THE FUTURE OF INTANGIBLE ASSETS

digital assets, how to value IP software and brand. none of these show up on the balance sheet. in fact, it's tough

Intangible assets are non-physical assets that have value and can be sold, transferred, or licensed. Examples of intangible assets include patents, trademarks, copyrights, customer lists, software, trade secrets, and brand reputation. Unlike tangible assets, intangible assets do not have a physical form and can only be valued based on their expected future economic benefits. Intangible assets are recognized and recorded on a company's balance sheet if they have been acquired and have a limited useful life.

HOW DO YOU VALUE INTANGIBLE ASSETS?

Intangible assets are non-physical assets that have value to a company, such as patents, trademarks, copyrights, trade secrets, customer relationships, and brand recognition. The value of intangible assets is typically estimated using various methods, including:

• Market approach: This involves analyzing the prices of similar intangible assets that have been sold or licensed in the past.

• Cost approach: This involves estimating the cost of developing or acquiring the intangible asset, taking into account the cost of researching, developing, or acquiring the asset, as well as any costs associated with maintaining the asset over time.

• Income approach: This involves estimating the future economic benefits that will be generated by the intangible asset and discounting those future benefits back to their present value.

• Expert opinions: In some cases, the value of intangible assets may be estimated by experts in the field, such as accountants, economists, or lawyers.

It is important to note that the value of intangible assets can be difficult to estimate and can change over time, so it is important to approach the valuation of these assets with caution.

HOW DO INTANGIBLE ASSETS GET ON THE BALANCE SHEET?

Intangible assets get on the balance sheet when they are acquired by a company. Intangible assets are recorded as assets on a company's balance sheet when they meet certain criteria, such as being identifiable, having a useful life that can be estimated, and being expected to generate future economic benefits. To value intangible assets, companies use methods such as the income approach, market approach, or cost approach, depending on the nature and type of intangible asset being valued. Companies also need to regularly review the carrying value of their intangible assets, as the value may change over time due to various factors such as changes in the economy, technology, or market conditions.

WHAT ARE THE RISKS WITH INTANGIBLE ASSET VALUATIONS?

There are several risks associated with valuing intangible assets:

Reliance on Estimates: Valuing intangible assets often involves significant estimates and assumptions, which can introduce subjectivity into the process and increase the risk of inaccuracies.

Difficulty in Measuring Value: Intangible assets often lack a clear market value and are difficult to measure objectively, making it challenging to determine their true value.

Changes in Market Conditions: Market conditions can rapidly change, causing the value of intangible assets to become outdated and incorrect.

Changes in Legal or Regulatory Environment: Changes in legal or regulatory environments can impact the value of intangible assets, as certain types of intangible assets, such as intellectual property, may lose protection or become subject to restrictions.

Changes in Business Strategy: Changes in a company's business strategy can impact the value of its intangible assets, such as if the company decides to exit a particular market or product line.

Lack of Historical Data: With intangible assets, it can be difficult to establish a historical track record to support the value estimates.

Valuation of Intangibles Acquired in Mergers & Acquisitions: Valuing intangible assets in mergers and acquisitions can be challenging, as they may be subject to negotiations and other factors that can impact their value.

WHAT ARE THE CHALLENGES OF INTANGIBLE ASSETS?

Difficulty in quantifying their value: Intangible assets often have no physical presence and are often not easily quantifiable.

Lack of market comparables: Unlike tangible assets, it is often challenging to compare intangible assets with similar assets in the market, making it difficult to determine their value.

Incomplete information: Companies may not have complete information about their intangible assets, such as patent portfolios, trade secrets, or customer relationships.

Changes in technology: The rapid pace of technological change means that intangible assets can become obsolete quickly, reducing their value.

Legal restrictions: Intangible assets may be subject to legal restrictions, such as patents, trademarks, and copyrights, which can limit their value and use.

Depreciation and amortization: Unlike tangible assets, intangible assets are often not depreciable, making it difficult to account for their long-term value.

Measurement error: Companies may have difficulty accurately measuring the value of intangible assets, which can lead to over- or under-valuation of these assets.

WHY INVEST IN INTANGIBLE ASSETS?

Look, the balance sheet is invisible. But that doesn't mean there isn’t value to be had. In fact, the invisible hand may give you the slight edge required to outperform the market.

Remember when Warren Buffett was deeply focused on cigar butt stocks? He would look for the cheapest stocks trading way below book value. But as more equity investors entered the market, buying cheap book value was not possible anymore. He had to improve his investment strategy. And thanks to Charlie Munger, it worked.

You see, Munger convinced Buffett that great businesses can be bought at a fair price. Which means shifting your focus from asset value to compounding cash flows. This was how Buffett first came across stocks like Coca-Cola. When he changed his mindset, he unlocked a whole new world of investing.

His strategy was focused on brand value. What is the indistinguishable moat that cannot be replicated? See’s Candies was another good example where customers would remain loyal for life.

But did you know that investing in intangible assets is quite common today? In fact, it is most popular with pharmaceutical stocks and content studios. Where the intellectual property determines the future value of cash flows. Disney is an excellent example of ever expanding IP. If you can defend this intangible value then your profit margins will increase overtime.

I believe this is coming to more industries today. The next best example is software, where the intellectual property is behind the unique process. Sure some software may look the same on the front-end but that’s not the case for the backend. Digital assets will become more tangible when processes become more unique.