Understanding intangible assets and how they generate value for investors and businesses

• An intangible asset is a type of asset that you can't physically touch or see but is still just as valuable.
• Examples of intangible assets are licenses, copyrights, a brand's name, and computer software.
• Intangible assets are more difficult to value than tangible assets, but are crucial to a company's success.

Assets are anything you own that have value, and can be tangible or intangible. An intangible asset is an asset that is not physical but still worth value that can be converted to cash. Intangible assets can be things like someone's intellectual property, a brand, copyright, or even a mailing list of clients.

The key aspect that makes intangible assets stand apart from other types of assets is that they are not physical in nature and don't have an obvious physical value attached to them. However, this doesn't make intangible assets any less valuable.

How intangible assets work

Intangible assets are most common among businesses and are classified by their growth and value over time. They're long-term assets that the company plans to use for more than one year.

An intangible asset can be classified specifically as definite or indefinite. An example of a definite intangible asset would be a patent or copyright with no current plans to extend the legal agreement. This intangible asset is considered 'definite' because there's a foreseeable end to the asset's value which in this case is when the legal agreement for the patent ends.

An indefinite intangible asset represents something like a company or brand's name. There are no limits based on age, contract, or regulatory obligations. Companies tend to record intangible assets on a balance sheet but include only things that the business buys or acquires (like a patent, email list, or a solid website) are included. The intangible asset must have a long life span and value that's clearly identifiable.

Sooner or later, a business will acquire an intangible asset whether it's obtaining a license to operate, building the brand's name (which results in a direct increase of profit), or trademarking something. These assets can be acquired by:

• Purchasing them
• Receiving a government grant
• Creating them in-house (software or a company that performs research that leads to the creation of a product or solution)

Common characteristics of intangible assets

• Not physical and don't have an obvious physical value
• Holds long-term value for a business
• Can be amortized, which refers to the process of spreading the cost of an intangible asset over a specific period of time (usually the life of the asset's value)

Quick tip: Amortization is great to consider for intangible assets you acquire at a price. For example, if a company buys a $30,000 license that is active for 10 years, the annual amortization for the license will be $3,000 per year (30,000/10). This means the asset will decline in value by $3,000 each year.

How do you value intangible assets?

Intangible assets can have incredible value. However, sometimes it can be challenging to determine their exact value. There are well-known million-dollar brands right now that contribute to the overall value of the company if it were ever sold. Determining how much intangible assets contribute to the overall value of the company or calculating how much it would cost someone to duplicate your asset are both common valuing tactics.

"Companies will often provide a value via an expense booking for intangible assets that are required," says Daniel Milan, managing partner at Cornerstone Financial Services. "Examples would include the cost of filing for and creating a patent or the time and effort it took to create a customer mailing list. While they may not create a quantifiable book value for the business, you will often see the realized value of tangible assets in the premium a purchasing company pays for a company they acquire."

Another way companies measure value is by taking amortization into account to determine how much the intangible asset is worth for the current year and future years. Finally, businesses can use cash flow projections to measure the future benefits the specific asset will bring to the business.

What are the 5 intangible asset types?

There are five main types of intangible assets. Here is a summary and each one and how to tell the difference.

1. Goodwill

Goodwill is an intangible asset when one company acquires another. Things like the value of a company name and brand, customer loyalty, or even good employee retention are examples of a goodwill asset. You can calculate a rough estimate of a goodwill asset by using this formula:

P - (A - L)

P = Purchase price of the target company

A = Fair market value of assets

L = Fair market value of liabilities

"Goodwill does not always make it onto a balance sheet and will show up on a separate line than other intangible assets if it does," says Milan. "This is somewhat due to the more difficult nature of measuring them directly from a valuation standpoint."

Note: A balance sheet is a financial statement that's commonly used by companies and shows both intangible and tangible assets, debts, and equity at any given point in time. Companies shouldn't add intangible assets that are not valued or that were created and not acquired to a balance sheet.

2. Brand equity

Brand equity represents the worth of a brand and its ability to generate sales and profit for the company. Depending on the company, the brand name can be critical to the success of the business. When a company has a positive brand equity, customers may be more willing to pay a high price for its products, even if they could get the same thing from a competitor for less.

"An example of this is the brand recognition of Pepsi for PepsiCo," says Milan. "It has intangible value that has a significant impact on the sales for PepsiCo, and thus, the success of the business."

3. Intellectual properties

Intellectual properties (IP) is what's created in someone's mind that can be used to produce a positive result, service, or product. Some examples of intellectual properties include trademarks, copyrights, patents, franchises, designs, literary works, and trade secrets that are valuable to the company and its products or services. Research and development (R&D) is another type of intellectual property and refers to when a company performs research with the goal of developing a new product or solution. IP and R&D go hand-in-hand because the research alone may or may not produce a valuable asset, but the development side will.

4. Licensing

A license is another example of an intangible asset. It can be something that legally enables a business to operate and make money. A business may also purchase licensing to use a particular software in order to operate and make sales.

5. Customer lists

Customer lists like mailing lists are a valuable intangible asset because having it can help businesses increase or sustain profits. If you have a list of people who have placed an order before or prospects that are likely to become customers in the future, you can use this information in your marketing and sales strategies.

Intangible assets vs. tangible assets

Assets are usually divided into two main groups: tangible and intangible. Both can be bought and sold and do share some similarities. However, they are mainly opposites. Here's how both of them differ from each other.

The financial takeaway

While intangible assets can't be seen or touched, they can still hold value and are important when it comes to ensuring the success and growth of a business. These types of assets can also contribute to shareholder value as well.

If you invest in specific companies, you may want to examine which intangible assets have contributed to the company's value and success. Consider what you think or feel when you hear the words Coca Cola, Apple, or Starbucks. Just those brand names alone demonstrate Goodwill value.

Keep in mind that you also have open access to view any publicly-traded company's balance sheet via their quarterly or and annual reports. You can usually find this information by going to the company's website and clicking on a tax for 'Investors' or 'Investor Relations.' That way, you can examine their assets in more detail.