Maximizing M&A Value with Intangible Assets
DEFINING AND COMMUNICATING M&A VALUE IS DIFFICULT AND COMPLEX
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:
- What makes my company valuable?
- How can I communicate that value to buyers better than my competition?
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.
INTANGIBLE ASSETS ARE THE GREATEST DRIVERS OF M&A VALUE
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
BUYERS SPEND NINE TIMES MORE MONEY ON INTANGIBLE ASSETS THAN TANGIBLE ASSETS
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.
IDENTIFY, DEVELOP, AND MONETIZE INTANGIBLE ASSETS TO MAXIMIZE M&A VALUE
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.
STEP 1: Identify what makes your company valuable
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.
STEP 2: Develop, prove, and maximize the identified value over time
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.
STEP 3: Monetize your assets by communicating your value better than your competition
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
M&A VALUE MAXIMIZES WHEN THE SELLER ACCURATELY MEASURES RELEVANT INTANGIBLE ASSETS
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.
ABOUT THE RESEARCH
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.
ABOUT JAHANI & ASSOCIATES
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.
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