The Role of Venture Capitalists in the Identification and Measurement of Intangible Assets

Abstract

The increase in the importance of intangibles in business competitiveness has made investment selection more challenging to investors that, under high information asymmetry, tend to charge higher premiums to provide capital or simply deny it. Private Equity and Venture Capital (PE/VC) organizations developed contemporarily with the increase in the relevance of intangible assets in the economy. They form a specialized breed of financial intermediaries that are better prepared to deal with information asymmetry. This paper is the result of ten interviews with PE/VC organizations in Brazil. Its objective is to describe the selection process, criteria and indicators used by these organizations to identify and measure intangible assets, as well as the methods used to valuate prospective investments. Results show that PE/VC organizations rely on sophisticated methods to assess investment proposals, with specific criteria and indicators to assess the main classes of intangible assets. However, no value is given to these assets individually. The information gathered is used to understand the sources of cash flows and risks, which are then combined by discounted cash flow methods to estimate firm's value. Due to PE/VC organizations extensive experience with innovative Small and Medium-sized Enterprises (SMEs), we believe that shedding light on how PE/VC organizations deal with intangible assets brings important insights to the intangible assets debate. 1-Introduction During the last 25 years intangible assets (i.e., human capital, organizational capital and intellectual property rights) have surpassed tangible assets (i.e., physical and financial assets) as the most relevant value drivers for companies in the competitive environment (Lev, 2001). However, intangible assets are hard to identify and measure (Litan and Wallison, 2003), thus imposing high information asymmetry for innovative firms in general and the special segment of small and medium-sized enterprises (SMEs) in particular. When faced with uncertainties about the true value of a company, financiers tend to require higher costs to provide capital, making credit and specially equity prohibitively expensive for innovative SMEs (Botosan, 1997), with a negative impact in the efficient allocation of capital in the economy (Blair et al., 2001).

What makes SMEs attractive to external successors?

“…The company analysis, or due diligence, constitutes a crucial part of this phase. The due diligence process found in many small firms cannot be compared to that conducted in large firms in which specialists for each topic of analysis are involved (Ribeiro and Tironi, 2006). Instead, one may expect it to be a generally less comprehensive procedure of which the main part is conducted by the successors themselves.…”

Toward a Venture Capital-Backed Entrepreneurship Model in Brazil

“…De Negri and Kubota (2008) argue that due its intangible profile, innovative enterprises face financing constraints. According to Ribeiro and Tironi (2006) and Melo (2007), the innovation financing gap in Brazil can be mitigated by venture capital. Campos and Barbieri (2002) and Titericz (2003) also argue that venture capital presents a very interesting alternative funding source for innovation in Brazil.…”