Business Combinations - PPA PDF

Part 1 of BVR’s Special Series on Fair Value
Business Combinations:
Case Studies in Purchase Price Allocations
March 23, 2016

Webinar Handbook
© 2016 Business Valuation Resources, LLC. All Rights Reserved.

Case Studies in
Purchase Price Allocations
Webinar Handbook
March 23, 2016
Presenter:
Nathan DiNatale (SC&H Group)
Please note: This Handbook does not qualify for self study CPE credits.
Copyright © 2016 Business Valuation Resources, LLC (BVR). All rights reserved. The materials
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Table of Contents
About the Presenter 4
Transcript 5
Rebroadcast Q&A 35
Presentation Materials 39
About the Presenters
Nathan DiNatale
CPA/ABV, CVA
SC&H Group
Nathan is a Principal at SC&H Group, LLC, a regional CPA and management consulting firm in Baltimore,
Maryland. Has over 21 years of professional experience in financial statement audits, fraud investigations,
business valuation, litigation support and economic damages. He concentrates primarily on financial reporting
valuation and fair value engagements including purchase price allocations, goodwill impairment analysis
and stock option valuations. He currently serves on AICPA Business Valuation Committee and the Maryland
Society of CPAs FVS Committee. He has also been qualified as an expert witness providing testimony in
state and federal courts in the areas of business valuation and economic damages.

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Andy Dzamba: Hello everyone, and welcome to today’s webinar, Case Studies in Purchase
Price Allocations. Our presenter for today is Nathan DiNatale, who I will introduce in a
moment. My name is Andy Dzamba, and I am the executive editor here at BVR.
Before we begin, I would like to remind you that if you have any questions for our presenter,
we will take them in writing only. To do so, please use the Chat function on the left side
of your screen.
If you have any trouble with audio streaming today, please refresh your screen, and that
should fix the issue. If it does not, please call the phone number provided in your login
email to receive audio over your telephone.
We are very pleased to have Nathan DiNatale with us today. He is a principal at SC&H
Group, a regional CPA and management consulting firm in Baltimore, where he specializes
in financial reporting and fair value engagements including purchase price allocations,
goodwill impairment analysis, and stock option valuations. He is currently on the AICPA
Business Valuation Committee, and he is an expert witness, testifying in state and federal
courts in the areas of business valuation and economic damages. You can read his full
bio on the Web page for today’s event.
With that, I will now turn the program over to our presenter for today, Nathan DiNatale.
Nathan DiNatale: Thank you, Andy. I appreciate the introduction. Andy had mentioned the
hand raise function. We are not going to use that for questions, but at some point during
the presentation I may ask the question, and, if you are there, you can raise a hand, a
yea or nay. That would be helpful just to understand how many people are doing this and
what areas they practice in, so we may be using that periodically. It is something new that
I have not used before, but I say we go ahead and try it.
I’ll go through the standard disclaimer (Slide 2). These are all obviously views expressed
by me; they don’t necessarily represent the views, positions, or opinions of BVR or any
presenter’s respective organizations. These are just opinions at this point in time to go
through and figure out what it is we are trying to learn today and how to get through all of
this and really understand it.
Here is a quick summary of my bio (Slide 3). We are not going to talk about it, but I have
over 21 years of experience in a public accounting firm, primarily focused in fair value, but
I really do a lot of different things. Obviously, most CPAs out there will understand that. I
have been involved in a lot of fair value engagements and have really been self-taught or
through some of the experts in the field. I then got into the economic damages and the
application of fair market value in economic damages business valuations. One thing I really
enjoy is actually getting back, and that is why I am an avid member of the CPA Business
Valuation Committee. I like putting things together, research papers, whatever we can

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Business Combinations: Case Studies in Purchase Price Allocations
produce. Keep an eye on that committee and the AICPA FVS section for new things that
may come out. I am a member of the 2015 FVS Conference Planning, which is going to
be held in about three weeks, as well as next year’s, which we are already starting to plan.
My contact information is in here. Please feel free to reach out to me at any point in time
if you ever have questions about fair value or just valuation in general or recommended
topics at a future conference. I would be happy to incorporate those in there.
The focus of today’s presentation is really going to be a fundamental overview of ASC 805:
Business Combinations. A lot of people like to refer to these as purchase price allocations.
It actually used to be more of a purchase price allocation in the past; now it is really the
identification and valuation of intangibles and then assessing what the consideration
transferred is. We will provide an illustrative example. It is a very basic example of how
to go through and value some intangibles and how to incorporate all of the basic steps
in doing the allocation. I think it is a good starting point for those that either don’t do it or
have not done enough of this to kind of see the things that I think about when I go through
a purchase price allocation.
The learning objectives we are going to familiarize you with are obviously the history
of business combinations and fair value measurements. This is one of the things that
I really have a quirk about when I go to conferences, which is I don’t like to hear a lot
of the background. I like to move into the “do it” and “show me,” but really in fair value
and purchase price allocation you really need to understand the literature. You need to
understand the fair value measurement. I know it is boring, but it really does pay to get
into the literature and read it. If you don’t like the way the literature is written, go to one
of the Big Four shops. On their websites, they typically have an overview or illustrative
guide of their thoughts on fair value and business combinations and they give you some
meaningful things to think about, so that is a really good way to go through that.
We are going to talk about the fair value concepts and ASC 820—again, not completely
entertaining, but it is very important for what we are going to do. We will just provide some
overall key terms used in preparing the valuation of intangible assets and allocating the
consideration. We are going to talk a lot about valuing intangible assets and what you need
to think about. I did a whole presentation on this a couple of years ago, and we are going
to go through a little bit of that because, again, it is important that you understand how to
value the intangibles and identify them as you are doing these calculations.
Then we are going to walk through an ASC 805 case study. I know we have about an hour
and 40 minutes, or 100 minutes, so I will make sure we leave enough time to go through
the case study because I think that is where we will get the most questions in relation to
some things you have been working on. If during the time we breeze through some of
this, I don’t think anybody will mind. Those of you who have Picture and Picture, you can
follow my presentation as well as watch the Benghazi proceedings on your other monitor.

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Here is an overview of what we are going to cover (Slide 6): the ASC 820 fair value concepts,
an overview of ASC 805, methodologies for valuing intangibles, a case analysis, and then
what I like to call the reporting considerations. When you are going through these items and
these calculations, what are some things you need to think about because your end user
is not only the company, but it is also the company’s auditor, so you need to keep in mind
what the auditor may be looking for and how they are going to address your allocation in
your work. It is a little bit different than a fair market value 409A or estate and gift valuation.
Let’s move into ASC 820. Fair value under ASC 820 measures—the fair value measurement
emphasizes this notion of market participants and exit values. Historically, before this came
around, we did not really get into the exit value, so they actually define that in the literature:
“the price that would be received to sell an asset or paid to transfer liability in an orderly
transaction between market participants at the measurement date.”
So there are a couple of things to consider here. It assumes an orderly transaction. By an

orderly transaction, it is really one where the parties understand the business and have time
to make an offer. Picture this as a sell side engagement. You are looking at this company
as if it was for sale and what types of companies would be interested in it and how they
would affect that transaction. The objective again is to determine the exit price that occurs
in the principal or most advantageous market from the seller’s perspective. Again, it is very
different than fair market value, which is price as it sits—willing buyer, willing seller. Here
we are dealing with what the principal is or most advantageous market. Is it a financial
buyer? Is it a venture capital buyer? Where would it go? Who would pay the most and
what is the most advantageous?
We kind of heard that before in the past. We have all heard about real estate. Real estate
is highest and best use or principal or most advantageous. What could it be used for? So
keep that in mind when you are going through this concept of putting this value together.
Here is the term highest and best use (Slide 9). Again, fair value measurement assumes
the highest and best use of the asset by these market participants. If we think back about
highest and best use and its reliance on market participants, one of the main things we need
to do is really identify our market participant. Who would participate in buying this company
to exit? Identifying those is key in making some of your market participant assumptions
and the highest and best use for those market participants.
But the highest and best use refers to the use of an asset by market participants that would
maximize the value of the asset or group of assets within which the asset would be used.
So, for example, ASC 820 has a lot of examples in the appendices that are really good to
go through some of those examples. It really clarifies a lot for you. The application—you
can put this application to the concept of land, which was kind of mentioned earlier.
Think about land acquired in a business combination. The land is currently used for a factory
but could be developed as a residential site. The highest and best use is determined by
the greater of the value of the land in continued use for a factory, which the factory may

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not generate a lot of income. As a result, the land may not be perceived as being worth a
lot. However, the other piece would be the value of the land as a vacant site for residential
development, taking into account the cost to demolish or raze the factory and including any
kind of uncertainty about whether they could actually convert this into an alternative use.
It would really be the higher of either one of those, and that would be the fair value under
that example. So be mindful of what our assumptions are when we are going through and
valuing these things. We know later it is important to state those assumptions and quantify
those, so we actually have support to show what the highest and best use would be, at
least in our opinion.
That was Example 1. Example 2: A pharmaceutical company acquires a company with

two drugs. I see this all the time in some companies I have and I work with, which is to
basically have a Drug A, which is cholesterol lowering, which is moderately effective as
is stated in the example. Drug B, which is moderately effective, but when you put them
together they are extremely effective. So on a stand-alone basis the fair values for each of
these are very different. They are pretty low. But on a combined basis they are a lot higher.
The highest and best use would really be to sell these drugs together. So that is how I
think they should essentially be valued in a group as opposed to just one or the other.
As a result, the total fair value of Drug A and B should be equal to the $650 million in the
example, and that value should be allocated to Drug A and B in a systematic and rational
way reflecting the contributions of each drug. As long as this rational method is supported,
you should be OK. So the allocation of price could be based on financial metrics or maybe
some other metric that measures its effectiveness in the body, but some allocation would
be helpful, and then explaining that allocation again through your reports later just to make
sure everybody is on the same page with how you came up with it and what factor you
relied on.
A little bit about synergies—fair value rules state that buyer-specific synergies be excluded
from this calculation of value. There is an exception that unless those synergies could be
sustained at the market participant level. So if everybody would realize these synergies
then you may have to include it in there, but if one company, if a company selling widgets,
for example, and the widgets would add nicely to a current product offering by one company,
however, the other companies would not be able to vertically integrate that product and
it would still be a stand-alone, then you would not really consider the synergy of those
widgets with the other product because no one else would be able to realize those. It is
important to understand when and when not to consider those synergies.
Market participant assumptions—we talked a little about that, but here is taking it a little
further to assigning those. They must have all of the following characteristics: independent
of the reporting entity; they are knowledgeable; they have a reasonable understanding
about the asset or liability and the transaction based on all available information including
information that might be obtained through due diligence efforts that are usual and
customary (again, that is the exit price notion—it is as if this thing was marketed for sale
and everybody interested was at the table); they must be able to transact for the asset

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or liability (obviously, they have to be financially stable and be able to actually buy the
company—I don’t think a market participant, say a $2 million ma-and-pop shop would be a
market participant for a Fortune 500 company looking to value something under fair value,
so you would exclude somebody who was not able to transact); and then willing to transact
for the asset or liability, so they are motivated but not forced or otherwise compelled to
do so. It is important to differentiate and make sure of that when you are selecting those
market participants.
I typically use guideline public companies. I may pull some of those guidelines out because
they just don’t fit—they are too small—they would not be an interested party—or they may
be too diversified or even specialized depending on just the type of company that you are
valuing and where you need the fair value measurement.
A little bit of background—the principal market and the most advantageous market. The
principal market must be available to the reporting entity and accessible to that reporting
entity. If there is a principal market, the fair value should be determined using prices in that
market. If there is no principal market or the reporting entity does not have access to the
principal market, fair value should be based on the price in the most advantageous market.
In other words, the market in which the entity would maximize the amount received to sell
an asset or minimize the amount that would be paid to transfer a liability.
It is important to consider those types of issues. The determination of the most advantageous
market may require the reporting unit to consider multiple potential markets and appropriate
valuation premises in each of those valuation markets. In other words, is it really a financial
market we are going out to, a financial buyer? Is it really a venture capital? How would
we assess each one of those? Once you identify those markets, then assess the value of
the asset in each market to determine which one is the most advantageous. Again, it is
that theory of market participants and making sure that we are considering all the different
markets that this asset could be sold and the company could exit.
ASC 820 also talks about the hierarchy of inputs to valuation techniques. We have Levels
1, 2 and 3. Inputs Levels 1 and 2 are observable, so Level 1 would be quoted prices for
identical items in active invisible liquid markets such as stock exchanges. Level 2 is going
to be observable information for similar items in active or inactive markets. For example,
a similar building in a residential area when you are finding the fair market value of a
different building, so you could relate this to comparables that are sitting out there or
transactions of comparable companies that are not listed but may be listed. Then Level 3
are the unobservable, where there are no markets, they don’t exist, they are illiquid, and
they could present some type of credit risk. At this point, any kind of fair market valuation
becomes highly subjective because you just don’t know. There is not really a whole lot
of Level 3s that you can really put your finger on, so it is good to show those Level 1 or 2
inputs and where you are obtaining them from.
That’s the fair value. Let’s go to questions and see if we have any questions. We have
a question, “Can you state examples when to include and when to exclude synergies?”

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Sure, you can think of this as if you have a company that produces—I use the example
of a widget. You have to think about whether or not that widget is going to be used the
same for everybody. If it can be integrated differently by one party in so much that it adds
additional value to it, sometimes software companies deal with this. You have a piece of
software that you could sell externally and somebody is selling externally. However, in
addition to selling it externally, Company B is already in the software business and they
can group it as an additional platform on top of what they are already selling and really
vertically integrate that into their already used customer list. That would be an example
of synergies.
It is really a case-by-case specific, but you really want to identify the cash flows that a
company is projecting and if they include any kind of synergies with this company that
other companies out there would not exhibit. If so, you need to exclude them. It is not if
any of those market participants—and, again, it really depends on who you identify as
those market participants—if any of the other ones would also enjoy those synergies, you
could include that.
We have another question. “What if the market encompasses both strategic and financial
buyers?” Well, again, you have to look at the most advantageous market. I always refer to
this in fair value when I am looking at goodwill impairments if it is more advantageous to
have a taxable or nontaxable transaction. Which one would yield the highest proceeds to
the seller? You can kind of look at it like that. If it is a financial buyer, they step in and they
wouldn’t necessarily be able to change the structure. It would be somebody like myself
buying the company. However, if you have another company in the market that is coming
in from a strategic position or a venture capital position to put it in their portfolio of other
companies, they may be able to show a little bit—they may have higher proceeds from
that because they could absorb some of these administrative accounting and CFO roles
because they already have that in house.
I have had some situations where we have looked at it both ways and the most advantageous
way really wasn’t the way that it happened because there were no deals in the market. In
other words, there were no other entities similar to this that were actually buying companies.
They exited the market because the market was doing so poorly, so the only thing that was
left was financial investors and, therefore, was not potentially the most advantageous but
it was the principal market.
Let’s move along to ASC 805—Business Combinations (Slide 16). A little history—this was
issued as FAS 141 and 141R, APB 16—it goes on and on how many revolutions this thing
has had. But it describes the proper accounting treatment to be used by an acquirer in a
business combination. It applies to business combinations with an acquisition date on or
after beginning on the first annual reporting period beginning on or after Dec. 15, 2008
(2009 for acquisitions of nonprofits). It provides a broader definition of business, which we
never had in the past. It requires the use of the acquisition method. It recognizes assets
acquired and liabilities assumed at fair value.

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Under ASC 805, all business combinations are accounted for by applying what they call
the acquisition method, which requires identifying the acquirer. The process of identifying
the acquirer really begins with the determination of the party that obtained control. You
have to look at the actual transaction and, based on the consolidation standards, what
party gained control? Those standards are referenced in ASC 810 for U.S. GAAP. They
generally say 50% or more acquisition.
The date the acquisition takes place is physically the date on which they obtain control.
It is exactly when they come in and obtain that which is usually the asset purchase date
when they finalize that and transfer consideration. Recognizing identifiable assets acquired,
liabilities assumed, all at fair value, recognizing goodwill, or, in the case of bargain purchase,
a gain. It is important to note that assets not intended to be used—because I get this
question a lot—is, “We acquired a company. We are not going to use the trade name. We
don’t need to value the trade name.” Well, that is not true.
An acquirer for competitive or other reasons may not use an acquired asset or may intend
to use the asset in a way that may not be in its highest and best use. For example, you pull
in a trade name. You vet it irrelevant. I’m going to use my bigger trade names. However,
you still need to value that trade name. Assume it to be a fair value because for other
market participants there may be a value to that trade name. The standard specifies that
the intended use of the asset by the acquirer does not affect its fair value, so keep that in
mind when you are thinking through the things that you may want to acquire or not acquire
or value based on what you acquired. They all pretty much need a valuation there.
A quick question is: “What resources do you use to find M&A transactions occurring in
the market?” We use a variety of resources. We use Capital IQ to look at publicly held
companies, as well as guideline comparables. Again, we use items provided by BVR,
Pratt’s Stats and Done Deals, any of those types of databases to show smaller transactions.
Obviously, I am not looking at those for most of the SEC companies. I am looking at the
comparables and other transactions in the market. It really depends on the type of company
you are dealing with to determine the level of transactions you want to look for.
Recognition criteria—an asset is identifiable if it either is separable, being capable of being

separated or divided from the entity, or sold or transferred, licensed—we are not going to
read through all of this—or arises from contractual or other legal rights—I am sure a lot
of people understand that the actual guidance has a lot of different examples of what can
be and what cannot be separately recognized intangibles. I think we go through a little bit
of this in my intangibles stuff in the back, so we will get to that as well.
Some of the key points of ASC 805—the term “business” is actually defined. It is an
integrated set of activities and assets that is capable of being conducted and managed
for the purpose of providing a return. Anybody who does this type of work really needs
to just read through that definition and what the standards say about it because it really
is important. I had a case, not a case, but a client who really bought a contract. That is
essentially what they did, but under the definition that contract qualified as a business.

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It had inputs and employees working on the contract. It had laptops, and it had working
capital. It just wasn’t a business, but it was a long-term government contract, and as a result
it was an acquisition, so you really need to understand what that means and continue to
go back to it every time you have a question from somebody about whether this qualifies
for business combination.
The term “business combination” was defined as a transaction or other event in which an
acquirer obtains control of one or more businesses. Again, we spoke about control being
greater than 50%, so it is important to go through the asset purchase agreement or stock
purchase agreement to understand what is really happening there.
Then they talk about these inputs and processes (Slide 20). A business really does have
these inputs and processes applied to inputs that have the ability to create outputs.
Although a business usually has outputs, outputs are not required to qualify as a business.
Development-stage enterprises have no revenues, but they may still be considered
businesses. They are not really outputting anything yet. So to determine if a development-
stage enterprise is a business there are a couple of key factors such as: Do they have
planned principal operations and have they started? Do they have employees, intellectual
property, other inputs and processes present? Are they researching and developing? They
are doing all of these items. Do they have a plan to produce outputs and they are pursuing
that plan? Obviously, or they wouldn’t be around. They have access to customers that
would purchase the outputs that could be obtained.
If all of these things—you don’t have to have all of them—but if some of these things or most
of these are in existence then that development-stage enterprise is obviously a business.
For example, under previous U.S. GAAP, a development-stage enterprise typically was not
considered a business until it had commenced its planned principal operations, although
a fact to consider that would not be a prerequisite under the new standards. So generally
development stage enterprises that have employees capable of developing a product
would be considered a business.
I find these to be the most challenging because you are valuing something that really
doesn’t have cash flow at the moment, so you are really trying to figure out what the value
of these intangibles are. We deal with a lot of these, but they are a more difficult type of
purchase price allocation.
Key points—the fair value of the business combination is measured at the fair value of
the consideration transferred. Consideration could come in a lot of different ways—cash,
note payable, transfer of equity interest, contingent consideration. I have actually seen in
the past the payoff of a note from one of the former shareholders of the company they are
acquiring. You really have to read those purchase agreements pretty good to understand
what is being transferred and what kind of consideration that they are receiving.
Transaction-related costs are expensed rather than capitalized as they used to be. I
also have a few examples where I have seen people use a flow of funds to determine

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the consideration transferred. Be careful with that. Flow of funds typically has some
reimbursement for transaction expenses or it may include sell side, M&A fees, or something
else, so you are not really capturing the true amount. Don’t just look at the number; make
sure you understand every coin in that flow of funds and make sure that you understand
how they are flowing and whether there is consideration or not. That is really important.
Assets and liabilities that are of a contingent nature will be recorded at their relative
fair values if reasonably determinable. Again, there is some literature on reasonably
determinable and how to do that.
A question is: “Are purchase accounting standards expected to change for all companies,
including publicly listed companies similar to private-company accounting standards?” I
am not really sure. I know there was some discussion about that, but I don’t know for sure
that is going to happen. I think people would want to move towards that from a savings
perspective, but I am not sure that is going to happen. It really depends. I don’t know
what it depends on but, from a privately held company side, I have seen a lot of different
controversy on those standards and how they are applied and a lot of errors in applying
that. So it may take some time before the public companies actually come together and
we move this up to be addressed on the public side. If you want more information on that,
feel free to reach out to me and I can actually put you in touch with somebody who can
probably answer it a little better than I can.
Allocation of assets and liabilities—ASC 805-20-25 requires that all identifiable assets
and liabilities acquired including the identifiable intangible assets be assigned a portion
of the purchase price. The value of the business acquired usually is measured the same
as the acquisition date values with the exception of consideration transferred for the
acquiree—I’m sorry—values of the following: consideration transferred, equity interests and
the noncontrolling interests held by third parties. The phrases that have the noncontrolling
interest, we are not going to get into it now, but there is some guidance on there on how to
value that noncontrolling interest. It may seem a little bit different but make sure you read
through whenever you have a noncontrolling interest that is either transferred or exists
because it is very important to understand how those are handled.
Total consideration transfer—again, it is allocated among the fair value of the tangible and
the intangible assets. We all know goodwill is a residual amount and is represented. If
there is no residual amount, you may have a bargain purchase. This is a little excerpt I took
out of the AICPA guide that I put together for the business combinations Quick Reference
Guide (Slide 23). Consideration transferred plus the value of any noncontrolling interest
plus acquisition date fair value equals the net amount of acquisition date amounts of assets
acquired and liabilities assumed.
Again, take a look at this formula. It is fairly simple. There is a good guide that I reference
later that you can look through, so a Quick Reference Guide that I put together that really
is on point to this.

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Contingent consideration is commonly referred to as an earn-out. It represents this obligation

of this acquirer for future events or conditions if they are all met. I see this on and off, and it
really just depends on the types of customer or client you have and what industry they are
in. It is not always there but make sure that when it is there you understand how to value it.
It is typically determined by either a probability weighted specific well-supported outcome
where you basically weight—we will get into that method—or a Monte Carlo simulation
model or maybe some other similar risk simulation tools. Some of the more complicated
ones really need to be modeled under Monte Carlo especially if you are working with the
Big Four. They really want to see a more robust way of developing this other than your
thumbs in the air and just determining percentages. So this is helpful for when you use
the Monte Carlo.
A question is: “Why wouldn’t payments to the seller to reimburse them for their transaction
expenses be considered a part of purchase consideration?” You just have to make sure that
it is labeled right in the flow of funds. If you have a flow of funds, what I meant is that you
need to make sure that you pulled the right number in there. Transaction costs obviously
aren’t capitalized, but you want to make sure—again, you want to get away from looking
at one number in the flow of funds. This is the net amount transferred to them. This is it.
Well, that is not true because you could owe them $10 million if you reimburse their
transaction expenses for $500,000 and you transferred $9.5 million. Make sure you are
not taking the $9.5 million—it should be the $10 million. I didn’t mean to confuse you
there, but the payment, if you are reimbursing them, you are paying basically for them,
as long as they are not your expenses on your M&A side. Just make sure that the main
point there was make sure you understand all of the points in the flow of funds and don’t
just take one number such as amount transferred to acquiree is what I am going to use.
That is almost wrong all the time. I think I addressed your question, but, obviously, that is
not what I intended there.
Contingent consideration (Slide 24)—again, make sure you have specific relevant
projections. Management should prepare multiple sets of projections that rely on
independent future outcomes. These projections are weighted to determine the most
appropriate probability weighted outcome for the contingent consideration. Changes from
events after the acquisition date, such as meeting an earnings target, reaching a specific
share price, reaching a milestone. The acquirer shall account for changes in the fair value
of contingent consideration that are not measurement period adjustments as follows. It
gives an outline of how to handle contingent consideration moving forward. Typically, the
changes in this are on a period-by-period basis are recognized in earnings. Once you have
a measurement there, if it is a fairly long earn-out, you are going to be required to update
that on an annual basis to make sure that it is consistent with the current assumptions in
the earnings projections.
Bargain purchase—you probably all know what a bargain purchase is. The key thing here
is, after you have this review, if you still have this bargain purchase, it should be recognized
in earnings and attributed to the acquirer. I rarely, rarely ever see this. Usually if you hit a

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bargain purchase it means you did something wrong but not necessarily. The guidance is
such that, if you get a bargain purchase, go back, review it again, and make sure all your
assumptions are right. Make sure you didn’t miss anything.
The new standards require disclosure of the amount of the gain, the line item where the
gain is recognized, and a description of the reasons why the transaction resulted in this
bargain purchase gain. Basically say, “Look, we went through everything. Here is what
happened.” So just make sure you have all those considerations.
Additional terminology (Slide 27)—some of this is littered through the Quick Reference
Guide and some of the other guides out there. PFI, prospective financial information, is
going to be projections to affect the transaction. IRR, internal rate of return, weighted
average return on assets, business enterprise value, tax amortization benefit, and
multiperiod excess earnings. Noncontrolling interest is another, NCI. When you see these
terminologies, they are typically abbreviated or have shortcuts. Just keep that in mind as
you are going through this stuff.
That is kind of the overview of ASC 820 and 805. If anybody has any further questions,
feel free to ask. We are going to move into some intangible assets and what the thought
processes are, and then we will move right into our case. Intangible assets are long-term
resources of an entity but have no physical existence. They arise from contractual or legal
rights. They are capable of being separated from the entity and transferred to another entity.
You can kind of see how the business value is put together: monetary, tangible, identifiable
intangible, and goodwill.
They don’t have the obvious physical value, the factor of equipment, but they can prove
very valuable to firms, obviously, and be critical to their long-term success or failure. For
example, let’s take Pepsi. It wouldn’t be nearly as successful if not for the high value
attained through brand recognition. Brand recognition is not a physical aspect you can see
or touch, but, obviously, that positive effect on the recurring customers coming back to buy
Pepsi because they like it. They are linked to it. They see the ads. So that is something
you would need to consider.
We have intangible assets in two different types of categories: Limited life intangible assets
such as patents, copyrights, and goodwill; and then you might have an unlimited such as
a trademark. Trademark can really be limited or unlimited depending on how you set it up,
but trademark or domain names typically could be perpetual trademark.
Intangible assets are really defined a bunch of different ways. I put these together a couple
of years ago on how to define these, but there is not one general definition of intangible
(Slide 31). Everybody kind of defines it differently. I have included all of these up here.
We are not going to read through each one of them, but the key terms here is that it is
nonphysical and it provides value. As you look through all of these, again, they are all
nonphysical and provide value. That is kind of the thing to think about when you are looking
through what intangible assets could actually be identified and valued in an acquisition.

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ASC 805-55 actually provides examples of identifiable intangible assets acquired in a

business combination. Anybody who has not been through this, probably most have, should
really go through and review the types of intangibles. Some differ by industry. Some are
in every industry. Obviously, artistic related may not be in every industry, but more or less,
customer- or contract-based will probably be in every industry. It is important to understand
what they have. We will go through a couple of these and how they relate to the acquisition
and identification of the intangible assets.
Marketing related are assets primarily used in the marketing or promotion of products or
services: trademarks, service marks, Internet domain names, noncompete agreements.
Obviously, all of these below (Slide 33), we fully recognize, so they are linked to the
marketing side. Every common form of marketing-related intangible asset are trademark
or trade name. A trademark or trade name is a word, a phrase, sometimes a symbol. Let’s
go back and look at those. Obviously, we all know Starbucks. We know the drugstore. The
right to use those trademarks or trade names really under common law rests exclusively
with the original user as long as that user continues to use it. They create immediate
product identification in our minds and obviously enhance marketability of that product.
So customer-related intangible assets occur as a result of interaction with outside parties.

I often get the question, “Would you have a customer-related asset or a contract-related?”
That really rests on the type of company you are valuing. Customer relationships, let’s
say you have a box company. Typically, there are customer relationships there, and they
are with the companies that buy boxes from you that have bought for years. Government
contracting—obviously, you are going to have a contract for a set amount of time over
a set period of time that may be renewable over that time, so it is a little more clear cut
versus a customer relationship, which is really just based on that customer being able to
keep coming back to you because they like you.
Another question is, “For fair value or GAAP purposes, ASC 805 should govern …” You
are basically saying for fair value purposes, ASC 805 should govern for the definition of
an intangible, not the International Glossary of BV Terms. You know, ASC 805 has a really
good discussion, which we are going through, of those intangible assets, but I think it is
important to look to everything and say, “First of all, let me understand what an intangible
asset is, and I kind of understand that, so I am not going to go to the Glossary of BV Terms
and say, ‘Look, this is an intangible so, therefore, it must qualify.’” Well, it is not listed, and,
obviously, fair value ASC 805 does not consider that, then, obviously, you are right. We
would not consider that.
But, again, I think the overview of the definitions is really just to say keep these things in
mind when you are looking for intangible assets because that is important. But, ultimately,
these lists that we are going through right here, this is how I identify them, and this is what
I question my clients about. So that is a good question.
Artistic-related—again, this is books, magazine, newspapers, plays, operas. There is a

bunch of this stuff. I have probably valued dozens of these. Contract-related are franchise

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and licensing agreements, which are typical. Employment agreements, any kind of favorable
supply agreements.
Technology-related—computer software. We always have that. Patents, process patents,

trade secrets. Again, these are just examples of what you could be looking for when you
are trying to inquire and have that meeting with the client of what they have internally.
Obviously, McDonald’s and Subway have a lot of value in their franchising and licensing
agreements. BP may have valuable construction permits for oil lines and drilling rigs, and,
obviously, they have significant value as well. It depends on the industry; it depends on
the clients you are dealing with. But, again, based on the standards, understand the client
before you get into a BV engagement. Before you try and do fair value, make sure you
understand what they are dealing with and what could be out there.
The Houlihan Lokey Purchase Price Allocation Study is really a great study that they put
together on an annual basis. I would recommend getting this study every year, reading
through it. It is sure to put you to sleep at night, but the content is really good when you
are comparing these purchase price allocations. They look at transactions completed in
2012 for the 2013 study, and they summarize the results of the various intangibles. There
were 1,200 completed transactions reviewed, 422 transactions held significant data, 13
industry categories, so they really go in depth.
As an overview, it didn’t really turn out that great from a picture, but it really shows you
the percentage of identifiable intangible assets in the current year, and what it is as a
percentage of the sample, and the median percentage of purchase consideration. Again,
it is a really good reference to see consistently I’ve had about 50% of my companies have
trademarks, and the value percentage of purchase considerations have only been about
3% (Slide 39). You can kind of see what I am getting at with this—depending on the types
of companies, and this is broken out by industry, so it is very good to use if you have an
aeronautical company that you are dealing with. They have that industry. Look at the end of
the day when you come up with your allocations if it makes sense. Is mine greatly different
than what I am seeing in here from an aeronautical industry?
For example, my trademark might actually be 15%, while we have 3% consistently over
three years. So that may not make a whole lot of sense. Alternatively, you could be in the
customer-related assets and we are dealing here with the 11%, 14%, and 16%. That is
pretty consistent. You can see it is going down over time. I am not sure what that trend
refers to, but, again, keep this in mind as you are going through those. It has proven to
be a helpful tool for me.
Valuation methodologies for intangibles—we are going to kind of breeze through this.
Everybody should be fairly familiar with these (Slide 41). Cost approach is used for minor
intangibles, typically where income and market data are not available. The market approach,
I seldom apply this. We use market multiples or market percentages for the royalty rate,
but, ultimately, it is based on income. The income approach is the most commonly used
method chosen based on characteristics of the asset value.

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A quick definition of how FASB defines the cost approach. It is based on the amount that
currently would be required to replace the service capacity of an asset, which is current
replacement cost. From the perspective of a market participant, the price that would be
received for the asset is determined based on the cost to market participants to acquire or
construct a substitute asset of comparable utility or obsolescence. Again, you don’t see the
cost method used very often. You do have some obviously in your purchase price allocation
typically used for telecoms and some other random assets. You have workforce that we
use the cost approach for and some software, to rebuild software. But by far it is usually
not on the primary asset primarily is used under the multiperiod excess earnings method.
It is based on the economic principles of substitution, so we have the pros and cons of
using the cost approach (Slide 43). Obviously, the pros are really—it can be looked at to
provide minimum value. It is not going to provide anything based on cash flows. Obviously,
you don’t have market or revenue data, so it is hard to define. The cons really outweigh the
pros here. It is really what I consider as a last resort to value intangible assets. Nonetheless
it still is actually used to value.
Again, insufficient data would be a reason to use it. Cost data are still available for the
subject asset such as a recently developed software. Obviously, the cost data are still
there. The company’s expertise—whenever we are valuing software using the cost basis
and coming up with a cost—I need that expertise internally. I am not an expert in software
or software design or what it takes, but it really takes a lot of discussion with the internal
employees who were used to build this. You want to make sure that you have that expertise
from an hours’ perspective and cost.
Assets that lend themselves to the application of the cost approach are obviously recently
developed intangibles such as the software we discussed. Training manuals—again, under
the same assumption, it takes hours and time to put into it, and there is employee workforce.
I have a question. “When valuing trade names and customer lists, can there be overlap?
Customers may deal with the company because of brand. How do you avoid double
counting?” We will get into that a little bit later in the presentation, but essentially your
primary asset has to use a multiperiod excess earnings method and that multiperiod
excess earnings method uses a contributory asset charge model. One of the contributory
asset charges would be the trade name. The trade name would be valued first based on a
royalty rate based on again what the market would perceive that trade name to be worth.
You go through your cash flows, and then you would use the value of that trade name to
charge the customer list valuation or the contract valuation with a charge for the use of
the trade name.
The remainder of that value would be customer list. So you pick everything up first. The
excess earnings would come over to the customer list, so there is no real overlap. There
may be an overlap because they are coming to you for a trade name, but, quite frankly, if
they like your trade name, they are coming to the people that are in there. You definitely

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won’t be double counting in value. It is just a matter of if we positioned a little further to the
right in trade name or to the left in customer list, but we will go through that.
Limitations of the cost approach—no direct incorporation of economic benefits, risk is not
incorporated, it somewhat is but not, nor future upside benefits. Obsolescence is difficult
to quantify. Typically, I am looking at obsolescence and I am talking to the company. How
obsolete is this? 30%, 40%? What is the difference between 20% and 30%? It really is a
little difficult to go through, and there is some other divergence in practices—treatment of
taxes, entrepreneur’s profit, and opportunity costs. Sometimes I am asked about those,
why didn’t you incorporate it, and sometimes I am not. So there really is a divergence in
practice.
If you got through the cost approach, Robert Reilly has a really good paper on that out
there. I don’t think I have included it here, but it is a really good paper to read through on
the cost approach and intangible assets. We definitely are not short on resources when
related to these intangible assets and purchase price allocations.
Income approach—we are all familiar with the income approach. I am not going to read
through it. There are pros and cons. It is difficult to differentiate between the business
enterprise value and the value of intellectual property that supports the business. We will
go through our use of the income approach here in an example. I just wanted to throw
some things in here related to the different approaches to intangibles.
It requires a projection of future income. The discount rate must incorporate the risk
associated with the generation of income. Anybody who does valuation in general is familiar
with how the income approach works. In intangibles, we use the relief from royalty where
we basically find a royalty rate. We will also talk about that. We apply it to the revenue and
discount it at the tax to show essentially what we would have paid by not paying a royalty,
and that is the value, excess earnings, Greenfield method, which quite honestly I don’t know
a lot about and I don’t think I have ever used it. The “with or without” for noncompete—there
are a bunch of different methods out there for income approach (Slide 49).
Market approach—hopefully we are all familiar with this, the market and how to look through
comparables. We will get a little more into that. They are valued utilizing actual transaction
values derived from the sale, license, or transfer of similar assets. The problem here is
that in the market side we really don’t have a lot of good comparables to be able to say,
“My trade name is exactly like your trade name. and it is sold for X,” or, “My technology is
exactly like yours that is sold for Y.” It is very difficult to use this.
We have a couple questions. “Does current GAAP ignore separate identification valuation
of assembled workforce? If not, it would seem that its asset value counteracts the ongoing
expense in the projected cash flow.” GAAP doesn’t ignore it. We do value the assembled
workforce for a contributory charge, but, obviously, the assembled workforce has an
important role in actually producing the cash flows. We do pick it up when we use the

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excess earnings method, and I will show you how we get to that. But essentially we ignore
the value, and it is just coupled with goodwill; we don’t recognize that value there.
Again, going forward, I think this relates to the private-company counsel stuff that is going
on. For anybody who thinks we just don’t have to value our customer list, that is not
exactly true. You have to read the literature a little bit better that, if it is not salable, you
have to actually support the fact that it is not salable, and that does not exclude you from
still valuing potentially the other assets and potentially the assembled workforce for the
purpose of determining a charge somewhere. It is important to make sure that the entire
calculation makes sense.
“What are your thoughts on how to treat deferred revenue in a multiperiod excess earnings
method? Do you deduct the deferred revenue in multiperiod excess earnings method?”
I probably would refer you to a paper that was produced by The Appraisal Foundation.
I believe it is The Appraisal Foundation. It could be the AICPA, but there is a paper out
there that talks about the treatment of deferred revenue, and I think it is on point with the
multiperiod excess earnings, but follow up with me and I can try to find that paper. That
is just a little bit more detail than we can get into at this point, but I can follow up with you
at a later point in time.
Tangible assets—there is not a whole lot to be said here. Quite honestly, when I am doing
these allocations of purchase price, I typically will defer to the Big Four on this firm and
ask how they want to handle it. If I believe there is a substantial amount of fixed assets on
the book, I will say, “Do you think we need an appraisal? It is not the material threshold.
What are your thoughts?” If it is in a special industry, it may have a lot of obsolescence.
We probably want to go through that.
But, generally, if they don’t own their own plant, land, or building and just have minor
equipment, we typically take the net asset value and run that through. Again, I want what
is in the best interest of the client when I am going through this, but as we all know clients
have budgets. They don’t want to spend money they don’t need to. And. typically, unless
the accounting firm says we absolutely need it, we are not going to go forward.
Andy Dzamba: Excuse me, Nathan, if I may interrupt just for a second. I would like to
remind our listeners if you have any questions for our presenter, please use the Chat
function on the left-hand side of the screen. Thanks very much, and back to you, Nathan.
Nathan DiNatale: Let’s get into the case study here. This can literally be as easy or as
complex a process as each one is completely different and really requires a unique thought
complex much like your typical valuation. But because of the nature of the intangible assets
you really need to think through how you address these. I will go through the facts here
and we will go along and take questions because we are going to touch on some stuff.
We may come back to some slides.

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Typically, when I look at these, well, let’s go through the facts first (Slide 55). We have
Fortune Inc. acquired M&P Co. on April 1, 2014. I should have made it easier on myself
and made it December 31, but M&P is an advertising agency that provides strategic
consulting services, creative execution, and print and production management capability.
The consideration was $50 million in cash plus additional contingent consideration that
had the following terms: The one-year earn-out, maximum contingent consideration of
$15 million, annual EBITDA must be greater than $7 million to get it, if EBITDA is higher
than $7 million but less than $10 million, then there is a formula to basically go through
the calculation of what the earn-out would be.
Those are the facts. The identifiable intangible assets were a trade name, customer
relationships, noncompete agreements, the assembled workforce, and obviously the
contingent consideration. The first step that I always look to when doing one of these is I
really want to come up with the business enterprise value of the acquired company. In my
opinion, this is really somewhat of a cyclical calculation. You have to think about what PFI
is out there, prospective financial information, and what they used or relied on to make
the offer.
In a perfect world, the company would have had due diligence, put together projections
based on what they thought they could attain, and apply an appropriate discount rate and
come down to $50 million. Lo and behold, this is what we are going to pay for the company;
if we do better, we will give you more. That is not always the case. Some people will; some
people won’t. It is really based on the sophistication of the client, but, ultimately, your first
step is what you used in the way of projections to determine the purchase price.
We want to make sure that when we put this together it is really to confirm that this purchase
price is representative of the fair value and, obviously, it is not a bargain purchase or an
overpayment, keeping in mind that the primary purpose of the enterprise value is to evaluate
the cash flows that are actually used to measure the fair value of the assets acquired and
liabilities assumed. So they need to be consistent.
We also need to validate the reasonableness of the cash-flow projections to be relied upon
in applying the income approach of certain intangibles. When we put these together, we
sometimes have to think about just in a normal business valuation have you considered
enough CapEx to support the growth that you use to support the value here. Is your growth
adequate or is it too excessive? Have you considered the appropriate depreciation? So it
is important to understand how to use that.
Another question is: “Is information for DCF not available as capitalization of earnings
approach to determine the enterprise value the next best method?” You could use that,
but as you know the capitalization of earnings would just assume you are dealing with a
mature company already and there is really no upside for the acquirer. You could potentially
use that. I have seen it used in the past. However, I have been able to look at that used
in the past and see it is incredibly wrong because they are actually going to do more than
that and it should have been used under a discounted cash flow. However, I have seen

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how that actually was what they used to figure out the value of the company, so it could
be a good starting place.
But, just remember, if you don’t have projections, how are you going to figure out the
royalty rates? You need to understand the projections of net worth and capital and whether
they are adequate, what your royalty rate is because you are going to need projections of
revenue and EBIT for the royalty going forward, and especially customer lists. While it is
based on existing customers, you will need to get into the change potentially in existing
EBIT levels rolling through a customer list calculation or customer contract, whatever it is.
So to the extent that those are available it is much better to use that.
Again, if you don’t, then you want to go through and just evaluate in general. I think that
would be fine, too, if it was just the—when you get to the end, I would hate to see you look
at it and say, “None of it makes sense. I don’t have enough information. I put together half
my projections. So I would push for a discounted cash flow. I know in valuation typically
especially in some of the smaller clients we get a lot of push that is so expensive. I can’t
afford that.” I always stress, look, you want to do it right. Honestly, the risk with a smaller
client I realize is not there, but, again, as valuation professionals, our names are on the
line with how we do this. We want to make sure we at least get this done right. If you go
through the capitalization of earnings and you feel that the ending answer is correct and
you have done everything, it should be OK, but, again, just review it when you are done
and make sure it makes sense.
Substantiate the reasonableness of the required rates of return applied in the valuation
of the intangible assets. We will talk about those required rates of return and why they
could be different, greater than, or less than the weighted average cost of capital or the
IRR. Validate the estimated fair values from the assets are reasonable relative to business
enterprise value of the acquired company. It is essentially looking at the weighted average
return on assets.
The internal rate of return is used to assess essentially the value of the—the rate in which
the consideration was given for the cash flows. But they are all interrelated: the internal
rate of return, the present value of contingent consideration, and the discounted cash flow.
If you think about this conceptually, if you have a straight discounted cash flow that says,
“You are worth $50 million.” You then say, “If you do better—that is, revenues higher, EBIT
higher—I’ll give you some more.” Where do you think that is going to come in at?
You have to incorporate those weighted average considerations of contingent consideration

or the projections used in the contingent consideration in your discounted cash flow
because essentially if you don’t you are assuming the company is not going to perform
at that level and then there is no reason to have contingent consideration. In other words,
one of your examples in contingent consideration could be enough and achieve it, which
is the current state of $50 million. My second is I am going to achieve it, and I am going to
hit it out of the ballpark, and I am going to get $15 million. Well, if so, you need to weight
that in from a probability perspective not only in the contingent consideration piece, but

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the cash flows in the total purchase price because that is going to affect your IRR. Keep
that in mind when you go through that process and just make sure it makes sense that, if
you have an enterprise value that assumes same cash flows over time equals $50 million,
you can’t have contingent consideration unless you go above that $50 million or EBIT is
higher if you have to pump up that EBIT a little bit. That is how I look at it.
Here is present value purchase price by cash considered (Slide 58). I will go through a
present value of my contingent consideration right here and then essentially what we will
do is we will mirror that up with the DCF and come down to a difference. My DCF is linked
to this internal rate of return. I essentially try and solve for my internal rate of return by
making my difference zero. Once we get through these two, we value this in order to get
down to this difference of zero right here in order to give me my IRR.
Over time you have to be patient with this because it is going to change as you change
the value of the intangibles and whatever. You will come back and say, “Wow, I have a
difference here, so we need to go through the goal, so you can come through.” Again,
that is how I handle it. Come down to an internal rate of return, so there is no difference
in these two numbers so that these two numbers right here are equal.
I have two questions. “How can you test the reasonableness of the IRR and WACC and
would you do it through solve?” Well, essentially, you are going to calculate the internal
rate of return, and you are going to calculate the weighted average cost of capital. We are
going to talk about the inner relation between those two. Ideally they should be pretty close
to one another, if not identical. If they are not, you probably have some synergies in there
or have lack of some synergies that should be considered from a market-participant level.
Again, I always try to look for those as making them equal, so when I start this process I
come up with a weighted average cost of capital for the company, and I start there. Then I
solve for the internal rate of return and see how close they are. If they are relatively close,
I may actually use the internal rate of return because that is actually the information that
was used to acquire the intangibles. So they will still be pretty similar, and we will get into
the weighted average return on assets as well.
Another question is: “I have an 805 project with a noncompete. It is the most material
intangible, and the only other separable intangibles are two contacts each having their
own income stream projections. The earnings of the contacts are not material to the overall
company earnings. Is it easier to apply the ‘with or without’ for each intangible? Is it OK
to avoid the multiperiod excess earnings method altogether given these facts given the
primary asset needs the ‘with and without’ method?”
We should talk about this offline with you if you wanted to. My gut is the noncompete is
not the primary asset of this business and that there is some other primary asset you
potentially could be missing. Nobody buys a business because it owns a noncompete. The
noncompete is the result of buying the business. So there is some other valuable intangible

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there. I guess you will have to get more information on that, but I would be happy to set
up a time to talk to you and go through and help you in any way I can.
My email is at the end or beginning or somewhere in this course—just email me and we

can set up a time to talk. I am always happy to do that. I love learning and teaching, and,
to the extent that I don’t know anything, I always ask people. It is just good to talk about it.
Another question real quick is: “Why would it require a calculation of the IRR before
calculating the DCF? I would think the DCF result is the IRR.” You are correct. If you
calculate it without the DCF, essentially the discounted cash flow you would put together
before the discount, and you would want to make that the value after the discount equal to
the consideration. So it would get rid of contingent consideration. That $50 million is your
answer to the DCF. Quite frankly, contingent consideration just makes it all messy, but $50
million would be your answer. You know what the cash flows are. You solve for obviously
the discount rate or the WACC, which is your IRR at that point. Ideally you are coming
up with a separate weighted average cost of capital. You would come up with an equal or
corresponding cost of capital that matches that IRR from market participant perspective.
Hopefully that answers your question.
So present value of contingent consideration, because it is based on unknown future

performance, it is best to consider various scenarios to calculate the probability weighted
consideration. As you go through this, again, this is just one method. This is the quick
and dirty method. You can see the subjectivity in here. We have EBITDA projections over
time (Slide 61). We have the projected earn-out based on those EBITDA projections.
Then basically we ask management, “What did you consider? Did you have multiple sets
of projections where you felt that you could achieve or not achieve? What is the most
conservative estimate? What is the moderate? What is the most aggressive?”
We probability weight all of those with the present value factor and come down to the
present value of the cash flows. That is essentially how very quickly you can come up with
a value under contingent consideration. The change in the value over time is a lengthy
contingency, which will be based on the probabilities and the changes in thoughts or in
cash flow. Obviously, if we looked at this in six months at different reporting periods or three
months and SEC company different reporting periods and they say, “We are getting closer.
I think we are going to have to be more aggressive; let me shift a little of that 85% over to
the aggressive side.” Obviously, that is going to change the value, and we would run that
through earnings. That is how you would change that as you gain additional information.
The other way to use this is really to kind of go through a Monte Carlo approach, if you
can create a Monte Carlo spreadsheet that goes through various projections and you can
get even more detail. You can look at revenue projections. You can look at the change in
revenue or the change in EBITDA—I mean this could be as detailed as you want. This is
a very simplistic way in which to do this.

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On the discounted cash flow, you want to analyze the reasonableness of the projections
that we spoke about. I think these may have been out of order, but we are getting into
the DCF and business enterprise value. Analyze the reasonableness of the projections.
Consider what market participants would consider in their analysis of the DCF. What is
typical in the industry? Is it going to be—do I look at an asset acquisition? Would I look at
a stock acquisition? What is going on? Adjust the ongoing depreciation. Make sure you
are using tax depreciation, not book. Typically, you are going to see book there.
You want to make sure that you are looking at this in the right fashion before you go forward.
Consider an H Model to capture additional growth between the projection period and the
terminal year. There are a lot of different things to consider in a discounted cash flow and
Gordon growth at the end. We will look at that. Use the market participant tax rates. What
kind of tax rates do these market participants have? What does their net working capital
look like? What do they require as opposed to what the business actually has? Use the
internal rate of return. Include a tax amortization benefit for those intangible assets. Again,
to the extent that they don’t have intangibles on their books, the most advantageous is
obviously going to be to consider this as an asset acquisition, which is consistent with how
to treat these, so you would consider the tax amortization for intangible assets.
You come up with a $50 million value in your DCF and as a result of subtracting out the
tangibles you may have a value and what do you come up with? That is going to be the
intangible that you use.
Let’s move along. We have one question, but I will get to that one shortly on the exposure
draft. Company valuation—let’s talk quickly on the company valuation. This is essentially
a discounted cash flow of what they expected when they had the acquisition. You can
see revenue growing at 10% per year. You see a drop off in the terminal period. You are
dropping off at 3% in the terminal period. EBITDA is pretty consistent, EBITDA margins
are pretty consistent, EBIT is pretty consistent, and the estimate of gross cash flow.
We follow the gross cash flow to here. We have changes in net working capital. That 8% is
going to be where market participants would expect a normal working capital percentage
to be. The company may actually be working at 12.5%. However, you are looking at other
comparable companies that would come in here, maybe they were run more effectively
and there is a better chance they could have a net working capital requirement far less
than what the company originally had. So it is important to draw this conclusion from our
market participants.
Capital expenditures—I am just kind of freelancing here—with capital expenditures, you

want to look at if there are enough expenditures in there to support the growth. You want
to make sure you have, if you recall, we had this 10% growth coming out here. Do we have
enough capital expenditures listed here to support that growth? You want to make sure you
look at that. Here we have a partial year. A factor to consider for the actual 4114. Then we
come up with this present value of the cash flows (Slide 62). Notice the tax amortization
benefit in there. Again, anybody buying this company for $50 million is going to consider

25
the additional tax amortization benefit they get based on the net tangible assets and the
intangibles over that 15-year period.
I have a couple questions here. “I assume that you would only add the tab in your DCF
as the transaction actually was an asset deal.” No, that is incorrect. I think I had this
somewhere back in the slides, but essentially you would consider every deal to be an
asset deal regardless of tax or stock deal. So every asset should be an asset deal. That
is what deferred taxes are for. It is basically to make up this difference.
“Should the WACC or the IRR be used in the DCF calculation intangible asset valuation?
What is the difference between WACC and IRR?” Ideally they are the same number. You
need to look at what the weighted average cost of capital is and what the internal rate of
return is. Ideally in every one of these we have the same number. Usually what we do is
we do an independent calculation of the weighted average cost of capital and then we
figure out what the internal rate of return is. We look at it. Ideally I use the internal rate
of return number if it is different because that is what they expected, but the internal rate
of return could have included some synergies that should not be included because they
included them in their cash flow. So that is where we have to go back to management and
ask them if there are any synergies, so you want to make sure that you understand where
those numbers and projections are coming from.
But ideally they are the same number. That is what you are striving for. “In the case that
the tax rates change through the transaction, what tax rate would you use? Before or after
transaction rate?” Well, it is really the tax rate of the market participant. If you are dealing
with a market participant that has an average tax rate of 30%, and, typically, Capital IQ
will give those to you. We use 30%, or we use a blended, whatever it comes out to. We
have to look specifically if it would change. I am dealing with one now where it is a U.K.
transaction and they don’t recognize tax benefits, so as a result we can’t include tax benefit
because you always follow the jurisdiction in which the company would be. So if you are
a U.S. company and you are buying a foreign company and the foreign company is going
to be the one paying tax through the acquiring company, then you would use the foreign
tax rates.
“If you incorporate the amortization deduction in the effective tax rate, wouldn’t valuing the
tax benefit of an economic asset be double counting?” Deduction in the effective tax rate—I
don’t think we included that, the amortization deduction in the effective tax rate. Essentially
what you want to do is I pull all amortization benefit out and I use the actual tax rate in my
discounted cash flow, and then as part of that I calculate the amortization benefit individually
because it is easier to calculate that rather than plugging in amortization benefit because,
obviously, if I paid $50 million for a company and I have $10 million worth of assets and
$40 million are intangible, once I go through the tax benefit calculation, I would probably
come down to a number, which is obviously $9.9 million, so I have included that in there.
One last question—nope, we got that one. So we are going to move along because we
have a couple more slides to get through. WACC—calculating the equity using M&P Co.’s
data—be sure to select company-specific risk factor that coincides with the risk a market

26
participant would face with acquiring the M&P Co. Calculate the cost of debt using market
participant debt and tax assumptions. Again, WACC should typically be very close and
typically within 1%. Keep that in mind.
Here you will notice we do this differently for all engagements. This one I just wanted to show
simplistically, but in here we are using the Duff & Phelps (Slide 64). We are normalizing that
risk-free rate to a 4% and taking the equity risk premium. Over here we are using the tax
rate of 40%, which, again, for presentation purposes is rounded. Actual market participants
could be 38.5, could be 25—it just depends on the jurisdiction and where you are.
We are using this capital structure here that coincides with the capital structure in the
market. It is not the actual company’s capital structure. It is what is in the market and what
participants would view this as because it is going to be their acquired company.
This is really helpful. I have included this in the Quick Reference Guide in the AICPA that
I put together. It follows the assumptions, it summarizes the relationship between the IRR
and the WACC and the implications. I found this pretty helpful. It helps if you are a member
to download that. It is a really simple guide that answers a lot of really simple questions.
Reconcile the WACC to the IRR. The WACC should reflect the industry weighted average
return on debt and equity from a market participant perspective. You want to make sure
that is what it reflects. Again, make sure you get in there.
I had a slide somewhere that went in a little bit further. Again, look at these values right
here. These are pretty explanatory of what is wrong or what could be wrong. It doesn’t
necessarily mean it is wrong, but it basically tells you to go back and look at it again. Double
count—I try not to do a “garbage in, garbage out,” but, if the client gives you something,
really review it. Ultimately, it is your name on it when you are putting it in your report, so, if
you don’t understand it, ask questions. If you ask questions and you still don’t understand,
call somebody. I am always happy to discuss how I deal with things. That is kind of how
we all learn.
Trade name—if you look at the trade name here (Slide 66), we are using the revenue for
the total company, so this is total company revenue. Pretax relief from royalty of 2%, so
that is selected from a group of tax royalties, which are relief from royalty rates that are
actually pulled from Royalty Source. You come down to an after-tax. We apply the present
value factor again to the IRR/WACC. We account for the tax amortization benefits, come
up with the fair value of the trade name. It is pretty simplistic.
I think one thing you want to look at in here that is pretty—note that it is a three-year life. In
this situation, they were not going to use the trade name, so in this situation we essentially
said, “It is probably a three-year shelf life before anybody else would forget about it.” Is
three the right answer? Well, not really. The answer that we used here could be four. It
could be five. I usually don’t use less than three. This name really was not recognizable,
so that is why three is in here. Be careful when you go into trade names. Make sure you
talk to the auditors. Make sure you talk to the client. Some people will put an indefinite life

27
on the trade name. It could be one of those where they decide to use the trade name, so
make sure it is truly indefinite and not a 10-year because essentially what you are doing
under the indefinite lived asset is making it testable every year. Some clients don’t want
that. Just make sure it makes sense to limit it beforehand and usually you can talk to the
auditors about those. In this case, they are not using it, so it makes it easy—three or four
years off the balance sheet it is gone.
Contributory assets—this is where we start getting into contributory assets for the
multiperiod excess earnings. We are going to move quickly because we are short on
time. I know we can go over a little bit. There are secondary assets that are necessary to
support the earnings. You take a contributory asset charge against the cash flows of the
primary asset for each additional asset. If you are doing this work, read this literature. The
Appraisal Foundation has this out there. Download it. Read through it. It is fairly high level,
but it does walk you through and it is really important to understand what these mean and
how to get through these. These are great guides from them.
Prior to completing contributory asset calculation, you need to go through the customer
attrition rate and then remaining customers shown as an allocated—or allocated as a
percentage of contributory charges to expected revenues. That is a big difference here.
The trade name you are using total revenue. Contributory assets will be calculated, and
then you are going to apply that to the customer list of remaining customers. So if you
think about the way this—you basically have this line of revenue going up over time, and
essentially your customer revenue is going down over time. So everything in between here
is new revenue, new clients. Well, we are not valuing that, so we want to stay completely
below and only value the items that truly exist as of the date of acquisition, so keep that
in mind. There are going to be some different cash flows.
So contributory assets—here we had a little bit different (Slide 69), but this is a contributory
asset calculation that shows our net working capital, fixed asset balances, assembled
workforce, trade name, and noncompete. All of these are valued. So the values are in here.
You then have your required returns on net working capital, fixed assets, and assembled
workforce. Notice the difference in the rates. These don’t always have to be the same. These
here don’t have to be the same—they are intangibles, but if there is a different risk level,
for example, customer list, they are already in the house. The contracts are already in the
house. Maybe that risk is lower because you already have them. That risk could be 18%.
Think about the different risk levels as you are doing this. They don’t have to be the same
as your weighted average cost of capital. I typically will go two points below and up to two
points above based on the risk of the intangible assets. IP R&D, I will go two or three points
above my WACC or internal rate of return because it hides higher risk. It is not completed,
and there is no certainty. Make sure you look at that. Working capital and fixed assets are
these right here. Make sure to look at how you develop these.
Net working capital should in best practice really be based on banking needs. If you have a
net working capital line of credit, what would it be? Well, it is based on having receivables
in X amount. It is not purely based on a rate, a rate offered on short-term financing, but

28
it could be a blended rate. Similar to fixed assets—fixed assets you can’t buy the whole
thing on credit. Some of it you can, but some want 20% down, so you might have 80%
based on a lending rate, and you may have 20% based on your cost of equity, and that
gets you a 6.7. Factor in all of those things when you are thinking about the required rates
of return on these assets.
Then these returns will be applied in the next slide (Slide 70). Another thing to note here is
to look at these here. These stop over time, so it is important to understand why they stop
here. The noncompete is going to stop. You would only apply the charges to the economic
life of the asset unless it is necessary to support the PFI. Well, the noncompete is not
necessary to support that. That is based on the acquirer and what he wanted, but if you
notice the trade name stops here. There are two views on this. I just put it in here to show
this to cause controversy, but the trade name that you are acquiring you are not going to
use any longer, so you could argue that I don’t need it. It is not going to support the PFI.
However, in most situations, it is wise to continue that out because, instead of using this
trade name to support the PFI, you are going to be using the acquirer’s trade name. So in
those situations this really should go all the way across and include the trade name all the
way. Again, things to consider are outlined in the guide. It is very good to go through that.
We have a question. “Why is the workforce value increasing over the years?” That is a
good point. This is something I started a couple of years ago, which is again included in
The Appraisal Foundation literature for best practices. Your assembled workforce is not
the same. It is the same on the day you buy it, but, if there are any contributory asset
charges moving forward, your assembled workforce is going to grow based on the growth
in your revenue just like the fixed assets are going to grow. They are going to change over
time. You notice those change over time, so you have to grow your assembled workforce.
There is a function to grow that at 3% or whatever the percentage is to grow it over time
to support the revenue and support the expenses and you have to take a charge for that.
Otherwise you may be overvaluing the customer list. So that is a good question.
Here is where they are actually pulled from (Slide 70). You have the projected revenue
here. You have revenue attributable to existing customers, and you have the customer
relationship allocation, so this is the existing customers and this is the total revenue. We
essentially would take 83% of our previous return or charge for the contributory asset, and
that would come over to here. As you go on, less and less of your charge, which is 13%
back here, is going to be attributed to the actual asset because it is declining over time.
Again, this is really laid out well in The Appraisal Foundation guide. I suggest you read
through it. It does take a while to understand, but once you go through it they have these
examples. They are set up the same way. They are very good.
Customer attrition—we actually had two different types of customer relationships here. We
are not going to get into both of them, but the main points here are to think about what you
have. If you have large customers and small customers, the larger ones tend to stay on

29
longer; the small ones come in and out. Consider bifurcating your customer relationships
into two sections. The key for doing that though is to make sure your revenue is bifurcated
as well when you do the multiperiod excess earnings because you don’t want to do two
separate period earnings on the same revenue or you will be overcounting. You want to
make sure that you separate them.
We don’t do that often, but it did happen a couple of times. It happened in this example.
Typically, you only have one customer list, so you won’t really see this, but it is important
when looking through customer lists to really understand how these customers are hanging
on and what the attrition looks like. We use multiple models to kind of look at this. There is
a lot of literature out there on the models to use to look at attrition, but you basically look
at revenue by the year for the customers over a four-, five-, or six-year period. Figure out
how consistent they are, whether they grow new customers in, old customers out, and
calculate something that shows the actual value of those customer relationships.
When you are dealing with contract backlogs, and we don’t have that in this case, we are
just dealing with the customer relationships, but in contract backlogs you want to make sure
if you have any, or contract value. You want to make sure if you have any backlog to pull
that out separately. Because, if you have backlog that can be amortized at a much shorter
time frame, it will be cleared out of the system quicker, and your remaining contractual
relationship will stay on the balance sheet over a period of time as an intangible. So think
those things through from an accounting perspective as you are going through these
calculations.
The existing customer net revenue assuming no attrition—again, this is just a quick run
through of what these look like. Expenses would come down, EBIT, operating margin, taxes,
net operating profit after taxes, and then we have our required return on contributory assets,
and that should tie into the one that we hit back here—that’s probably the higher one, so
we didn’t hit that one. But essentially this would be your charge based on that remaining
revenue that we calculated a couple slides back. That would come directly off here again,
based on this revenue based on the calculations. Then you have this present value factor
(Slide 73). Then you come down to your tax amortization benefit, and that is pretty much
how you would calculate the value of the customer list.
Again, these are really well documented throughout a bunch of publications. It is really
important to go through and make sure we understand how they are calculated and what
they look like at the end of the day.
Customer relationships ideally you want to take out until you get down to some nominal
amount down here. If it goes out for 20 years, top level, talk to the client. Is it really a 20-
year customer or did you get the attrition wrong? Double-check that, and make sure that
you are counting the attrition the way that it is. We get a lot of comments on that. We had
to support those fairly well, so good discussion around that is useful.
That is the smaller company size calculation. Noncompete agreements—we do a “with or

without,” identify agreement terms, discuss with management what would likely happen,

30
impact on revenue and profitability. Ideally these aren’t simple. Typically, they are more
robust than what a client wants to put into it, so push them and try to get some useful
information. I am sorry this slide (Slide 77) is a little tough to read but essentially looking
at the with noncompete, which should tie into your projections, and without, which is tied
to projections and then what would happen in decline to revenue here. I’m going to lose
revenue. I might lose a couple customers. Can you identify specifics that would leave with
the owner?
If so, how does that impact EBITDA? Are they big customers, large margin customers,
smaller customers? Be very specific on how this looks. I have seen some that just look
at a without noncompete, “with and without” is just a little bit smaller, and everything else
stays consistent, the percentages, etc. That doesn’t really work. That is not how a business
works, so, again, you might have to look down here in the changes in net working capital
and the capital expenditures. It is like a minivaluation for the cash flow that you actually
come down to.
Then you compare these two amounts here, present value them, and then we come down
to this big subjective matter. What is the probability they are going to compete? While we
have a number here of $1.8 million, it really comes down to if they are going to compete.
Again, that is based on the client. The only thing I can tell you is supported based on
discussions, based on intentions. He’s 97 years old. There is no way he is going to compete.
I have had zero there before. I have had 100%. Just be careful on how you support that.
Assembled workforce, training—you basically account for training, recruiting costs. This is
essentially how these are put together (Slide 80). You show all of the positions by group,
by individual, salary, their fringe, their total salary, fringe percentage based on different
salaries, annual training costs to train them, recruiting costs. Some of them are more.
Some of them are not as much. Then you have total costs. You have your interview and
HR, standard, internal. Again, we are subtracting the replacement cost here. We are adding
the amortization benefit to come up with the fair value of the assembled workforce.
This is a fairly easy process. There is a guide at the back that I will show you very quickly
that has the representation of this. Again, I would recommend reading from this. With
goodwill, the difference between the present value of consideration transferred and the
sum of all identifiable tangibles and intangibles. You can see there is our contingent
consideration calculation. We are low on time, but one thing I want to tell you about
contingent consideration is, when you are looking at the probability outcomes for when the
payout of contingent consideration is, make sure that your discount rates are in compliance
with when the earn-out is paid, not completed.
For example, if you have January to December earn-out period, your discount rate should
not be based on December. Typically, there is a 30- or 60-day call for review, a 30-day
agreement. Most likely, it is paid 90 days after close of the books, so your discount period
for contingent consideration under that earn-out side is going to be March 31, 2016, or

31
whatever that date happens to be. Just make sure they coincide and that you are not just
breezing through looking at that.
A couple of questions are: “Why would you always include the tab for overall business where
a stock deal may be more advantageous for a market participant?” I have something in
here. I am trying to figure out where I put that literature, but, essentially, if you go through
most of the Big Four guides and the 805, you always have to account for it as an asset
deal. The SEC kind of came into this in 2004 (I may be wrong), but there is a statement
from the SEC about concerns about practitioners not doing things correctly. This is the
genesis of the new intangible credentials coming down the line. They said there was some
concern that people were not doing the right thing and that the tax amortization benefits
should always be considered and the way that it is counteracted from a taxable/nontaxable
transaction is through your deferred tax assets or liabilities. There is a really good reason.
I am flustered to try to get through the end of this, but I cannot remember where, but if you
email me I can send it to you.
“If there are perks in a bargain purchase or strategic purchase, will the WACC equal the
IRR? If not, the WACC/IRR could be utilized in the DCF and intangible assets bargain
purchase where the enterprise value from the DCF equal to the purchase.” Whew, that
is a lot in one big question. Go back to the one slide (Slide 82) that talks about the IRR,
the differences between the WACC, the IRR, and the weighted average return on assets.
There could be different situations. It could be a bargain purchase and your IRR, or one
of those would be less than the other.
If so, you have to use the representative measure in that, the internal rate of return most
likely, to show that there are some synergies in there or to show that there is a bargain
purchase. That will guide that. If you go through some of the guides, especially the Quick
Reference Guide that I put together, it will explain that a little bit better. I am happy to follow
up afterwards with you if you need to.
The WARA, WACC, and internal rate of return reconciliation—this may get into your question
as well—but compare these three. They assist in assessing the reasonableness of the
asset-specific returns for these identifiable intangibles. They should all be in alignment
here. Under a bargain purchase, financial theory critiques the following relationship and
this really goes to this question. The IRR would greater than the WACC, which would be
greater than WARA. The IRR would tend to be the highest because its subject company
was purchased at a low price in a purchase. This indicates that the buyer is requiring an
above-market rate of return on the investment.
The WACC is in the middle because it is calculated without regard to the purchase price and
hence is unaffected by the nature of the acquisition. The WARA tends to be the lowest rate
of return because in a bargain purchase there is no goodwill, which typically has a higher
required rate of return than any other assets. Goodwill would be present in the normal
market assumption associated with the WACC. Hopefully that answers the last question
in a little bit more detail. I had some notes on some of these items here.

32
Here is the weighted average return on assets (Slide 83). The big thing when you are going
through this, regardless of how you have everything completed, this number should be
larger than these other ones. We are skimming by here, which may mean there could be
an issue up here, but this can’t be lower. I always calculate that so that my return equals
my IRR. I am basically solving for this answer by coming in and saying 18% of this equals
this here and then solving for this number, and this should be higher than all of these. That
is kind of what I do there.
We had a question on the discount period. If you want to email me, I can explain a little
bit more about that. It is pretty simple. But please feel free to reach out to me, and I will
get back to you.
Reporting considerations—earn-out—consider Monte Carlo method to calculate. Is this

considered purchase price or owner compensation? Be very careful with this. There is a
lot of good literature out there about this. Additional consideration is considered employee
compensation when it is contingent upon the employee being employed by the company.
As a result it would not be considered contingent consideration; instead it is expensed on
the opposite end as employee comp, so just be warned about that.
Trade names, limited life, infinite life, consider the implications of the user and how to
weigh those with the specific circumstances. Customer list—don’t forget to take out your
customer marketing expenses to new customers. Everybody markets to new customers.
Take that stuff out. We don’t need that in there because you already have the customers,
so your EBITDA is going to be higher.
Consider the backlog in contract valuations. It is shorter economic life. It will get that off the
books faster. We talked about the earn-out. For WACC, consider different risk levels for
different intangibles. We talked about that. Discuss the process of identifying intangibles.
Noncompete—consider dual projections for revenue and EBITDA.
Resources—Fair Value Measurement by Mark Zyla. It is a great book. Always go back to

that one. Quick Reference Guide, I was referencing in business combinations. Valuation for
Financial Reporting by Mard, Hitchner, and Hyden. These are from The Appraisal Foundation
and are really good reads. The best advice is the Big Four Business Combination reference
guides. They are really good to read through. They give you practical examples. I really
like them a lot. If you work with the Big Four, you want to use their guide.
That is about it. We have two more questions. “Valuing customer relationships using
multiperiod excess earnings and brand is determined to be a contributory asset, what
should the return be applied to: brand revenue or customer relationship revenue?” I think
you are trying to ask the question about trade names. Trade name or trade brand would be
contributory asset and the return would be applied against the cash flows of the company
essentially under multiperiod excess earnings method plus the goodwill method. You are
figuring out all these returns that you have and whatever is left is distributable under the
multiperiod excess earnings to the primary asset or the customer list. That would actually

33
be applied against the cash flows of the company just like assembled workforce, fixed
assets, or net working capital, and then you would come down and have a remaining asset.
I think that answers your question.
“Noncompetes—do you ever include the cash flow intact of noncompete from period after
the end of the noncompete term?” I typically do not see that, but you could. You would
have to stretch out that valuation a little bit more. Obviously, if a noncompete lasts for a
period of time, you could stretch it out even further. I have not seen or utilized that, but
that is a good question.
“In noncompete valuation, should the tab be calculated after the 30% probability was
applied?” Either way I think you are coming down to the same answer. It is just simple
multiplication. You apply it before you take 30% of that or take 30% and apply the tab. I
think theoretically you should come down to the same answer, but that is a good question.
I guess that is it. Does anybody have any further questions? If not, we are completed for
today, and I thank you much for sticking around and enjoying this presentation. If you have
any questions that you want to follow up on, please feel free to contact me. I am always
around.
We have one further question. “Do we consider valuing the fair market value of the deferred
revenues?” Yes, deferred revenues are valued. There is a specific way to value them. Again,
go through the literature and look through how to actually value those deferred revenues.
It is not just the book value. Typically, it is the cost to complete the project that results in
that deferred revenue.
That wraps us up for today.
Andy Dzamba: Very good. Nathan, I don’t see your email address on there. Can you give
that out to anybody who has any further questions?
Nathan DiNatale: It is ndinatale@scandh.com.
Andy Dzamba: Terrific, thanks very much. If we didn’t get to your questions or if you have
any questions, please email Nate and he would be happy to respond. We are running late,
so thank you all for hanging in there.
On behalf of BVR, I want to thank Nathan DiNatale for a very, very excellent presentation,
and of course I want to thank all of our listeners for attending.
You can get a transcript and recording of this webinar and all BVR webinars at bvresources.
com/training.
As a reminder, if you have any questions related to the content or format of this webinar,
please email BVR at questions@bvresources.com.
Again, thank you all for listening, have a great rest of the day, and you may now disconnect.
34
March 23, 2016
Rebroadcast Q&A
Andy Dzamba: Terrific, thanks very much, Nathan, and I do see that we have some time
left, and I do see some questions that have come in during the program in the queue. If
you are able to answer some of these, that would be great, Nathan.
Nathan DiNatale: Great, thanks, Andy. We had a question related to under what
circumstances would you segregate the in-place workforce rather than assume it is part
and parcel of the acquisition. I am not sure I exactly understand what they are referencing
in the question, but the assembled workforce is very much a part of the business and
obviously absent the workforce the business could not continue.
So, with all valuation of intangibles, the workforce would be valued and then would obviously
be comprised with the goodwill piece when you allocate the actual purchase price. So I
don’t know if there is ever a time you would not value the assembled workforce. There may
be some specific circumstances where people are buying select assets and no workforce,
but, to really understand, at least under the multiperiod excess earnings method, you need
to understand all contributory assets to that, and, obviously, the workforce would be one
of them.
“Why is it necessary to value the tax amortization benefit as opposed to embedding tax
advantages in the assumed tax rate?” That is a good question. Ideally the tax amortization
benefit—it is common practice to include that when estimating the fair value of an intangible
asset regardless of whether the asset was acquired in a taxable or nontaxable transaction.
The SEC had a speech on this I believe in 2004 or 2006 in D.C. related to errors that they
found in practice with people excluding the tax amortization benefit when valuing intangibles.
You can really look to the guidance of FAS 109 to specifically understand why it should be
included, but, absent that tax amortization benefit in your intangible assets, you may be
misrecording some of the FAS 109 deferred tax assets when stating those for the financial
statements. So it is important to include that in there.
Now, there are cases where you specifically would not include that in there, and that is when
none of the market participants would actually enjoy that amortization benefit. We actually
have another case study that I am going over tomorrow that goes through that example
where all of the market participants happen to be U.S. based. However, they are buying a
foreign company, and the foreign company does not enjoy the actual amortization benefit
that we do in the U.S. In that specific circumstance, no relative buyer would consider the
benefit of a tax amortization benefit in the intangibles. That was actually a good question.
“I have heard that a P.O. may be considered a contract-related intangible.” I actually had
to look that one up. From my audit background, I would say I believe they would be. If you
have standing purchase orders that go over a long period of time, it is a contract to buy,
and that contract can be valued as a liability. Obviously, that liability would go beyond just
your normal AP or accrued expenses that are considered in net working capital. Much like

35
deferred revenue, where someone has paid you upfront for continuous use or continuous
production over a period of time and get the value of that deferred revenue and the cost
to create that product, I can understand how you would want to look for purchase orders
where there is a continuing P.O. out there or outstanding purchase order contract that
could be valued.
Most of these issues really should come up during your discussion with clients. At the
beginning of the allocation or identification of the assets and liabilities acquired, what
is going to stretch beyond the current spectrum of what you see on the balance sheet?
Any kind of contingencies other than the payables and liabilities—if there is a purchase
order obligation that goes three or four months out, obviously, a buyer is going to acquire
that unless it is specifically excluded. Again, it is really important to understand what is
happening with the balance sheet and what they have acquired.
“What if the cost method is greater than the income approach? Would you use the cost
or default to highest and best use as received by market participants?” When valuing the
assets, again, market participant synergies and expectations are among the most important.
It is your perception as to what you believe is happening in the marketplace. Obviously, a
willing buyer in the marketplace, knowledgeable of all aspects, which would be considered
a market participant, would be looking at a cost as well as a market or income approach.
So you have to consider the actual market participants and what they would consider in
their actual acquisition or purchase of that asset.
Obviously, they would consider both, but again it is subjective. Some people could say that
cost would be the most important. Why would somebody pay more on a cost perspective if
it doesn’t generate enough income to validate the actual value? It is really in the way that
you support your conclusions with research and with what others have done in the past.
“How do you use an IRR? It is either greater than or less than the acquirer’s threshold.”
The IRR is basically the rate in which the transaction is taking place and you are solving
for that. It is the dollar value of the transaction and essentially the fair market value or the
fair value of the actual company and whatever rate it is to equal that. That is essentially
what they are assuming to be their internal rate of return.
Again, I compare that to WACC on every engagement that I produce. Some are lower.
Some are higher. Most are right around that 1% different range, and then we obviously
value those intangibles based on the internal rate of return.
“Do you apply the tax amortization benefit to the intangibles whether it is a stock or asset
purchase?” Yes, we just went over that one. You do regardless of whether it is a stock or
asset, unless specifically the market participants would not be able to enjoy those benefits.
Now, if you are dealing in a goodwill impairment situation, I have seen it both ways because
ideally you would not include the tax amortization benefit if there is a higher benefit for the
company to actually go out on a stock transaction, whether they have additional NOLs

36
out there that exceed the benefit produced by the tax amortization. But it is something to
document your conclusions and rationale in deciding what type of transaction it would be.
PFI—that is prospective financial information—we talked a little bit about the term, but we
did not define it. Essentially it is a broad term that looks at several types of forward-looking
financial information, anything that the client produces to essentially say into the future this
is what we expect to happen. In layman’s terms, we look at it as forecast or projections.
“What do you do when the Royalty Source data are really not comparable to the value
of the company you are valuing?” I can say that probably happens a lot. You are never
going to find, or it is probably very rare that you are going to fine exact comparables. But
I think if you do a search for royalty data that kind of encompasses the general industry,
as you look at enough of that, you will gauge a sense of what certain royalty rates are for
certain types of trade names. If you read the details, just don’t look at the data, but read
the details of the agreement, you will be able to pull out some and realize that most of
these are done in the 1%-to-5% range that I have seen personally. The more you do, the
more comfortable you will get with trying to understand which one is more applicable to
you. But, at the end of the day, like everything in valuation, it is highly subjective and open
to the rationale that you choose and your supporting documents.
“Workforce growth may have both wage and level of effort components.” Correct. This
refers back to the workforce growing in the contributory asset charge, and I agree; the
workforce should not stay static over a period of time because, as revenue increases,
workforce will increase to play a similar role in its contributory nature to the revenues
being generated. [audio break 10:15] first remain static and the revenue grew over time,
then you would have a mismatch and potentially more of the value would be attributable
to the actual intangible being valued, in this case, the customer list. It is important to grow
the representative dependence of that revenue at the same rate at least of the revenue
moving forward.
“How did you determine attrition in this particular example?” I don’t actually recall the
complete analysis that we went through, but typically we will look at year-over-year analysis
and percentage of clients lost. I think this one we actually bifurcated to large and small
clients and looked at larger clients that stayed on for a longer period of time, smaller clients
that kind of popped in and out, and developed two types of attrition rates. But there are
lots of different ways to calculate attrition. There are some guides out there. I don’t know
any off the top of my head, but I would be happy to look into those and get back to you if
you need to know.
“How do you justify the fair value workforce being less than replacement costs? Why don’t
you consider developer’s profit and entrepreneurial incentives?” I typically look at the
cost approach of the workforce as being the actual value there. I am not a fan of adding
developer’s profit and entrepreneurial incentive to the workforce. In a software environment,
I can see that because you could actually develop something, package it, and sell it and it
could potentially be a higher value, but, in a workforce, the typical allocation of workforce

37
is really not to package it and sell it as a workforce; it is really a kind of in process asset.
That is just my own personal opinion. I have never really had any kickback on that and
never really included anything else related to that, so I typically justify that based on the
replacement costs.
“How do you deal with all the subjective decisions you make in doing such a report when
dealing with a Big Four auditor?” Again, it really boils down to, and you are going to see
a little bit more of this coming out soon, but it is really important to document everything.
Think of your valuation report as part of a bigger picture, as part of an audit. So if you
design your procedures and your documentation as such and make it very easy to follow,
the auditor knows, the valuation specialist knows that it is subjective as long as you
document that the royalty rate was one to three. I really had no choice of why it should
be one, two, or three—I kind of used the median there of two. It seems reasonable. Most
of them were in that range, and that is why we made that choice. If you kind of document
all of your decisions and support in that fashion, I don’t think you are going to have any
issues. There may some differences of opinion that will have to be addressed, but at least
they will understand your rationale and your support.
I think those are all the questions that we are going to get through today. Obviously, I am
always available. My email address was made available. If you ever have any questions,
I am always happy to answer emails or call from a phone about something. I am not the
end all, be all, but, if I don’t know the answer, I can certainly guide you to somebody who
does. I want to thank you again for your time today.
Andy Dzamba: Thank you very much, Nathan DiNatale, for a very excellent presentation.
I want to thank all of our listeners for attending and all the great questions.
For a schedule of future BVR webinars, please go to bvresources.com/training. You will

also find information on BVR’s Training Passport and Passport Pro, which offer unlimited
access to our webinar series.
As a reminder, if you have any other questions related to this or future webinars, please
email BVR at questions@bvresources.com.
Again, thank you all for listening, have a great rest of the day, and you may now disconnect.
Thank you very much.

38
March 23, 2016
Questions@BVResources.com 1
© 2015 Business Valuation Resources, LLC
DISCLAIMER
The views expressed by the presenters do not necessarily
represent the views, positions, or opinions of BVR or the
presenter’s respective organization.
These materials, and the oral presentation accompanying them,
are for educational purposes only and do not constitute
accounting or legal advice or create an accountant‐client or
attorney‐client relationship.
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Nathan E. DiNatale, CPA/ABV, CVA, ABAR
 Principal at SC&H Group, LLC, Sparks, MD
▫ Leads the Business Valuation & Litigation Support Group for SC&H
▫ More than 21 years of public accounting experience
▫ Broad experience in fair value valuation and valuation standards
applicable for financial reporting purposes
▫ Testifies as an expert witness in valuation and economic damage cases
▫ Member of the AICPA Business Valuation Committee
▫ Member of the 2015 AICPA FVS Conference Planning Committee
▫ Member of the Appraisal Foundation Business Valuation Resource Panel
▫ Past Chairman of the MACPA Forensic and Valuation Committee
Focus of Today’s Presentation
 This session is a fundamental overview of ASC 805: Business
Combinations, often referred to as purchase price allocations. The key
points of ASC 805 will be discussed, how to address the valuation of
intangibles and the overall process of the engagement. The session will
provide illustrative examples.
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Focus of Today’s Presentation
 Learning Objectives:
▫ Familiarize the participants with the history of business
combinations and fair value measurements
▫ Provide an overview of fair value concepts and ASC 820
▫ Provide an overview of key terms used in preparing valuation of
intangible assets in allocating total consideration
▫ Review generally accepted methodologies for valuing intangible
assets
▫ Walk through an ASC 805 case study
Overview
 Overview of ASC 820 ‐ Fair Value Concepts
 Overview of ASC 805 – Business Combinations and Key Terms
 Valuation Methodologies for Intangibles
 Case Analysis 1
 Reporting Considerations
 Resources
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Overview of ASC 820 ‐ Fair Value Concepts
ASC 820
Fair value under FASB ASC 820: Fair Value Measurement emphasizes market
participant assumptions and exit values and is defined as:
“The price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date.”
Fair value assumes an orderly transaction that assumes exposure to the
market for a period prior to the measurement date to allow for usual
and customary marketing activities for transactions involving such assets
or liabilities
Objective is to determine the exit price that occurs in the principal or
most advantageous market from the seller’s perspective
May be different than the entry price (the price paid to acquire the asset
or received to assume the liability)
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ASC 820 – Highest and Best Use
Highest and Best Use – A fair value measurement assumes the highest and
best use of the asset by market participants, considering the use of the asset
that is physically possible, legally permissible, and financially feasible at the
measurement date. In broad terms, highest and best use refers to the use
of an asset by market participants that would maximize the value of the
asset or the group of assets within which the asset would be used.
Highest and best use is determined based on the use of the asset by the
market participants, even if the intended use of the asset by the reporting
entity is different. The asset must be valued based on whether its highest
best use is “in use” or “in exchange”.
In use — The maximum value of the asset is in combination with other
assets as a group
In exchange — The maximum value of the asset is when it is on a stand‐
alone basis
Example 1
In the example, the land is currently used for a factory, but could be
developed as a residential site. The highest and best use is determined
by the greater of (1) the value of the land in continued use for a factory
(in combination with other assets) or (2) the value of the land as a
vacant site for residential development (taking into account the cost to
demolish the factory and including uncertainty about whether the
reporting entity can convert the asset to the alternative use).
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Example 2
 A pharmaceutical company acquires a company with two drugs. Drug A
is a cholesterol lowering drug. By itself, Drug A is moderately effective.
Drug B is another moderately effective cholesterol lowering drug. When
taken together, Drug A and Drug B are highly effective at lowering
cholesterol levels.
On a standalone basis, Drug A has a fair value of $100 million and Drug B
has a fair value of $150 million. When the drugs are valued together,
Drug A and Drug B have a combined fair value of $650 million.
 What is the highest and best use, and resulting fair value of these drugs?
The highest and best use of these drugs is to sell the products together.
As a result, the total fair value of Drug A and Drug B should equal $650
million. The value should be allocated to Drug A and Drug B (units of
account) in a systematic and rational way reflecting the contributions of
each drug.
ASC 820
Synergies — Fair value rules state that buyer‐specific synergies be excluded
from the calculation of value unless the synergies could be sustained at the
market participant level. In that case, they would be included in the
calculation.
Market Participants Assumptions — ASC 820 defines market participants as
buyers and sellers in the principal (or most advantageous) market for the
asset or liability that have all of the following characteristics:
Independent of the reporting entity (that is, they are not related parties)
Knowledgeable, having reasonable understanding about the asset or
liability and the transaction based on all available information, including
information that might be obtained through due diligence efforts that
are usual and customary
Able to transact for the asset or liability
Willing to transact for the asset or liability (that is, they are motivated
but not forced or otherwise compelled to do so)
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ASC 820
 Principal market:
The market in which the reporting entity would sell the asset or
transfer the liability with the greatest volume and level of activity for
the asset or liability.
 Most advantageous market:
The market in which the reporting entity would sell the asset or
transfer the liability with the price that maximizes the amount that
would be received for the asset or minimizes the amount that would
be paid to transfer the liability, considering transaction costs in the
respective market(s).
ASC 820
 Hierarchy of Inputs to Valuation Techniques
▫ Observable inputs
• Level 1 – quoted prices for identical assets
• Level 2 – quoted prices for similar assets, used without significant
adjustment
▫ Unobservable inputs
• Level 3 – used when observable inputs are unavailable, reporting
entity’s own assumptions about the assumptions that market
participants would use
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Overview of ASC 805 – Business Combinations and Key
Terms
ASC 805, Business Combinations
Originally issued as SFAS 141(R), ASC 805 supersedes APB 16 (1960) and
SFAS 141 (2001)
FASB ASC 805: Business Combinations describes the proper accounting
treatment to be used by an acquirer in business combinations. ASC 805:
 Applies to business combinations with an acquisition date on or after the
beginning of the first annual reporting period beginning on or after Dec.
15, 2008 (Dec. 15, 2009, for acquisitions by not‐for‐profit entities)
 Provides a broader definition of a business
 Requires the use of the acquisition method
 Recognizes assets acquired and liabilities assumed at fair value as
defined in ASC 820: Fair Value Measurement
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The Acquisition Method
 Under ASC 805, all business combinations are accounted for by
applying the acquisition method, which requires:
▫ Identifying the acquirer
▫ Determining the acquisition date and the fair value of the acquisition
price
▫ Recognizing identifiable assets acquired, liabilities assumed and non‐
controlling interests at accounting date fair value
▫ Recognizing goodwill, or in the case of a bargain purchase, a gain
Recognition Criteria
 An asset is identifiable if it either:
▫ Is separable, that is, capable of being separated or divided from the
entity and sold, transferred, licensed, rented, or exchanged, either
individually or together with a related contract, identifiable asset, or
liability, regardless of whether the entity intends to do so; or
▫ Arises from contractual or other legal rights, regardless of whether
those rights are transferable or separable from the entity or from
other rights and obligations.
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ASC 805 – Key Points
 The term “business” is defined:
”An integrated set of activities and assets that is capable of being
conducted and managed for the purpose of providing a return.”
 The term “business combination” is defined:
“A transaction or other event in which an acquirer obtains control of
ne or more businesses.”
A business consists of inputs and processes applied to those inputs that have
the ability to create outputs. Although a business usually has outputs,
outputs are not required to qualify as a business.
Inputs
Ability to
Create
Outputs
Processes
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 The fair value of the business combination is measured at the fair value
of the consideration transferred.
▫ Cash
▫ Note payable
▫ Equity interests
▫ Contingent consideration
 Transaction related costs are expensed rather than capitalized
 Assets and liabilities that are of a contingent nature will be recorded at
their relative fair values if “reasonably determinable”
Allocation of Assets and Liabilities
ASC 805‐20‐25‐1 requires that all identifiable assets and liabilities acquired,
including identifiable intangible assets, be assigned a portion of the
purchase price based on their fair values.
The value of the business acquired usually is measured as the sum of the
acquisition‐date values (measured at fair value with a few exceptions) of the
following:
Consideration transferred for the acquiree
Equity interests in the acquiree held by the acquirer immediately before
the acquisition date (for an acquisition achieved in stages, also known as
a step acquisition)
Non‐controlling interests in the acquiree held by third parties (in a
partially owned subsidiary)
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ASC 805 – Allocation of Assets and Liabilities
Total consideration transferred is allocated among the fair value of the
identifiable tangible and intangible assets and liabilities assumed.
Goodwill
Goodwill is considered a residual amount that represents the future
economic benefits arising from the other assets acquired in a business
combination that have not met the criteria for being individually
identified and separately recognized. If the fair value of net assets
acquired is less than the total consideration paid for the acquired
entity, the difference is recorded as goodwill.
ASC 805 – Contingent Consideration
Contingent consideration, commonly referred to as an earn‐out, represents
an obligation of the acquirer if future events or conditions are met. All
contingent consideration is included in business combination accounting
and is measured at its fair value as of the acquisition date.
Typically, the fair value of contingent consideration is determined by
probability weighting specific well‐supported outcomes via a Monte Carlo
simulation model or similar risk‐simulation tool.
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ASC 805 – Contingent Consideration
 Specific, Relevant Projections — Management should prepare
multiple sets of projections that rely on independent future
outcomes. These projections are weighted to determine the most
appropriate probability‐weighted outcome for the contingent
consideration expected to be paid.
 ASC 805‐30‐35‐1 states that changes resulting from events after the
acquisition date, such as meeting an earnings target, reaching a
specified share price, or reaching a milestone on a research and
development project, are not measurement period adjustments.
 The acquirer shall account for changes in the fair value of contingent
consideration that are not measurement period adjustments as follows:
▫ Contingent consideration classified as equity shall not be remeasured
and its subsequent settlement shall be accounted for within equity.
▫ Contingent consideration classified as an asset or a liability shall be
remeasured to fair value at each reporting date until the contingency
is resolved. The changes in fair value shall be recognized in earnings.
ASC 805 – Bargain Purchase
In some cases, an acquirer may make a bargain purchase, a business
combination where the acquisition‐date amounts of identifiable net assets
acquired, excluding goodwill, exceed the sum of the value of consideration
transferred. This standard requires the recognition of a gain for a bargain
purchase.
Paragraph ASC 805‐30‐25‐4 requires the acquirer to reassess whether it has
correctly identified all of the assets acquired and all of the liabilities.
The objective of the review is to ensure that the measurements
appropriately reflect consideration of all available information as of the
acquisition date.es assumed before recognizing a gain on a bargain purchase
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Additional Terminology
 PFI – Prospective Financial Information
 IRR – Internal Rate of Return
 WARA – Weighted Average Return on Assets
 BEV – Business Enterprise Value
 TAB – Tax Amortization benefit
 MPEEM – Multi‐Period Excess Earnings Method
Typical Intangible Assets
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Intangible Assets
Definition Monetary Value
 Long‐term resources of an entity,
Business Value
but have no physical existence
Tangible Assets
 Arise from contractual or legal
rights, or capable of being Identifiable Intangible Assets
separated from the entity and
transferred to another entity
Goodwill
Intangible Assets
• Patents
Limited • Copyrights
Life • Backlog
• Goodwill, etc.
Intangible Assets
Intangible
Assets
Unlimited • Trademarks
Life • Domain Names, etc.
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Intangible Assets
• International Accounting Standards (“IAS”) 38 defines an intangible asset as “an
identifiable non‐monetary asset without physical substance”
• Accounting Standards Codification (“ASC”) 350 defines an intangible asset as
“Assets (not including financial assets) that lack physical substance. (The term
intangible assets is used to refer to intangible assets other than goodwill.)”
• Cambridge dictionary defines an intangible asset as “something valuable that a
company has that is not material, such as a good reputation.”
• The International Glossary of Business Valuation Terms defines intangible assets
as “non‐ physical assets such as franchises, trademarks, patents, copyrights,
goodwill, equities, mineral rights, securities and contracts (as distinguished from
physical assets) that grant rights and privileges, and have value for the owner.”
GAAP Guidance
 ASC 805‐55 provides examples of identifiable intangible assets acquired in
a business combination.
 This list is specifically intended to present the identifiable intangible assets
that are recognized for acquisition accounting purposes as follows:
▫ Marketing‐related intangible assets
▫ Customer‐related intangible assets
▫ Artistic‐related intangible assets
▫ Contract‐based intangible assets
▫ Technology‐based intangible assets
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Marketing‐Related
 Marketing‐related intangible assets are those assets primarily used in the
marketing or promotion of products or services
▫ Trademarks, service marks, or trade names
▫ Internet domain names
▫ Non‐compete agreements
Customer‐Related
 Customer‐related intangible assets occur as a result of interactions with
outside parties
▫ Customer lists
▫ Customer contracts and relationships
▫ Expected customer contract renewals
▫ Non‐contractual customer relationships
▫ Contract backlog
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Artistic‐Related
 Artistic‐related intangible assets involve ownership of artistic works
(copyrights)
▫ Books, magazines, newspapers, and literary works
▫ Plays, operas, and ballets
▫ Musical works such as compositions, song lyrics, and advertising jingles
▫ Photographs and drawings
▫ Video and audiovisual material including movies, music videos, and TV
programs
Contract‐Related
 Contract‐related intangible assets represent the value of rights that arise
from contractual arrangements
▫ Franchise and licensing agreements
▫ Construction permits
▫ Broadcast rights
▫ Favorable supplier contracts
▫ Employment agreements
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Technology‐Related
 Technology‐related intangible assets relate to innovations or technological
advances
▫ Computer software
▫ Trade secrets
▫ Product patents (cover actual physical products)
▫ Process patents (govern the process by which products are made)
Houlihan Lokey 2013 Purchase Price Allocation Study

 Houlihan lokey produces a study which reviews public filings for
transactions completed in 2012 and summarizes the results for various
intangibles and percentage of purchase consideration
▫ 1,223 completed transactions reviewed
▫ 422 transactions held significant data
▫ 13 industry categories
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Houlihan Lokey 2013 Purchase Price Allocation Study
Source: Houlihan Lokey 2013 Purchase Price Allocation Study
Valuation Methodologies for Intangible Assets
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Valuation Methods
 Cost Approach
▫ Typically used for minor intangibles, where income and market data
is unavailable
 Market Approach
▫ Seldom applied
▫ Limited guideline transaction data
▫ When sold, they usually are sold as a group
 Income Approach
▫ Commonly used
▫ Method chosen based on characteristics of asset valued
The Cost Approach
 FASB defines the cost approach as follows :
“The cost approach is based on the amount that currently would be required to
replace the service capacity of an asset (often referred to as current replacement
cost). From the perspective of a market participant (seller), the price that would be
received for the asset is determined based on the cost to a market participant (buyer)
to acquire or construct a substitute asset of comparable utility, adjusted for
obsolescence. Obsolescence encompasses physical deterioration, functional
(technological) obsolescence, and economic (external) obsolescence and is broader
than depreciation for financial reporting purposes (an allocation of historical cost) or
tax purposes (based on specified service lives). – ASC 820
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The Cost Approach
 Based on the economics principle of substitution:
“a buyer will pay not more for an asset than the cost to obtain an asset
of equal utility, whether by purchase or by construction.” – IVSC Technical
Information Paper 3 The Valuation of Intangible Assets
Pros Cons
• Useful when there is a lack of market • Finding enough relevant information
or revenue data
• Difficult to calculate: costs are often
• Can often be looked upon as providing difficult to determine
a minimum value for the intangible
assets in question. • Does not recognize any economic
benefits associated with marketplace
activity
The Cost Approach
 Reasons to use the Cost Approach:
▫ Insufficient data for the income or market approach
▫ Cost data is still available for subject asset
▫ Company has expertise in assisting analyst in estimate of current
development cost and remaining useful life.
 Assets that lend themselves to the application of the cost approach:
▫ Recently developed intangible assets such as custom software
▫ Internally developed training manuals
▫ Employee workforce
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The Cost Approach
 Limitations to the Cost Approach
▫ No direct incorporation of economic benefits (duration, timing, or
trends in benefits)
▫ Risk is not incorporated, nor future upside benefits
▫ Estimates become more subjective as time elapses from the date of
original creation
▫ Obsolescence is difficult to quantify
▫ There is divergence in practice in the treatment of taxes,
entrepreneur’s profit, and opportunity costs
*Mark Zyla presentation, October 2012
The Income Approach
 FASB defines the income approach as follows :
“The income approach uses valuation techniques to convert future amounts (for
example, cash flows or earnings) to a single present amount (discounted). The
measurement is based on the value indicated by current market expectations about
those future amounts. Those valuation techniques include present value techniques;
option‐pricing models, such as the Black‐Scholes‐Merton formula (a closed‐form
model) and a binomial model (a lattice model), which incorporate present value
techniques; and the multiperiod excess earnings method, which is used to measure
the fair value of certain intangible assets”– ASC 820
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The Income Approach
 Based on the estimated future income streams expected from the use of
the intangible asset
 The future income streams are then discounted to determine their current
value
Pros Cons
• Particularly applicable to situations in • Difficult to differentiate between the
which the intangible asset is used to business enterprise value and the value of
generate a measurable amount of income the intellectual property that supports
the business
• Information is usually relatively accurate,
and often readily available • Requires the inclusion of many risk
estimates
The Income Approach
 An asset is worth the present value of the future economic benefits
▫ Requires a projection of future income
 The discount rate used must incorporate the many risks associated
with the generation of the future income
▫ Overall market risk, specific industry risk, and risks associated with
the assets and operation being analyzed
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The Income Approach
Income Approach Methods
Relief from Excess With or

Greenfield
Royalty Earnings Without
The Market Approach
 FASB defines the market approach as follows :
“The market approach uses prices and other relevant information generated by
market transactions involving identical or comparable assets or liabilities (including a
business). For example, valuation techniques consistent with the market approach
often use market multiples derived from a set of comparables. Multiples might lie in
ranges with a different multiple for each comparable. The selection of where within
the range the appropriate multiple falls requires judgment, considering factors
specific to the measurement (qualitative and quantitative). Valuation techniques
consistent with the market approach include matrix pricing. Matrix pricing is a
mathematical technique used principally to value debt securities without relying
exclusively on quoted prices for the specific securities, but rather by relying on the
securities’ relationship to other benchmark quoted securities.” – ASC 820
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The Market Approach
 Intangible assets are valued by utilizing actual transaction values
derived from the sale, license, or transfer of similar assets in similar
markets
Pros Cons
• Best if an active market exists that can • Most intangible assets are not traded
provide several examples of recent arm’s frequently enough
length transactions
• Difficult to ensure that a truly comparable
• Practical, logical, and applicable to all situation exists
types of intangible assets
• Difficult to get enough details on the few
available transactions to be certain that
all the elements that make for a good
comparable have been revealed.
Tangible Assets
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Tangible Assets
 Tangible assets are best valued with the market or income approaches.
If adequate data are not available to derive an indication of value
through these methods, an appraiser may use the replacement cost
method, which adjusts the original cost for changes in price level to
determine its replacement cost new (RCN). The RCN is then adjusted
due to physical use or functional obsolescence.
 Property, Plant and Equipment (PP&E) must be recognized at fair value
for current capacity. Accumulated depreciation is not carried forward.
An appraiser may use the cost approach, in which a market participant
would pay no more for an asset than the amount necessary to replace
it to produce at current capacity.
Case Study
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Case Specific Facts
 Fortune, Inc. acquired M&P Company on April 1, 2014
 M&P is an advertising agency that provides strategic consulting, creative
execution, and print and production management capabilities.
 Consideration was $50 million cash plus additional contingent
consideration with the following terms:
▫ 1 Year
▫ Maximum contingent consideration of $15 million
▫ Annual EBITDA must be greater than $7 million
▫ If EBITDA higher than $7 million but less than $10 million, then the
contingent consideration will be equal to the product of $15 million
multiplied by ((Annual EBITDA minus $7 million) / $3 million)
Identified Intangible Assets
 Trade name
 Customer relationships
 Non‐compete agreement
 Assembled workforce (included in goodwill)
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Company Valuation
 Estimating the enterprise value of the acquired company using a DCF
method is the initial step in performing a PPA. This step is performed in
order to:
▫ Confirm that the purchase price is representative of fair value and that it
was not a bargain purchase or overpayment
▫ Validate the reasonableness of the cash flow projections to be relied on
in applying the income approach to value certain intangible assets
▫ Substantiate the reasonableness of the required rates of return applied
in the valuation of the intangible assets
▫ Validate that the estimated fair values of the assets are reasonable
relative to the business enterprise value of the acquired company
Company Valuation
 IRR
▫ The IRR, PV of contingent consideration, and the DCF are inter‐related.
▫ Calculate the IRR of the transaction that yields an enterprise value that is
equal to the consideration transferred.
▫ There may be a difference between the DCF and total consideration as
you are working on the PPA assignment; however, once the model is
built, the IRR can be recalculated so that the values are equal.
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Company Valuation
 PV of Contingent Consideration
▫ Because contingent consideration is based on unknown future
performance, it is best to consider various scenarios to calculate the
probability‐weighted expected consideration
▫ Use the IRR in the calculation of the present value rate
Earnout Period ‐ 4/1/2014 ‐ 4/1/2015
Conservative Moderate Aggressive
EBITDA projection $ 8,321,000 $ 9,626,100 $ 10,737,000
Projected Earnout $ 6,605,000 $ 13,130,500 $ 15,000,000

Probability 7.5% 85.0% 7.5%
Probability Weighted Earn‐Out $ 495,375 $ 11,160,925 $ 1,125,000

Present Value Factor 18.5% 0.84 0.84 0.84
Present Value of Cash Flow $ 418,101 $ 9,419,926 $ 949,511
Sum of Present Value of Cash Flows $ 10,787,538
Company Valuation
 DCF
▫ Analyze the reasonableness of projections
▫ Consider what market participants would consider in their analysis of the
DCF. Purchase method, what is typical in the industry.
▫ Adjust ongoing depreciation.
▫ Adjust the projections, if necessary, to match the probability‐weighted
projections used in the contingent consideration calculation.
▫ Consider an H‐model to capture additional growth between the
projection period and the terminal year.
▫ Use market participant tax rates and net working capital.
▫ Use the IRR in the calculation of the present value rate.
▫ Include a tax amortization benefit for intangible assets.
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Company Valuation
($ in Thousands) 2014 2015 2016 2017 2018 Terminal

Total Revenue $26,465 $29,112 $32,023 $35,225 $38,748 $39,910
10.0% 10.0% 10.0% 10.0% 3.0%
EBITDA 9,737 10,780 11,208 12,329 13,562 13,969

EBITDA Margin (% of Net Revenue) 36.8% 37.0% 35.0% 35.0% 35.0% 35.0%
Less: Depreciation (62) (126) (192) (196) (198) (204)

EBIT 9,675 10,654 11,016 12,133 13,364 13,765
EBIT Margin (% of Net Revenue) 36.6% 36.6% 34.4% 34.4% 34.5% 34.5%
Taxes 40.0% (3,870) (4,262) (4,406) (4,853) (5,345) (5,506)
Net Operating Profits After Taxes 5,805 6,392 6,610 7,280 8,018 8,259

Plus: Depreciation 62 126 192 196 198 204
Gross Cash Flow 5,867 6,518 6,802 7,476 8,216 8,463
Company Valuation
($ in Thousands) 2014 2015 2016 2017 2018 Terminal
Gross Cash Flow 5,867 6,518 6,802 7,476 8,216 8,463
Less: Net Change in Working Capital 8.0% (200) (212) (233) (256) (282) (93)

Less: Capital Expenditures (186) (192) (198) (198) (198) (204)
Free Cash Flow $ 5,481 $ 6,115 $ 6,371 $ 7,022 $ 7,736 $ 8,166

Terminal Value $ 52,743
Growth Transition Period Value (H‐model) $ 8,745
Partial Year Factor 0.75 1.00 1.00 1.00 1.00 1.00
Present Value Rate 18.5% 0.94 0.81 0.68 0.58 0.49 0.49
3,861 4,950 4,350 4,047 3,763 29,910

Present Value of Cash Flows $ 50,881
Tax Amortization Benefit 9,907
Enterprise Value $ 60,788
Notice Tax
Amortization
Benefit
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Identified Intangible Assets
 Trade name
 Customer relationships
 Non‐compete agreement
 Assembled workforce (included in goodwill)
WACC – Used in Intangible Asset Valuations
 WACC
▫ Calculate the cost of equity using M&P Company’s data.
▫ Be sure to select a company specific risk factor that coincides with the
risk a market participant would face with M&P Company.
▫ Calculate the cost of debt using market participant debt and tax
assumptions.
▫ The WACC should be close to the IRR (typically within 1%).
Cost of Equity Capital Tax Pretax Post‐tax % of Capital

Capital Rate Cost Cost Structure WACC
Debt 40.0% 4.7% 2.8% 18.0% 0.5%
Risk‐Free Rate 4.0%
Equity 22.2% 22.2% 82.0% 18.2%
Equity Risk Premium 14.2%
Company Specific Risk 4.0% WACC 18.7%
Selected WACC 19.0%
Cost of Equity 22.2%
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WACC – Used in Intangible Asset Valuations
The following summarizes the relationship between the IRR and WACC and
the implications for the selection of PFI in the instance of a business
combination:
 IRR = WACC — Indicates that the PFI likely properly reflects market
participant assumptions, and the transaction consideration is likely
representative of the fair value
 IRR > WACC — Indicates that the PFI may include some or all of the impact
of entity‐specific synergies, may reflect an optimistic bias, may reflect a
bargain purchase, or all three
 IRR < WACC — Indicates that the PFI may exclude some or all of the impact
of market participant synergies, may reflect a conservative bias, may
reflect an overpayment, or all three
Trade Name
($ in Thousands) 2014 2015 2016 2017
Net Revenue $ 26,465 $ 29,112 $ 32,023 $ 35,225

Growth 10% 10% 10%
Pretax Relief from Royalty 2.00% 529 582 640 705
Income Taxes 40.0% (212) (233) (256) (282)
After‐tax Royalty 318 349 384 423
Partial Year Factor 0.75 1.00 1.00 0.25

Present Value Factor 19.0% 0.94 0.81 0.68 0.57
Present Value Relief from Royalty $ 223 $ 281 $ 260 $ 60
Sum of PV Relief from Royalty $ 824
Amortization Benefit  Relief‐from‐Royalty method
Rate of Return 19.0%
Tax Rate 40.0%
▫ Relied upon RoyaltySource for trade name
Tax Amortization Period 15 royalty rates
Amortization Benefit $ 136
 Use WACC
Fair Value of Trade Name $ 961  Include tax amortization benefit
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Contributory Assets
 Contributory assets are secondary assets that are necessary to support the
earnings associated with the subject intangible asset
▫ Identify and value all contributory assets
▫ Determine the rate of return for each asset
 A contributory asset charge is deducted from cash flows for each asset
valued with a MPEEM to cover a reasonable return “on” the asset
 Literature:
▫ Identification of Contributory Assets and Calculation of Economic Rents:
Toolkit
▫ Best Practices for Valuations in Financial Reporting: Intangible Asset
Working Group ‐ Contributory Assets
Contributory Assets
 Prior to completing the contributory asset calculation, you need to
calculate customer attrition.
 Remaining customers are allocated a percentage of contributory charges
to total expected revenues.
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Contributory Assets
Returns on Contributory Assets
($ in Thousands) 2014 2015 2016 2017 2018 2019 2020

Asset balances
Net working capital $ 2,354 $ 2,566 $ 2,799 $ 3,055 $ 3,337 $ 3,603 $ 3,846
Fixed assets 124 190 196 198 198 198 198
Assembled Workforce 2,178 2,243 2,311 2,380 2,451 2,525 2,601
Trade Name 961 961 961 961 ‐ ‐ ‐
Non‐Compete 477 340 204 68 ‐
Required returns on Rate
Net working capital 3.8% 89 97 106 115 126 136 145
Fixed assets 6.7% 8 13 13 13 13 13 13
Assembled Workforce 19.0% 414 426 439 452 466 480 494
Trade Name 19.0% 183 183 183 183 ‐ ‐ ‐
Non‐Compete 19.0% 91 65 39 13 ‐ ‐ ‐
$ 784 $ 783 $ 779 $ 776 $ 605 $ 629 $ 652
Notice different
rates
Contributory Assets
Contributory Asset Charges Make sure this
matches projections
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Customer Relationships
 Customer attrition
▫ Analyze historical customer data trends to calculate the average attrition
or churn
▫ Through our analysis, we noticed the M&P Company had two different
customer types:
• Larger customers that were loyal and had a 20% attrition rate
• Smaller customers that were short‐term and had a higher attrition rate of 45%
 Contributory assets
▫ Identify the assets that contribute to the company’s ability to generate
cash flow with current customers
▫ Calculate the required return on contributory assets and subtract them
from the cash flows
 Larger Customers
▫ Utilize MPEEM
▫ Base projections on LTM revenue (not NTM), as we are interested only in
revenue attributable to current customers
▫ Use WACC (consider adjusting the rate)
▫ Include tax amortization benefit
▫ Extend analysis until PV of cash flows begins to be immaterial
• Our analysis was cut down to 2019 for illustration purposes; however, the full
analysis extended through 2028
• PV of cash flows for 2014‐2019 totals $9.895 million and 2020‐2028 totals
$1.331 (total PV of $11.226 million)
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9 Months Ending Ye
(S in Thousands) 12/31/2014 2015 2016 2017 2018 2019 2020
Existing Customer Net Revenue Assuming No Attrition $ 16,700 $ 22,914 $ 23,601 $ 24,309 $ 25,039 $ 25,790 $ 26,563
Cumulative Existing Customer Retention Rate 85.0% 68.0% 54.4% 43.5% 34.8% 27.8% 22.3%
Forecasted Revenue Attributable to Existing Customers 14,193 15,579 12,837 10,578 8,716 7,182 5,918
Expenses 8,564 9,395 8,023 6,606 5,440 4,482 3,693

EBIT (Operating Income) 5,628 6,184 4,814 3,971 3,276 2,700 2,225
Operating Margin 39.7% 39.7% 37.5% 37.5% 37.6% 37.6% 37.6%
Taxes 2,251 2,474 1,926 1,589 1,311 1,080 890

NOPAT (Net Operating Profit After Taxes) 3,377 3,711 2,888 2,383 1,966 1,620 1,335
NOPAT Margin 23.8% 23.8% 22.5% 22.5% 22.6% 22.6% 22.6%

Required Returns on Contributory Assets 441 400 293 216 123 97 77
Cash Flows Attributable to Existing Customers 2,936 3,311 2,596 2,167 1,843 1,523 1,258
Present Value Factor 0.94 0.81 0.68 0.57 0.48 0.40 0.34

Present Value of Cash Flows $ 2,750 $ 2,665 $ 1,756 $ 1,232 $ 881 $ 611 $ 424
Net Present Value of Cash Flows $ 11,226
Amortization Benefit
Tax Rate 40.0%
Tax Amortization Period 15
Amortization Benefit $ 1,855
FV of Customer List $ 13,081
 Smaller Customers
▫ Utilize MPEEM
▫ Base projections on LTM revenue (not NTM), as we are interested only in
revenue attributable to current customers
▫ Use WACC (consider adjusting the rate)
▫ Include tax amortization benefit
▫ Extend analysis until PV of cash flows begins to be immaterial
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9 Months Ending Year Ending December 31,
(S in Thousands) 12/31/2014 2015 2016 2017 2018
Existing Customer Net Revenue Assuming No Attrition $ 1,832 $ 2,514 $ 2,589 $ 2,667 $ 2,747
Cumulative Existing Customer Retention Rate 66.2% 36.4% 20.0% 11.0% 6.1%
Forecasted Revenue Attributable to Existing Customers 1,213 916 519 294 166
Expenses 732 552 324 184 104

EBIT (Operating Income) 481 363 195 110 63
Operating Margin 39.7% 39.7% 37.5% 37.5% 37.6%
Taxes 192 145 78 44 25

NOPAT (Net Operating Profit After Taxes) 289 218 117 66 38
NOPAT Margin 23.8% 23.8% 22.5% 22.5% 22.6%
Required Returns on Contributory Assets 48 44 32 24 13
Cash Flows Attributable to Existing Customers 240 174 85 43 24
Present Value Factor 0.94 0.81 0.68 0.57 0.48

Present Value of Cash Flows $ 225 $ 140 $ 57 $ 24 $ 12
Net Present Value of Cash Flows $ 458
Tax Rate 40.0%
Amortization Benefit $ 76
FV of Customer List $ 534
Non‐Compete Agreement
 Use With or Without analysis
 Identify agreement terms
 Discuss with management what would likely happen if there was no non‐
compete agreement in place
▫ Impact on revenue
▫ Impact on profitability
 If there are multiple non‐compete agreements, determine if they can be
analyzed on a combined basis or if each agreement should be analyzed
individually
 Estimate the probability of competition
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With Noncompete With‐out Noncompete
9 Months Ended 3 Months Ended 9 Months Ended 3 Months Ended
($ in Thousands) 2014 2015 2018 2014 2015 2018
Revenues, net $ 19,849 $ 29,112 $ 8,006 $ 19,849 $ 29,112 $ 8,006
Decline in Revenues Due to Competition ‐ ‐ ‐ (794) (7,011) (2,001)
Total Projected Revenues, net $ 19,849 $ 29,112 $ 8,006 $ 19,055 $ 22,101 $ 6,004
EBITDA $ 7,303 $ 10,780 $ 2,802 $ 7,303 $ 10,780 $ 2,802

Decline in EBITDA Due to Competition ‐ ‐ ‐ (292) (2,596) (701)
Total Projected EBITDA $ 7,303 $ 10,780 $ 2,802 $ 7,010 $ 8,184 $ 2,102

Less: Depreciation (47) (126) (48) (45) (96) (36)
EBIT $ 7,256 $ 10,654 $ 2,754 $ 6,966 $ 8,088 $ 2,066

Taxes 38.6% (2,801) (4,112) (1,063) (2,689) (3,122) (797)
Net Operating Profits After Taxes $ 4,455 $ 6,542 $ 1,691 $ 4,277 $ 4,966 $ 1,268

Plus: Depreciation 47 126 48 45 96 36
Gross Cash Flow $ 4,502 $ 6,668 $ 1,739 $ 4,322 $ 5,062 $ 1,304

Less: Net Change in Working Capital 8% (150) (212) (58) (144) (161) (44)
Less: Capital Expenditures (140) (192) (50) (134) (146) (37)
Free Cash Flow $ 4,212 $ 6,264 $ 1,631 $ 4,044 $ 4,755 $ 1,223

Present Value Rate 0.94 0.81 0.48 0.94 0.81 0.48
Present Value of Cash Flow $ 3,946 $ 5,043 $ 779 $ 3,788 $ 3,828 $ 584
Sum of Present Value of Cash Flow $ 9,768 $ 8,201
With Noncompete With‐out Noncompete
Sum of Present Value of Cash Flow $ 9,768 $ 8,201
Tax Rate 38.6%
Amortization Benefit $ 1,549 $ 1,300
$ 11,317 (A) Value With Non‐Compete $ 9,501 (B) Value Without Non‐Compete
Raw Value of Noncompete $ 1,816 (A‐B)

Probability of Competition 30.0%
FMV of Non‐Compete $ 545
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Assembled Workforce
 Training
▫ Estimate the amount of time a replacement employee of comparable
skills will need to be in training
▫ Estimate the replacement’s employee’s level of inefficiency during the
training period
▫ Include fringe benefits in the calculation of training costs
 Recruiting
▫ Estimate the recruiting cost per employee
• Percentage of salary to be paid to an external recruiter (remember to exclude
fringe benefits from the employee’s salary, as recruiters are paid only a
percentage of base salary)
• Cost of advertisement if recruiters are not typically used in the industry
▫ Be sure to include the cost associated with the company’s HR staff
interviewing and processing the new hire
Assembled Workforce
20% 50%
Annual Recruiting
Position Annual Salary Fringe Total Salary Training Training Cost Recruitment Total Costs
President $ 450,000 $ 90,000 $ 540,000 50% $ 135,000 25% $ 112,500 $ 247,500
SVP, Group Acct Dir 225,000 45,000 270,000 50% 67,500 25% 56,250 123,750
SVP, Dir Strategy 350,000 70,000 420,000 50% 105,000 25% 87,500 192,500
SVP, GM ‐ SF 175,000 35,000 210,000 50% 52,500 25% 43,750 96,250
SVP, ECD 300,000 60,000 360,000 50% 90,000 25% 75,000 165,000
Account Representative 45,000 9,000 54,000 8% 2,250 5% 2,250 4,500
Assoc. Account Director 71,250 14,250 85,500 17% 7,125 10% 7,125 14,250
Account Supervisor 52,180 10,436 62,616 17% 5,218 10% 5,218 10,436
Account Support 92,173 18,435 110,608 17% 9,217 10% 9,217 18,435
Assoc. Account Director 115,000 23,000 138,000 25% 17,250 15% 17,250 34,500
Account Director 100,000 20,000 120,000 25% 15,000 15% 15,000 30,000
Account Supervisor 73,000 14,600 87,600 17% 7,300 10% 7,300 14,600
Total $ 3,104,420
HR and Interview expense $ 10,800
Tax Effect
Replacement Cost of Assembled Workforce $ 3,115,220
Less: Taxes @ 40.0% (1,246,088)
Costs Avoided, Net of Tax $ 1,869,132
Amortization Benefit $ 308,933
FV of Assembled Workforce $ 2,178,065
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Goodwill
 Goodwill is the difference between the PV of consideration transferred
and the sum of all identifiable tangible and intangible assets
 Inclusive of assembled workforce
Consideration Allocation
Form of Consideration Amount Assets Acquired Amount
Cash Paid at Closing $ 50,000,000 Net Working Capital $ 2,154,380

Contingent consideration 10,787,538 Fixed Assets 83,270
Trade Name 960,738
Fair Value of Total Consideration Transferred $ 60,787,538 Customer Relationships 13,615,350
Non‐Compete Agreement 544,665
Goodwill 43,429,135
Total Purchase Price $ 60,787,538
WARA, WACC, & IRR Reconciliation
 The WARA analysis is applied to the fair value of the assets to generate the
implied rate of return on goodwill based on the IRR. The purpose of the WARA
analysis is to determine the reasonableness of the returns for the identifiable
intangible assets and the implied return on goodwill.
 Compare the WARA, WACC, and IRR
 Assists in assessing the reasonableness of the asset‐specific returns for
identified intangible assets and the implied return on goodwill
 These rates should be in alignment (within 1%)
▫ Except in the event of a bargain purchase
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WARA, WACC, & IRR Reconciliation
Value as of
4/1/2014 Cost of Capital Return WACC IRR
Net Working Capital $ 2,154,380 3.77% $ 81,295

Fixed Assets $ 83,270 6.68% $ 5,561
Trade Name $ 960,738 19.00% $ 182,540
Customer Relationships $ 13,615,350 19.00% $ 2,586,916
Noncompete $ 544,665 19.00% $ 103,486
Assembled Workforce $ 2,178,065 19.00% $ 413,832
Goodwill $ 41,251,070 19.06% $ 7,861,175
Total Assets $ 60,787,538 $ 11,234,807
18.48% 19.00% 18.48%
Reporting Considerations
 Earn out – Consider Monte Carlo method to calculate.
▫ Is this considered purchase price or owner compensation?
▫ Additional consideration is considered employee compensation when it is
contingent upon the employee being employed by the Company.
 Trade name – limited life or infinite (RUL)? Consider the implications to the user
and how to weigh those with the specific circumstances.
 Customer list – consider marketing expenses to new customers
 Consider bifurcating customer list based on types of customers
 Consider backlog in contract valuation – Shorter economic life
 Earn‐Out ‐ consider Monte Carlo simulation on future earnings
 WACC – Consider different risk levels for different intangibles.
 Discuss the process of identifying intangibles
 Non‐compete – Consider dual projections for revenue and EBITDA.
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Resources
 Fair Value Measurement, Second Edition, Mark Zyla, John Wiley & Sons, Inc.
 AICPA Quick Reference Guide to Valuing Assets in Business Combinations
 Valuation for Financial Reporting, Mard, Hitchner Hyden, John Wiley & Sons,
Inc.
 Identification of Contributory Assets and Calculation of Economic Rents:
Toolkit, The Appraisal Foundation
 Best Practices for Valuations in Financial Reporting: Intangible Asset Working
Group ‐ Contributory Assets, The Appraisal Foundation
 Big 4 Business Combination reference guides
 ASC 805
 ASC 820
Questions
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Part 1 of BVR’s Special Series on Fair Value

March 23, 2016

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So there are a couple of things to consider here. It assumes an orderly transaction. By an

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That was Example 1. Example 2: A pharmaceutical company acquires a company with

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Recognition criteria—an asset is identifiable if it either is separable, being capable of being

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Contingent consideration is commonly referred to as an earn-out. It represents this obligation

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ASC 805-55 actually provides examples of identifiable intangible assets acquired in a

So customer-related intangible assets occur as a result of interaction with outside parties.

Artistic-related—again, this is books, magazine, newspapers, plays, operas. There is a

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Technology-related—computer software. We always have that. Patents, process patents,

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You have to incorporate those weighted average considerations of contingent consideration

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My email is at the end or beginning or somewhere in this course—just email me and we

So present value of contingent consideration, because it is based on unknown future

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Capital expenditures—I am just kind of freelancing here—with capital expenditures, you

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That is the smaller company size calculation. Noncompete agreements—we do a “with or

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Reporting considerations—earn-out—consider Monte Carlo method to calculate. Is this

Resources—Fair Value Measurement by Mark Zyla. It is a great book. Always go back to

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That wraps us up for today.

Nathan DiNatale: It is ndinatale@scandh.com.

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For a schedule of future BVR webinars, please go to bvresources.com/training. You will

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Houlihan Lokey 2013 Purchase Price Allocation Study

Houlihan Lokey 2013 Purchase Price Allocation Study

Source: Houlihan Lokey 2013 Purchase Price Allocation Study

© 2016 Business Valuation Resources, LLC. All Rights Reserved.

© 2016 Business Valuation Resources, LLC. All Rights Reserved.

© 2016 Business Valuation Resources, LLC. All Rights Reserved.

*Mark Zyla presentation, October 2012

© 2016 Business Valuation Resources, LLC. All Rights Reserved.