Companies own a wide range of assets, but broadly speaking they fall into two primary categories: tangible assets and intangible assets. As the name suggests, tangible assets are physical in nature, meaning they have a definite form and substance that can be touched, seen, or measured. These include items such as cash, real estate, machinery, equipment, and inventory. On the other hand, intangible assets represent non-physical resources that a company owns, which do not have a clear, physical presence but may still hold significant value.
In this article, we will unpack what intangible assets are, how they are developed and nurtured within a business, their direct impact on performance, and how they influence the overall value of a company.
What Are Intangible Assets?
Intangible assets contribute to a company’s earning power and competitive edge. Unlike machinery or property, you cannot touch or see them – but they can be some of the most valuable components of your business. Examples include:
- Copyrights and trademarks
- Customer contracts, relationships, and loyalty
- Intellectual property (IP)
- Software and databases
- Proprietary processes and know-how
- Goodwill
These assets are often long-term in nature and result from years of strategic effort – building a strong brand, cultivating customer trust, developing efficient internal systems or innovative products.
Importantly, intangible assets often do not appear on the balance sheet unless they were acquired from another company (under acquisition accounting rules).
Despite being difficult to identify and measure, intangible assets can comprise a large portion of a company’s value.
Impact of Intangible Assets on Your Business
Intangible assets create value from how they impact your business’s operational performance, including by driving sales growth, creating efficiencies, increasing pricing power, and ultimately resulting in greater profitability. Here’s how:
- Customer Loyalty Drives Revenue: A strong brand and loyal customer base reduce churn, support premium pricing, and encourage repeat business and referrals.
- Operational Efficiencies: Proprietary software, internal databases, well managed teams, and refined processes can reduce operating costs and improve margins.
- Differentiation and Pricing Power: Intellectual property like patents or trademarks, or less formal service/product improvements and brand reputation can allow a company to charge more for products or services.
How Intangible Assets Are Created
Many intangible assets are created organically through both daily operations and strategic investments. Examples include:
- Branding and Marketing: A recognizable brand is the result of consistent messaging, customer satisfaction, and market presence.
- Customer and Vendor Relationships: Long-term relationships, referrals, and loyalty are built through excellent service and engagement.
- Innovation and IP: Developing unique products, technologies, or services often leads to patents or proprietary advantages.
- Workforce and Culture: Employees create value for your company and that value can be compounded when they are part of effective teams that deliver greater efficiency and better service.
- Processes, Networks and Systems: Internal processes, well-developed systems, and know-how provide competitive advantages.
Businesses build many of these assets without ever thinking about it through their normal operations, but maximizing these assets (and the growth, profitability, and value they generate) requires thoughtful planning and a strategic vision for your company. Decision making about operational expenses such as hiring, marketing, and product or process improvement takes on a critical new dimension when considered through the lens of the intangible assets they can create.
Intangible Assets’ Value
Investing in tangible assets is often an easier decision for business owners and management than investing in developing intangible assets. Inventory, buildings, and machinery can be seen, touched, quantified, and appraised for value, qualities that let them sleep well at night. So, what about intangibles’ value?
The value of intangible assets is on full display in the most valuable companies in the U.S.: Microsoft, NVIDIA, Apple, Amazon, and Google all derive most of their value from intangible assets. The effect isn’t limited to technology companies; other top companies such as JPMorgan Chase, Eli Lilly, and Visa stand out for their significant intangible assets in relationships, intellectual property, and networks, respectively. You would struggle to find any top companies without a broad mix of intangible assets that contribute to their high valuations.
Markets’ lofty valuations of these companies stem from their intangible assets, which have enabled them to achieve better financial performance than peers that are quantifiable in terms such as growth, profit margin, and market share.
The same is true for small and medium sized businesses. Intangible assets that produce greater financial returns for a company create value, both for the current owners and in the eyes of potential buyers. However, the specific intangibles that can have the greatest impact on performance and the ones most valued by buyers can vary across industries and market position.
Next Steps for Unlocking the Value of Intangibles
Intangible assets are the hidden engines of profitability, growth, and long-term business value. They can be challenging to quantify, but their impact is undeniable. For small and medium-sized business owners, recognizing and nurturing these assets can be transformative. However, understanding which investments in intangibles can generate the most value to your business requires strategic planning by the company’s owners, management, and advisors.
If you are unsure how to capitalize on intangibles you may have already developed, which ones you should be investing in, or just where to start, please contact us or click here to learn about our business valuation services. A well-prepared valuation can identify not only the existing values of intangible assets, but also the investments and strategic opportunities that can result in substantial future growth.