BVR’s recently released third edition of Benchmarking Identifiable Intangibles and Their Useful Lives in Business Combinations seeks to provide context for experts valuing intangibles after all the recent guidance, international regulatory action, and new standards.

Empirical data from actual valuations is also included to help business valuers facing complex assets. Benchmarking Identifiable Intangibles and Their Useful Lives in Business Combinations includes data focused on:

• Useful lives of intangible assets as reflected in almost 16,000 purchase price allocations;

• What intangibles are being discovered, categorized, and valued in specific industries;

• Remaining useful life guidance; and

• A target companies’ intangible property strength, amortisation strategies, and their composition of goodwill.

The valuation of intangible assets relies on the three distinct approaches that are familiar to all valuation professionals. Chapter 2 of the new edition summarises these approaches:

1. The cost approach uses the cost of reproduction or replacement of the asset;

2. The market approach uses transactions involving similar assets as the basis for valuation of a specific asset; and

3. The income approach estimates asset value based on the present value of a future income stream (remaining useful life of the asset is a critical element).

While knowing what these approaches are is obviously very important, understanding which method to use in a given situation can very easily make or break your valuation.

Cost approach: This technique reflects the amount that would be required to replace the service capacity of an asset. Oftentimes, this approach is referred to as the replacement cost.

Cost is most often defined in terms of either historical cost, reproduction cost, or replacement cost, as follows:

• Historical cost considers the actual cost that had been incurred to develop the asset;

• Reproduction cost considers the cost of producing an exact replica of an asset using the same or similar materials at current prices; and

• Replacement cost considers the cost of acquiring a substitute asset of comparable utility.

For fair value projects, replacement cost new is the most meaningful basis of value when the views of market participants assessing an asset are considered.

When an intangible asset is less useful than its ideal replacement, its value should be adjusted to reflect loss of economic value due to:

• Functional (technological) obsolescence: impairment of its functional utility according to market standards at the valuation date;

• Economic obsolescence: market conditions, competitors; and

• Physical deterioration: not generally applicable to intangible assets.

The cost approach is often applied to value assets that are not directly responsible for the income generation of the business.

Income approach: The income approach employs a range of valuation techniques that convert future amounts (e.g., cash flows, income, or expense savings) to a single current (i.e., discounted) amount. The fair value measurement is determined on the basis of the value market expectations indicate at the valuation date about those future amounts.

Alternative methods within the income approach reflect differences in the quantification of the benefit stream. Key methods include:

1. Multiperiod excess earnings method (MPEEM):

• Estimate total income for business or business unit;

• Deduct shares of income for all “required” assets; and

• Calculate present value of remaining income (excess earnings after returns for other required assets (contributory assets)) using appropriate risk-adjusted discount rates.

2. Relief from royalty method:

• Estimate projected future revenues associated with an intangible asset;

• Develop estimate of royalty rate for use of the asset; and

• Calculate present value of royalty savings.

3. Cost savings methods:

• Relief from royalty method (RFR method);

• Income increment/cost decrement method (with and without method, or WWM); and

• Direct estimate of cost savings.

4. Greenfield or build-out methods.

The MPEEM is best suited for assets that “drive” surplus cash flow of an enterprise. These assets are referred to as primary or enabling assets.

Market approach: Typically, in valuation engagements that use the income approach, there are availability and comparability issues with the market approach. Given this, the market approach is infrequently applied in the valuation of most intangible assets. To employ the market transaction method, the valuation will require:

• Arm’s-length market transaction data for similar, guideline assets; and

• Adjustment for material differences between guideline and subject asset.

A number of factors reduce the ability to employ the market approach to value intangible assets. These include:

• Intangible assets are often very unique;

• There are limited guideline transaction data for intangible assets;

• When intangibles are sold, they are typically sold with other components of a business enterprise; and

• If sold individually, transactions are not often subject to public disclosure.

The working group made up of representatives of the Royal Institute of Chartered Surveyors (RICS) and the International Valuation Standards Council (IVSC), as well as the American Society of Appraisers (ASA), the Saudi Authority for Accredited Valuers (TAQEEM), and the Canadian Institute of Chartered Business Valuators (CBV Institute), developed and released the new International Valuation Glossary—Business Valuation last month, which is intended to replace the glossary last published in 2001.

Many other organizations, such as the Institute of Chartered Accountants in England and Wales (ICAEW), the National Association of Certified Valuation Analysts (NACVA), and The Appraisal Foundation, were consulted to guarantee concensus.

You may download the new International Valuation Glossary here (free registration required).

Not authoritative: The release of this final Glossary was somewhat delayed after the initial draft release in December 2020 by concerns that they could be seen as standards or that business valuers would be “quizzed” on them during contentious valuations. No group in the UK or elsewhere recognises them as standards, and the working group does not intend the new glossary to be authoritative.

BVWire—UK notes that many financial terms and standards of value defined in the draft version of the glossary that are not regularly used in business valuation reports have been removed in this final version.

RICS (and TAQEEM, the CBV Institute, and the ASA) will publish the new glossary as a practice aid/guidance to their members. The IVSC is supportive of the new glossary, but the International Valuation Standards (IVS) define only terms used within IVS.

The working group says it “encourages other organisations to use and reference the glossary in any way they see fit.”

The spring 2021 issue of the journal of the Organismo Italiano di Valutazione (OIV), the valuation standards-setter in Italy, contains the following articles:

• “Cross-Border DCF Valuation in a Nutshell” (Andreas Schueler);

• “Level 3 Reporting Quality: Trend Analysis of Derivative Instruments’ Restatements” (Joel M. DiCicco, Richard S. Gendler, Uliana Filatova, and Teodora Minkova); and

• “Business Valuation and Fundamental Analysis” (Mauro Bini).

To download the journal, click here.

In addition, the latest Summer 2021 issue of the ASA’s Business Valuation Review has been added to BVR’s BVResearch Pro platform. BVResearch Pro contains the full archive of BV Review (going back to 1982!), the business valuation journal of the American Society of Appraisers. The new issue includes these articles:

• “A Current View of the Restricted Stock Studies and Restricted Stock Discounts” (Z. Christopher Mercer, Mercer Capital). Restricted stock studies can be helpful for marketability discount determinations, but too many valuation analysts continue to rely on simplistic comparisons with averages of restricted stock discounts from dated studies.

• “When Averaging Multiples, the Arithmetic Mean Is Inferior to the Harmonic Mean” (Gilbert E. Matthews, Sutter Securities). A multiple is an inverted ratio with price in the numerator. The harmonic mean is a statistically sound method for averaging inverted ratios. It should be used as a measure of central tendency for multiples, along with the median.

• “Attrition Analysis, Midperiod Convention, and Customer Retirement Forecasts” (Richard K. Ellsworth). Valuation practitioners that develop an attrition analysis founded on a midperiod retirement convention should not then apply an end-of-period convention when forecasting customer retirements.

• “Business Valuation: An Integrated Theory.” This is a review by William H. Frazier of the recently published third edition of Business Valuation: An Integrated Theory (BVIT) by Z. Christopher Mercer and Travis W. Harms.

Stand-alone subscriptions to the ASA’s BV Review may be obtained here.

The last several months have seen multiple agreements designed to reduce international tax competition and minimise the abuses that result from offshore asset schemes. At the same time, HMRC have initiated a “nudge letter” campaign to taxpayers who may be holding undisclosed crypto accounts—and the UK’s High Court has done its part by denying a request to reverse an offshore Employee Benefit Trust scheme on the grounds of “mistake.”

The ruling in the case of Bhaur & Ors v Equity First Trustees (Nevis) Ltd & Ors [2021] EWHC 2581 (CH) offers a thorough explanation of the type of complex structures wealthy families use to minimise taxes. Mr and Mrs Bhaur ran a property partnership that incorporated and set up a first remuneration trust for the benefit of employees, funded by a partial transfer of the properties.

Then BVI company (BVI) was set up with interests transferred. Soon after, a Nevis company was formed and the property BVI held was transferred to Nevis, which created a second remuneration trust (the specifics of these transactions are fully documented in the High Court decision). These weren’t enough, so properties and shares were transferred to “an employee” in Nevis who would use the assets to purchase annuities that would be transferred to yet another Nevis trust.

Some of the assets transacted business with new companies formed in Mauritius. The Bhaur family acted as investment advisor and collected fees from many of these various entities, and experts valued various corporate assets to support transfers at each stage.

It all worked until the scheme tried to make payments to junior members of the Bhaur family in 2016. HMRC demanded substantial tax payments on these benefits paid to “employees,” so the Bhaurs challenged the payments and the junior family members refused to accept them. Realizing that the scheme had not achieved its goal, and that the trustees intended to dissolve some of the trusts and give 90% of the assets to the default trust beneficiary (in this case, the National Society for the Prevention of Cruelty of Children), the Bhaurs asked that the first and second trust be set aside on the grounds of mistake, saying that the scheme was unlawful and dishonestly promoted.

The High Court dismissed the case and refused to set aside the scheme, including either of the remuneration trusts. The judge referred to the new structure as a “dangerous game of double or quits,” which was consciously played and which strongly suggested there was no mistake when the Bhaur family first entered into the scheme.

Valuation experts frequently receive forecasts that start modestly but accelerate dramatically in future years. Many academic studies conclude that overly optimistic forecasts are the norm—and few SMEs ever meet their targets. It’s generally up to business analysts to adjust forecasts as part of their business valuation work.

But what if the valuation expert has confidence in what may appear to be unrealistic projections from management? How can the expert provide evidence in support of those future claims?

In a blog post, Chris Mercer (Mercer Capital) recalls having a hockey-stick projection from a bank that currently had low earnings. It appeared that the bank could not possibly achieve that level of performance found in the bank’s own current capital plan for the next five years, which had been prepared for regulatory review in the normal course of business. Mercer was accused of unrealistically relying on the bank’s capital plan.

In response, Mercer referred the attorney to an exhibit in the valuation report that compared the previous five years’ performance with the earnings and returns of the capital plan. “There, it was clear that the projected returns (on assets and equity) were within the levels achieved by the bank in the previous few years, and below the current level of the bank’s peer group,” Mercer writes. “Value today is a function of expectations for future performance—and the expectations used were in line with past performance, management’s stated plans, management’s business plan, and the performance of similar banks.”

This situation illustrates the importance of professional skepticism, especially when reviewing management’s prospective financial information (PFI). Common procedures include, but are not limited to, a comparison of prior forecasts to actual results, comparison of PFI to industry expectations, checking the PFI against other internally prepared financial information for consistency, a comparison of entity PFI to historical trends, an understanding of who prepared the PFI and how often it is prepared, and math and logic checks.

1-9 December: Practical Business Valuation, ICAEW live—online (four sessions) 09:30-12:30 BT

3-5 October 2022: 12th Annual International Valuation Conference, Riyadh, Saudi Arabia

Want to share a news item? Have feedback or comments? Please contact David Foster at ukeditor@bvresources.com.

Want to share a news item? Have feedback or comments? Please contact
David Foster at ukeditor@bvresources.com.