Case value intangibles in business combinations

Case value intangibles in business combinations provides a comprehensive business case of valuation of an acquisition of a regional provider of professional services, ProfServCo. The following intangible assets were identified as of the date of the combination:

  1. Trade name Case value intangibles in business combinations
  2. Service concession number Case value intangibles in business combinations
  3. Customer relationships Case value intangibles in business combinations
  4. Non-competition agreements. Case value intangibles in business combinations

ProfServCo was acquired as part of a business combination under IFRS 3 by AcquiCo on 30 September 20×2.

1. Trade name

ProfServCo operates in a region of the United States and has been a leading provider in its service market since it was founded in the 1970’s. The Company’s trade name and logo are therefore well-established and recognised within their industry. The trade name is registered; therefore, it meets the contractual-legal criterion for identifiability. It was determined the proper method for measurement of the trade name was through the relief-from-royalty method. Case value intangibles in business combinations

Key inputs

After a review of recent similar business combination transactions in the marketplace, management determined that an appropriate royalty rate if the trade name were to be licensed to others would be 4%. From the perspective of a typical market participant, an income tax rate of 30% is estimated as appropriate. Lastly, the asset-specific discount rate is estimated at 18%. Case value intangibles in business combinations

Measurement

The table below illustrates the fair value measurement of the trade name using the relief-from royalty method.

Table – Valuation of trade name: relief-from royalty method

Case value intangibles in business combinations

2. Service concession number

The industry in which ProfServCo operates is regulated by a governmental agency, which limits the number of service providers that may operate in the geographic region. Therefore, a concession number must be obtained in order to provide services. In order to apply for a concession number, an entity must first establish a book of business during a trial period, which is estimated as six months. The costs of providing services during the trial period in order to establish a book of business are considered by management to represent the primary costs of obtaining the concession number. Once a concession number has been obtained for a region; however, it may be transferred or sold separately from the business; it therefore meets the separability criterion for identification as an intangible asset. Due to the time and cost associated with establishing the business base and applying for a concession number, it is common for market participants who wish to enter the industry to purchase a concession number as a stand-alone asset. It was determined that the proper method for measurement of the trade name was through the reproduction cost method. Case value intangibles in business combinations

Key inputs

Management of ProfServCo estimates the direct and indirect costs of providing services during the six-month trial period to approximate CU1,800,000. From the perspective of a typical market participant, an income tax rate of 30% is estimated as appropriate.

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Measurement

The table below illustrates the fair value measurement of the service concession number using a reproduction cost method.

Valuation of service concession number – reproduction cost method (in CUs)

Case value intangibles in business combinations

3. Customer relationships

The services that ProfServCo provides to its customers are long-term in nature; however, they do not frequently enter into contract agreements. The Company’s customer service department however is responsible for building and maintaining the relationship with the customer contacts and must be in weekly communication with them in order to coordinate delivery of the services and maintaining customer satisfaction. Though non-contractual in nature, the customer relationships are considered to be separately identifiable. The multi-period excess earnings method (MEEM) is considered as the most appropriate method of measuring the fair value of the customer relationships.

The main feature of the MEEM is the specific consideration it gives to contributory asset charges (CACs) in identifying the residual income stream that the intangible asset is expected to generate. The fundamental premise of the MEEM is that the value of an intangible asset is equal to the present value of the net income that is attributable to it. The income streams attributable to the intangible asset are those in excess of the fair returns on all assets that contribute to the income generating process (‘contributory assets’).

The assembled workforce is technically not an identifiable intangible asset and is therefore subsumed into goodwill. Nevertheless, for the purpose of acquisition date fair value measurement it is seen as a resource because a typical market participant typically needs a workforce to generate income with the intangible asset under review. In practice, CACs for the assembled workforce are therefore commonly taken into account under the MEEM. The assembled workforce is often the only element of goodwill that is especially considered as a contributory asset.

Some contributory assets such as property, plant and equipment and working capital are readily identifiable and have been recognised in the acquiree’ s pre-combination financial statements. However, some contributory assets may not have been recognised as an asset by the acquiree or by the combined entity and further analysis is therefore necessary. This applies particularly to intangible assets other than the intangible asset in question. If the acquired business relies on third-party assets (such as in leasing or outsourcing arrangements), these assets might also need to be taken into account. Case value intangibles in business combinations

The actual usage of contributory assets also needs to be analysed. Some contributory assets will contribute to the income generation of more than one intangible asset. For these shared contributory assets, any related CAC needs to be allocated amongst relevant intangible assets by reference to the actual level of usage of the contributory asset. Case value intangibles in business combinations

Key inputs

In order to determine the appropriate cash flows attributable to the existing customer relationships a number of adjustments have to be made to the Company’s overall projected revenues: Case value intangibles in business combinations

  1. removal of revenues not attributable to customer relationships: although ProfServCo primarily provides services to customers on a recurring, long-term basis, they do occasionally receive requests for non-recurring services. In addition, some revenue is derived from other sources (eg internet or walk-ins) outside of the customer service department
  2. removal of revenues attributable to new customer relationships: the Company’s PFI includes projected revenues that are expected to be derived from customers that are added in a future period. Since these relationships do not exist as of the date of the business combination, they must be removed from the calculation.
Something else -   Adjusted net asset method

In addition to the above adjustments, the customer relationships calculation must be adjusted to take into account contributory asset charges, which include but are not limited to certain of the other intangible assets. Royalties of 4% of revenues assumed to be paid for use of the trade name (see above) must also first be deducted. Other CAC’s include:

  • net working capital Case value intangibles in business combinations
  • fixed assets Case value intangibles in business combinations
  • service concession number (see above #2) Case value intangibles in business combinations
  • non-competition agreements (see below #4) Case value intangibles in business combinations
  • assembled workforce (see below). Case value intangibles in business combinations

Contributory asset – assembled workforce

In order to derive the contributory asset charge for the related assembled workforce, the below calculation is performed to determine the expected value of the intangible asset:

Case value intangibles in business combinations

Measurement

The two tables below illustrate the fair value measurement of the customer relationships, using the multi-period excess earnings method.

Valuation of customer relationships: multi-period excess earnings method (MEEM) – first part

Case value intangibles in business combinations

Valuation of customer relationships: multi-period excess earnings method (MEEM) – second part

Case value intangibles in business combinations

4. Non-competition agreements

In conjunction with the acquisition agreement, certain members of ProfServCo’s management team were required to enter covenants not to compete in the event that they leave the combined entity. The non-competition agreements are deemed to be identifiable for measurement given their nature as a contractual-legal agreement. Case value intangibles in business combinations

Key inputs

In order to recognise the probability of competition as well as the effect of beginning competition in different years, the expert assessed four possible scenarios, based on discussion with management of ProfServCo and AcquiCo, and weighted the resulting value estimate based on the probability of occurrence. Each scenario reflects the amount of sales that could be captured depending on whether the covered employee is competing and when he/she decided to competition. The scenarios are summarised as follows:

  1. the first scenario assumes no competition and is the base calculation for the model Case value intangibles in business combinations
  2. the second scenario assumes that competition begins as soon as possible and is able to capture a small amount of sales in the first year. ProfServCo would be expected to gradually regain business in the years beyond as the Company begins to combat the new competition. The value of this scenario is the present value of the cash flows in Scenario 1 less the present value of the cash flows from Scenario 2. This scenario is perceived by management to be the most likely if the covered persons chose to competition
  3. the third scenario assumes that competition begins in year two after the valuation date. The competition is assumed to have the same impact as in Scenario 2; however, the effect is delayed. Consistent with Scenario 2, ProfServCo would be expected to be able to combat the new competition beyond year two. The value of this scenario is the present value of the cash flows in Scenario 1 less the present value of the cash flows from Scenario 3 Case value intangibles in business combinations
  4. the fourth scenario assumes that competition begins in year three after the valuation date. The effect on ProfServCo’s sales is similar but delayed. The value of this scenario is the present value of the cash flows in Scenario 1 less the present value of the cash flows from Scenario 4. Case value intangibles in business combinations

The asset-specific discount rate for the non-competition agreements is assumed to be 18.5%. From the perspective of a typical market participant, an income tax rate of 30% is estimated as appropriate. Case value intangibles in business combinations

Measurement

The tables below illustrate the fair value measurement of the non-competition agreements using the comparative income differential method for each scenario. Case value intangibles in business combinations

Valuation of non-competition agreements – comparative income differential method (CIDM)

With NCA – Base case (Scenario 1)

Case value intangibles in business combinations

Without NCA – competition begins in Yr 1 (Scenario 2)

Case value intangibles in business combinations

Without NCA – competition begins in Yr 2 (Scenario 3)

Case value intangibles in business combinations

Without NCA – competition begins in Yr 3 (Scenario 4)

Case value intangibles in business combinations

Probability Weighted Present Value of Non-competition Scenarios

Case value intangibles in business combinations

5. Summary of intangible assets’ fair values

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The summary of fair values determined for the identifiable intangible assets under IFRS 3 for the ProfServCo business combination as of 30 September 20×2 is as follows: Case value intangibles in business combinations

Case value intangibles in business combinations

The above table is not a complete allocation of the purchase price for ProfServCo because the total purchase price (or consideration) involved in this business combination has not been completely discussed in this Case. The total purchase price consists of the (revalued) net assets acquired, identified intangible assets and the residual component consisting of goodwill.  Only the identified intangible assets have been discussed! Case value intangibles in business combinations

Case value intangibles in business combinations

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Something else -   The acquisition method

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