Financial valuation Applications and Models phần 9 potx

remainder or residual amount equates with goodwill. Keep in mind, goodwill includes assembled workforce, but assembled workforce was valued separately to obtain a contributory return for IPR&D and technology. As a result and pursuant to SFAS No. 141, the indicated value of assembled workforce must be added to the indicated value of goodwill to arrive at the fair value of goodwill for financial state- ment reporting purposes. 96 For financial reporting purposes, included in the goodwill value is the fair value of the assembled workforce of $1,790,000. Based on this analysis, the fair value of Goodwill on December 31, 2001, was $62,050,000 (Exhibit 20.14). ALLOCATION OF PURCHASE PRICE The summary allocation of values is presented in Exhibit 20.15. In this exhibit, the valuation conclusions are separated into three groups: total current and tangible assets, total intangible assets, and goodwill. Individual asset valuations are pre- sented within each group. In addition to presenting the summary of values, this schedule provides a gen- eral sanity check in the form of a weighted return calculation. The weighted return calculation employs the rate of return for each asset weighted according to its fair value relative to the whole. The weighted return can equal or approximate the over- 814 VALUATION OF INTANGIBLE ASSETS 96 FASB, Statement of Financial Accounting Standards No. 141, at B169. Exhibit 20.14 Target Company: Valuation of Goodwill as of December 31, 2001 ($000s) Cash and Acquisition Costs $150,000 Debt-Free Current Liabilities 25,000 Current Maturities of Long-Term Debt 4,000 Long-Term Debt 30,000 _______ Adjusted Purchase Price 209,000 Less: Fair Value of Current Assets (41,500) Less: Fair Value of Tangible Assets (41,000) Less: Fair Value of Intangible Assets Software (7,070) Customer Base (6,490) Trade Name (23,760) Noncompete Agreement (9,300) Technology (13,500) In-Process Research and Development (4,330) _______ Residual Goodwill $ 62,050 _______ _______ Note: Some amounts may not foot due to rounding. © Copyright 2002 by John Wiley & Sons, Inc. Used with permission. all weighted average cost of capital for the business, although the rates may not exactly be equal because the WACC equates to the business’s invested capital (here, $184,000,000) while the weighted return calculation represents total asset value ($209,000,000). The returns for each asset are those actually used in the forgoing valuation methodology, that is, for tangible assets and contributory intangible assets. For con- tributory intangible assets that were valued using a form of the income approach (trade name and noncompete agreement), the return is equal to the discount rate used to value that asset. Finally, the return for the assets valued under the multi- period excess earnings approach is also their discount rate. It should be clear that the one asset for which we do not have a return is good- will and, admittedly, the return assigned is determined by trial and error. The good- will return is imputed based on the overall weighted return needed to equal the weighted average cost of capital. Allocation of Purchase Price 815 Exhibit 20.15 Target Company: Valuation Summary as of December 31, 2001 ($000s) Percent To Fair Market Purchase Weighted Asset Name Value Return Price Return __________ __________ _______ ________ ________ Cash $ 1,500 5.00% 0.7% 0.04% Investments in Marketable Securities 8,000 5.00% 3.8% 0.19% Accounts Receivable 17,000 5.00% 8.1% 0.41% Inventory 12,000 5.00% 5.7% 0.29% Prepaid Expenses 3,000 5.00% 1.4% 0.07% Land and Buildings 22,000 7.00% 10.5% 0.74% Machinery and Equipment, net 19,000 8.00% 9.1% 0.73% __________ Total Current and Tangible Assets $ 82,500 __________ __________ Software $7,070 18.00% 3.4% 0.61% Technology 13,500 18.00% 6.5% 1.16% In-Process Research and Development 4,330 25.00% 2.1% 0.52% Trade Name 23,760 16.00% 11.4% 1.82% Customer Base 6,490 18.00% 3.1% 0.56% Assembled Workforce 1,790 16.00% 0.9% 0.14% Noncompete Agreement 9,300 16.00% 4.4% 0.71% __________ Total Intangible Assets $ 66,240 __________ __________ Goodwill (excluding assembled workforce) $ 60,260 28.00% 28.8% 8.07% __________ ______ __________ Total Assets $209,000 16.05% __________ ______ __________ ______ Note: For financial reporting purposes, the fair value of goodwill includes the fair value of assembled workforce for a total fair value of residual goodwill of $62,050.000. Note: Some amounts may not foot due to rounding. © Copyright 2002 by John Wiley & Sons, Inc. Used with permission. 816 VALUATION OF INTANGIBLE ASSETS If a goodwill return of, say, 10 percent is required to achieve a weighted return of approximately 16 percent, this signals a problem and the analyst will have to go back and review and revise his or her work—something is wrong! In this calcula- tion, the goodwill return of 28 percent suggests that goodwill is substantially riskier than all of the other assets but, at a return of 28 percent, still well within reason for a proven going concern. Thus, the returns chosen for each asset are reasonable. By its nature, goodwill is the riskiest asset of the group and there- fore should require a higher return than the overall business return. ValTip Appendix 817 APPENDIX—INTELLECTUAL PROPERTY One of the major difficulties in valuing intellectual property is determining value in the context of licensor/licensee negotiations. All too often this context is assumed or sim- plified, resulting in market royalty rates being applied out of context. Most valuation analysts traditionally develop royalty rates from any of three traditional sources: 1. Negotiated licensing agreements 2. Surveys performed by various professionals, generally in cooperation with trade associations 3. Judicial opinions which vary greatly depending on individual fact patterns These traditional tools can now be augmented by databases of licensing agree- ments extracted from publicly available sources. Such direct market data is some of the most compelling evidence available to determine the appropriate royalty rate in a valuation. The market comparison-transaction method approach initially has four steps to derive an overall value estimate: 1. research the appropriate market for comparable intellectual property transac- tions; 2. verify the information by confirming that the market data obtained is factually accurate and that the license exchange transactions reflect arm’s length market considerations; 3. compare and apply the guideline license transactions’ financial and operational aspects with the subject intellectual property; and 4. reconcile the various value indications into a single value indication or range of values. Empirical Research and Verification of Royalty Rates Proprietary research of intangible assets and intellectual properties is important in business valuation. The value the market perceives in intellectual property-intensive companies is associated with their intangible assets and intellectual properties. Valuation of such companies is often an exercise in intangible asset valuation meth- ods rather than traditional business valuation methods. Emphasis should be placed on proprietary studies (industry research, industry pricing metrics, and comparable intellectual property transactions). Research and verification of comparable data can be a time-consuming process. Recently, advances in information technology and the availability of online public records have made research of intellectual property transactions a realistic endeavor. Databases that gather and organize comparative intellectual property transac- tions are rapidly becoming the tool of the future to those analysts who specialize in intellectual property valuation. At the time of publication, three Internet sites pro- vide information for a fee: 1. RoyaltySource (www.royaltysource.com) 2. Consor ® (www.consor.com) 3. The Financial Valuation Group (www.fvginternational.com) 818 VALUATION OF INTANGIBLE ASSETS Comparing and Applying the Data Intellectual property transactions should be compared to the subject company using the following guidelines: • The specific legal rights of intellectual property ownership conveyed in the guide- line transaction • The existence of any special financing terms or other arrangements • Whether the elements of arm’s length existed for the sale or license conditions • The economic conditions that existed in the appropriate secondary market at the time of the sale or license transaction • The industry in which the guideline intellectual property was or will be used • The financial and operational characteristics of the guideline properties, com- pared with the company’s intellectual property Reconciliation The last phase of the market approach valuation analysis is the reconciliation. The strengths and weaknesses of each comparable transaction are considered; the relia- bility and appropriateness of the market data are examined, including the analyti- cal techniques applied. After considerable review, transactions selected should be reasonably comparative to the company transaction and then synthesized into a rea- sonable range. Detailed Example of an Intellectual Property Database The intellectual property transactions database of The Financial Valuation Group is based on publicly available data. It includes approximately 40 fields comprised of the names of the licensor and licensee, both the Standard Industrial Classification (SIC) and North American Industry Classification System (NAICS) numbers for the licensor and the licensee, the type of agreement (i.e., trademark, patent, copyright), the industry name, the remuneration structure, royalty percentages (base rate, the low end and high end of variable rates), royalty dollars (base flat fee, annual and variable fees), a descrip- tion of the product or service, and so on. Custom searches of the database (using key- words, SIC/NAICS numbers, or both) can be performed to obtain market comparables. Searches of “all transactions” in The Financial Valuation Group database at the publication date revealed: Transactions by Industry Industry groups as represented by the first two digits of the U.S. government SIC codes are represented in transactions in the database as shown in Exhibit 20.16. Intellectual Property Typically Licensed While there are approximately 90 distinctly different intangible assets, the majority of assets licensed are intellectual property assets which can be grouped within cate- gories as shown in Exhibit 20.17. Patents tend to be the most-licensed intellectual property, with trademarks, products, and technology following respectively. Appendix 819 Payment Structures of Intellectual Property Transactions A comparison of the royalty payment structures disclosed in each transaction reveals that approximately half of the licensing agreements are based on a set per- centage or set dollar amount. There are many transactions that involve high/low payments, which are usually based on performance, sales, or both. Annual Fee and Monthly Fee agreements tend to be set at a fixed amount paid on a regular basis throughout the life of the agreement. Exhibit 20.18 shows the various royalty rate payment structures by the reported transactions analyzed. Reasons to Use the Database The database is used to support: • Damages in an intellectual property litigation case • Reasonable royalty percentage rates • Accurate valuation conclusions • Rebuttal of unreasonable value estimates put forth by others • Transfer pricing opinions Because royalty rates derived from transactions take so many economic struc- tures, it is difficult to interpret them in a manner that is useful for a particular need. Analysis of licensing transactions similar to a particular fact situation would be nec- essary to determine a market royalty rate applicable to that situation. The analyst with requisite skill, education, and experience will be able to draw upon the data to form better-founded and defensible conclusions and opinions. Exhibit 20.16 Intellectual Property Transaction Database—Transactions by Two-Digit SIC Industry 1% 4% 20% 25% 19% 4% 10% 4% 13% 10 - Mining, Construction (4%) 20 - Pharmaceutical, Apparel (20%) 30 - Electronics, Instruments (25%) 40 - Transportation, Utilities (4%) 50 - Wholesale, Retail (10%) 60 - Finance, Real Estate (4%) 70 - Services, Computer (19%) 80 - Health, Research (13%) 90 - Public Administration (1%) © Copyright 2001. The Financial Valuation Group, LC. Used with permission. 820 VALUATION OF INTANGIBLE ASSETS Exhibit 20.18 Payment Structures of Database Transactions Fixed Dollars and Fixed Percent Combined (12%) Fixed Percent (25%) Percent Variable (14%) Percent and Dollar Combined, Variable (7%) Dollar Variable (4%) Fixed Dollars (25%) Royalty Free (8%) Undisclosed/Unknown (5%) © Copyright 2002. The Financial Valuation Group, LC. Used with permission. Exhibit 20.17 Database Percentages for Intellectual Property Types 21.9 17.5 16 15.9 8.3 7.7 12.8 0510 15 20 25 Patent Trademark Product Technology Franchise Software Other Percent © Copyright 2002. The Financial Valuation Group, LC. Used with permission. 821 Marketing, Managing, and Making Money in a Valuation Services Group PURPOSE AND OVERVIEW In addition to providing intellectually challenging work projects with almost endless variety, the field of business valuation offers potential for outstanding compensation. However, it is possible to win an engagement and provide quality client service but fail to bill and collect a fair fee and/or incur sizable cost overruns due to poor practice management. Optimizing the potential of a business valuation practice is not acciden- tal, nor is it the natural result of merely “doing good work.” It involves developing a strong skill set in nontechnical areas such as marketing and practice management. For the purposes of this chapter, the term “good economics” will be used to indicate a business valuation practice that has optimized its potential, given such practice characteristics as the types of clients, the geographic market served, type of services offered, staff size and quality, and age of the practice. This chapter explores the key determinants of good economics for a given business valuation practice, summarized as: • The qualifications of the practice professionals to provide the particular services offered by the firm • The existence of niche valuation services that the firm can serve profitably • The temperament suitability of the practitioners, especially the leadership, for the type of engagements undertaken • The practice’s acceptance criteria for engagements and its adherence to these criteria • The management/operating practices of the firm When the three Ms—marketing, managing and money—are all properly syn- chronized, business valuation in a professional services firm can be a rewarding career. It is important to note that these very broad and informal engagement and practice guidelines outline suggested goals that may not be achievable depending on the nature and type of practice. They are also more applicable to a group practice. WHAT GOOD ECONOMICS LOOKS LIKE Record Maintenance and Analysis To attain good economics, a practice should set realistic goals for operational results and analyze unfavorable variances to determine the changes that should be made to CHAPTER 21 achieve specified goals. Management should keep complete and timely records of key practice results and analyze the results against previous periods and against budgets and goals. Higher Billing Rates Until a practice’s reputation is established in the marketplace, it may not be able to command top fees. However, practices should attempt to exit a market or type of service that will not allow for higher rates over time, unless there are compelling rea- sons to remain in that market or offer that service, such as a high volume of engage- ments, to gain experience or because of the type of marketplace. Realization and Productivity If the practice’s rate structure (hourly or fixed fees) is appropriate for its skill sets and marketplace, and engagements are managed for top efficiency, then the realiza- tion percentage should be more than 90 percent. Most practices count standard hours as 2,000 or 2,080 a year, or the number of hours a part-time professional is available. Obviously, to attain a healthy aver- age, the less experienced people should be 90 percent or more productive and the professionals with leadership and sales responsibilities should be less productive. Unless the practice fields a large team, say more than 8 people, then the practice leader(s) should be productive for 40 to 50 percent of standard hours, since the practice’s highest billing rates are charged by its leadership and leadership is involved in marketing and other critical, nonbillable work. 822 MARKETING, MANAGING, AND MAKING MONEY IN A VALUATION SERVICES GROUP Some practices whose revenues are based primarily on fixed fees make the mistake of failing to maintain or to evaluate time records and other information about efficiency and profitability that would indicate problem areas that need corrective action. ValTip It is desirable that chargeable hours for engagements should, on aver- age, result in billings equal to 90 percent or more of the recorded hours. ValTip Few Uncollectible Accounts Bad debts and postengagement fee adjustments are unavoidable. Many practi- tioners view them as a cost of doing business. With appropriate engagement acceptance processes, including collecting significant retainers that are held as deposits, and close engagement management, uncollectible receivables can be min- imized. Since uncollectible accounts and billing adjustments occur on a client-by- client basis, there does not seem to be a minimum or “acceptable” range for which to strive. Profit Margin Greater Than 40 percent Before any compensation charges for the practice leaders, but after all other expenses, the profit margin of the practice can be at least 40 percent. A well-man- aged and efficient, highly productive practice can maintain a 50 percent or more profit margin. Obviously this has a lot to do with the type of services offered and the percentage of fixed fee competitive work. Right Fit Practices often start their life taking whatever type of valuation services they can get, or whatever the leader is accustomed to performing or comfortable delivering. Over time practices may evolve to other lines of services and may become entrenched in one or more specific service niches. To attain good economics, the practice leader(s) and key senior professionals must become highly qualified in a particular service line and be temperamentally well suited for the requirements of the service. For exam- ple, not everyone is comfortable with or interested in the requirements of dispute resolution work. What Good Economics Looks Like 823 On average, a group practice should be charging billable hours to engagements for more than 70 percent of the standard hours available for them to work. ValTip In spite of the higher profits offered by litigation services, some practi- tioners find that being an expert witness is disruptive to the processes needed to direct a practice that must deliver valuation reports on a reg- ular basis. ValTip [...]... COMPUTATIONS AND BUSINESS VALUATIONS The differences between the assumptions and methodologies used in commercial damage calculations and those used in business valuations are slight in some regards and great in others The most common differences between business valuations and 840 BUSINESS (COMMERCIAL) DAMAGES Exhibit 22.4 Common Differences Between Lost Profit Calculations and Business Valuations (FMV)... States, 47 Fed Ct 382 (U.S Claims 2000) 8 Burger King Corporation v Barnes, 1 F Supp 2d 1367 (S.D Fla 199 8) 9 Knox v Taylor, 99 2 S.W.2d 40 (Tex App 199 9) 7 846 BUSINESS (COMMERCIAL) DAMAGES Olson v Neiman’s, Ltd 10 The appellate court allowed the expert’s damage opinion for the plaintiff that used a 19. 4 percent discount rate based on a 14.4 percent normal return for public companies plus a 5 percent... the methods selected and implemented, and the professional judgments used throughout the valuation Bias toward Training and Quality Improvement All business valuation practitioners are “practicing” their craft and seek, like other professions, to constantly improve their performance A practice aspiring to good economics must invest in regular training and improvement of its staff’s and leadership’s abilities... Billings, and Collections Again, the nature of disputes—with their uncertain scope of work and propensity for an abrupt ending—requires an even greater awareness and attention to the principles needed to attain good economics ValTip Preparing a work plan and budget for known tasks and obtaining approval, aid the client and the attorney to understand the likely fee levels required Additional work plans and. .. reliable principles and methods, and (3) the witness has applied the principles and methods reliably to the facts of the case.” Daubert and Rule 702 emphasize that expert witnesses must apply accepted methods in the proper context and should expect to defend such methods not only through ipse dixit (“because I said so”) but also through external proofs of various kinds Since the 199 3 Daubert case, the... lines of valuation services really suit the skill sets, the temperaments, and career goals of the practice team and its leader(s)? OPERATIONAL KEYS FOR GOOD ECONOMICS Certain key attitudes and habitual actions in operating a business valuation practice are important to the attainment of good economics Bias toward Proactivity Successful and profitable engagements do not result from sitting back and waiting... however, the distribution of the valuation professional’s report is limited, as is scrutiny of report details, underlying data, and the valuation professional’s qualifications Differences Between Damage Computations and Business Valuations 841 ValTip In litigation, the financial expert can expect to be challenged regarding qualifications, the proper application of valuation theory, and the appropriateness of... Worth, TX: Practitioner Publishing Company, 2000), ¶ 303.37 and Dunn, Recovery of Damages, § 6. 19 842 BUSINESS (COMMERCIAL) DAMAGES many situations, this may not fit the standards established by the business valuation profession for fair market value In business valuation, not only do the fair market value standards exclude specific buyers and sellers in favor of the “hypothetical” buyer/seller, but... invoices, and any action required by the client ValTip Do not assume anything without frequent and clear communication with the client and the client’s attorney CONCLUSION Professionals in service firms, particularly the leaders, need to practice the three Ms (Marketing, Managing, and Making Money) to ensure a rewarding and fulfilling career and successful practice The disciplines of planning and supervision... on taxes and discount rates, see G Hallman and M Wagner, “Tax Effects of Discount Rates in Taxable Damage Awards,” CPA Expert (Winter 199 9): 1-5 Tax Considerations Business damages are subject to taxation under the Internal Revenue Code.11 Therefore, the Internal Revenue Service will tax a court award or settlement, and taxes should be considered in the damage calculation The thought process and calculation . or approximate the over- 814 VALUATION OF INTANGIBLE ASSETS 96 FASB, Statement of Financial Accounting Standards No. 141, at B1 69. Exhibit 20.14 Target Company: Valuation of Goodwill as of December. and implemented, and the professional judgments used throughout the valuation. Bias toward Training and Quality Improvement All business valuation practitioners are “practicing” their craft and. MARKETING, MANAGING, AND MAKING MONEY IN A VALUATION SERVICES GROUP Preparing a work plan and budget for known tasks and obtaining approval, aid the client and the attorney to understand the likely