Intangible Assets as a Driver of Business Value

IRS Revenue Ruling 59-60 provides guidance for the valuation of closely held common equity interests. When issued in 1959, the ruling specifically referred to valuing “... the stock of closely held corporations where market quotations are not available.”

Rev. Rul. 59-60 lists eight factors that should be considered when valuing the stock of closely held companies:

  1. The nature of the business and the history of the enterprise from its inception.

  2. General economic outlook and the condition and outlook of the specific industry in particular.

  3. Book value of the stock and the financial condition of the business.

  4. Business's earning capacity.

  5. Business's dividend-paying capacity.

  6. Sales of the stock and size of the block of stock to be valued.

  7. The market price of stocks of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter.

  8. Whether or not the enterprise has goodwill or other intangible value.

Intangible assets include software, customer relationships, patents, copyrights, trade secrets, trademarks, brands, and technical know-how. Intangible assets today drive a significant portion of the market value of companies, as evidenced by the wide disparity between the market value and the book value of many publicly traded companies.

To further illustrate this point, the graph below shows the exponential growth in the number of patents issued between 1976 and 2009. Additionally, during the past ten years, licensing revenues have grown from $15 billion to $110 billion.

Given the increase in the number of companies that derive their revenue from intangible assets, the Financial Accounting Standards Board (FASB), the IRS and other regulatory bodies have added rules requiring companies to more accurately calculate and report the value of those assets. Within recent years, the FASB has issued several pronouncements that address the valuation of intangible assets. These pronouncements – SFAS 141 and SFAS 141R (later codified as ASC 805), SFAS 142 (later codified as ASC 350), and SFAS 157  (later codified as ASC 820) – define “goodwill” and “fair value,” provide a framework for measuring fair value, and establish guidelines for recognition and impairment of goodwill.

The implementation of these rules and the proliferation of intangible assets in today's economy are causing a wider disparity of price-to-book value (PBV) ratios than in decades past. For example, in one 2011 analysis, the average PBV ratio of companies in the application software industry was 11.7 (indicating that the market priced the value of the average application software company at 11.7 times the net asset value recorded on its balance sheet). In comparison, relatively low-tech Georgia-Pacific had a PBV of 2.0 (indicating that its market value was twice its balance sheet net value).

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