The valuation of customer-related intangible assets is a key element of many business appraisals. These intangibles lack physical substance but are crucial assets for a company's success, often representing significant value beyond easily identifiable items like trademarks or patents. They are often linked to a company's reputation and goodwill. Purchase price allocations under ASC 805 are among the more common reasons why customer relationships and contracts are valued. However, such intangible assets might also need to be valued for tax allocations, fresh start accounting, and long-lived asset impairments, to name just a few. It is therefore important to know some key questions to address when performing an intangible valuation for customer-related intangibles.
What is the nature of the customer intangible?
When valuing a customer-related intangible asset, it is important to understand the nature of the asset. Is a customer relationship being valued? If so, is the relationship contractual in nature, or non-contractual? Or, is the customer asset being valued more akin to a customer list? The answers to these questions will go a long way in determining how the appraiser will value the asset.
What valuation methodologies are appropriate to utilize when valuing customer intangible assets?
A business appraiser may choose among several different possible methodologies when valuing customer-related assets. Commonly accepted methodologies include the multi-period excess earnings model (“MPEEM”), a method under the income approach, as well as the cost approach.
With the MPEEM method, the prospective earnings of the single subject intangible asset are isolated from those of the group of assets by identifying and deducting portions of the total earnings that are attributable to the contributory assets. This is done in order to estimate the remaining or “excess” earnings attributable to the subject intangible asset. The identification of earnings attributable to the contributory assets is accomplished through the application of contributory asset charges (“CACs”) in the form of returns “on” and, in some cases, “of” the contributory assets. These CACs represent an economic charge for the use of the contributory assets. The “excess” earnings (those that remain after subtraction of the CACs) are attributable to the subject intangible asset.
Unlike depreciation, which applies to tangible assets, amortization is the expensing method typically applied to these types of intangibles.
What revenue stream should I use?
Only those forecasted revenues which are subject to the customer contract, or non-contractual customer relationship, being valued, should be included in the MPEEM model. For example, if a particular type of customer contract is being valued, then only the revenues associated with that contract type should be included. On this note, it is typically not advisable to perform more than one MPEEM analysis in a single allocation, unless the separate MPEEM’s have separate distinct forecasted revenue streams ascribed to them.
When and how should attrition be applied?
When valuing customer intangible assets, an attrition rate is typically applied to the forecasted revenue to reflect the expected loss of current customers over time. An attrition rate can be calculated many different ways, and is a key input into a customer relationship valuation. In our experience, the attrition rate is an input that typically receives a great deal of scrutiny from auditors and other regulators when reviewing asset appraisals. The manner in which attrition is applied can differ between different types of customer assets, including contractual and non-contractual customers.
What contributory asset charges should be considered?
Another key input to a MPEEM analysis is the charges to be taken for contributory assets. Contributory assets are defined as assets that are used in conjunction with the customer intangible asset to realize the prospective cash flows associated with the customer intangible. Some typical contributory assets to consider when valuing a customer intangible asset include:
- Working capital
- Fixed assets
- Assembled workforce
- Other intangible assets
A customer intangible asset appraisal is a cornerstone of many business valuations, particularly for high-stakes events like purchase price allocations or asset impairment analyses. Carefully considering and addressing these five key questions is essential. This preparation will help ensure a smoother, more defensible valuation process.
Because the valuation inputs, assumptions, and methodologies used in a customer-related intangible appraisal are often heavily scrutinized by auditors and regulators, clarity and precision are paramount. Understanding these nuances helps your business achieve credible results, allowing you to confidently meet regulatory requirements and support your financial reporting needs.
