Last month we highlighted the growth in the Middle East and North Africa (MENA) investment space. In this newsletter, we will dive into funding by industry and region.
In next month’s newsletter, we will walk through the steps to create a successfully closed deal in the region based on success stories and lessons learned. This information will be a guide to expansion in the region supported by capital placement.
Jahani and Associates (J&A)—a top New York investment bank led by Managing Director Joshua Jahani—has found that these private company buyers create returns for their investors and management through two ways:
This strategy has proven to be very effective. Since 2010, private equity returns have outperformed standard market returns.2 However, PE buyers are faced with two problems when it comes to generating returns for their management and investors. These problems are grounded in the fact that intangible assets matter most when it comes to generating returns and make up over 80% of M&A value. The problems are:
The following research, evidence, and strategies provide a solution for both these problems. The solution to problem one is to perform a more insightful purchase price allocation (PPA) than is typically done in the market. The solution to problem two is to execute a better sell-side process driven by acknowledging that intangible assets matter most.
Purchase price allocation is done near or after the closing of an M&A transaction. The goal of PPA is to relate the total money paid for a target company to the assets of that target. PPA work is based on five asset categories: cash, tangible assets, intangible assets, goodwill, and liabilities.
Intangible assets lack physical properties. They have the potential to either generate income or save costs for the owner. Most of the time, intangibles are not contained in a firm’s balance sheet. These may include customer contracts for health insurance companies and in-house developed technology for consumer product companies. Intangibles are usually amortized between three to 15 years based on their characteristics and useful life. The useful life of intangibles is subject to legal, regulatory, or contractual provisions that are considered during valuation.3
Intangible assets are typically valued by one of three methodologies:
Income valuation considers the incremental value an intangible brings to a firm’s cash flow. Market valuation involves identifying the price an asset trades at in an efficient market, then applying that value to an identified intangible asset. Cost valuation requires estimating the amount of money that would be spent to replace the intangible asset. In general, income and market valuation methods value assets at their highest, whereas cost valuation creates a lower asset value.
Landing on a unified valuation method between buyers and sellers can be challenging. Determining a fair value for both buyers and sellers requires a deep level of expertise in operational, financial, and regulatory due diligence. At Jahani and Associates (J&A), our experienced team of tech investors and wellness investors led by Managing Director Joshua Jahani have designed a valuation solution based on the analysis of thousands of purchase price allocations and our collective industry experience for startups and Fortune 500 companies.
M&A studies have shown that intangible assets and goodwill make up most of M&A deal value.4,5 Intangible assets and goodwill are amortized differently. Amortization is the process of writing off the cost of an intangible asset, just as depreciation is the process of writing off the cost of a tangible one. High amortization or depreciation lowers net income in a company’s financial statements. Private companies amortize goodwill over 15 years as an asset, and public companies do not amortize goodwill. Instead, public companies must undergo costly impairment tests for goodwill each year. Goodwill impairment tests include studying intangible assets to determine if their fair market value and useful life has significantly changed since the asset was acquired.6
Intangible assets, apart from goodwill, can be amortized between three to 15 years. Therefore, when a buyer allocates more of its purchase price to intangible assets than to goodwill, it can increase the company’s amortization expense, lower its net income, and optimize its financial reporting.
However, this does not change the overall purchase price; it only changes the amounts allocated to goodwill and intangible assets. Figure 1 is an illustrative example of how allocating more purchase price to intangibles can optimize a buyer’s financial reporting.
The Financial Accounting Standards Board (FASB) and the Accounting Standards Codification (ASC) 805 outline the rules for acquisition accounting that can be used to determine which assets and what asset amounts can be placed into the intangible asset category, separate from goodwill. The key to performing an intelligent PPA is rooted in understanding FASB ASC 805.
Jahani and Associates have analyzed over 6,000 PPAs from publicly traded companies to determine the intangible assets that matter most. The intangibles that matter most are determined by industry verticals. For example, customer contracts are overwhelmingly valued in health insurance companies, but technology developed for in-house use makes up most of the M&A value for consumer product companies.
There is good news for private equity buyers: the performance of a better purchase price allocation process can optimize financial reporting.
Jahani and Associates’ experienced team of tech investors and wellness investors led by Managing Director Joshua Jahani have created this process based on our experience and through researching thousands of purchase price allocations. We offer a step-by-step guide that identifies the intangibles that matter, values them, and subsequently optimizes financial reporting. Each step of the traditional process is disrupted by Jahani and Associates’ methodology.
At its core, the process uses publicly available data and best practices valuation methods to create a strong case for the value of each identifiable intangible asset. The prevalence of intangible assets differs by industry. Therefore, industry dynamics are carefully analyzed during purchase price allocation work to identify the assets that matter most today and will likely matter most in the future. Figure 3 shows this disruption along each step of the process.
Jahani and Associates have reviewed thousands of purchase price allocations to determine the most common intangible assets by industry. Before starting a purchase price allocation project, this analysis is required to make sure industry standards are followed, and identified intangibles align with reality.
Based on FASB’s rules, buyers and their advisors must understand what constitutes an intangible asset. The criteria are separability, measurability, and predictability. An asset must meet all three of these criteria to be considered an intangible asset. Income, cost, or market valuation methods can be used to determine the fair value of an intangible asset.
After calculating each assets’ fair value, goodwill can be determined and minimized for the buyer. Increasing the allocation of intangibles with less than 15 years of useful life will always increase the amortization of the new entity and, therefore, optimize financial reporting. In some cases, amortization may need to be minimized. This may be the case if buyers want to maximize net income for reporting or competitive purposes.
Beyond purchase price allocation, understanding how intangible assets perform creates powerful insights for the M&A sell-side process. Sell-side M&A is Jahani and Associates’ most active service offering and has gained popularity because of the focus on intangibles. Intangible assets allow sellers to naturally create the buyer’s business case when running a process. Figure 4 shows the steps that can be used to accomplish this.
This M&A strategy is based on increasing a firm’s valuation according to FASB rules. The valuation process draws from asset and market valuation methodologies with a focus on intangible assets. Because intangible assets are often more elusive and difficult to quantify, the first step is to identify precisely what will be valued, why it will be valued, and how it will be valued. The quantitative drivers for this are often key performance indicators (KPIs) specific to the business. For example, ad-tech KPIs may include daily active users, time spent inside an application, or the number of interfaces integrated into the technology. KPIs must be very specific and consistently measurable. If they are not, then the valuation will be indefensible.
The process to identify a company’s valuation requires a deep understanding of the firm’s industry, potential buyers, M&A activity, and internal strengths. Business owners should conduct an internal assessment of their perceived strengths and then compare those strengths to measurable intangibles identified through market analysis as shown in this paper. The owners must determine how to value these intangibles and collect relevant information as required through income, market, or asset valuation methodologies.
The process of developing an intangible asset becomes the process of doing business. In fact, business as usual and intangible asset development are often two ways to describe the same thing. The only difference between business as usual and developing intangible assets is the data collected along the way.
The relevant data collected during market analysis, the process of identifying what makes a company valuable, is also the data that should be used to develop intangible assets carefully. For example, suppose time spent on the application is identified as an intangible asset in the market. In that case, a company should record both the costs and effort to develop those assets through user experience design, added functionality, better graphics, and any other relevant business processes.
For the business owner, monetization happens once the transaction is consummate and the investment banking process is complete. M&A provides an excellent way to measure the impact of intangible assets on a company’s valuation and confirm their role in the purchase price. As of December 2018, all public and private companies are required to allocate M&A purchase prices according to FASB ASC 805.3
Intangibles make up over 90% of M&A value, according to Jahani and Associates’ research. The best time to maximize identifiable intangibles is during purchase price allocation. This effort creates significant ROI when the business is later sold. Private equity buyers can then reap the benefits of their careful thinking by having proof of the intangibles that exist in their businesses several years later. Without performing more informed purchase price allocations, this case is very difficult to make. Innovating purchase price allocation, which Jahani and Associates does, creates significant financial benefits when private equity firms look to exit. Intangible assets make up most of the value in both private and public capital markets today. Because these assets are not subject to the same standardized reporting as tangible assets, buyers are disadvantaged when it comes to understanding and investing in them.
The principles laid out in this whitepaper give buyers actionable tools to optimize their financial reporting and boost their balance sheet value for future sell-side performance. There is a plethora of evidence that intangible assets make up most of the financial value in both private and public equity markets.
Ignoring intangible assets during purchase price allocation or sell-side M&A is a mistake that can cost private equity firms millions or tens of millions of dollars. The buyers must make purposeful investments to understand, identify, develop, and monetize intangible assets to maintain a competitive edge in increasingly competitive industries.
In 2019, Jahani and Associates reviewed M&A activity among the largest companies in the financial services, healthcare, energy, IT services, and branded consumer products industries to determine the intangible assets that matter most in each industry. Intangible-asset pro formas were taken from the Securities and Exchange Commission (SEC) reports only. J&A also surveyed over 15 private equity business leaders in the United States to understand how executives used intangible-asset reporting to make business decisions.
Jahani and Associates (J&A) is an independent investment bank located in New York, New York. The firm specializes in healthcare and technology and provides specialized M&A and capital markets advisory services. The combination of J&A’s unmatched skills in technology, engineering, and business operations allows the firm to create sustainable value for its clients. J&A works at the intersection of cutting-edge financial theory and business practicality. Creativity is highly valued within the firm, which allows J&A to continually improve the way businesses thrive.
A video of the final presentation can be seen here.
The work was also featured as a top performer in subsequent Cornell news. This can be found here.
After most M&A deals close, the new business does not create the value that executives predicted.1 Jahani and Associates (J&A)—a top New York investment bank led by Managing Director Joshua Jahani—has determined this is because of two reasons:
The following describes J&A’s strategy along with supporting empirical research for health insurance M&A buy-side decisions. This evidence is based on the M&A activity completed by the United States’ largest health insurance companies between 2010 and 2017: Aetna, Anthem, Centene, Cigna, Humana, Magellan, Molina, UnitedHealthcare, and Wellcare. This analysis is specific to health insurance M&A; similar analysis can be done for any industry.
J&A’s research has proved that intangible assets make up over 90% of M&A value. Within this 90%, customer-related intangible assets are most prominent for health insurance companies. Customer-related intangibles account for approximately 65% of the M&A deal value.
This research also relates specific intangible assets to financial performance. Medicaid buyers such as Molina and Centene achieved the greatest revenue growth between 2010 and 2017. J&A believes Medicaid acquisitions caused revenue growth for these companies based on regulatory dynamics. The final part of this paper delivers the strategy J&A uses for its health insurance and healthcare clients to help them make better buy-side M&A decisions.
The international health insurance M&A market is very large, representing between $70 and $120 billion per year between 2010 and 2017. Figure 1 shows the international health insurance M&A deal size from 2010 to 2017. This data does not include initial public offerings. The majority of deals were completed by corporate M&A buyers. These buyers comprised over 80% of the money spent and over 70% of the transactions completed.
The most common way to describe M&A value is through financial statement metrics such as earnings before interest, tax, depreciation, and amortization (EBITDA) or revenue. But financial statements have become decreasingly relevant since the dot-com boom in 1995 because they do not contain information about intangible assets. This is a challenge for buy-side M&A decision-making. Without standard reporting, it is very difficult to collect data on members related to Medicare, Medicaid, duals, commercial, and other populations. These challenges are especially prevalent in the private markets. Private company reporting is ad hoc, disorganized, and unstandardized.
Because of this information gap, health insurance companies must have a better strategy to acquire the right intangibles and integrate those intangibles into the buyer’s existing business during buy-side M&A. They need to collect information about intangibles throughout scouting, solicitation, diligence, closing, and integration. Collecting and analyzing this information must be part of the buy-side M&A process, which is usually led by an investment banker.
To define the intangibles that create the most M&A value for the buyer, J&A collected the purchase price allocations for all acquisitions completed by Aetna, Anthem, Centene, Cigna, Humana, Magellan, Molina, UnitedHealthcare, and Wellcare from 2010 to 2017. These purchase price allocations show that health insurance giants spent 14 times more money on intangible assets than tangible ones. Customer-related intangibles accounted for 65% of health insurance M&A deal value.
Customer-related intangibles include both contractual and non-contractual assets. Contractual health insurance customer relationships are active members across all lines of business. Non-contractual relationships include past customers or customers who have terminated coverage for a variety of reasons. Examples of customer intangible assets according to the Financial Accounting Standards Board (FASB) are customer lists, order backlog, current members, and past members.
Not all intangibles are created equal: the top revenue growth performers purchased specific customer intangibles. UnitedHealthcare purchased the most customer intangibles among its competitors but did not achieve the greatest proportionate revenue growth when compared to Molina and Centene.2 In fact, top performers in health insurance buy-side M&A purchased mostly Medicaid customers. Simply buying the most customer-related intangibles did not guarantee the greatest revenue growth.
J&A chose revenue growth as the major indicator of M&A performance because of the health insurance business model. Literature review supports the performance of Molina’s and Centene’s stock prices above their competitors.2 Top performers purchased more Medicaid customers than any other kind of membership. This decision was driven by the Affordable Care Act (ACA).
The ACA increased federal poverty limits for Medicaid, SNAP, CHIP, and TANF populations.3 This increased the volume of those eligible for Medicaid and, therefore, the size of the market. Combined with insurance exchanges and an individual mandate to acquire health insurance, this also increased Medicaid funding for the states.4 The combination of an individual mandate, increased Medicaid spending, and an increase in the Medicaid population allowed health insurance companies like Molina and Centene to outperform competitors in revenue growth. Molina’s and Centene’s premium revenues grew 373% and 934% respectively from 2010 to 2017, whereas all other health insurance companies’ premium revenues increased an average of 109% during the same time period. Molina and Centene made 20 acquisitions specific to Medicaid; all other health plans combined made only four.
Not all health insurance members are equal since not all health insurance lines of business are equally valuable at the same time to buyers. The most effective way to perform integration analysis during the buy-side M&A diligence process is to confirm that a company’s definition of customer value overlaps between the buyer and the seller. When possible, data related to Net Promoter Score (NPS) can also be used to identify customer sentiment in a selected target. None of these indicators are contained in the financial statements, and they are generally outside the investment banker’s due diligence process. However, buyers, bankers, and advisors must utilize these tools to identify and acquire the intangibles that are needed. The importance of integration is supported by J&A’s health insurance M&A analysis showing 87% of the top performers purchased companies in regions where the buyer had existing operations. Growing in existing markets was more attractive than expanding to new markets.
When customer contracts are the most important asset
Since J&A’s research revealed that health insurance M&A dollars are mostly spent on customer-related intangibles, health insurance buyers must take care to make sure their buy-side process recognizes this by measuring the intangible assets that matter before, during, and after a deal is closed. The first step in identifying the intangibles that will drive value is to understand internal corporate strategy. In the case of Molina, the buyer used an existing competitive advantage of serving Medicaid populations to expand its market share. Other top-performing examples include Cigna’s acquisition of Great American Supplemental Benefits to increase cross-selling and up-selling opportunities to Cigna’s already large population of members. All top revenue performers purchased homogeneous customer intangibles and customer lists.
These findings show companies must determine which lines of business are most profitable, which ones are best positioned for growth, and how that growth and success are internally measured. Successful buy-side M&A starts with applying internal growth measurement standards to the target’s intangibles during the process.
Tools like Net Promoter Score (NPS) or customer service ratings are often bullet points for marketing that are managed by a few business leaders who invest in improving the scores. But these metrics show important information about how customers perceive the value of their health insurance provider. Not utilizing these metrics during the buy-side process will lead to poor intangible reporting and, therefore, increased risk of a failed acquisition.5,6
Jahani and Associates has provided examples of how to use CLTV, CAC, NPS, and regulatory strategy analysis to make better health insurance buy-side M&A decisions. These examples are not limitative, and many others should be considered to minimize the risk of derailing the M&A process.
Through all of this, buyers can integrate their targets more seamlessly post-acquisition by measuring the most important assets before a deal is signed.
Intangible assets matter most, and customer-related intangibles matter most to health insurance buyers. Health insurance buyers must run a buy-side M&A process that integrates this intangible reality into the entire process.
For a health insurance M&A acquisition to be successful, purchased intangibles must create tangible value. The only way for buyers to accomplish this transformation is to remain disciplined and diligent during the integration process. This integration process is completely dependent on what is measured and acquired. Knowing what to measure and how to measure are two key factors to creating a winning strategy. Ignoring these facts exacerbates the two challenges stated earlier: overstated or overambitious executive goals and the lack of intangible asset reporting or understanding that leads to failed acquisitions.
Removing the disconnect between traditional M&A buy-side practices and intangible reporting can dispel negative consequences from overstated executive goals during the M&A process. In the age of the intangible economy, typical reporting is inadequate. Buyers must take careful and deliberate steps to develop a better understanding of intangibles in order to drive M&A performance. Mergers and acquisitions fail to create desired value when post-merger integrations do not perform. By focusing on intangible assets, buyers can collect and analyze key integration activity and information before a deal is closed. By collecting intangible asset information upfront, buyers will conduct a more precise M&A process and maximize shareholder returns. Buyers should determine their buy-side M&A goals, then utilize Jahani and Associates’ strategy during scouting, solicitation, diligence, closing, and integration.
Health insurance companies should utilize lifetime value principles to determine the best membership populations to buy and integrate. More importantly, the definition of customer lifetime value must align between the buyer and the target. This alignment must be determined before the health insurance M&A acquisition is closed. Fundamental differences in defining success and value cause significant barriers to accretion and effective integration.6,7
CLTV is a balance of the revenue generated and costs needed to service a customer. Therefore, both cost savings and revenue growth factors are relevant to CLTV calculations. Insurance companies spend significant sums of money on customer service. CLTV can show buyers the efficacy of dollars spent and identify areas for potential cost synergies.
There are many models and methodologies used to measure customer lifetime value. Buyers should remember that the way CLTV is measured is more important than the exact number calculated. Overlaps in measurement methodology, inputs, and outputs will create more synergy post-acquisition.
Customer acquisition costs may be the most important intangible KPI for health insurers. Since health plan revenue is a function of membership and membership is predictable within a calendar year, cost containment is the best way insurers can improve profit margins. Cost reporting and measurement are also essential for current regulations regarding medical loss ratio and risk adjustment standards.
CAC is calculated by dividing total sales and marketing expenses by the number of customers acquired, usually on an annual basis. Much value can be extracted from this by determining the CAC by the line of business.
As an example, comparing digital marketing customer acquisition and traditional marketing customer acquisition can give buyers insights into cost synergies. Based on this information, buyers can then decide on this information if the target has a proven customer acquisition strategy that is in line with the mandate.
Raw NPS data is usually available upon request. Reviewing NPS shows the buyer what kind of customers were surveyed, where they were surveyed, and how they were surveyed. Comparing the target’s information to the buyer’s provides tremendous insight into how customer relationships are maintained and managed.
Due to the increased retailing of the health insurance industry, customer service has become an increasingly expensive cost center. Because investments in customer service are represented as costs on financial statements, diligence is required to make sure investments generate results and that those results overlap with the same success factors of the buyer’s internal systems. The costs to generate meaningful intangible assets should be treated differently than costs with less impact.
Customer service metrics can be tricky to compare if they are not calculated the same way. Buyers need to make sure they are speaking the same language as the target in terms of the definitions of KPIs such as NPS; this goes beyond the number itself.
The United States health insurance market is a common political topic and a pillar in party platforms. Due to this, political changes influence the health insurance market through regulation. Medicaid growth in the United States is an example of this. Additional examples are the ACA, the creation of Medicare in 1965, and President Trump’s recent proposals to change Medicaid, CHIP, and the ability for health insurers to sell across state lines.
Therefore, no health insurance buy-side strategy is complete without regulatory analysis. Health insurers should monitor political dynamics with careful consideration of which healthcare policies will survive multiple election cycles. Court decisions, such as National Federation of Independent Business v. Sebelius in 2012, and litigation are the best indicators for which policies will endure. National Federation of Independent Business v. Sebelius solidified many of the regulations passed in the ACA.8,9
Healthcare regulation changes constantly. Campaign promises are not always implemented into law. Buyers must find strategies for growth that are difficult to politically influence. This minimizes risk and can lead to lasting returns no matter the political climate.
Jahani and Associates recommend health insurance M&A buyers use KPIs such as Net Promoter Score and other customer service quality metrics to evaluate acquisition targets. As stated earlier, analysis should focus on methodology and not on the actual numerical values. There is no conclusive evidence that the scores of customer service KPIs directly correlate to stock performance. These intangible metrics do provide valuable insight into customer-related intangibles. J&A does not suggest that similar KPI numbers create revenue, cost, or operational synergy but that similar KPI measuring methodologies do.
In 2018, Jahani and Associates reviewed 62 significant health insurance M&A acquisitions and recorded their purchase price allocations. Information was only collected from publicly available data sources. Intangible-asset pro formas were taken from Securities and Exchange Commission (SEC) reports only. J&A also surveyed over 34 business leaders from health insurance companies to understand how executives used intangible asset reporting to make business decisions.
Jahani and Associates (J&A) is an independent investment bank located in New York City. The firm specializes in healthcare and technology and provides specialized M&A and capital markets advisory services. The combination of J&A’s unmatched skills in technology, engineering, and business operations allows the firm to create sustainable value for its clients. J&A works at the intersection of cutting-edge financial theory and business practicality. Creativity is highly valued within the firm which allows J&A to continually improve the way businesses thrive.
5. Alex Edmans, “Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices,” Journal of Financial Economics 101, no. 3 (2011): 621–640.
6. Hao Jiang, “Institutional Investors, Intangible Information, and the Book-to-Market Effect,” Journal of Financial Economics 96, no. 1 (2010): 98-126.
7. Alex F. De Noble, Loren T. Gustafson, and Michael Hergert, “Planning for Post-Merger Integration—Eight Lessons for Merger Success,” Long Range Planning 21, no. 4 (1988): 82-85.
Copyright 2019 Jahani & Associates. All rights reserved.
All business owners want to increase the value of their company. But defining value is a challenge for most of them. This challenge particularly presents itself when selling a business and considering merger and acquisition (M&A) options. All leaders of companies, from startups to those in the Fortune 500, are faced with the same difficult questions when building their company’s value:
Selling a business is a unique process. M&A buyers think differently than customers, vendors, and partners. The skills business leaders develop over years of building their business does not overlap with the skills they need to communicate and negotiate with M&A buyers. As a result, executives are often unprepared, lacking clear and effective answers to questions about the value of their company. To make matters for the business owner more complex, the M&A industry is full of advisors who provide different areas of expertise to the M&A process but often fall short of providing a clear, comprehensive, and long-term strategy for maximizing M&A value. Owners need a strategy that helps them show how their company is valuable and how to communicate that value during the M&A process. The strategy should be customizable to a business’ unique characteristics and simple to implement. Business owners have full agendas. They cannot spend years on exit strategy planning.
Identifying and defining M&A value is only possible with a deep understanding of how valuation is influenced by a business’ assets, proprietary data, and unique strengths. Because of this, top NYC investment bank Jahani and Associates (J&A) analyzed 334 M&A transactions between 2010 and 2016. To uncover what really drives value, J&A examined the purchase price allocations of each M&A transaction and then segmented them by industry. Conducted by J&A’s team of tech investors led by Managing Director Joshua Jahani, the study focused on technology companies and included buyers such as Alphabet, Amazon, Facebook, Twitter, Microsoft, Apple, and Yahoo!. Out of the 334 companies purchased by major tech giants and the more than $94 billion spent between 2010 and 2016, intangible assets accounted for over 90% of M&A dollars. These intangible assets included customer contracts, customer lists, patents, trademarks, copyrights, and business combinations. In contrast, only 10% of M&A dollars were spent on tangible assets. Examples of tangible assets include office space, machinery, and equipment.1
The vast majority of M&A dollars spent on intangible assets is a surprise to many business owners. M&A is generally viewed as a tangible and financial process. M&A valuation methods are almost always driven by cash flows and income analysis. However, due to technology, intangible assets have played an increasingly central role in international capital markets since the dot-com boom.2
Another reason for the increased role of intangible assets in M&A is how their definition has evolved over time. The Financial Accounting Standards Board (FASB) updated its definition of what constitutes an intangible asset (including business combinations) 26 times since 2010.3 As technology has become more sophisticated and businesses have invested more in their intangible capabilities, the FASB updates have become more specific. For example, in March 2018, there was a proposed change to FASB’s accounting rules for implementation costs incurred during a cloud computing arrangement. All of this shows that intangible assets and their measurement are more important now than ever before for business owners, especially in an M&A setting.
Business owners know intangible assets are valuable. But they struggle to understand which assets are more valuable than others and how to measure that value accurately. FASB provides guidance for measuring and defining intangible assets. Valid intangible assets must possess three characteristics. They must be separable, measurable, and predictable.
Separability means they should be able to be sold, transferred, or licensed. An example of a separable asset is a creative work, such as a book. Measurability refers to that which can be quantified (for example, the number of times a book is licensed). And predictability connotes access to historical performance and that historical performance is related to future performance.
Armed with this information, business owners can now understand what truly makes their company valuable. For example, culture is often identified as an intangible asset. But culture can only be an intangible asset as much as it can be separated and sold, as during an M&A, measured through demographic diversity or uniformity, and predicted: if a company has a specific culture today, it will have the same or similar culture tomorrow.
This broad range of intangible asset definitions may provide business owners the opportunity to sigh in relief. They always knew their culture was valuable. Now they can prove it. But the flexibility of the definition of an intangible asset actually creates a whole new set of challenges for business owners. Namely, determining how they can start capturing information and using it to inform the M&A process, thus increasing M&A value.
The shift of value from traditional income-driven metrics like earnings before interest, taxes, depreciation, and amortization to intangible assets means business owners need a very specific strategy to successfully complete an M&A. To understand this, J&A investigated the intangible assets valued at the greatest dollar amount for ad tech acquisitions. Two intangible assets create the greatest ad tech target-firm value. They are data interfaces and data processing power. Acquisitions that support this include FameBit, DeepMind, Adometry, Invite Media, Teracent, Navic Networks, Admeld, and Interclick.
Measuring intangible assets like these are outside the ability of the traditional M&A banker or CFO. Ad tech businesses are fast-moving and highly technical. Because of this, transparency, organized processes, and clear objective outcome–oriented measurements are needed in select business units to create the greatest purchase price for the M&A seller.
Effectively delivering this enhanced separability, measurability, and predictability inside the M&A process requires a technical skillset as well as a deep understanding of M&A. Therefore, business owners must combine diverse skillsets within their organization, from technological to financial, before starting the M&A process. When brought together, this strategy generates a tremendous competitive advantage.
Business combinations and other intangible assets are always process-driven and industry-specific. According to FASB, business combinations are only generated when two processes create something that neither the buyer nor the seller possessed independently prior to the M&A.4 This means the same intangible assets will be valued differently by different buyers. Therefore, business owners will need to plan for a range of valuations based on who they approach to buy their business.
Utilizing this strategy answers both what M&A value a company presents and how to communicate that value better than the competition. During an M&A, FASB rules must be preserved to make a strong case to the buyer. This strategy is successful because it focuses on combining technical components, such as interfaces and processing power, with FASB valuation rules for intangible assets.
The figure below outlines the new M&A strategy successful companies use when selling their businesses. M&A bankers often cite the lack of measurable information as the number one barrier to better negotiation outcomes.5 This strategy removes that weakness and gives business owners a road map for how to combine the right talent from relevant business units to systematically increase M&A value.
This strategy aligns business owners with drivers that will improve valuation and negotiation positions based on M&A market activity. It shows owners and leaders how to determine the market forces responsible for intangible assets in M&A at the business level, not just generic financial indicators. The strategy then walks business owners through implementing these intangible asset drivers.
This M&A strategy is based on increasing a firm’s valuation according to FASB rules. The valuation process draws from asset and market valuation methodologies with a focus on intangible assets. Because intangible assets are often more elusive and difficult to quantify, the first step is identifying exactly what will be valued, why it will be valued, and how it will be valued. The quantitative drivers for this are often key performance indicators (KPIs) that are specific to the business. For example, ad tech KPIs may include daily active users, time spent inside an application, or the number of interfaces integrated into the technology.
KPIs must be very specific and consistently measurable. If they are not, then the valuation will be indefensible. This process requires a deep understanding of a firm’s industry, potential buyers, M&A activity, and internal strengths. Business owners should conduct an internal assessment of their perceived strengths and then compare those strengths to measurable intangible assets identified through market analysis as shown in the tech giant analysis explained above. The owners must determine how to value these intangible assets and collect relevant information as required through income, market, or asset valuation methodologies.
The process of developing an intangible asset becomes the process of doing business. In fact, business as usual and intangible asset development are often two ways to describe the same thing. The only difference between business as usual and developing intangible assets is the data collected along the way. Developing intangible assets means carefully collecting data that was previously identified as valuable and relevant from the market analysis in step one. For example, if time spent on the application is identified as an intangible asset in the market, then a company should record both the costs and effort to develop those assets through user experience design, added functionality, better graphics, and any other relevant business processes.
For the business owner, monetization happens when the transaction is consummated and the investment banking process is complete. M&A provides an excellent way to measure the impact of intangible assets on a company’s valuation and confirm their role in the purchase price. As of December 2018, all public and private companies are required to allocate M&A purchase prices according to FASB Accounting Standards Codification Rule (ASC) 805.6
Jahani and Associates’ experience using this strategy for our clients has been very successful. With this strategy, our driven team of tech investors consistently creates scientific evidence for why a business should be valued at the highest end of valuation ranges or in a new valuation range altogether. Implementing this strategy allows our sell-side client to speak directly to the corporate development officer’s or private equity buyer’s business case. The buyer no longer has to search for information and make extravagant assumptions. Most importantly, it allows our clients to communicate what makes their business special to begin with, bringing to light decades of the owner’s hard work and sacrifices.
The foundation of this strategy is demonstrated through the study of thousands of M&A transactions from buyers in industries that consistently place more value on intangible assets than tangible assets, such as technology and healthcare.7 Business owners are at a disadvantage when selling their companies because there is no standardized reporting for intangible assets. Most business owners are not M&A experts. They are unaware of how the absence of reporting limits the value of their company. It is difficult for business owners to take time away from serving customers, coaching employees, and developing products or services. But when armed with this strategy and the help of a top investment bank for M&A, business owners have a concrete plan that allows them to build their business and prepare for the most valuable exit possible. Without this strategy, owners face a difficult, uphill battle.
Intangible assets are the greatest drivers in M&A value-driven conversations today. These conversations are not limited to scientists, technologists, tech investors, and software developers. C-suite leaders and financial executives are at the center of them.
As technology continues to play a more dominant role in the global economy, intangible assets will become even more relevant. Business owners must be prepared to speak the language of intangible assets when communicating the value of their businesses in cross-border capital markets.
In 2017, Jahani and Associates reviewed 334 acquisitions from technology giants and recorded their purchase price allocations. Information was only collected from publicly available data sources. Intangible asset pro formas were taken from the Securities and Exchange Commission (SEC reports only). J&A also surveyed over 100 business leaders from startups and Fortune 500 companies to explore strategic areas and opportunities where companies are harnessing technology to increase business value.
Jahani and Associates (J&A) is an independent investment bank located in New York, New York. The firm specializes in healthcare and technology and provides specialized M&A and capital markets advisory services to its clients. The combination of J&A’s unmatched skills in technology, engineering, and business operations allows the firm to create sustainable value for its clients. J&A works at the intersection of cutting-edge financial theory and business practicality. Creativity is highly valued within the firm which allows J&A to continually improve the way businesses thrive.
1. All data is sourced from publicly available data sources such as the annual reports for Alphabet, Apple, Microsoft and others.
2. Baruch Lev and Feng Gu, “The End of Accounting and the Path Forward for Investors and Managers.” 2016.
4. FASB Accounting Standards Codification Rule 805.
5. Conversation with Kenneth Marks in December 2017, managing director of High Rock Partners and coauthor of Middle Market M&A: Handbook for Investment Banking and Business Consulting.
All data is sourced from publicly available data sources such as the annual reports for WellPoint, UnitedHealth Group, Centene, Aetna, Anthem, Cigna, Humana, WellCare, Molina, and Kaiser Permanente. This document makes descriptive references to trademarks that may be owned by others. The use of such trademarks herein is not an assertion of ownership of such trademarks by Jahani and Associates and is not intended to represent or imply the existence of an association between Jahani and Associates and the lawful owners of such trademarks.
Copyright 2018 Jahani & Associates. All rights reserved
We want to thank all our Florida partners, clients, and employees for attending the “Exiting vs Thinking Defensively” dinner in January. It is always a pleasure to experience the energy of everyone we work with. We will continue to deliver peak performance for our Florida clients.
– Joshua Jahani, Managing Director
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