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11 Nov Software & Technology: The Valuation of Intangible Assets

Today’s technology and software deals include a greater number of highly-valuable, yet intangible assets than ever before. The explosion of big data is certainly facilitating this rapid ascent. Fortunately, the Financial Accounting Standards Board (FASB) has issued vital information on the valuation and treatment of various intangible assets including patented technology, trade secrets, databases and software/code.

Patents are typically a bit more solid when it comes to valuation metrics. The income and royalty streams derived from most patents can be fairly easily quantified over the course of patent’s useful life. Unfortunately, other intangibles such as software, trade secrets or data are a bit more difficult to nail. Valuing these assets for M&A purposes can be even more difficult, particularly if  they represent a reason a buyer may want to buy a business for more than it’s worth.

The Useful Life Issue of Valuing Software Tech

Settling on a useful life for software and technology is perhaps the biggest issue and challenge for business valuation professionals. Newer, leapfrog technologies may arise that expand computing power, provide better communications capabilities and completely eliminate the need for a previous version. The rapidity and speed with which this occurs further compounds the difficulty of a valuation assessment.

As a result, there is typically a heavy discount placed on the expected life and longevity of any software technology, particularly if it provides a competitive advantage within its industry. If the technology in question is expected to maintain its relative leadership position in an industry through continued development, engineering, R&D and re-tooling, then the valuation of the tech or software is likely to be much higher as a result.

Valuation of Goodwill & R&D 

In the United States, the SEC requires all in-process research and development (IPR&D) to be evaluated for capitalization and/or expense purposes. The technology will also be assessed for potential write-off requirements. For example, if a software company acquisition included the purchase of significant IPR&D then it is likely the capitalized value of this asset will be required to be written-off immediately following the transaction–creating a negative impact on the company’s goodwill.

The reason: you cannot include the value of the next version of the software if the current version is fully completed. In other words, the technology behind the software will eventually change enough that it should be treated as a completely new business asset.

Due to tax incentives, most companies will work to maximize goodwill and minimize IPR&D. In the past, the incentives were actually inverted. For tax purposes, shareholders will always desire low valuations and short-lived assets. Uncle Sam wants the reverse.

When making the assessment of asset valuation for an M&A event, it is important to understand the following key points:

1. What is the tax incentive or liability of the decision to acquire?

2. How will the incentives treat my valuation of the technology?

3. What is the short and long term impact to goodwill? IPR&D? Software valuation?

What often appears simple, seldom is. Software is certainly no exception. As you attempt to navigate your next software deal, your deal team will most likely include the likes of specialized accountants, investment bankers and attorneys to ensure structure for both short and long term tax treatment creates a win for all parties involved.

  • Steve Szirmai

    Intangible assets are always the most difficult aspect of a valuation analysis, as they are often a key driver of Enterprise Value for a business, but as an intangible it is often difficult to assign cash flows to them. There are several methods of IP valuation beyond the 3 basic valuation methodologies (cash flow, market or book value, competitive valuation). The IP definitely has great value for most firms with IP, but a valuation expert will be needed to assess the value of the IP.

  • Peter Bell


    Often when companies are valued, a discounted cash flow model is first to be utilized. While for most companies this first step is in the right direction, technology and software companies may take a different approach because at early stages, without significant bottom line earnings and cash flow, the intangible assets might be the only significant value the company has. Even then, some of the intangibles are much easier to value, like you acknowledged with patents vs. goodwill or software/code. Its great that you point out the difficulty of valuing these assets yet note that we, and the Financial Accounting Standards Board (FASB), are in constant pursue of being able to quantify these intangibles as more companies in this day and age employ them and need intangibles to be accurately valued in their company valuation.

    Thank you for the useful information Nate.

  • Alex Sierra

    This topic reminds me of a company in the tech industry that I’ve recently been looking at. On paper, the company is an absolute mess with negative margins, negative cashflows, and ridiculously negative retained earnings. The only possible way to find any value in this company is to look at its In-Progress R&D. While a new, game-changing technology may be in the works, valuing this company becomes incredibly complicated when there is no evidence to demonstrate whether the market will accept or reject the new technology. It’s fortunate that the FASB has been seeking solutions, but valuing intangibles within technology and software companies will continue to be challenging due to the ever-changing nature of the industry.

  • Dominic Niolu

    When an asset is valued using cash flow analysis, one of the most vital pieces of information is the useful life of this asset. Looking back at the tech boom of the early 2000s, we can say with some certainty that the useful life of singular intangible technology/software based assets are quite limited. This makes it very difficult to value these assets and as you stated, this is why the value of such assets are heavily discounted.
    However, in a competitive market with many firms producing the same good (or in the case of tech/software, goods with the same purpose), it is important to remember that it is not profitable for anyone to constantly replace these goods with newer, better ones. It will only become profitable to introduce a new good once the previous good has produced cash flows to a point where it’s terminal value has been reached. Much like this example, if we consider these goods as intangible tech based assets, we can say that it will only be profitable to acquire or create these assets if current ones have produced enough cash flows to give them a positive NPV. Therefore intangible assets may need to be valued on a basis of previous acquisitions.

  • Joshua Sea

    Nate, you make a valid point regarding the useful life of an intangible asset. Software, especially, is and will continue to grow at an exponential rate. This will make the computation of useful life even more difficult. Other factors to consider are rapidly growing competition within the industry and the threat of new entrants gaining market share. This would potentially impact already established companies.

  • One brief observation relating to research and development. When
    it comes to the medical field and in particular pharmaceutical startups they
    have several major issues to contend with. Very often these startups are very
    small with a high degree of expertise in the development of new drugs.
    Additionally these startups are fighting the clock against the larger
    pharmaceutical companies that of course have major resources and could be
    working towards developing a similar new drug. From a forward-looking approach,
    these startups could be considering being acquired by a larger pharmaceutical
    company along with their expertise, if they reach the finish line 1st
    and develop a successful product then they could theoretically grow the company,
    alternatively, accept a cash buyout or exit value and move on to developing new

    • Nate Nead

      Thank you Peter. Yes, the parallels between software/tech and drug and biotech R&D are uncanny, particularly in the race for IP. Thanks for contributing.