The rules applied by the Financial Accounting Standards Board (FASB) extend to some pretty important business assets:
- Patented technology
- Trade secrets
Patents have been valued for quite a while and their valuation presents no problems. Royalty income streams from licensing comparable intellectual property assets are the basis of valuing your patent portfolio. However, putting a value on trade secrets or software is likely to cause issues especially if you are considering business acquisition or merger.
Valuation of technology and, in particular, software technology often results in large sums that are likely to impact your bottom line, at least in the short term.
Software valuation challenge – useful life
The main issue when valuing software is how to set the useful life. Why is this an issue? Software is unique in that it is constantly undergoing change. As new technologies come along that improve user access, increase available computing power, or provide better ways to communicate your results, software must be improved to keep up.
So software products are likely to change even in the short run. If you value software in its current product form, the value is likely to be lower due to the short expected life. On the other hand, if the software technology is valued by factoring the change in, the value will be much higher.
Values of R&D assets and business goodwill
In the US, the Securities and Exchange Commission (SEC) has created the requirement to evaluate the so-called in-process research and development assets or IPR&D for short. If you are buying a software company, you would need to assign considerable value to this asset class because R&D needs to be written off right away. The amount of business goodwill is thus reduced.
The idea is that you can’t include the value of future generation software once the current version is fully completed. Put differently, software eventually becomes different enough to treat it as a new business asset.
In the past, most companies tried to maximize this IPR&D and minimize business goodwill. Now, because goodwill can no longer be amortized, the situation is reversed.
So what it means to you is that there is a disconnect between the business owners looking for low values and short asset lives, while the government will want exactly the opposite. As the saying goes, you can’t avoid death and taxes.