How the DCF Equation Applies to High-Growth Company Valuations 

How the DCF Equation Applies to High-Growth Company Valuations 

Companies seeking to raise money in private capital markets need an understanding of how to create value based on cash flow. This report reviews an aspect of valuing such companies through the discounted cash flow (DCF) method, the primary method used for cash flow analysis across all asset classes.

When evaluating loss-making companies for extended periods, it is difficult to utilize the DCF for anything other than discounting forward looking profitability. In this article, J&A introduces an alternative approacha modified DCF modelthat analyzes a company’s investment worthiness by understanding its risk profile and the investor’s expected returns. 

The DCF model is used as a way to approximate the value of an investment. A DCF valuation starts by forecasting the future cash flows that an investment is expected to generate and considers the expected future growth of the asset’s cash flows. The equation incorporates risk factors by adjusting the discount or interest rate. In practice, the cash flows (CF1) include cash inflows and outflows such as revenue, expenses (excluding non-cash items such as depreciation and amortization), taxes, and other financial metrics related to the investment being evaluated. The discount rate (r) is determined based on factors like the cost of capital, the required rate of return, or a suitable benchmark rate.

Discount Rate Substituted for Interest Rate

For high-growth companies, one uses the cost of capital as a substitute for the discount rate. This number is simply the factor by which future cash flows are reduced to account for the time value of money and the risk profile of a project. Typically, riskier projects require a higher cost of capital to compensate investors for taking on more risks.

The cost of capital includes multiple components, such as the cost of debt (interest rate on borrowed money) and the cost of equity (required rate of return expected by equity investors).

The weighted average cost of capital (WACC) is a weighted average of a company’s cost of equity and cost of debt based on the money the company has already raised or the cost of raising capital at the moment in time. 

Required Return of Equity or Cost of Equity

The required return on equity, also referred to as the cost of equity, is the minimum rate of return that shareholders (equity investors) expect to earn on their investment. 

For high-growth companies that prioritize reinvesting their earnings to fund expansion and growth, the following formula is used:

In this formula, rf represents the risk-free rate of return on a risk-free investment, the beta is the measure of the stock’s risk, and rm is the expected return above the risk-free rate for investing in the overall market.

Abbreviated DCF Equation for High-Growth Companies

By using algebra, the DCF is actually:

The equation above is the correct proper, mathematically detailed equation to calculate a business’s discounted cash flow at a future period. Some of these variables matter more for high-growth companies than others. Variables that are less important can be removed to create a more concise picture of how the DCF behaves.

Focusing on the Variables that Matter

Small, high-growth companies receive investments because investors are betting they will become large companies, so the possible outcomes of these companies should be measured in extremes.

The purpose of a DCF equation for a high-growth company is to evaluate the extremes of potential value based on realistic cash flow scenarios in the future. Said differently, “If the company generates $100 million of cash flow but has to lose $200 million per year for three years, what is the asset’s value?” The DCF equation allows a financial modeler to create cash flow scenarios based on a projected income statement and calculate a likely business value. The DCF model also allows decision-makers to determine how much cash needs to be generated to meet valuation targets. A company that wants to be worth $1 billion will have mathematical cumulative cash generation requirements, taking into account losses based on a determined interest rate, cost of equity, and cost of debt. 

For high-growth companies, one can ignore many variables that a traditional DCF model requires, such as the tax rate. A variable like the tax rate is important when an investor considers deploying large sums of money for low percentage returns, such as investing $100 billion cash into a treasury bond. But the tax rate is meaningless when considering investing $10 million into a company worth $0, $10 million, $100 million, or $1 billion in the future. 

In other cases, companies might:

Based on all this, the appropriate DCF equation for a high-growth, early stage company is:

The variables considered by investors and decision-makers for companies of this profile are beta, the market’s return, and the asset’s cash flow. We will now investigate beta and rm in more detail. 

This more thorough view of the DCF equation allows us to analyze the relationships between its variables more rigorously. Investors in high-growth companies know they take on a lot of risk with their investments. Investors in high-growth companies expect to be compensated through this risk-taking by getting an outsized return. For the DCF model, this return can only come in cash flow that warrants a greater valuation than what the investor is paying for the asset. Based on these assumptions, many parts of the DCF equation become irrelevant because they do not impact the final valuation number the investor seeks to compensate for this risk.

Selecting Beta and rm for High-Growth Companies

There is no perfect answer to determining the right beta for a small, high-growth company. Beta is a statistical measurement derived from the volatility of the S&P Index. The S&P has a beta of 1. If a stock also has a beta of 1, then the stock will move the same amount as the S&P 500 Index. If the S&P goes up by 1%, a stock with a beta of 1 will also go up by 1%. If the S&P goes up by 200%, the stock with a beta of 1 will also go up by 200%. 

Beta plays a role in assessing a stock’s risk and how it moves in the overall market. Beta creates the slope, and it grows (or destroys) the underlying asset’s value based on performance. A beta of 15 is extremely high and would suggest the stock is volatile and risky since it moves 15 times more than the overall market. 

As beta grows, so does the volatility of the stock in relation to the S&P. If a stock has a beta of 7, then it will go up or down seven times as much as the S&P. Suppose the S&P goes up by 10%, the stock with a beta of 7 will go up by 70%. And if the S&P goes up by 15%, the stock with a beta of 7 will go up by 105%. Small changes in the beta lead to large changes, positive or negative, in the underlying stock price as it moves. A larger beta leads to a lower valuation. If an investment is extremely risky, an investor is likely to pay less for it because there is a greater probability that their investment will decline in value.

A perceived beta of 2 is different from 5 and is different from 100. Various qualitative factors, including pending litigation against a company, management changes, negative publicity, and industry sentiment can influence beta. These events introduce uncertainty and risk, which cause a stock’s beta to deviate from 1. Generally, a beta of 5 for NYSE listed equities is considered very high. 

The market return (rm) is easier to estimate and requires less data for statistical analysis. The rm can be calculated by multiplying possible investment outcomes by their probabilities and summing the results to reach a weighted expected return of the market. Venture capital (VC) funds have historical data on the return of different investments, which helps them estimate the expected return on their portfolio of investments. 

Nevertheless, historical performance does not guarantee future results, as investment outcomes vary significantly. Ideally, it will provide a conservative estimate of rm when compared with the asset managers’ future performance. 

Assume an investment in a Series A company has a 25% chance to either go to 0, increase by 50%, double, or quadruple equally. Note that we will not assume negative returns in this scenario since negative returns are most relevant for derivative trading. 25%*0+25%*50%+25%*1+25%*4 = 1.375%, so the rm of this scenario is 1.375%. 

These numbers can be altered to create a different rm based on the investor’s model. One important thing to note is that the rm will remain relatively static. It would be uncommon for any investment opportunity to have an rm of 4, 10, or 100; this suggests the returns are too good to be true. Some high-frequency trading algorithms can reach results of this magnitude, but they are not consistent. 

The selections for beta and rm simply reduce the expected value of the cash flow in a period. Both these variables appear in the denominator of the traditional DCF and the modified one in this report. As the denominator of a fraction grows larger, the ultimate value of that fraction becomes smaller, leading to a decline in the expected value of the asset. 

A larger beta leading to a lower valuation is intuitive. When an investment carries high risk, investors tend to offer a lower price due to the likelihood of potential losses. However, a greater rm also contributes to a lower asset value. How can this happen? Remember, the cost of equity in this equation refers to the return investors require for the risk they are assuming. So, while a higher rm seems like it should increase the asset’s value, this rm is used to calculate the required return of equity to the investor, consequently increasing the company’s cost of equity. This subtle psychological indication of this simple equation holds powerful implications for the issuer raising money. Founders and CEOs often assume that belonging to a high-growth industry increases their value. However, this equation clarifies that the asset’s value only increases based on its ability to generate future cash flow. Mathematically, according to the DCF, the higher the expected market return of the investor, the lower the asset’s valuation—a point of utmost importance.

Since different returns and their likelihoods derive rm, the positive and negative scenarios should be considered together. And counter-intuitively to many business owners, when a market is driving a return of 4, 10, or 40 times, it only puts the pressure on the company to provide higher returns, therefore reducing the valuation in the mind of the investor. 

Key Takeaways for Business Owners

Most of this is very theoretical. The equations used by cash flow and public equity investors were not developed for early stage, high-growth companies. However, there are vital lessons for business owners to grasp regarding investors’ thought processes. Private equity investors have expertise from public markets and were trained on financial fundamentals that include these equations. These equations provide a framework for an alternative investment to any subject seeking one. Investors possess the gift to choose where to allocate their capital. When an investment opportunity presents itself in a promising space, but its offering details are so outside the range of what is reasonable regarding these basic equations, investors will find it very difficult to commit to such an investment. This is particularly the case when these investors manage funds on behalf of their limited partners and are bound by a fiduciary duty to those whose capital they manage. 

Qualitatively, business owners need to consider how they compete with investment assets for investor funds and how the beta or expected market return (rm) of those other assets aligns with opportunities presented in a specific investment offering. 

Quantitatively, there are outbound limits for beta and expected market return (rm) that business owners can consider when determining what set of scenarios makes their investment offering enter the realm of mathematical reasonableness. 

For example, a beta cannot be 100. Generally, public-traded equities can have betas of up to 20. A small, high-growth business that doesn’t trade frequently, will decrease beta since the stock is less volatile. The rm of an offering shouldn’t be greater than 1 because it will lead investors to demand a greater return and therefore increase the cost of equity and lower the valuation of the business. Mathematically, an rm of less than 1 will reduce beta and its subsequent exponential change in the denominator of the DCF equation. 

The most important takeaway from this entire exercise for business owners is that companies must have sound valuations based on their planned profitability. This is now exemplified in the global high interest rate environment and companies like Uber are becoming profitable. Eventually, in a company’s life cycle, all investors will evaluate offerings based on these free cash flow models. Therefore, even if the equation may not be entirely applicable to a Series A company, it will apply to that company as it grows. Cash is king (or queen)—always.


Transaction Structure and Its Impact on Seller Liquidity in M&A

Transaction Structure and Its Impact on Seller Liquidity in M&A

Transaction Structure Impacts M&A Valuations 

Mergers and acquisitions (M&A) occur when one company purchases or combines with another, usually resulting in a change of ownership and control. M&A goals include creating shareholder value by growing profit, gaining market share, expanding into new markets or product lines, and accessing technologies.

A transaction’s structure refers to the combination of assets used to compensate the seller for the fair market value of the business being sold. In a complete sale, the seller is often compensated through a combination of cash, equity instruments, debt instruments, intangible assets, and tangible assets.

Liquidity refers to the ease and speed with which an asset or investment can be converted into cash. 

It measures how quickly an individual or organization can access their funds by selling an asset.

Types of Transaction Structures

Transaction structures are categorized into three types: unstructured, typically structured, and highly structured. These classifications shape the composition of the payout a seller receives based on the mix of assets involved.

An unstructured transaction is where the buyer acquires the target company by offering an all-cash payment in exchange for ownership. In an all-cash transaction, investors and sellers employ different methods to assess a company’s valuation and negotiate a price.

Financial performance, historical cash flows, tangible and intangible assets, and market multiples are common factors in this process. Public companies also have their share price, but negotiating this price is possible, especially in deals that involve significant stakes. In this structure, the buyer is assuming they can generate a return on investment. This return will likely come from revenue synergies, growth, or cost synergies to increase profitability.

In a typically structured M&A transaction, assets are diversified among cash, equity, debt, tangible, and intangible assets. The valuation is a blend of these components allowing both the buyer and seller to negotiate the final price based on the expected return of non-cash transaction components.

For example, a business with a total value of $100 million would be considered typically structured if the sellers received $60 million in cash at close, $20 million of equity in the acquiring entity, $10 million worth of a promissory note paid to the sellers (note holders) over two years, $7 million worth of employment agreements and bonus potential, and the $3 million company yacht at the time of sale.

This approach allows buyers to reduce risk and optimize capital allocation, as well as incentivizes the sellers to support the company’s long-term growth.

A transaction is highly structured when the majority of the fair market value is placed in non-cash assets such as intangibles, equity, and debt. The valuation is more complex, and valuation methods involve assessing the future cash flows of intangible assets, such as intellectual property (IP), contracts and agreements, research and development (R&D), licenses and permits, and customer relationships. For example, a large tech company would acquire a startup with cutting-edge software and IP to enhance the buyer’s product offering, just like a large consumer goods company would acquire a niche brand to increase sales of the niche brand across the large brand’s sales channels.

In a highly structured transaction, the buyer assumes they will achieve a desired return on investment (ROI) within a specified timeline primarily from the acquired intangible assets based on factors like the ability to license the intellectual property (IP) and the market demand on the products associated with the intangible assets.

Equity, Debt, and Intangibles Drive Transaction Structures

Equity-Driven Structures

An equity-driven structure emphasizes the exchange of ownership stakes in the acquiring and target company. Equity instruments are financial securities that represent ownership in a company and give the equity holder a claim to the company’s assets and earnings. Equity instruments include:

  1. Options: Financial derivatives that give the holder the right but not the obligation to buy or sell a specific amount of a company’s stock at a predetermined price within a specified timeline.
  2. Preferred or common equity: Carries preferences or rights over common stock, which include priority in receiving dividends, liquidation preferences, and other rights that may be outlined in the company’s bylaws.
  3. Equity: Public companies’ equity is traded on stock exchanges and subject to market fluctuations, while private companies’ equity is not publicly traded and involves negotiated agreements among investors.
  4. Restricted or controlled stock: Shares that are subject to certain restrictions or conditions on their transferability or sale.

Equity-driven M&A structures attract strategic investors who are typically corporations or businesses looking to expand their market presence, product portfolio, or geographical reach. Strategic investors acquire companies that align with long-term strategic goals.

Consider an example of a large professional services firm acquiring a mid-sized professional services firm. The larger firm would offer profit-sharing units or equity to the mid-sized firm. The mid-sized firm would consider this deal because it creates access to more potential clients and can smooth out the volatility of dividend payments for more niche service lines. 

Intangible Asset-Driven Structures

Intangible asset–driven structures usually create the lowest near-term fair market value but the greatest long-term upside. Intangible assets also possess a slightly riskier profile. Several types of intangible assets and payouts exist, each with distinct characteristics.

  1. Bonus payouts: Additional financial rewards given to key employees or executives as a form of extra compensation, which is based on their performance, achievements, or contributions.
  2. Employment agreements: Legal contracts that outline the terms and conditions of employment for the target company’s key employees after the acquisition.
  3. Earnouts: Arrangements where a portion of the purchase price is contingent upon the future performance of the acquired company and is paid to the seller based on achieving specific financial or operational milestones after the completion of the acquisition.
  4. Reselling agreement: Allows the acquiring company to continue selling the target company’s products or services.
  5. Revenue sharing agreement: Outlines how the revenues generated from products or services will be shared between the acquiring and target companies.
  6. Royalty agreement: Payment of royalties to the target company for the use of its intellectual property.

Large corporations seeking strategic acquisitions focus on intangible assets that complement their existing businesses. A tech giant aiming to strengthen its position in the smartphone industry would acquire a startup known for its innovative smartphone display technology and a portfolio of patents related to this technology. Out of an intangible asset–driven structure, the tech giant would gain a competitive advantage in the smartphone industry and increase returns through sales related to reselling, revenue share, and royalty agreements.

Debt-Driven Structures

In a debt-driven M&A structure, the seller becomes the financier or lender to the company and the buyer. This differs from a leveraged buyout when the note holder is a private lender, not the original seller. In this scenario, the seller transfers control of the business and receives a note entitling that seller to a debt repayment secured by the business just sold, the assets of the buyer, or a combination of the two. A majority debt structure is only common for distressed or semi-distressed assets. Debt instruments include: 

  1. Senior secured debt: Takes precedence in repayment over other debt instruments, often backed by collateral like real estate, and it usually offers lower interest rates due to its lower risk for lenders.
  2. Debentures: Unsecured debts backed by the buyer’s general creditworthiness rather than specific collateral.
  3. Convertible note: Allows the seller to convert the debt into equity (typically common stock) of the acquiring company at a later stage.
  4. Promissory note: A written promise to pay a specific sum of money by a certain date. It outlines the terms of repayment, the principal amount, and the interest rate.

Debt-driven transaction structures are less common in private equity markets. Debt is often a component of the structure but rarely the majority of the fair market value. This is because sellers and buyers generally have access to the same set of debt when they own the same or largely comparable assets.

Transaction Structure Components Effect on Seller Liquidity 

M&A sellers want to know the likelihood they will receive a non-cash asset’s perceived fair market value. For this reason, each part of a transaction structure should be analyzed based on the likelihood that the asset can be liquidated for cash near or equal to the fair market value determined at the time of a transaction. Extremes of non-cash liquidity examples include common stock in Alphabet, the parent company of Google, and shares in a private equity business with $1 million in revenue. Google shares can be sold on a public exchange with relative ease and may only be limited by the SEC Rule 144 volume and timing restrictions. Whereas shares of a $1 million private equity company will likely not be liquid until the company grows significantly. A red-green-yellow ranking of general transaction structure elements and the likelihood that these can be converted to their associated cash value is presented below. Green suggests the highest likelihood, such as in the Alphabet example, and red indicates a lower likelihood, such as with the small privately owned company. 

Business owners need to understand that transaction structures have a significant impact on the fair market value of an asset and the ultimate return a seller can receive from the sale of their business. This can be in either the buyer’s or the seller’s favor. Both parties need to consider what ultimate payout they seek and their risk appetite to achieve it. Cash, equity, debt, and intangible assets can all be structured together to create a wide variety of possible outcomes and payouts for sellers. These require careful consideration by the seller.
One of the best examples of how an M&A transaction can be structured and still benefit the buyer and seller more than an all-cash transaction is when Alphabet bought Double Click. At the time of the transaction, digital advertising was still the minority of spending for most brands. But as this budget item grew, Google was able to accelerate its market share more quickly. The transaction structure of the Double Click acquisition is not public, but a more structured transaction would certainly have benefited both parties.


Part 3: Monetizing Intangibles in Ad Tech M&A Value

Part 3

Monetizing Intangibles in Ad Tech M&A Value

In this article, we will briefly explain how to monetize intangibles.

In the first two articles of this series, Identifying Intangibles in Ad Tech M&A Value and Developing Intangibles in Ad Tech M&A Value, we specified how you, the business owner, can identify and develop your company’s most valuable intangible assets to maximize your value.

In any M&A deal, sellers highlight the importance of their intangibles so the buyer can use them to create a competitive advantage. The third step in this process, learning how to monetize your business’ intangible assets, is where you reap the fruits of your labor. This step occurs when the buyer pays a price for the intangibles you have identified and developed. This includes the steps leading up to the sale, such as valuation, negotiation, pitching, and due diligence. So how do you monetize intangibles?

How to Monetize Intangibles When Selling Your Company

An M&A valuation can be conducted in several ways, including through a business appraisal or the valuation of a public company’s stock. The valuation of your company often amounts to a number that is negotiated between the seller and the buyer. Middle-market companies in particular possess a range of values based on the buyer’s profile. Fair market valuation is the most common valuation technique.

Fair market valuation occurs when you determine how similar businesses have sold based on multiple types and multiple factors. Multiple types include earnings before interest, taxes, depreciation, and amortization (EBITDA), annual recurring revenue (ARR), and, in some cases, book or tangible asset value. Multiple factors (referred to as 3X, 4X, or 10X) simply identify the number you agree to multiply the selected factor by to determine the valuation number.

Obviously, multiple types and factors depend on industries with similar characteristics to the company being valued. For example, industry growth, the strength of the management team, competitive advantages, access to suppliers, and access to buyers can all influence multiple types and factors.

How to Use ASC 805 to Maximize Your Valuation

The Accounting Standards Codification (ASC) 805 allows the business owner to understand how the expected purchase price can be broken down based on the transaction’s fair market valuation and associated purchase premium or goodwill. In the ad tech industry, the amount paid for goodwill makes up, on average, 70% of the purchase price. This means, for example, that a company with a fair market valuation of $100 and 70% goodwill was purchased for $170.

At J&A, our banking practice conducts detailed M&A studies of goodwill and purchase price allocation to understand why companies command a premium and how business owners can make sure they land at the top of valuations when selling their businesses. After looking at over 500 M&A transactions executed by technology giants over a six-year period, we segmented purchases by industry and certain goodwill parameters, narrowing our study to 34 purchased companies. These 34 ad tech M&A transactions completed at the greatest premiums had the following two things in common: the target company increased the data interfaces of the acquiring company and the target company increased the data processing power of the acquiring company.

Data interfaces and data processing power are both intangible assets. These intangibles were systematically identified and developed by the business owners over time before they sold their companies. The monetization of those assets became effective when the companies were purchased at higher than average premiums.

This analysis becomes the cornerstone of an effective M&A strategy. Armed with the framework of identifying, developing, and monetizing intangible assets, business owners have a predefined plan they can take to increase their company’s value.

As a business owner, you should always study different purchase premiums in your industry to identify drivers that will create the highest return for your business. Using ASC 805 principles to uncover M&A value allows you to create a roadmap that will help you land on the high end of valuation because it is a scientific way to tie your valuation to intangible assets.

The Takeaways of Intangible Asset Monetization

Intangible assets can only be monetized if you have measured them in-depth. There is an infinite number of intangible assets you can identify, develop, and monetize.

As a business owner, you must determine which ones you can leverage most effectively. Trusted advisors can help you create a clear vision and strategy to maximize your company’s value. The role of intangible assets in M&A markets will increase over time. The most successful companies will use the information presented in these articles to maximize the value of their company.

Part I: Identifying Intangibles in Ad Tech M&A Value >
Part 2: Developing Intangibles in Ad Tech M&A Value >

Photo by Vincent Tantardini on Unsplash


Part 2: Developing Intangibles in Ad Tech M&A Value

Part 2

Developing Intangibles in Ad Tech M&A Value

In this article, we will briefly explain how to develop intangibles.

In our earlier article Identifying Intangibles in AdTech M&A Value, we explored how you, as a business owner, can identify the intangible assets that make your company more valuable during the M&A process. After identification is complete, the next step is to develop those same intangible assets. Developing intangible assets relies on key performance indicators (KPIs) in the same way identifying intangibles does. KPIs are the metrics you choose to represent the performance of an intangible asset.

Developing an intangible asset is the set of actions you will take to optimize a KPI. For example, we previously explored how more data interfaces can lead to optimized conversion. Therefore, the intangible asset is the data interface and conversion is the KPI. Optimizing conversion means increasing or decreasing it based on drivers like technology, advertising spends, or advertising quality.

To measure conversion, you must define the desired final action you wish your customer or visitor to take. This could include clicking an ad, buying a product, or providing an email address. The development of the intangible asset (e.g., data interfaces) becomes any action, investment, or improvement you perform to accomplish the final objective (e.g., click, buy, provide email). These developments increase M&A value. In our next article, Monetizing Intangibles in Ad Tech M&A Value, we will show you how to monetize them.

There are multiple ways to develop an intangible asset. Building a company for sale requires considering accounting and banking principles as well as intuitive, strategic ones. Imagine a company that performs direct digital marketing. If this firm wants to increase the number of people who click ads served to drive more website traffic, they have several options to encourage their users to do so:

  • Create more compelling marketing content and design
  • Acquire new contact information of people who are more likely to click the links in the body of the message
  • Retarget consumers by making sure prospects are seeing ads in multiple locations and in multiple instances
  • Invest in new technology that places more relevant ads in front of potential “clickers”
  • A combination of some or all of the above

The best choice for the company is likely a mixture of the five options laid out above. The company must understand that each choice represents a distinct set of intangible assets, all of which are inherently identified and developed when the decision is made. The investments made in one, some, or all of these options are a part of “developing” the intangible asset. The intangibles must be measured and monitored so they can increase corporate value at the time of M&A.

As a business owner, how you choose to develop an intangible asset affects the accounting options available to your management team. Capitalization is a common technique for recording expenses as assets to minimize long-term costs. Specific rules exist about how and when to capitalize expenses that overlap with the development of the intangible assets recommended here. For example, you can capitalize costs to develop patents, copyrights, trademarks, and even proprietary software intangibles, but those costs must be recorded correctly. You cannot simply download a credit card statement 11 months after the expenses were incurred and then claim them as assets.

The principles of identifying and developing intangibles are relevant to business owners because they tie together strategies for growth, development, accounting, and exits. When used correctly, they break down silos between business units and bring together the operation and value of a business. Most venture-capital investors wait for companies to be purchased so the investor can then achieve liquidity. All owners desire M&A options for their hard work. Developing intangibles is the only way to combine the traditional business operations of growing, scaling, and building a company with the gritty accounting principles that affect the valuation and closing of an M&A deal.

Companies are rarely acquired with the intention to conduct business the same way it was conducted before the purchase. Therefore, it is important for you, the seller, to highlight the most valuable intangible assets of your business through their development and investment. This allows the buyer to utilize these intangibles to their own advantage. Ad tech companies are driven by these intangible assets, such as data interfaces, and new technology development that engages specific customers. Measuring these intangibles through the life cycle of the company will affect your exit valuation, creating a more accurate picture of what a buyer is ultimately paying for.

Part 1: Identifying Intangibles in Ad Tech M&A Value >
Part 3: Monetizing Intangibles in Ad Tech M&A Value >

Photo by Alice Achterhof on Unsplash


Part 1: Identifying Intangibles in Ad Tech M&A Value

Part 1

Identifying Intangibles in Ad Tech M&A Value

Identifying Intangibles is the first article in our series about intangible assets.

Part 2: Developing Intangibles in Ad Tech M&A Value >
Part 3: Monetizing Intangibles in Ad Tech M&A Value >

What makes your company special, unique, or valuable? As a business owner, you will be asked this question countless times when you are talking to potential buyers for your ad tech company. But the value of a company is not inherently defined; value is defined differently by parties based on their respective goals, biases, and objectives. For a banker, this discussion is the foundation for all buy-side and sell-side M&A conversations. Based on our experiences and research at Jahani and Associates (J&A), intangible assets make up over 90% of M&A value. There are simple, repeatable processes you can use to increase your company’s value, especially in the ad tech industry (J&A, “Understanding Ad Tech M&A Value”). So how to identify intangibles for M&A?

How Accounting Standards Codification (ASC) 805 Can Be Used to Maximize M&A Value

In 2014, the Financial Accounting Standards Board released an update to ASC 805 addressing how to account for intangible assets in business combinations. ASC 805 is the basis for the financial reporting of intangible assets post-acquisition. Although it is not necessary for you to follow the ASC 805 framework, if you do not utilize it to uncover and measure your company’s intangible assets, you will ultimately limit that value. Businesses can use FASB’s ASC 805 as a framework for maximizing their value prior to beginning M&A conversations.

Step 1: Define the Most Valuable Intangible Assets for Your Ad Tech Business

The first step to maximizing your company’s value is to determine which intangible assets are the most valuable. In order to do so, you must define your desired business objectives. If you are not sure where to start, begin by asking yourself the following questions:

  • Who are my customers?
  • How is the strength of my customer relationship measured?
  • What will my revenue stream rely on over the next one to five years?

Your business’ relationship with its customers is a symbiotic one: your company exists to serve your customers and your customers are the ones who keep your company in business. Utilizing valuable intangible assets will only enhance the business-customer relationship.

For example, if your desired business objective is to increase the number of users who click the ads placed on your platform (in other words, increase conversion), you need to provide more relevant ads to the user. Tracking cookies from a user’s browser history to service these ads is a common practice to accomplish this relevant placement. This is also known as retargeting. At its core, retargeting is accomplished by increasing the number of data interfaces an ad publisher uses to determine which ads are shown to a user.

Therefore, driven by the objective to increase conversion, data interfaces are intangible assets. Collecting this browser history allows ad publishers to uncover novel patterns, enhance ad relevance, and create new solutions that increase conversion. According to an analysis conducted by Gallup, “companies that apply the principles of behavioral economics outperform their peers by 85% in sales growth and more than 25% in gross margin.”

Data interfaces are just one example. As an owner, you must determine the most valuable intangible assets for your business objectives.

Step 2: Determine How the Most Valuable Intangible Assets Affect Your Revenue Streams

Once you have defined your company’s most valuable intangible assets, you must document the way those intangibles affect your company’s revenue streams. How many events must take place for your intangible asset to create revenue? At J&A, we refer to these as “steps removed” in a process flow. For example, when a user clicks on an ad, the platform owner generates revenue. Therefore, if the intangible asset is a data interface and the presence of more data interfaces increases conversion and revenue, then that asset is one step removed from revenue. Social connections are a more complex example. The presence of social connections on a platform encourages a user to spend more time on the platform, and the more time a user spends on a platform, the more ads the user will click over time. This is two steps removed. The number of steps removed in a process flow completely depends on the business model and business objectives employed. Conversion is important for multiple types of businesses, but the steps between conversion and data interfaces can be drastically different for an infrastructure company and a platform company.

We chose to use revenue in this example because our objective was conversion. Other objectives can include reducing costs, managing risk, or increasing cash flow.

Once you have determined which intangible assets are the most valuable, it is important to measure the outcomes for the selected business purpose over time. Generally, intangible asset data and key performance indicators (KPIs) should be measured for at least one year. Business owners need to determine the right KPIs and track them regularly. The KPIs most related to encouraging conversion are traffic, traffic sources, the technology used to serve ads, and the data that determines when an ad is served.

Knowing how and what to measure is essential to increasing your company’s value. Certain interfaces are more valuable than others. A valuable interface must enhance a desired business objective. Therefore, if your goal is to increase conversion and a certain interface supports that, it is an intangible asset. A popular example of this in the M&A world is Facebook’s purchase of Instagram. Facebook approached Instagram for purchase because Facebook’s application program interfaces (APIs) were increasingly being pinged by Instagram users. Before the acquisition, a Facebook API made Instagram more valuable because it allowed Instagram to use Facebook’s large pool of customer data to enhance its own platform. J&A’s research has also shown that more data interfaces lead to higher purchase price premiums (J&A, “Understanding Ad Tech M&A Value”). Before the acquisition, this integration did not necessarily increase the value of Facebook.

Conclusion About Identifying Intangibles

Measuring important aspects of your business and tying them together with corporate financial statements is powerful. Data analyses conducted for thousands of M&A transactions confirm that they can be used to maximize the transactional value for both sides of an M&A before the sale is closed (J&A, “Understanding Ad Tech M&A Value”).

As a business owner, you can utilize the information herein to maximize your company’s value. When developed correctly, this material can significantly impact the value of your organization. Along with specialized bankers, you are uniquely positioned to develop the relationship between intangible assets and corporate financial metrics. Defining the assets that are valuable and then measuring those assets over time is the simplest yet most effective process you can use to increase the overall value of your company.

Part 2: Developing Intangibles in Ad Tech M&A Value >
Part 3: Monetizing Intangibles in Ad Tech M&A Value >


Photo by Neven Krcmarek on Unsplash


Cornell Systems Seminar: Using Systems Engineering to Maximize Corporate Value by Measuring and Developing Intangible Assets

Cornell Systems Seminar

Using Systems Engineering to Maximize Corporate Value by Measuring and Developing Intangible Assets

The rise of intangible assets is well underway. Since 1995 and the dot-com boom, the value of companies has shifted from their financial statements and into their intangible assets. The narrow definition of intangible assets by regulators and investors causes innovative companies to be consistently undervalued. This undervaluation exacerbates the difficulty innovators have when aligning their competitive advantages, such as operational efficiencies, competitive business combinations, and cutting-edge technology with the business needs of a market. Systems engineering represents a powerful framework for solving this problem.

Joshua Jahani is a Cornell alum, NYU lecturer, and owner of Jahani and Associates, an investment banking firm focused on identifying and developing a company’s intangible assets to maximize its value. The firm’s Intangible Asset Methodology™ (IAM) is built on systems engineering principles to identify, develop, and monetize intangible assets across a variety of verticals. Utilizing proven qualitative and analytical skills driven by business objectives and up-to-date technology, he has spearheaded the movement towards rapid evolution and sustainable growth using rigorous profitability, ROI, and TCO analysis for organizations of all sizes. Working with exciting startups in digital advertising or large Fortune 500 companies keeps him traveling all over the world.

Joshua Jahani earned his M.Eng. in Systems Engineering from Cornell University in 2012 and teaches courses on strategy, finance, and entrepreneurship at NYU. His current research interests are intangible assets, goodwill calculation and sustainability, the customer franchise value in subscription businesses, and value-based healthcare systems and technology. He has a passion for uncovering how to create corporate value that is not shown on financial statements.


Enhance Your Company’s Strategic Assets to Increase Value

Enhance Your Company’s Strategic Assets to Increase Value

What are a Company’s Strategic Assets?

A company’s strategic assets sit at the intersection of tangible and intangible assets and create recurring benefits, are unique, and difficult to imitate. Such strategic assets can include intellectual property, customer relationships, proprietary business processes and algorithms, novel revenue streams, and brand value.

Why focus on strategic assets?

The definition of strategic assets is related to the accounting term goodwill, which is an intangible asset that results from the acquisition of a company at a premium value. The premium is the amount an acquiring company pays for a target company in excess of the target company’s book value. Strategic assets have historically been difficult to quantify, but are known to make a company more valuable.

Corporate buyers have been placing increased emphasis and value on strategic assets compared to tangible assets like property, equipment, and manufacturing facilities. Corporate resources applied to build a robust set of a company’s strategic assets are increasingly providing a higher return on investment than those focused strictly on earnings growth.

High-profile transactions such as Facebook’s acquisition of WhatsApp, AT&T’s purchase of DirecTV, and Campari’s acquisition of Wild Turkey all demonstrated the high percentage of purchase price allotted to goodwill due to the seller’s strong set of strategic assets.

According to research by Carol Corrado, “companies put far more money into non-physical assets, such as customer databases, than in building new factories. In 2014, companies invested the equivalent of 14% of the private sector’s gross domestic product in intangible/strategic assets. The investment in physical assets was about 10% of that sum, which is essentially the reverse of 40 years ago when 13% of the private sector GDP went to tangible/physical assets and only 9% to intangible/strategic assets.”

There is currently more than $2.5 trillion in goodwill on corporations’ balance sheets (source: Time magazine). Why? As corporate awareness of intangible asset value is increasing, fewer companies are pursuing acquisitions to add production facilities and other tangible assets. For example, when Microsoft bought LinkedIn, it was almost exclusively for their intangible and strategic assets, such as their brand, website platform, user/customer data, and perhaps the management team and their connections (e.g., Reid Hoffman!).

How to determine which company’s strategic assets to pursue?

Over the past few months, Gates and Company, in conjunction with Jahani and Associates, have been working to determine the strategic assets that help companies achieve premium valuations that can be identified and developed. Knowing that the concept of strategic assets would not benefit every business, and would certainly vary sector by sector, the team began by reviewing M&A deals in the tech sector. Over 500 transactions that closed between 2010 and 2016 were analyzed to determine strategic asset characteristics and goodwill drivers.

Some of the tech M&A deals reviewed for this initiative included:

  • Google acquired Waze for $969 million and allocated $843 million to goodwill
  • Yahoo! paid $990 million for Tumblr, with $750 million going toward goodwill, including $182 million for customer contracts and relationships
  • Facebook’s $17.2 billion acquisition of WhatApp had an astonishing $15.3 billion recorded as goodwill
  • Microsoft acquired LinkedIn for $27 billion and allocated $16.7 billion of its purchase price to goodwill; and when it acquired Skype for $8.6 billion, $7.1 billion went to goodwill

In each of these examples, the target company’s strategic assets (IP, customer relationships, brand, etc.) were valued significantly higher than their tangible/physical assets (plants, property, equipment, etc.). Results from the tech sector analysis indicated that companies with recognizable strengths in social media, web advertising, and data analytics consistently received valuations above market. Additionally, an active user/subscriber base was a driver in over 60% of the acquisitions.

Corporate leaders, business owners, and investors face a critical issue: in order to maximize value, they must enhance the set of strategic assets in their company and/or portfolio of businesses. A thorough analysis of transactional data to identify strategic asset characteristics and goodwill drivers must be considered in conjunction with corporate core competencies, market dynamics, and economic trends to build out the most relevant value-enhancing strategic assets.

About Gates and Company

With offices near Philadelphia and Munich, Germany, Gates and Company is an investment banking and management consulting firm dedicated to helping companies grow. With an impressive track record of helping numerous companies reach their goals, Gates and Company specialize in M&A, market research/analysis, growth strategy formulation, business plan development, product/venture launch, and financial advisory services.

Gates and Company’s management consulting team has invested significant time and resources to refine and validate its methodology of determining strategic asset characteristics and goodwill drivers in the tech sector. Current efforts are underway in the health IT sector. By reviewing market dynamics and hundreds of M&A deals on a sector-by-sector basis, Gates and Company offer these insights to their clients so they can better understand how to identify and develop an optimized set of strategic assets. Gates and Company’s investment banking team helps companies seeking liquidity with comprehensive M&A services to sell businesses or business units, including identifying and assessing those potential buyers most likely to be attracted to a company’s current and developing set of strategic assets.

For more information about Gates and Company, visit gatesandcompany.com.

Company’s Strategic Assets to Increase Value Articles


Identify, Develop, and Monetize Your Intangible Assets

Identify, Develop, and Monetize Your Intangible Assets

Jahani and Associates utilize a proprietary Intangible Asset Methodology™ (IAM) to help our clients identify, develop, and monetize their most valuable intangible assets. We recently led a Cornell Seminar on the same topic.

Intangible assets take work and time to develop into the premium commanding, goodwill-driving assets that maximize value in capital raises, M&As, and other scenarios. Think about a platform that boasts an above-average amount of time users spend on the technology per day. Such an intangible asset will command a premium, but only if it is identified and measured. Being able to measure this intangible asset (users spending more time on your platform than others) is work in and of itself. Some technological sophistication is required.

Developing the intangible asset takes the longest time out of the three steps:

Sticking with the same example of time spent on a platform per day, the theoretical firm in question must determine why users are spending more time on their platform, and then they must find ways to increase the user’s positive experience inside this intangible asset. Does the user want more videos? More pictures? Will the user share more on your platform when the colors are brighter? All these questions require testing. They require a rigorous process of engineering and business acumen.

Developing intangibles inside the IAM™ is done with consideration of those that generate the highest premium. This is always determined as part of the preceding identify phase. These two phases build on each other to empower the third and final phase: monetize.

Monetizing intangibles is done through investment banking scenarios. This can be done when bringing a company to market for an M&A, when performing investor relations for publicly traded companies, when raising capital from VCs, or a variety of other scenarios. This is when J&A takes its powerful, data-driven story to command a premium in the marketplace.


Startup Valuations and Intangibles: Take Back the Power

Startup Valuations and Intangibles: Take Back the Power

Startups are at the mercy of investors when it comes to seeking large amounts of capital for scaling their business. The solution? Startups must identify how their intangible assets will be monetized in a respective market through intelligent investment banking analysis and services.

Owners are in a better position to value their intangible assets and competitive advantages than any investor. This is because the real value of a startup isn’t found in the financial statements, financial terms, or traditional financial metrics that are used by investors on a regular basis. Startup assets are fundamentally intangible. These intangible assets are always unique to an industry and in many cases unique to a company.

Examples of these intangible assets are daily active users (DAUs), customer data to improve pricing, sales funnel optimization, and costs of customer acquisition.

Startups must work to identify, develop, and monetize their intangible assets by generating a narrative for predictable and repeatable processes. Additionally, they need a pro forma that allows the startup to monitor and improve corporate performance based on intangible metrics.

When these two goals are met, the power is in the owner’s hands. Now there is a clear way to define value, show how the market responds to it, and then maximize it to increase the value of the company.

Contact Jahani and Associates today. Take back the power and no longer be at the mercy of investors when seeking funds.

Read our next article: Identify, Develop, and Implement Intangible Assets to Maximize Your Value


M&A Insights: Use the Power of Intangibles to Maximize Your Value

M&A Insights: Use the Power of Intangibles to Maximize Your Company Value

M&A Insights: Two kinds of intangible assets

In the world of investment banking, there are two kinds of intangible assets. The first is known as “identifiable” intangibles. These are things like patents, trademarks, copyrights, and customer relationships. In short, these are intangibles that GAAP and FASB have determined are consistent enough to be subject to specific valuation rules. When valued these assets are referred to as “intangible assets.”

The second category of intangible assets is known as “unidentifiable” intangibles. These are essentially everything else. Examples include selection algorithms (Netflix, Amazon, and Hulu), operational synergies, talent, and other business combination advantages. When valued these assets generally fall under goodwill. Goodwill is defined as the amount over fair market value an acquirer pays for a target company.

These two kinds of intangibles play a significant role in the valuation of a company. In fact, Jahani and Associates analyzed over 500 M&A transactions among tech giants such as Apple, Alphabet, Facebook, and Microsoft to determine exactly how much value was placed in these categories. The results were astounding.

Intangible assets represented 22% of the money spent on acquisitions for these tech giants. Goodwill accounted for 77% of the money spent on acquisitions from 2010 – 2016. Together, identifiable and unidentifiable assets made up 99% of the purchase price for all acquisitions made by tech giants from 2010 – 2016.



M&A Insights: Maximizing a company’s value

These results are astounding, to say the least. They are astounding for two reasons: 1) They provide a clear and measurable path to maximizing a company’s value and the likelihood of being acquired by a tech giant and 2) they provide insight into why a tech giant will buy targets based on their business model.

M&A Insights: The way a company uses this information, and the unique value Jahani and Associates brings to our clients’ business, is based on three factors:

  1. The industry vertical of the target
  2. The specific business processes that are congruent with those of selected acquirers
  3. A proprietary and data-driven investment banking process

Owners of candidate businesses must consider these factors when building their business. The considerations play a significant role well outside of the traditional investment banking timeline. Meaning the business owner must identify, develop, and implement these intangible assets more than 12 months before they plan to sell their company.

Read our next article: Identify, Develop, and Implement Intangible Assets to Maximize Your Value


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