Traditional valuation approaches tend to treat customer relationships as a company’s primary asset and thus may overstate their value, particularly when an IP asset (such as a brand or technology) is the key business driver. In these instances, analysts at Valuation Research Corporation (VRC) determined that using market observations of both wholesalers and distributors as inputs in a multiperiod excess earnings method may be an appropriate approach to valuing certain types of customer relationships.

“The method assumes, and is best used when, the relationships held by a distributor with its customers are similar to those held by a company whose primary asset is something other than customer relationships, i.e. brands, technology, capital assets,” explain P.J. Patel and Ed Hamilton (both of VRC). “Distributors and the subject company have the same key driver: the ability to provide the desired product or service in a timely manner. As such, distributor inputs are a reasonable proxy when valuing the relationships of the target company.”

Patel and Hamilton are currently working on a case study of the DM for the Business Valuation Update. In the meantime, the DM will be part of The Appraisal Foundation’s (TAF) best practice guidance for valuing customer relationships, says Patel; look for the working draft to be released by the end of March.