The purchase price of an operating business is usually attributable to net tangible assets and intangible assets, such as customer relationships or a brand name. Intangible assets may comprise a sizable portion of the total assets acquired.
Reporting entities are required to allocate the acquisition cost to (and separately recognise) the target's "identifiable" assets, liabilities and contingent liabilities at their fair values at the acquisition date (subject to certain provisos).
Identifiable assets arise from contractual or other legal rights or are capable of being separated from the entity and transferred or rented. Examples include customer contracts and related customer relationships, customer lists, trade names, domain names and computer software. Consequently, a target's qualifying intangible assets must be valued by reporting entities at their fair values for financial reporting purposes.
Goodwill, if any, is recognised as the residual cost of the business after recognising the above items. Before the introduction of Australian equivalents to International Financial Reporting Standards (AIFRS), goodwill was usually recognised as the acquisition cost in excess of net tangible assets only.
More acquirers are mandating intangible asset valuations earlier in the transaction process to supplement due diligence and offer transaction pricing insights. Reasons include the following:
Key Business Drivers
The identification and valuation of intangible assets typically includes a detailed analysis of the key business drivers, with a commercial focus. For example, customer relationships valuation considerations may include the following:
- What proportion of the purchase price is for existing customers (identifiable intangible asset) versus potential new customers (goodwill)? What is the relative required return and value for these two asset groups?
- What proportion of projected revenue growth is attributable to existing customers versus potential new customers? What is the anticipated revenue growth and profit margins of each customer group?
- How "sticky" are customers? Are all customers homogenous? If not, should certain customer groups be valued separately?
Often the nature of the industry drives anticipated
customer retention rates. The table below provides a
snapshot of the customer relationship amortisation periods
(estimated life) and implied average attrition rates
(assuming straight-line) of selected ASX-listed companies
in each designated industry:
Implied Average Annual Attrition Rate (%)
10 – 20
5 – 10
10 – 20
5 – 10
3 – 8
12 – 33
- What are the working capital requirements of each customer group? What are the valuation implications?
Split Of Intangible Assets
Under AIFRS, intangible assets are split into smaller and more meaningful components (i.e. qualifying intangible assets and residual goodwill). In turn, goodwill is usually a smaller and more understandable number, only representing a payment made in anticipation of future economic benefits from assets that are not capable of being individually identified and separately recognised.
In light of these examples, acquirers are encouraged to consider intangible asset valuations earlier in the transaction process to maximise the insights available from the valuation process.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.