Intangible assets & goodwill are now viewed with increased importance when completing business valuations. The Transport & Logistics sector provides a great example of how our thinking has moved in recent times. Historically, a Transport company with a truck fleet was purchased based on the market value of the trucks, this is very rarely the case in 2020 with the majority of transport M&A transactions using an EBITDA/EBIT multiplier as the valuation methodology.
The key reason behind the move away from using fixed assets as a driver for valuations has been the trading bank’s view that business profitability and cashflow is the most important repayment characteristic for any company, and asset values are a distant second in priority from a banking perspective.
The same mindset is now prevalent in rural banking where historically the value of the land asset was the key item in deciding whether to advance a bank loan. Today, positive cashflow and profitability are viewed as being more important and if those numbers do not meet the bank’s criteria, the land asset values become largely irrelevant.
For mature and traditional businesses, goodwill is the cashflow generating ability of a company over and above their asset value; that is if a transport business is generating $1.0m of EBIT, sells for $4.0m, and has trucks with a market value of $2.0m, the goodwill value is $2.0m*.
*The business valuation of $4m is made up of $2m of Trucks (fixed assets) and $2m of goodwill
So what does the prominence of goodwill/profitability/cashflow as the number one priority for banks mean for traditional businesses today?
When preparing a business for a sale, the priority needs to be generating documents (financial statements and forecasts) that confirm and illustrate the profitability and cashflow of your business. A fixed asset list, whilst important, will play less of a part in ascertaining the value of the business. If you want the purchaser of your business to have the ability to get bank funding, they will need robust evidence showing the profitability and cashflow of your company and the bank will be less interested in the tangible/fixed assets.
When we start talking about the new generation of companies that come from the technology sector, intangible assets play a greater part in the valuation process; we have corporates like Xero with a market capitalisation of $10.5B and they are yet to make a material profit and have virtually NO fixed assets. The Xero situation and similar types of companies provide a different slant on intangible assets where value is derived from IP, data, software code, licensing agreements and website domain names. There is a clear trend that new businesses are moving away from owning fixed assets and instead are becoming experts in inventing/innovating, gathering data and implementing new processes/platforms that generate an intangible asset value for their investors.
Further detail on valuing intangible assets in the new digital world is attached in the article from EverEdge below: