Valuing Your Data With GAAP
Properly Valuing Your Data Could Lower Your
Healthcare Organization Debt & Open Up Other Sources of Funds
As the economy transitions from the Industrial to the Information Age, generally accepted accounting practices (GAAP) have come under fire from analysts and business owners. The issue is the valuation of Intellectual Property (IP) — those non‐physical assets such as trademarks, copyrights, patents, and proprietary databases that have value for their owners. Currently, these assets, if recognized at all, are captured in a catch‐all category of “goodwill.”
According to the U.S. Bureau of Economic Analysis, IP (2012‐2018) investment has grown at a 6.2% annual rate, reaching $938 billion. IP investment represents one third of the country’s GDP, more than the yearly investment in physical structures and approaching the expenditure for equipment.
Yet, business balance sheets reflect only a small portion of intangible asset values.
The absence of intangible assets on your financial statements means that your debt-to-equity (D/E) ratio—a significant factor in financial institutions’ decision to lend money—does not reflect the real value of your business. The absence of IP understates the equity value and can negatively affect your ability to qualify for grants and other funding.
GAAP Treatment of Intangible Assets
While the category “Goodwill” intends to represent a company’s intangible assets, GAAP limits intangible assets solely to the difference between a company’s acquisition price and its balance sheet or book value.
For example, Joe’s medical practice has an equity value of $100,000 when Tom offers to buy it for $250,000. Tom’s new medical practice would have a balance sheet with $250,000 of equity. After the purchase, Tom’s balance sheet would include a new asset titled “Goodwill” valued at $150,000, the amount necessary to stay in balance. Under existing GAAP rules, goodwill only appears on a balance sheet following an acquisition.
To understand the inequity of the treatment of the intangible assets, consider the following comparison of the ratio of Intangible Assets to Total Assets reflected on the balance sheets of Microsoft (16.7%), Google (8.2%), and Apple (0%).
Microsoft has more than $50 billion of intangible assets, including $43 billion of goodwill. In contrast, Apple has no value for IP or Goodwill on its balance sheet.
The difference is the consequence of Microsoft’s strategy in purchasing companies and reflects the differences between the equity on the balance sheet and Microsoft’s purchase price. Apple’s strategy is to make investments below a 50% ownership in companies for control – reflected in the $106 billion in Investments. The three companies have billions of dollars of value tied up in intangible assets unaccounted for in the financial statements. Can any company be appropriately evaluated by shareholders, lenders, analysts, or potential buyers without such important information?
The Unrecognized Value of Data
The appearance of supercomputers and AI enabled massive amounts of data to be analyzed and used to determine corporate marketing strategies, align medical and health treatments with issues, discover anomalies, and probable project outcomes. This ability allows data, once hidden away in paper files as administrative trivia, to have real economic value. For some companies, data – one form of intangible assets ‐ is their most valued asset.
Samantha Campbell of Alqami, a consulting firm dedicated to the use of data in new ways, believes that companies increasingly understand the “true value of their data in terms of being a tangible corporate asset on their balance sheets.” She notes that Alqami’s Corporate Finance clients are now demanding “the capability to include a company’s data asset when valuing a corporate transaction.”
Financial analysts Feng Gu and Baruch Lev, professors of accounting at the State University of New York and New York University, agree that current accounting regulations, i.e., GAAP, no longer reflect the “strategic assets” of a company and need to be updated. Another report delivered at the 2018 Jackson Hole Economic Policy Symposium pointed to the global transition to a more intangible‐intensive economy. The researchers suggested that national governments might have to “directly underwrite and potentially guarantee intangible‐based lending.” The call for government intervention is the lack of IP transparency on financial statements and the difficulty of valuation by credit analysts for collateral purposes.
No Changes in GAAP on the Horizon
Will the Financial Accounting Standards Board (FASB) revise GAAP to allow realistic IP values appear on a balance sheet? Probably not, at least in the next five to ten years. David Riley of Alqami writes, “From a practical perspective, this means that although people recognize that data is valuable, quantifying that value and treating it as an on balance sheet asset is still difficult with no unified methodology across the market.”
Protecting the Value of Your Business
While the accounting rules in place preclude the showing of your data’s value in your financial statements, there are steps that you can take to protect your intangible assets:
1. Identify your internally generated IP
Intangible assets take many forms, including patents, copyrights, brands, logos, and databases. Healthcare companies and medical practices typically retain data categorized by their nature (data type, availability, exclusivity, granularity, and source); data quality, maturity, and analytic insight (raw, curated, or analyzed); the complexity of data capture (open source or paid, auto‐collected or not); and use/application (impact, limitations on use). They may have a recognizable brand or logo that would benefit a buyer or patents secured through research. Most of these assets are not listed on a balance sheet or carried on their cost basis (generally much lower than market value.
2. Establish processes to manage and preserve IP assets
Failure to manage assets risks losing their value, whether physical or intangible. Companies with IP should create policies and processes to protect their proprietary value. For example, allowing free access to databases reduces their value. Why pay for something you can obtain for free?
3. Value your IP assets
Valuing an intangible asset can be difficult due to their nature. Relying on costs alone typically understates value, especially for those assets that grow more valuable with time. The more common valuation methods include
- Relief from Royalty Method (RRM). The RRM is the theoretical value only the payments required if the asset was leased, rather than owned. One example of its use would be valuing an internally generated mailing list by comparing the cost or renting a list over multiple mailings during a period.
- Multiperiod Excess Earnings Method (MPEEM). The MPEEM is effectively a discounted cash‐flow analysis by subtraction. The estimator projects cash flow for the entity then subtracts the cash flow portion attributable to the tangible assets. The remainder is the cash flow attributed to IP, discounted to present value.
- With and Without Method (WWM). Less complicated than the MPEEM, WWM is the difference between a discounted cash‐flow for the enterprise with the IP and a second discounted cash‐flow for the enterprise without the IP.
- Real Option Pricing. This method developed from the Black‐Scholes option pricing model, a calculation for an asset that will have cash flow in the future but is idle at present.
- Replacement Cost Method Less Obsolescence. The value is based on the estimated cost to create the intangible asset considering its length of utility and potential declines in values.
Valuing intangible assets can be complicated and may justify using an independent Certified Valuation Analyst (CVA).
4. Update values regularly
Intangible assets can change in value over time. Additions to, or new insights from, a database can increase its market appeal and price significantly. Changes in competitive landscapes affect the values of brands and logos. A new patent can revitalize organizations. When revaluing an intangible asset, employ the previously used method of valuation for consistency.
As we have seen, properly valuing your data and other intangible assets is a highly desirable strategy to implement. Doing so can lower your healthcare organization debt and open up other funding sources.