuation of their intangible assets, companies risk leaving a lot of money on the table during these times.
Some methods used to value intangible assets include cost, market and income approaches. The cost approach estimates the cost of creating the intangible asset, the market approach evaluates the value of similar assets sold in the market and the income approach calculates the present value of expected future cash flows generated by the intangible asset.
Types of Intangible Assets
Although companies dealing with intangible assets each have their boxes of these assets, the core set of intangible assets include:
Intellectual property – this includes copyrights, trademarks, patents, trade secrets, industrial designs, trade dress, geographic indicators, plant varieties, domain names, software.
Goodwill – this includes brand reputation, customer relationships, supplier relationships, employee relations, intellectual property, distribution networks, market position and contracts and licenses.
Human capital – this refers to the skills and knowledge of a company's employees.
Customer relationships – this includes the value of a company's customer base and the relationships it has built with them.
Software - this includes the value of a company's proprietary software programs and applications.
Advantages of Intangible Assets
Intangible assets aren’t everything for companies. Some estimates suggest intangible assets constitute about 90% of the value of a modern business, but this is really only accurate if the company understands what they are and has a strategy for deploying them. Without a plan, intangible assets are a bit like money that doesn’t spend – they actually become a liability.
But, if a company understand its intangible assets, they can confer a significant amount of value.
Competitive advantage – intangible assets, such as brand and patents, can give a company a serious leg up over its rivals that may be stuck in doing the “status quo” and can’t see the future.
Revenue generation – used wisely and even coupled together, intangible assets can generate new revenue streams for businesses through licensing agreements and royalties.
Brand building – a strong brand can increase customer loyalty, leading to increased sales and profitability.
Increased valuation – a company's intangible assets can increase its overall valuation, making it more attractive to potential investors. As mentioned above, this outcome depends on the correct appraisal of such assets, which often requires thinking outside the box (a useful skill for any business).
Disadvantages of Intangible Assets
It’s not all rainbows and unicorns, however. Intangible assets also have some disadvantages, including:
Difficulty in valuation – once again, intangible assets can be difficult to value accurately, making it hard to determine their true worth. This difficulty can convince some business owners to avoid the appraisal process altogether, which can be a real shame.
Risk of obsolescence – software and technology can become obsolete quickly, reducing their value. It’s important to know what you have and the right time to pivot to something new or learn to constantly be updating and improving these intangible assets.
Vulnerability to infringement – intangible assets, such as patents and trademarks, can be infringed upon by competitors, reducing their value. There are countless stories of companies spending millions of dollars on marketing a neat idea only to discover the new territory to which they are expanding is already dominated by a competitor that happens to own the same trademark. Ouch.
Companies with Intangible Assets
No matter the size or sector, every company has its own set of intangible assets, particularly businesses in the technology, pharmaceutical and consumer goods sectors.
Nevertheless, here are some well-known examples:
Apple – Apple’s brand recognition and customer loyalty are intangible assets that have contributed to its success.
Coca-Cola – Coca-Cola’s brand is one of the most recognisable in the world, contributing heavily to its market dominance. It’s an expensive goal (Coke spends about $4 billion each year on advertising).
Pfizer – Pfizer’s patents on its pharmaceutical products are valuable intangible assets that generate significant revenue for the company.
The type of intangible asset common to each of the above corporates is intellectual property (IP), which includes trademarks, patents, copyrights and trade secrets. Many people think intangible assets are the same thing as IP, but in practicality, IP is just one type of intangible asset.
IP provides significant value to a company by protecting its products, brands and inventions from being used by competitors. For example, Apple has a vast portfolio of patents that cover its innovative products and technologies such as the iPhone, iPad and MacBook. But while IP might defend a brand in a court of law, the intangible asset of a brand has nothing to do with IP.
Similarly, software fits into the definition of “anything you can’t drop on your foot” yet is different to IP. Software is its own category of intangible asset that deserves IP protection but should receive a separate strategy from any other asset. It’s these nuances that make thinking about intangibles so insightful and crucial for company success.
Goodwill is another type of intangible asset people confuse as an umbrella word for “intangible assets.” Again, goodwill (which is an accounting term) is just one flower in the garden of intangible assets. It is created when a company acquires another company for more than the fair market value of its net assets. Goodwill is also generated through internal business activities, such as building a strong brand or developing a loyal customer base. For example, Coca-Cola has a significant amount of goodwill on its balance sheet, which reflects the value of its brand and reputation.
While tangible assets can be easily measured and valued, intangible assets require more complex and subjective methods of valuation.
However, companies that understand the importance of their intangible assets and effectively manage and protect them can reap significant benefits, such as higher market share, increased revenue and enhanced reputation.