Second Edition Excerpt from: Benchmarking Identifiable Intangibles and Their Useful Lives in Business Combinations
Benchmarking Identifiable Intangibles and Their Useful Lives in Business Combinations SECOND EDITION 1000 SW Broadway, Suite 1200, Portland OR 97205 (503) 291-7963 www.bvresources.com
Copyright 2015 by Business Valuation Resources, LLC (BVR). All rights reserved. Printed in the United States of America. No part of this publication may be reprinted, reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Sections 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher or authorization through payment of the appropriate per copy fee to the Publisher. Requests for permission should be addressed to the Permissions Department, Business Valuation Resources, LLC, 1000 SW Broadway St., Suite 1200, Portland, OR 97205; (503) 291-7963; fax (503) 291-7955; permissions@bvresources.com. Information contained in this book has been obtained by Business Valuation Resources from sources believed to be reliable. However, neither Business Valuation Resources nor its authors guarantee the accuracy or completeness of any information published herein and neither Business Valuation Resources nor its authors shall be responsible for any errors, omissions, or damages arising out of use of this information. This work is published with the understanding that Business Valuation Resources and its authors are supplying information but are not attempting to render business valuation or other professional services. If such services are required, the assistance of an appropriate professional should be sought. Editor: Adam Manson Publisher: Sarah Andersen Managing Editor: Janice Prescott Chair and CEO: David Foster President: Lucretia Lyons Vice President of Sales: Lexie Gross Customer Service Manager: Retta Dodge ISBN: 978-1-62150-056-8 Library of Congress Control Number: 2015951284
Table of Contents INTRODUCTION... 5 CHAPTER 1. PURCHASE PRICE ALLOCATIONS: DEFINITIONS AND AUTHORITY... 9 CHAPTER 2. TECHNOLOGY... 13 A. PATENTED TECHNOLOGY... 13 B. COMPUTER SOFTWARE... 16 C. UNPATENTED TECHNOLOGY... 22 D. DATABASES... 24 CHAPTER 3. TRADE SECRETS... 27 CHAPTER 4. MARKETING INTANGIBLES... 31 ARTISTIC INTANGIBLES... 40 CHAPTER 5. CUSTOMER-RELATED INTANGIBLES... 51 CHAPTER 6. FAVORABLE CONTRACTS (NOT SALES)... 59 CHAPTER 7. NONCOMPETES... 61 CHAPTER 8. INDEFINITE-LIVED INTANGIBLES... 65 GOODWILL... 65 ASSEMBLED WORKFORCE... 66 IPR&D (IN PROCESS RESEARCH & DEVELOPMENT)... 67 www.bvresources.com 3
Benchmarking Identifiable Intangibles and Their Useful Lives in Business Combinations CHAPTER 9. DATA SLICES: BY IDENTIFIABLE INTANGIBLE ASSET CATEGORY................. 71 USEFUL LIVES (YEARS)... 71 VALUE AS PERCENTAGE OF IDENTIFIABLE INTANGIBLE ASSETS... 72 VALUE AS PERCENTAGE OF TOTAL INTANGIBLE ASSETS... 73 CHAPTER 10. DATA SLICES: BY INDUSTRY... 75 AVERAGE INTANGIBLE LIFE (YEARS)... 76 AVERAGE INTANGIBLE VALUE AS A PERCENTAGE OF IDENTIFIABLE INTANGIBLE ASSETS... 78 AVERAGE INTANGIBLE VALUE AS A PERCENTAGE OF TOTAL INTANGIBLE ASSETS... 80 AVERAGE INTANGIBLE VALUE AS A PERCENTAGE OF SOLD BUSINESS VALUE... 82 MEDIAN INTANGIBLE LIFE (YEARS)... 84 MEDIAN INTANGIBLE VALUE AS A PERCENTAGE OF IDENTIFIABLE INTANGIBLE ASSETS... 86 MEDIAN INTANGIBLE VALUE AS A PERCENTAGE OF TOTAL INTANGIBLE ASSETS... 88 MEDIAN INTANGIBLE VALUE AS A PERCENTAGE OF SOLD BUSINESS VALUE... 90 4 www.bvresources.com
Introduction The value of an intangible asset is typically a function of the future economic income that is expected to be derived from the ownership or operation of that intangible asset during its expected remaining useful life (RUL). All three of the generally accepted intangible asset valuation approaches (i.e., income approach, market approach, and cost approach) depend, to varying degrees, on the expected RUL of the subject intangible asset. Traditionally, IP values have been underreported in financial statements, due mainly to two factors that stem from generally accepted accounting principles (GAAP): Internally grown intangible assets are neither capitalized nor reported on the balance sheet; rather, their historical costs (design, prosecute and maintain, promote, defend, etc.) are expensed as spent; and A vague/mysterious/opaque goodwill category has been utilized to capture the allencompassing excess of the purchase price over book value paid in mergers and acquisitions. In 2001, the Financial Accounting Standards Board (FASB) issued statements 141 (now ASC 805) and 142 to reform that practice. The changes created a uniform procedure whereby the acquiring entity in a business combination must perform a purchase price allocation (PPA) that matches the purchase price to asset values of the acquired company, including, importantly, intangible assets. Intangibles based on contracts and legal rights are distinguished from general goodwill, which remains a residual value. What intangibles are valuation analysts isolating and CFOs reporting in PPAs? What remaining useful lives are they assigning? Are there industry nuances? Heretofore, analysts have been on their own in estimating remaining useful lives, without significant benchmarks. Auditors have been at a similar loss, as have CFOs. Pamela Garland, in Estimating IP Remaining Useful Life, a 2004 Willamette Insights article, outlined the importance of remaining useful lives of intangibles: www.bvresources.com 5
Benchmarking Identifiable Intangibles and Their Useful Lives in Business Combinations When a cost approach method is used, RUL should be considered in the estimation of obsolescence. When an income approach method is performed, RUL should be considered in determining the term of the income projection period. When a market approach method is used, RUL is a factor (1) in assessing the comparability of the market transactions to the subject property and (2) in estimating any adjustments to make the guideline sale/license transactions more comparative to the subject property. Willamette Management Associates explained the difference between a business valuation and valuation of intangible assets in detail at a National Association of Certified Valuation Analysts (NACVA) conference. Exhibit 1 highlights the importance of a remaining useful life analysis in valuation of intangible assets. Exhibit 1. Importance of Remaining Useful Life Analysis in Valuation of Intangible Assets Analysis variables Intangible asset valuation Business valuation Operating income That portion attributable to asset All Life Limited remaining useful life (RUL) Usually in perpetuity Discount rate Higher Lower Obsolescence Affects RUL Business adapts Highest and best use Requires analysis Management usually knows Approaches Income, market, cost Income, market, asset-based Legal rights Several ownership interests Fee simple interest The purpose of the research in this publication is not to provide complete coverage of intangible property valuation methodologies and theory. Rather, it is a compilation of useful, reported data, particularly on remaining useful lives of intangible assets, as well as their value relative to the total amount of intangible assets and to the business s selling price, as reflected in over 6,000 purchase price allocations, gleaned from the databases available at Business Valuation Resources, LLC. 1 That being said, this work provides other useful data such as: 1. Valuing noncompete agreements. Analysts many times feel they have to work in a vacuum when valuing noncompetes. It is important to benchmark against what others are finding in similar industries and with similar deal sizes. Data in this volume provide such benchmarks. 2. Dominance of intangible assets. Scientific, financial, and lay press articles repeatedly suggest the ratio of intangible assets to total assets is large and growing. This concept buttresses the idea that these assets need to be managed, that growth and sustainability are dependent upon the attention paid to intangibles. To our knowledge, no statistical compilation derived directly from fair value valuations of intangibles and total assets has ever been compiled to support these statistical claims with hard data until now. The ratio of intangible assets to total assets defined by this detailed study of purchase price allocations is 72%. 1. Data analyzed for this study are contained in the Public Stats and Pratt s Stats databases, which are available at www.bvresources.com. 6 www.bvresources.com
Introduction 3. Spotlight on amortization tendencies. Benchmarking living data for intangibles also has the side benefit, primarily for investors, of spotlighting who is stringing out amortization, perhaps to inflate current income, and who is taking more rapid appreciation, perhaps to minimize taxes. Who will use this publication? 1. Valuation analysts will use this work to benchmark what intangibles are being discovered, categorized, and valued in specific industries, as well as to provide remaining useful life guidance, noncompete agreement benchmarks, and benchmarks as to industry. 2. Auditors want to know what others are doing. 3. CFOs take on the Sarbanes-Oxley responsibility when purchase price allocation valuations are reported and require a close look at amortization rationales. 4. Investors will see benchmark data they have never seen before, gleaned from public filings, to compare to a target company s intangible property strength, amortization strategies, and composition of goodwill. How to use this guide. There are three ways into this study. The first is by reviewing the various intangibles, wherein descriptions of valuation approaches are coupled with checklists of factors to consider. Here, readers get a good feel for the nature of the intangibles before proceeding to the statistical data on valuations and remaining useful lives (RULs). The second is to go directly to Chapter 9 for data slices organized by intangible. The third approach is to go directly to Chapter 10 for data slices showing how intangibles valued in business combinations are treated by industry. On page 9 is a brief explanation of purchase price allocations, the source of data for this study. Exhibit 2 on page 10 is a graphic representation of how to determine identifiable intangible assets in PPAs. On page 11 begins a long list of FASB-identifiable intangible asset categories. (Readers who wish to see what is being identified by industry can move directly to industry data slices in the back of the study.) www.bvresources.com 7
Chapter 9. Data Slices: By Identifiable Intangible Asset Category www.bvresources.com 71
Benchmarking Identifiable Intangibles and Their Useful Lives in Business Combinations * The total number of observations is the total number of purchase price allocations for each industry. The figure does not necessarily reflect the number of observations for each intangible asset class in the summary information. The count of observations excludes those for noncompetes; there were over 13,000 observations of noncompete lives and values. The purchase price allocations are organized by sector, according to the North American Industry Classification System. For more information, visit www.census.gov. 76 www.bvresources.com
10. Data Slices: By Industry * The total number of observations is the total number of purchase price allocations for each industry. The figure does not necessarily reflect the number of observations for each intangible asset class in the summary information. The count of observations excludes those for noncompetes; there were over 13,000 observations of noncompete lives and values. The purchase price allocations are organized by sector, according to the North American Industry Classification System. For more information, visit www.census.gov. www.bvresources.com 77
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