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.