Smith Holland M&A Resources
How to identify and value intangible assets in an M&A transaction.
Intangible and Tangible asset classes are generally the main negotiating topic when selling your business. The deal may include big contributions from goodwill, which directly affects the valuation positively against the market value. A thorough analysis of tangible and intangible assets is a defined procedure as outlined by the Financial Accounting Standards Boards (FASB).
As defined by FASB, an intangible asset represents a non-financial asset lacking physical substance. One prime example of that definition: goodwill. Yet FASB does not consider goodwill to be an intangible asset. The Board’s goal as outlined in Statement 142 and Topic 350 is to allow the identification of intangible assets as those that have a direct correlation with business operations. Goodwill receives its own classification.
As a buyer, how are intangible assets handled as part of a recent acquisition? Intangible assets move hands as part of an M&A deal, thus requiring the purchasing party to split goodwill apart from the other asset classes. This occurs when goodwill:
Is actually separable
Arises from a legal or contractual right
The classification of separable states that the purchaser should be able to divide the asset from the purchased business, in order to make ready for sale, rental, licensing, or exchange to a different business entity. Despite an intangible asset seeming like it cannot be transferred or sold separately, there are legal instruments available to do so. One might say an intangible asset is separable even if the purchasing party has no plans to use the asset in isolation after taking over the new company. The important factor is that the opportunity is there should a decision to split the asset at a later time present itself. The transaction should allow the buyer to feel comfortable about the future prospects of operating a business with or without the previous owner’s strategy.
Intangible assets common to M&A deals:
Non-compete agreements represent a contractual right, typically for five yerars, and thus easy candidates for intangible assets. At-will employee agreements are not intangible, unless a prior agreement stands.
IP expiring in 15 years and Patents. These are classified as intangible assets regardless of an intent to sell as they are a legal right.
Non-patent technology. This category brings in the separable lense, as technology, regardless of ability to claim as a legal right, is an intangible asset. One example are the lines of code that aren’t patent-protected, but are still considered an asset that is easily transferred.
List of customers. These documents don’t necessarily warrant a legal right, but they are considered separable as part of the business entity and ultimately are classified as an intangible asset.
After careful review, if an asset cannot be classified as intangible, it will be included as goodwill. In all M&A transactions, it is best practice to consult the advice of professionals. Getting the intangible asset equation correct can directly affect the company valuation for the positive, and conversely, not understanding the asset structure of the company can be a detriment in the buyer’s eyes -- especially for an asset sale!
M&A CALCULATIONS OFF GOODWILL
A simple equation to determine the goodwill of a company as part of the valuation is to take the purchase price minus fair market value. This implies that without goodwill, the business would be worth exactly what the fair market value of assets and revenues suggest the price should be. Many times the delta from FMV and asking price can be large, and one immediate possibility could be the seller and M&A team considers the goodwill of the business to be a strong component to success. To further examine this price difference, first aggregate the tangible and intangible assets (sans goodwill), then deduct the company’s liabilities. Goodwill should equate to that delta between gross intangible and tangibles as well as assumed liabilities.
M&A TREATMENT OF INTANGIBLES
In accordance to the rules outlined by the FASB, the steps required to treat intangibles during a company transaction are as follows:
The amortization expense will be deducted from an intangible asset by the purchaser during each reporting period. Usually enacted via straight-line accounting, or if a more applicable amortization method better exhibits the true value of the asset over time, the purchaser can use that. The lifespan of an intangible asset can be discovered to have an indefinite timeline. In this case, the potential purchaser must test the asset annually (and possibly more frequently) for any impairment. If the delta between FMV and book value proves a negative calculation, then a write-off of the asset may be acceptable.
The purchaser must ensure the intangibles are classified as separable in order to justify Fair Market Value. The price at which the asset could be sold or purchased between two reasonable and willing parties is what constitutes FMV (Fair Market Value). It is not the price at which the asset could be liquidated or purchased during times of duress.
If information is discovered that the asset could be impaired, a test must be put forth. The timeframe for impairment on an asset varies from the timeline for goodwill (or for an intangible asset with an indefinite life, as described in a prior bullet point). A fixed-life asset of intangible (and goodwill) or tangible nature incurs annual reviews for impairment can have the option to be written-down to either cost or FMV, whichever is lower.
Estimations are required to outline the useful economic life of an asset. The timeframe of how long an asset will contribute to business operations, and ultimately cash flows, is the main tenant a purchaser will be interested in. If the asset is no longer useful, the value should be null save for special criteria. A seller should be careful to understand if a buyer will need to replace such assets or incur a large expense in a few years if the company assets are nearly depleted -- this, of course, should lower company valuation.
As always, please see the help of experienced middle market M&A advisors when engaging in an M&A transaction. This article does not supplant the advice of lawyers, accountants, and other investment professionals. In all business dealings, keep an open mind, maintain a diligent eye on details, and insist on open and transparent communication.
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