J&A Subsidiary Firm BBMA is Featured by Cornell Tech Product Studio
Jahani and Associates subsidiary firm BBMA was selected to work with Cornell Tech’s product studio among other companies like Amazon, Apple, Alphabet, and Bloomberg.
The work was also featured as a top performer in subsequent Cornell news. This can be found here.
Jahani and Associates’ Strategy for Health Insurance Buy-Side M&A
After most M&A deals close, the new business does not create the value that executives predicted.1 Jahani and Associates (J&A)—a top New York investment bank led by Managing Director Joshua Jahani—has determined this is because of two reasons:
- Overstated and overambitious goals made by executives during the M&A process
- Intangible asset reporting that is below acceptable standards for both the buyer and seller
Jahani and Associates solves the problem created by inadequate intangible asset reporting through a unique strategy based on empirical evidence. J&A’s experienced team of tech investors and wellness investors suggests that solving this problem also reduces the ability of eager executives to overstate benefits, synergies, and business combinations during the buy-side M&A process. Passionate executives are good for international capital markets, but passion should be moderated with measurable value.
The following describes J&A’s strategy along with supporting empirical research for health insurance M&A buy-side decisions. This evidence is based on the M&A activity completed by the United States’ largest health insurance companies between 2010 and 2017: Aetna, Anthem, Centene, Cigna, Humana, Magellan, Molina, UnitedHealthcare, and Wellcare. This analysis is specific to health insurance M&A; similar analysis can be done for any industry.
J&A’s research has proved that intangible assets make up over 90% of M&A value. Within this 90%, customer-related intangible assets are most prominent for health insurance companies. Customer-related intangibles account for approximately 65% of the M&A deal value.
This research also relates specific intangible assets to financial performance. Medicaid buyers such as Molina and Centene achieved the greatest revenue growth between 2010 and 2017. J&A believes Medicaid acquisitions caused revenue growth for these companies based on regulatory dynamics. The final part of this paper delivers the strategy J&A uses for its health insurance and healthcare clients to help them make better buy-side M&A decisions.
Identifying the Intangible Assets That Matter in Health Insurance M&A
The international health insurance M&A market is very large, representing between $70 and $120 billion per year between 2010 and 2017. Figure 1 shows the international health insurance M&A deal size from 2010 to 2017. This data does not include initial public offerings. The majority of deals were completed by corporate M&A buyers. These buyers comprised over 80% of the money spent and over 70% of the transactions completed.
The most common way to describe M&A value is through financial statement metrics such as earnings before interest, tax, depreciation, and amortization (EBITDA) or revenue. But financial statements have become decreasingly relevant since the dot-com boom in 1995 because they do not contain information about intangible assets. This is a challenge for buy-side M&A decision-making. Without standard reporting, it is very difficult to collect data on members related to Medicare, Medicaid, duals, commercial, and other populations. These challenges are especially prevalent in the private markets. Private company reporting is ad hoc, disorganized, and unstandardized.
Because of this information gap, health insurance companies must have a better strategy to acquire the right intangibles and integrate those intangibles into the buyer’s existing business during buy-side M&A. They need to collect information about intangibles throughout scouting, solicitation, diligence, closing, and integration. Collecting and analyzing this information must be part of the buy-side M&A process, which is usually led by an investment banker.
Health Insurance Companies Spend 14 Times More Money on Intangible Assets Than Tangible Ones
To define the intangibles that create the most M&A value for the buyer, J&A collected the purchase price allocations for all acquisitions completed by Aetna, Anthem, Centene, Cigna, Humana, Magellan, Molina, UnitedHealthcare, and Wellcare from 2010 to 2017. These purchase price allocations show that health insurance giants spent 14 times more money on intangible assets than tangible ones. Customer-related intangibles accounted for 65% of health insurance M&A deal value.
Customer-related intangibles include both contractual and non-contractual assets. Contractual health insurance customer relationships are active members across all lines of business. Non-contractual relationships include past customers or customers who have terminated coverage for a variety of reasons. Examples of customer intangible assets according to the Financial Accounting Standards Board (FASB) are customer lists, order backlog, current members, and past members.
Not all intangibles are created equal: the top revenue growth performers purchased specific customer intangibles. UnitedHealthcare purchased the most customer intangibles among its competitors but did not achieve the greatest proportionate revenue growth when compared to Molina and Centene.2 In fact, top performers in health insurance buy-side M&A purchased mostly Medicaid customers. Simply buying the most customer-related intangibles did not guarantee the greatest revenue growth.
J&A chose revenue growth as the major indicator of M&A performance because of the health insurance business model. Literature review supports the performance of Molina’s and Centene’s stock prices above their competitors.2 Top performers purchased more Medicaid customers than any other kind of membership. This decision was driven by the Affordable Care Act (ACA).
The ACA increased federal poverty limits for Medicaid, SNAP, CHIP, and TANF populations.3 This increased the volume of those eligible for Medicaid and, therefore, the size of the market. Combined with insurance exchanges and an individual mandate to acquire health insurance, this also increased Medicaid funding for the states.4 The combination of an individual mandate, increased Medicaid spending, and an increase in the Medicaid population allowed health insurance companies like Molina and Centene to outperform competitors in revenue growth. Molina’s and Centene’s premium revenues grew 373% and 934% respectively from 2010 to 2017, whereas all other health insurance companies’ premium revenues increased an average of 109% during the same time period. Molina and Centene made 20 acquisitions specific to Medicaid; all other health plans combined made only four.
A NOTE ABOUT INTEGRATION: Creating Long-Term Value From Purchased Intangibles
Not all health insurance members are equal since not all health insurance lines of business are equally valuable at the same time to buyers. The most effective way to perform integration analysis during the buy-side M&A diligence process is to confirm that a company’s definition of customer value overlaps between the buyer and the seller. When possible, data related to Net Promoter Score (NPS) can also be used to identify customer sentiment in a selected target. None of these indicators are contained in the financial statements, and they are generally outside the investment banker’s due diligence process. However, buyers, bankers, and advisors must utilize these tools to identify and acquire the intangibles that are needed. The importance of integration is supported by J&A’s health insurance M&A analysis showing 87% of the top performers purchased companies in regions where the buyer had existing operations. Growing in existing markets was more attractive than expanding to new markets.
J&A’s Recommended Strategy for Health Insurance Buy-Side M&A
Phase 1: Identify
A buy-side M&A that is integration focused
- Determine how customer intangible performance is measured
- Understand market and regulatory dynamics
- Create integration plans based on acquired intangibles
- Set evidence standards for buy-side M&A decision-making
Phase 2: Develop
Buy-side M&A execution driven by intangible assets
- Create an acquisition target and due diligence process to confirm intangible synergy is present
- Solicit acquisition targets
- Conduct intangible and tangible asset due diligence
- Negotiate purchase prices through transparent value identification
- Close deal
Phase 3: Monetize
Acquisition integration resulting in accelerated accretion
- Utilize pre-built integration artifacts confirmed through the buy-side M&A process to inform stakeholders
- Integrate targets based on corporate strategy
Examples for Health Insurance M&A
When customer contracts are the most important asset
- Customer acquisition costs (CAC)
- Customer lifetime value (CLTV)
- Percentage of marketing spend that is digital
- Percentage of revenue generated from digital channels
- Profit margin by LoB
- Cash on hand
- Net Promoter Score
- Error rates
- Policy renewal rate
- MTM (blues plans only)
- First contact resolution rate
- Regulatory changes
PHASE 1: Identify How Customer Intangible Performance Is Measured
Since J&A’s research revealed that health insurance M&A dollars are mostly spent on customer-related intangibles, health insurance buyers must take care to make sure their buy-side process recognizes this by measuring the intangible assets that matter before, during, and after a deal is closed. The first step in identifying the intangibles that will drive value is to understand internal corporate strategy. In the case of Molina, the buyer used an existing competitive advantage of serving Medicaid populations to expand its market share. Other top-performing examples include Cigna’s acquisition of Great American Supplemental Benefits to increase cross-selling and up-selling opportunities to Cigna’s already large population of members. All top revenue performers purchased homogeneous customer intangibles and customer lists.
These findings show companies must determine which lines of business are most profitable, which ones are best positioned for growth, and how that growth and success are internally measured. Successful buy-side M&A starts with applying internal growth measurement standards to the target’s intangibles during the process.
PHASE 2: Develop an Acquisition Target and Due Diligence Process to Confirm Intangible Synergy Is Present
Tools like Net Promoter Score (NPS) or customer service ratings are often bullet points for marketing that are managed by a few business leaders who invest in improving the scores. But these metrics show important information about how customers perceive the value of their health insurance provider. Not utilizing these metrics during the buy-side process will lead to poor intangible reporting and, therefore, increased risk of a failed acquisition.5,6
Jahani and Associates has provided examples of how to use CLTV, CAC, NPS, and regulatory strategy analysis to make better health insurance buy-side M&A decisions. These examples are not limitative, and many others should be considered to minimize the risk of derailing the M&A process.
PHASE 3: Monetize Intangible Assets Through Better Integration to Create Lasting Returns
Through all of this, buyers can integrate their targets more seamlessly post-acquisition by measuring the most important assets before a deal is signed.
Intangible assets matter most, and customer-related intangibles matter most to health insurance buyers. Health insurance buyers must run a buy-side M&A process that integrates this intangible reality into the entire process.
For a health insurance M&A acquisition to be successful, purchased intangibles must create tangible value. The only way for buyers to accomplish this transformation is to remain disciplined and diligent during the integration process. This integration process is completely dependent on what is measured and acquired. Knowing what to measure and how to measure are two key factors to creating a winning strategy. Ignoring these facts exacerbates the two challenges stated earlier: overstated or overambitious executive goals and the lack of intangible asset reporting or understanding that leads to failed acquisitions.
Removing the disconnect between traditional M&A buy-side practices and intangible reporting can dispel negative consequences from overstated executive goals during the M&A process. In the age of the intangible economy, typical reporting is inadequate. Buyers must take careful and deliberate steps to develop a better understanding of intangibles in order to drive M&A performance. Mergers and acquisitions fail to create desired value when post-merger integrations do not perform. By focusing on intangible assets, buyers can collect and analyze key integration activity and information before a deal is closed. By collecting intangible asset information upfront, buyers will conduct a more precise M&A process and maximize shareholder returns. Buyers should determine their buy-side M&A goals, then utilize Jahani and Associates’ strategy during scouting, solicitation, diligence, closing, and integration.
Examples of J&A’s Approach for Health Insurance M&A
Customer Lifetime Value (CLTV)
Why It Matters
Health insurance companies should utilize lifetime value principles to determine the best membership populations to buy and integrate. More importantly, the definition of customer lifetime value must align between the buyer and the target. This alignment must be determined before the health insurance M&A acquisition is closed. Fundamental differences in defining success and value cause significant barriers to accretion and effective integration.6,7
CLTV is a balance of the revenue generated and costs needed to service a customer. Therefore, both cost savings and revenue growth factors are relevant to CLTV calculations. Insurance companies spend significant sums of money on customer service. CLTV can show buyers the efficacy of dollars spent and identify areas for potential cost synergies.
Driving Questions Used for Buy-Side M&A Decision-Making
- What method is being used to calculate CLTV?
- How much time is required to achieve a positive return on investment (ROI)?
- What revenue sources are inputs for CLTV?
What Buyers Should Remember
There are many models and methodologies used to measure customer lifetime value. Buyers should remember that the way CLTV is measured is more important than the exact number calculated. Overlaps in measurement methodology, inputs, and outputs will create more synergy post-acquisition.
Customer Acquisition Costs (CAC)
Why It Matters
Customer acquisition costs may be the most important intangible KPI for health insurers. Since health plan revenue is a function of membership and membership is predictable within a calendar year, cost containment is the best way insurers can improve profit margins. Cost reporting and measurement are also essential for current regulations regarding medical loss ratio and risk adjustment standards.
CAC is calculated by dividing total sales and marketing expenses by the number of customers acquired, usually on an annual basis. Much value can be extracted from this by determining the CAC by the line of business.
Driving Questions Used for Buy-Side M&A Decision-Making
- What method is being used to calculate CAC?
- What sales and marketing costs create the greatest ROI?
- Will costs be synergistic?
What Buyers Should Remember
As an example, comparing digital marketing customer acquisition and traditional marketing customer acquisition can give buyers insights into cost synergies. Based on this information, buyers can then decide on this information if the target has a proven customer acquisition strategy that is in line with the mandate.
Net Promoter Score (NPS)
Why It Matters
Raw NPS data is usually available upon request. Reviewing NPS shows the buyer what kind of customers were surveyed, where they were surveyed, and how they were surveyed. Comparing the target’s information to the buyer’s provides tremendous insight into how customer relationships are maintained and managed.
Due to the increased retailing of the health insurance industry, customer service has become an increasingly expensive cost center. Because investments in customer service are represented as costs on financial statements, diligence is required to make sure investments generate results and that those results overlap with the same success factors of the buyer’s internal systems. The costs to generate meaningful intangible assets should be treated differently than costs with less impact.
Driving Questions Used for Buy-Side M&A Decision-Making
- How is NPS data collected?
- How do profiles of promoters and detractors between the buyer and the target overlap?
- Are there customer service insights contained in NPS data?
What Buyers Should Remember
Customer service metrics can be tricky to compare if they are not calculated the same way. Buyers need to make sure they are speaking the same language as the target in terms of the definitions of KPIs such as NPS; this goes beyond the number itself.
Why It Matters
The United States health insurance market is a common political topic and a pillar in party platforms. Due to this, political changes influence the health insurance market through regulation. Medicaid growth in the United States is an example of this. Additional examples are the ACA, the creation of Medicare in 1965, and President Trump’s recent proposals to change Medicaid, CHIP, and the ability for health insurers to sell across state lines.
Therefore, no health insurance buy-side strategy is complete without regulatory analysis. Health insurers should monitor political dynamics with careful consideration of which healthcare policies will survive multiple election cycles. Court decisions, such as National Federation of Independent Business v. Sebelius in 2012, and litigation are the best indicators for which policies will endure. National Federation of Independent Business v. Sebelius solidified many of the regulations passed in the ACA.8,9
Driving Questions Used for Buy-Side M&A Decision-Making
- What political changes will happen in upcoming election cycles?
- What healthcare changes have been upheld by courts and what changes are political hyperbole?
- How will technology and regulation influence each other?
What Buyers Should Remember
Healthcare regulation changes constantly. Campaign promises are not always implemented into law. Buyers must find strategies for growth that are difficult to politically influence. This minimizes risk and can lead to lasting returns no matter the political climate.
A Word of Caution Regarding Customer Service Performance Indicators
Jahani and Associates recommend health insurance M&A buyers use KPIs such as Net Promoter Score and other customer service quality metrics to evaluate acquisition targets. As stated earlier, analysis should focus on methodology and not on the actual numerical values. There is no conclusive evidence that the scores of customer service KPIs directly correlate to stock performance. These intangible metrics do provide valuable insight into customer-related intangibles. J&A does not suggest that similar KPI numbers create revenue, cost, or operational synergy but that similar KPI measuring methodologies do.
ABOUT THE RESEARCH
In 2018, Jahani and Associates reviewed 62 significant health insurance M&A acquisitions and recorded their purchase price allocations. Information was only collected from publicly available data sources. Intangible-asset pro formas were taken from Securities and Exchange Commission (SEC) reports only. J&A also surveyed over 34 business leaders from health insurance companies to understand how executives used intangible asset reporting to make business decisions.
ABOUT JAHANI & ASSOCIATES
Jahani and Associates (J&A) is an independent investment bank located in New York City. The firm specializes in healthcare and technology and provides specialized M&A and capital markets advisory services. The combination of J&A’s unmatched skills in technology, engineering, and business operations allows the firm to create sustainable value for its clients. J&A works at the intersection of cutting-edge financial theory and business practicality. Creativity is highly valued within the firm which allows J&A to continually improve the way businesses thrive.
3. Tricia Brooks, Karina Wagnerman, Samantha Artiga, Elizabeth Cornachione, and Petry Ubri, “Medicaid and CHIP Eligibility, Enrollment, Renewal, and Cost Sharing Policies as of January 2017: Findings from a 50-State Survey,” Henry J. Kaiser Family Foundation, January 12, 2017, accessed January 3, 2019.
5. Alex Edmans, “Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices,” Journal of Financial Economics 101, no. 3 (2011): 621–640.
6. Hao Jiang, “Institutional Investors, Intangible Information, and the Book-to-Market Effect,” Journal of Financial Economics 96, no. 1 (2010): 98-126.
7. Alex F. De Noble, Loren T. Gustafson, and Michael Hergert, “Planning for Post-Merger Integration—Eight Lessons for Merger Success,” Long Range Planning 21, no. 4 (1988): 82-85.
8. Yaakov Weber and Shlomo Tarba, “Exploring Integration Approach in Related Mergers: Post-Merger Integration in the High-Tech Industry,” International Journal of Organizational Analysis 19, no. 3 (2011): 202–221.
9. “Centers for Medicare & Medicaid Services (CMS) Medical Loss Ratio (MLR) Annual Reporting Form Filing Instructions for the 2016 MRL Reporting Year,” Centers for Medicare & Medicaid Services, 2016, accessed January 3, 2019.
Copyright 2019 Jahani & Associates. All rights reserved.
Purchase Price Allocation to Maximize Sell-Side M&A Value and Tax Savings
Jahani and Associates recently presented to over 100 private equity buyers on how purchase price allocation can create tax savings and drive a competitive sell-side process. The presentation can be found here.
Exiting vs Thinking Defensively: M&A Strategies for 2019 and Beyond
J&A held an event for over 30 business owners in Florida. The topic of discussion was exiting vs thinking defensively in current markets. The presentation can be downloaded here.
We want to thank all our Florida partners, clients, and employees for attending the “Exiting vs Thinking Defensively” dinner in January. It is always a pleasure to experience the energy of everyone we work with. We will continue to deliver peak performance for our Florida clients.
– Joshua Jahani, Managing Director
Using Intangibles to Advance Your Sell-Side M&A Strategy
Download J&A’s latest whitepaper on a sell-side M&A strategy to maximize value.
Monetizing Intangibles in Ad Tech M&A Value
In this article, we will briefly explain how to monetize intangibles.
In the first two articles of this series, Identifying Intangibles in Ad Tech M&A Value and Developing Intangibles in Ad Tech M&A Value, we specified how you, the business owner, can identify and develop your company’s most valuable intangible assets to maximize your value.
In any M&A deal, sellers highlight the importance of their intangibles so the buyer can use them to create a competitive advantage. The third step in this process, learning how to monetize your business’ intangible assets, is where you reap the fruits of your labor. This step occurs when the buyer pays a price for the intangibles you have identified and developed. This includes the steps leading up to the sale, such as valuation, negotiation, pitching, and due diligence. So how do you monetize intangibles?
How to Monetize Intangibles When Selling Your Company
An M&A valuation can be conducted in several ways, including through a business appraisal or the valuation of a public company’s stock. The valuation of your company often amounts to a number that is negotiated between the seller and the buyer. Middle-market companies in particular possess a range of values based on the buyer’s profile. Fair market valuation is the most common valuation technique.
Fair market valuation occurs when you determine how similar businesses have sold based on multiple types and multiple factors. Multiple types include earnings before interest, taxes, depreciation, and amortization (EBITDA), annual recurring revenue (ARR), and, in some cases, book or tangible asset value. Multiple factors (referred to as 3X, 4X, or 10X) simply identify the number you agree to multiply the selected factor by to determine the valuation number.
Obviously, multiple types and factors depend on industries with similar characteristics to the company being valued. For example, industry growth, the strength of the management team, competitive advantages, access to suppliers, and access to buyers can all influence multiple types and factors.
How to Use ASC 805 to Maximize Your Valuation
The Accounting Standards Codification (ASC) 805 allows the business owner to understand how the expected purchase price can be broken down based on the transaction’s fair market valuation and associated purchase premium or goodwill. In the ad tech industry, the amount paid for goodwill makes up, on average, 70% of the purchase price. This means, for example, that a company with a fair market valuation of $100 and 70% goodwill was purchased for $170.
At J&A, our banking practice conducts detailed M&A studies of goodwill and purchase price allocation to understand why companies command a premium and how business owners can make sure they land at the top of valuations when selling their businesses. After looking at over 500 M&A transactions executed by technology giants over a six-year period, we segmented purchases by industry and certain goodwill parameters, narrowing our study to 34 purchased companies. These 34 ad tech M&A transactions completed at the greatest premiums had the following two things in common: the target company increased the data interfaces of the acquiring company and the target company increased the data processing power of the acquiring company.
Data interfaces and data processing power are both intangible assets. These intangibles were systematically identified and developed by the business owners over time before they sold their companies. The monetization of those assets became effective when the companies were purchased at higher than average premiums.
This analysis becomes the cornerstone of an effective M&A strategy. Armed with the framework of identifying, developing, and monetizing intangible assets, business owners have a predefined plan they can take to increase their company’s value.
As a business owner, you should always study different purchase premiums in your industry to identify drivers that will create the highest return for your business. Using ASC 805 principles to uncover M&A value allows you to create a roadmap that will help you land on the high end of valuation because it is a scientific way to tie your valuation to intangible assets.
The Takeaways of Intangible Asset Monetization
Intangible assets can only be monetized if you have measured them in-depth. There is an infinite number of intangible assets you can identify, develop, and monetize.
As a business owner, you must determine which ones you can leverage most effectively. Trusted advisors can help you create a clear vision and strategy to maximize your company’s value. The role of intangible assets in M&A markets will increase over time. The most successful companies will use the information presented in these articles to maximize the value of their company.
Developing Intangibles in Ad Tech M&A Value
In this article, we will briefly explain how to develop intangibles.
In our earlier article Identifying Intangibles in AdTech M&A Value, we explored how you, as a business owner, can identify the intangible assets that make your company more valuable during the M&A process. After identification is complete, the next step is to develop those same intangible assets. Developing intangible assets relies on key performance indicators (KPIs) in the same way identifying intangibles does. KPIs are the metrics you choose to represent the performance of an intangible asset.
Developing an intangible asset is the set of actions you will take to optimize a KPI. For example, we previously explored how more data interfaces can lead to optimized conversion. Therefore, the intangible asset is the data interface and conversion is the KPI. Optimizing conversion means increasing or decreasing it based on drivers like technology, advertising spends, or advertising quality.
To measure conversion, you must define the desired final action you wish your customer or visitor to take. This could include clicking an ad, buying a product, or providing an email address. The development of the intangible asset (e.g., data interfaces) becomes any action, investment, or improvement you perform to accomplish the final objective (e.g., click, buy, provide email). These developments increase M&A value. In our next article, Monetizing Intangibles in Ad Tech M&A Value, we will show you how to monetize them.
There are multiple ways to develop an intangible asset. Building a company for sale requires considering accounting and banking principles as well as intuitive, strategic ones. Imagine a company that performs direct digital marketing. If this firm wants to increase the number of people who click ads served to drive more website traffic, they have several options to encourage their users to do so:
- Create more compelling marketing content and design
- Acquire new contact information of people who are more likely to click the links in the body of the message
- Retarget consumers by making sure prospects are seeing ads in multiple locations and in multiple instances
- Invest in new technology that places more relevant ads in front of potential “clickers”
- A combination of some or all of the above
The best choice for the company is likely a mixture of the five options laid out above. The company must understand that each choice represents a distinct set of intangible assets, all of which are inherently identified and developed when the decision is made. The investments made in one, some, or all of these options are a part of “developing” the intangible asset. The intangibles must be measured and monitored so they can increase corporate value at the time of M&A.
As a business owner, how you choose to develop an intangible asset affects the accounting options available to your management team. Capitalization is a common technique for recording expenses as assets to minimize long-term costs. Specific rules exist about how and when to capitalize expenses that overlap with the development of the intangible assets recommended here. For example, you can capitalize costs to develop patents, copyrights, trademarks, and even proprietary software intangibles, but those costs must be recorded correctly. You cannot simply download a credit card statement 11 months after the expenses were incurred and then claim them as assets.
The principles of identifying and developing intangibles are relevant to business owners because they tie together strategies for growth, development, accounting, and exits. When used correctly, they break down silos between business units and bring together the operation and value of a business. Most venture-capital investors wait for companies to be purchased so the investor can then achieve liquidity. All owners desire M&A options for their hard work. Developing intangibles is the only way to combine the traditional business operations of growing, scaling, and building a company with the gritty accounting principles that affect the valuation and closing of an M&A deal.
Companies are rarely acquired with the intention to conduct business the same way it was conducted before the purchase. Therefore, it is important for you, the seller, to highlight the most valuable intangible assets of your business through their development and investment. This allows the buyer to utilize these intangibles to their own advantage. Ad tech companies are driven by these intangible assets, such as data interfaces, and new technology development that engages specific customers. Measuring these intangibles through the life cycle of the company will affect your exit valuation, creating a more accurate picture of what a buyer is ultimately paying for.
Identifying Intangibles in Ad Tech M&A Value
Identifying Intangibles is the first article in our series about intangible assets.
What makes your company special, unique, or valuable? As a business owner, you will be asked this question countless times when you are talking to potential buyers for your ad tech company. But the value of a company is not inherently defined; value is defined differently by parties based on their respective goals, biases, and objectives. For a banker, this discussion is the foundation for all buy-side and sell-side M&A conversations. Based on our experiences and research at Jahani and Associates (J&A), intangible assets make up over 90% of M&A value. There are simple, repeatable processes you can use to increase your company’s value, especially in the ad tech industry (J&A, “Understanding Ad Tech M&A Value”). So how to identify intangibles for M&A?
How Accounting Standards Codification (ASC) 805 Can Be Used to Maximize M&A Value
In 2014, the Financial Accounting Standards Board released an update to ASC 805 addressing how to account for intangible assets in business combinations. ASC 805 is the basis for the financial reporting of intangible assets post-acquisition. Although it is not necessary for you to follow the ASC 805 framework, if you do not utilize it to uncover and measure your company’s intangible assets, you will ultimately limit that value. Businesses can use FASB’s ASC 805 as a framework for maximizing their value prior to beginning M&A conversations.
Step 1: Define the Most Valuable Intangible Assets for Your Ad Tech Business
The first step to maximizing your company’s value is to determine which intangible assets are the most valuable. In order to do so, you must define your desired business objectives. If you are not sure where to start, begin by asking yourself the following questions:
- Who are my customers?
- How is the strength of my customer relationship measured?
- What will my revenue stream rely on over the next one to five years?
Your business’ relationship with its customers is a symbiotic one: your company exists to serve your customers and your customers are the ones who keep your company in business. Utilizing valuable intangible assets will only enhance the business-customer relationship.
For example, if your desired business objective is to increase the number of users who click the ads placed on your platform (in other words, increase conversion), you need to provide more relevant ads to the user. Tracking cookies from a user’s browser history to service these ads is a common practice to accomplish this relevant placement. This is also known as retargeting. At its core, retargeting is accomplished by increasing the number of data interfaces an ad publisher uses to determine which ads are shown to a user.
Therefore, driven by the objective to increase conversion, data interfaces are intangible assets. Collecting this browser history allows ad publishers to uncover novel patterns, enhance ad relevance, and create new solutions that increase conversion. According to an analysis conducted by Gallup, “companies that apply the principles of behavioral economics outperform their peers by 85% in sales growth and more than 25% in gross margin.”
Data interfaces are just one example. As an owner, you must determine the most valuable intangible assets for your business objectives.
Step 2: Determine How the Most Valuable Intangible Assets Affect Your Revenue Streams
Once you have defined your company’s most valuable intangible assets, you must document the way those intangibles affect your company’s revenue streams. How many events must take place for your intangible asset to create revenue? At J&A, we refer to these as “steps removed” in a process flow. For example, when a user clicks on an ad, the platform owner generates revenue. Therefore, if the intangible asset is a data interface and the presence of more data interfaces increases conversion and revenue, then that asset is one step removed from revenue. Social connections are a more complex example. The presence of social connections on a platform encourages a user to spend more time on the platform, and the more time a user spends on a platform, the more ads the user will click over time. This is two steps removed. The number of steps removed in a process flow completely depends on the business model and business objectives employed. Conversion is important for multiple types of businesses, but the steps between conversion and data interfaces can be drastically different for an infrastructure company and a platform company.
We chose to use revenue in this example because our objective was conversion. Other objectives can include reducing costs, managing risk, or increasing cash flow.
Once you have determined which intangible assets are the most valuable, it is important to measure the outcomes for the selected business purpose over time. Generally, intangible asset data and key performance indicators (KPIs) should be measured for at least one year. Business owners need to determine the right KPIs and track them regularly. The KPIs most related to encouraging conversion are traffic, traffic sources, the technology used to serve ads, and the data that determines when an ad is served.
Knowing how and what to measure is essential to increasing your company’s value. Certain interfaces are more valuable than others. A valuable interface must enhance a desired business objective. Therefore, if your goal is to increase conversion and a certain interface supports that, it is an intangible asset. A popular example of this in the M&A world is Facebook’s purchase of Instagram. Facebook approached Instagram for purchase because Facebook’s application program interfaces (APIs) were increasingly being pinged by Instagram users. Before the acquisition, a Facebook API made Instagram more valuable because it allowed Instagram to use Facebook’s large pool of customer data to enhance its own platform. J&A’s research has also shown that more data interfaces lead to higher purchase price premiums (J&A, “Understanding Ad Tech M&A Value”). Before the acquisition, this integration did not necessarily increase the value of Facebook.
Conclusion About Identifying Intangibles
Measuring important aspects of your business and tying them together with corporate financial statements is powerful. Data analyses conducted for thousands of M&A transactions confirm that they can be used to maximize the transactional value for both sides of an M&A before the sale is closed (J&A, “Understanding Ad Tech M&A Value”).
As a business owner, you can utilize the information herein to maximize your company’s value. When developed correctly, this material can significantly impact the value of your organization. Along with specialized bankers, you are uniquely positioned to develop the relationship between intangible assets and corporate financial metrics. Defining the assets that are valuable and then measuring those assets over time is the simplest yet most effective process you can use to increase the overall value of your company.
Cornell Systems Seminar
Using Systems Engineering to Maximize Corporate Value by Measuring and Developing Intangible Assets
The rise of intangible assets is well underway. Since 1995 and the dot-com boom, the value of companies has shifted from their financial statements and into their intangible assets. The narrow definition of intangible assets by regulators and investors causes innovative companies to be consistently undervalued. This undervaluation exacerbates the difficulty innovators have when aligning their competitive advantages, such as operational efficiencies, competitive business combinations, and cutting-edge technology with the business needs of a market. Systems engineering represents a powerful framework for solving this problem.
Joshua Jahani is a Cornell alum, NYU lecturer, and owner of Jahani and Associates, an investment banking firm focused on identifying and developing a company’s intangible assets to maximize its value. The firm’s Intangible Asset Methodology™ (IAM) is built on systems engineering principles to identify, develop, and monetize intangible assets across a variety of verticals. Utilizing proven qualitative and analytical skills driven by business objectives and up-to-date technology, he has spearheaded the movement towards rapid evolution and sustainable growth using rigorous profitability, ROI, and TCO analysis for organizations of all sizes. Working with exciting startups in digital advertising or large Fortune 500 companies keeps him traveling all over the world.
Joshua Jahani earned his M.Eng. in Systems Engineering from Cornell University in 2012 and teaches courses on strategy, finance, and entrepreneurship at NYU. His current research interests are intangible assets, goodwill calculation and sustainability, the customer franchise value in subscription businesses, and value-based healthcare systems and technology. He has a passion for uncovering how to create corporate value that is not shown on financial statements.