One of the challenges Mergers & Acquisitions advisors face is educating business owners about valuation. In an ideal world, owners would begin assessing the strengths and weaknesses of their companies years before they consider putting them up for sale. In this way they would come to a good understanding of what their businesses are worth to buyers and would already have a realistic idea of valuation and deal structure. Unfortunately, 90%+ owners procrastinate and inevitably are disappointed to discover their companies are not worth to buyers what they what they’ve estimated they’re worth. Proper valuation of a company takes into account a number of things. Here we will talk about the difference between physical capital and intellectual capital and how they affect valuation.
What Is Physical Capital?Physical capital is the physical property or tangible assets that the company owns. This would include the buildings or other real estate the company owns, machinery, tools, and equipment. These items can be sold directly, often depreciate over time or with use, and will be listed in financial statements as assets. It is relatively simple to estimate the value of physical capital, although it is advised to hire a certified appraiser of machinery and equipment at least 2-3 years prior to a sale, and then have the appraisal updated annually. The asset method of valuation considers the value of a company’s physical capital.
What Is Intellectual Capital?In comparison, intellectual capital is intangible and trickier to value. For most companies, intellectual capital comprises the larger share of value – perhaps up to 80% of valuation is dependent on things that cannot be held or sold directly. Intellectual capital is comprised of things the company’s management or employees contribute to its overall profitability like: