Understanding the valuation of intangibles

Abstract: Purpose: In order to close the gap between the reported value of intangibles and the activities companies undertake to achieve such values, new approaches to appraisal are constantly being developed. With professionals acting in the best interest of investors, said approaches aim to fundamentally understand the entirety of value creation, specifically targeting intangible value. Thus, in an effort to better understand the market value of companies, this study aims to shed light over what methods of valuing intangible assets investors utilize when valuing target firms. In addition, with valuation theory being concerned with the future prospects of a firm, it has been argued by Buchmann (2013) that it may be beneficial to understand the wealth generation potential of target firms in the process of valuing them. In his line of reasoning, innovation theory should provide insights to this dilemma, seeing as innovative activities may endow resources with novel capacities to create wealth and profitability in the future for a firm. Thus, having outlined a relationship between the two academic fields of valuation theory and innovation theory, analyzing the innovative activities that are being undertaken by target firms should enable an investor to draw conclusions on its potential future prospects. The research questions that this thesis tries to answer are thus: How do private equity investors use industry practices to value intangible assets prior to acquiring a company? And subsequently: How do private equity investors take into account the value of future prospects and wealth generation from innovative activities in a target firm prior to acquiring a company? Theory: The theory stems from three academic fields, namely: valuation theory, resource-based view and innovation theory. Key authors in the respective fields are: Damodaran (2012), Damodaran (2010), Berk and DeMarzo (2013); Barney (1991), Helfat and Peteraf (2003), Denrell et al. (2003); Schumpeter (1934), Buchmann (2013), Cooper (1990). From valuation theory, models such as Discounted Cash Flow (DCF), Leveraged Buyout (LBO), multiple approach and Internal Rate of Return (IRR) are discussed. From a resource-based view, several insights on how resources could be treated and analyzed as assets are presented. In addition, the notion of intra-specific relationships between resources is brought to light, and how this may be beneficial to industry practitioners of valuation. From innovation theory, models of how one manages innovation to deal with inherent risk and successes of projects are introduced. The presented theory also offers insight into the intricacies of innovative activities. Method: Through qualitative interviews professionals active within the industry of private equity shed light over how one determines the financial market value of a firm and its resources. With an inductive approach to the empirical data gathering, combined with an ontological position of constructionism, a qualitative research method was used to both gather the empirical data as well as analyze it. Result: As opposed to valuing assets and resources on a holistic level of a firm, private equity investors may benefit from the outlining of value inherent in specific resources or assets on a more granular level. Notwithstanding that this might be more adept for investors investing in target firms active in certain industries, it may be beneficial in the understanding of how target firm’s intangible assets and resources continue to deliver on continued profitability and growth.