Structuring the Intangible Asset Analysis Assignment

The standard 10 stages

In this first half of his two-part series, Robert F. Reilly summarizes six of the ten typical stages of any intangible asset analysis assignment. For purposes of this article, an intangible asset analysis may include a valuation, damages analysis, transfer price study, or other economic analysis. The business appraiser will typically consider these stages, or elements, before, during, and after performing any quantitative or qualitative analyses.

Intangible Asset Analysis

Business appraisers are often asked to analyze intangible assets for a variety of reasons, including sale or license transactions, financing collateral analyses, financial reporting and fair value accounting, income tax and ad valorem property tax, bankruptcy and reorganization, and litigation support and dispute resolution (such as breach of contract, infringement, and other tort claims). For purposes of this discussion, this category of assets includes any of the intangible assets listed in FASB Accounting Standards Codification (ASC) topic 805—plus goodwill and going concern value.

This article summarizes the ten typical stages of any intangible asset analysis assignment. For purposes of this article, an intangible asset analysis may include a valuation, damages analysis, transfer price study, or other economic analysis. The business appraiser will typically consider these stages, or elements, before, during, and after performing any quantitative or qualitative analyses. This is because consideration of these engagement elements typically makes (1) the subject analysis more efficient, and (2) the selected analytical procedures more effective. And, this is because the consideration of these engagement elements typically makes the analysis conclusion more credible, replicable, and supportable. Each of these ten engagement elements is summarized below.

Understand the Analysis Purpose and Objective

A clear and concise statement of understanding of the purpose and objective of the analysis will help the business appraiser throughout the engagement. Such an understanding will help the business appraiser plan and execute the analysis. And, such an understanding will help the business appraiser keep on track throughout the various stages of the analysis.

The first component of the purpose and objective of any intangible asset analysis is a complete description of the subject intangible asset. Before quantifying any valuation, damages, or other conclusion, the business appraiser should understand what intangible asset is included in the analysis. A written description of the intangible asset should allow a report reader (or other interested party) to understand the scope of the intangible asset encompassed in the subject analysis. With regard to a complex owner/operator, a complex litigation, or a complex transaction, such a written description will also help the report reader (or other interested party) understand what assets (tangible or intangible) are not included in the subject analysis.

The second component of the analysis purpose and objective is a description of the intangible asset subject property rights. An inexperienced business appraiser may assume that the subject bundle of rights is a fee simple interest. That assumption may coincidentally prove to be correct. However, many intangible asset valuation, damages, or transfer price analyses involve consideration of either a fractional ownership interest or a limited term interest. Differences in the subject bundle of legal rights can materially affect the intangible asset analysis conclusion.

The third component of the purpose and objective is to include a definitive statement of analysis objective. Unfortunately, owner/operators, legal counsel, and others are often imprecise when they describe the intangible asset assignment to the business appraiser. Such client parties often call the engagement a valuation when the defined value of the intangible asset is not the analysis objective. Before the engagement begins, the business appraiser, the client, legal counsel, and any other interested parties should understand if the analysis objective is to conclude a defined value, a fairness opinion, a solvency opinion, an exchange ratio (or a reasonably equivalent value), a royalty rate, a license fee, a damages measure, a transfer price, or some other conclusion.

The fourth component of the purpose and objective relates primarily to a valuation assignment. That is, if the engagement objective is to conclude an intangible asset value, what is the appropriate standard of value? The standard of value is also called as the definition of value. And, for the most part, the standard of value answers the question: value to whom? Before the valuation engagement begins, all parties should agree whether the intended standard of value is fair value, fair market value, owner value, use value, investment value, acquisition value, or some other standard of value.

The fifth component of the purpose and objective is the analysis as of date. Typically, the client or the legal counsel will inform the business appraiser of the appropriate as of date. That date will often relate to a specific transaction, transfer, contract, damages event, regulatory filing, or other reason to conduct the analysis. It is often helpful for the business appraiser to understand the significance of the selected as of date. The analysis date can either be historical (often called retrospective), contemporaneous (often called current), or prospective (that is, in the future). The business appraiser should also know if the analysis involves a series of dates, such as (1) a license agreement start date and stop date, or (2) a damages period first event date and a damages termination date.

The sixth component of the purpose and objective is a clear statement of the purpose of the analysis. The purpose of the analysis explains why the analysis was prepared. The purpose may also state (or at least indicate) who may rely on the results of the analysis. While there are numerous individual reasons to prepare any intangible asset analysis, most of these individual reasons may be grouped in the following categories of purposes:

1. Notational—for example, for financial accounting, regulatory compliance, or management information purposes
2. Transactional—for example, for sale, license, transfer, financing, or similar reasons involving an actual exchange of the subject asset or of cash
3. Litigation—for example, a measurement of value or damages to convince a finder of fact in a contemplated or actual litigation
4. Taxation—for example, for income tax, gift or estate transfer tax, or property tax planning or compliance
5. Other—for example, any other purpose that does not fit one of the above-mentioned categories

Consider the Intangible Asset Highest and Best Use

The business appraiser’s consideration and conclusion of highest and best use (HABU) affects each type of intangible asset analysis. HABU considerations affect intangible asset value, damages, transfer price, and other analysis conclusions. This is because the HABU conclusion affects whether the subject analysis considers the intangible asset as part of the following transactional scenarios (1) as a stand-alone, individual asset, (2) as part of an assemblage with other, related intangible assets, or (3) as part of a going concern business enterprise. Often, the client or the legal counsel instructs the business appraiser as to the appropriate HABU assumption, often called the appropriate premise of value. However, without such an instruction, the business appraiser may have to select the premise of value that concludes the intangible assets HABU.

The criteria that the business appraiser typically uses to assess an intangible asset’s HABU are the same as the criteria that an appraiser typically uses to assess a tangible asset’s HABU. The four typical criteria for HABU are:

1. Legal permissibility—the selected transactional premise must be legal
2. Physically possible—the selected transactional premise must be physically possible
3. Financially feasible—the selected transactional premise must provide a fair rate of return to
4. Maximally productive—the selected transactional premise must result in a higher value than the owner/operator the remaining alternative premises that meet the first three criteria

Discount the Above-Listed Elements in an Engagement Letter

The business appraiser can be an independent contractor working for a third party owner/operator. The possibility also exists that the business appraiser may be an employee working for an employer owner/ operator. In either case, it is a best practice for the business appraiser to document each of the above- described elements of the analysis in some form of written documentation. Typically, the independent business appraiser will prepare a written engagement letter for the client or the client’s legal counsel. The employee business appraiser will usually prepare a written assignment memorandum for the supervisor or for the assignment file.

In both cases, the business appraiser will describe the intangible asset assignment purpose and objective. Such documentation is a best practice because it helps ensure that the business appraiser and the client (or the employer) have a consistent understanding of the assignment. Such documentation alleviates the potential for misunderstanding between the parties. Such documentation serves as a guideline for the business appraiser throughout the assignment. That is, the business appraiser can refer to the engagement letter (or memo) to ensure that the analyst is actually performing the appraiser he or she set out to prepare.

The engagement letter will typically document important assignment due dates. Such due dates may include:

1. When the client (or employer) needs the quantitative analysis results
2. When the client (or employer) needs a written analysis report
3. The expected date of trial testimony, a board presentation, a regulatory hearing, or other presentation event
4. Dates of any other deliverables, such as audit assistance, negotiation between contract counterparties, litigation support, or any other post-report activities

The engagement letter should document not only the date of any other deliverables, but also the scope of any other deliverables. That is, the letter (or memo) typically documents any continuing business appraiser commitment to periodically update the analysis, appear before taxation or other regulatory authorities, be named as a valuation expert in a Securities and Exchange Commission filing or other public document, be named as a testifying expert in litigation, etc.

Determine the Appropriate Type of Report

The instruction as to the appropriate report form and format will typically come from the client or legal counsel. The business appraiser should be aware of the type of report that the client needs. The analyst should also generally be aware of why the client needs the specified type of report (e.g., for tax compliance, regulatory compliance, litigation, or other purposes). The business appraiser should understand the required report type from the inception of the engagement. That way, as each analysis is performed, the business appraiser can consider how that analysis can be described in the final report.

There are several forms and formats of reports that may be appropriate to the intangible asset analysis. The following report type descriptions are intentionally general. That is, the following report titles do not comply with the Uniform Standards of Professional Appraisal Practice (USPAP), the American Institute of Certified Public Accountants (AICPA) Statement on Standards for Valuation Services (SSVS), or any other specific organizational standard that the analyst may intend to comply with. That is because the aforementioned professional standards only apply to valuation engagements. In contrast, the following general report format descriptions are applicable to all types of intangible asset analyses.

1. Memo report—Often, a client or employer only needs a memorandum that states the analysis assignment, methodology, research analyses, and conclusions. Such a memo report may or may not include schedules or exhibits that summarize the related quantitative analyses.
2. Opinion report—Many types of reports have a typical format that is generally accepted by practitioners within the professional community. Some examples of such opinions include fairness (for a sale or license transaction) opinions, solvency opinions, and others.
3. Summary report—This type of report typically summarizes the analysis assignment, methodology, analyses, and conclusion. It may not include all of the analyst’s supporting work and all of the data sources relied upon however; it typically includes sufficient schedules and exhibits to allow the report reader to replicate the subject analyses and confirm the subject conclusion.
4. Narrative report—This type of report format typically describes the analysis assignment, methodology, analyses, and conclusions sufficiently to allow the reader to recreate the business appraiser’s thought process. This report typically includes virtually all of the business appraiser’s supporting work and the data sources relied upon. It typically includes detailed schedules and exhibits to allow the report reader to replicate all of the quantitative and qualitative analyses and to recreate the subject conclusion.
5. Oral presentation—Much like a written memo report, the client or employer usually only needs a summarized presentation of the business appraiser’s work and conclusion. The oral presentation may be accompanied by a presentation flipchart that includes an outline of the points made by the business appraiser during the oral presentation. Such a presentation is common when the appraiser is advising the owner/operator or other parties with regard to management decision-making. Such an oral report format is usually not applicable in a contrarian (e.g., litigation) environment.
6. Oral testimony—This type of oral report is usually presented in a contrarian environment where the business appraiser may be testifying under oath or at least is subject to some form of contrarian review. In such an oral report, the appraiser may completely describe all elements of the analysis assignment, methodology, analyses, and conclusion. The oral testimony may also be accompanied by either a summary written report or a narrative written report.

Business appraisers should be aware that the expert report prepared for litigation purposes may have to comply with specific reporting standards. The business appraiser should confer with legal counsel regarding the appropriate report form and format for the subject jurisdiction. For example, in a matter litigated in a federal court, the appraiser’s report may have to comply with the Federal Rules of Evidence Rule 26 regarding the admissibility of expert reports. Again, the appraiser should obtain legal instruction from counsel with regard to the form and format of such an expert report.

This article was originally published in the Second Quarter 2013 issue of Business Appraisal Practice.

[author] [author_image timthumb=’on’]http://www.willamette.com/our_people/images/r_reilly.jpg[/author_image] [author_info]Robert F. Reilly, CFA, ASA, CPA, CBA, is a managing director in the Chicago office of Willamette Management Associates, a valuation consulting, economic analysis, and financial advisory services firm. Robert can be reached at rfreilly@willamette.com.[/author_info] [/author]