Purchase Price Allocation

Mercer Capital is pleased to announce the release of the 2024 Energy Purchase Price Allocation Study.This study researches and observes publicly available purchase price allocation data from companies primarily contained in one of the four sub-sectors of the energy industry: (i) exploration & production; (ii) oilfield services; (iii) midstream; and (iv) downstream. This study is unlike any other in terms of energy industry specificity and depth.The 2024 Energy Purchase Price Allocation Study provides a detailed analysis and overview of valuation and accounting trends in these sub-sectors of the energy space. This study also enables key users and preparers of financial statements to better understand the asset mix, valuation methods, and useful life trends in the energy space as they pertain to business combinations under ASC 805 and GAAP fair value standards under ASC 820. We utilized transactions that reported their purchase allocation data in calendar year 2023 and not reported in previous annual filings.This study is a useful tool for management teams, investors, auditors, and even insurance underwriters as market participants grapple with ever-increasing market complexity. It provides data and analytics for readers seeking to understand undergirding economics and deal rationale for individual transactions. The study also assists in risk assessment and underwriting of assets involved in these sectors. Further, it helps readers to better comprehend financial statement impacts of business combinations.DOWNLOAD THE STUDY

Mercer Capital is pleased to announce the release of the 2022 Energy Purchase Price Allocation Study.This study researches and observes publicly available purchase price allocation data for four sub-sectors of the energy industry: (i) exploration & production; (ii) oilfield services; (iii) midstream; and (iv) downstream.  This study is unlike any other in terms of energy industry specificity and depth.The 2022 Energy Purchase Price Allocation Study provides a detailed analysis and overview of valuation and accounting trends in these sub-sectors of the energy space.  This study also enables key users and preparers of financial statements to better understand the asset mix, valuation methods, and useful life trends in the energy space as they pertain to business combinations under ASC 805 and GAAP fair value standards under ASC 820.  We utilized transactions that closed and reported their purchase allocation data in calendar year 2021.This study is a useful tool for management teams, investors, auditors, and even insurance underwriters as market participants grapple with ever-increasing market complexity.  It provides data and analytics for readers seeking to understand undergirding economics and deal rationale for individual transactions.  The study also assists in risk assessment and underwriting of assets involved in these sectors. Further, it helps readers to better comprehend financial statement impacts of business combinations.>> DOWNLOAD THE STUDY <<

This is the final article in a series on buy-side considerations. In this series, we will cover buy-side topics from the perspective of middle-market companies looking to enter the acquisition market. If you wish to read the rest of the series, click here. Growing up an avid sports fan, I always enjoyed picking up the paper and flipping to the sports section to see the box scores from the prior day’s games. While the headline score told you who won or lost, the box score gave more information and insights into who played well and the narrative of the game. For example, the box score might tell you that even though your favorite team won, they were dominated by the other team in all the categories except turnovers, or that the team that lost actually “won” each quarter except the fourth and their star player had a bad game. In my view, a purchase price allocation is similar to a box score in that it provides greater detail from which to derive insights on a particular transaction. While a purchase price allocation (PPA) analysis is primarily an accounting (and compliance driven) exercise, it is also a window into the objectives and motivations behind the transaction. When used proactively and/or during the M&A process, the disciplines of PPA analysis can provide buyers with important perspective concerning the unique value attributes of the target’s intangible asset base, which can help rationalize strategic acquisition consideration or forewarn of potentially unstable or short-lived intangible asset value. Below we explore PPAs further with a broad overview and then a deeper look into the pitfalls and best practices related to them.Introduction to PPAsAcquirers conduct PPAs to measure the fair value of various tangible and intangible assets of the acquired business. Any excess of the total asset value implied by the transaction over the fair values of identified assets is ascribed to the residual asset, goodwill.Intangible assets commonly identified and measured as part of PPA analyses include:Trade name - Trade name intangibles may be valuable if they enhance the expected future cash flows of the firm, either through higher revenue or superior margins. The relief from royalty method, which seeks to simulate cost savings due to the ownership of the name, is frequently used to measure the value of trade names.Customer relationships - Customer relationships can be valuable because of the expectation of recurring revenue.Technology - Technologies developed by the target business are valuable because the acquirer avoids associated development or acquisition costs. Patents and other forms of intellectual property may provide legal protection from competition and help secure uniqueness and/or differentiation.IPR&D - Ongoing R&D projects can give rise to in-process research and development intangible assets, whose values are predicated on expected future cash flows.Contractual assets - Contracts that lock in pricing advantages – above market sales prices or below market costs – create value by enhancing cash flow.Employment / Non-competition agreements - Employment and non-competition agreements with key executives ensure a smooth transition following an M&A transaction, which can be vital in reducing the likelihood of employee or customer defection. The value of an enterprise is often greater than the sum of its identified parts (both tangible and intangible), and the excess is usually reflected in the residual asset, goodwill. GAAP goodwill also captures facets of the target that may be value-accretive, but do not meet certain criteria to be identified as an intangible asset. Notably, fair value measurement presumes a market participant perspective. Goodwill may also include acquirer-specific synergistic or strategic considerations that are not available to other market participants. Consequently, goodwill has tended to account for a significant portion of allocated value in truly strategic business combinations.Pitfalls and Best Practices of PPAsBelow we highlight some pitfalls and best practices gleaned from providing purchase price allocations to acquirers since the advent of fair value accounting.What are some of the pitfalls in purchase price allocations?Sometimes differences arise between expectations or estimates prior to the transaction and fair value measurements performed after the transaction. An example is contingent consideration arrangements – estimates from the deal team’s calculations could vary from the fair value of the corresponding liability measured and reported for GAAP purposes. To the extent amortization estimates are prepared prior to the transaction, any variance in the allocation of total transaction value to amortizable intangible assets and non-amortized, indefinite lived assets – be they identifiable intangible assets or goodwill – could also lead to different future EPS estimates for the acquirer.What are the benefits of looking at the allocation process early?The opportunity to think through and talk about some of the unusual elements of the more involved transactions can be enormously helpful. Similar to a coach who may look at the box score from the first half of a game during the halftime break, we view the dialogue we have with clients when we prepare a preliminary PPA estimate prior to closing as a particularly important part of the M&A project. This deliberative process results in a more robust – well-reasoned analysis that is easier for the external auditors to review, and better stands the test of time requiring fewer true-ups or other adjustments in the future. Surprises are difficult to eliminate, but as they say, forewarned is forearmed.Can goodwill be broken into different components?If so, what are the different components and how are they delineated?In the world of FASB, goodwill is not delineated into personal goodwill and corporate or enterprise goodwill. However, in the tax world, this distinction can be of critical importance and can create significant savings to the sellers of a C corporation business.Many sellers prefer that a transaction be structured as a stock sale, rather than an asset sale, thereby avoiding a built in gains issue and its related tax liability. Buyers want to do the opposite for a variety of reasons. When a C corporation’s assets are sold, the shareholders must realize the gain and face the issue of double taxation whereby the gain is taxed at both the corporate level, and again at the individual level when proceeds are distributed to the shareholders. Proceeds that can be allocated to the sale of a personal asset, such as personal goodwill, may mitigate the double taxation issue.The Internal Revenue Service defines goodwill as “the value of a trade or business based on expected continued customer patronage due to its name, reputation, or any other factor.”1 Recent Tax Court decisions have recognized a distinction between the goodwill of a business itself and the goodwill attributable to the owners/professionals of that business. This second type is typically referred to as personal (or professional) goodwill (a term used interchangeably in tax cases).Personal goodwill differs from enterprise goodwill in that personal goodwill represents the value stemming from an individual’s personal service to that business, and is an asset owned by the individual, not the business itself. This value would encompass an individual’s professional reputation, personal relationships with customers or suppliers, technical expertise, or other distinctly personal abilities which provide economic benefit to a business. This economic benefit is in excess of any normal return earned on other tangible or intangible assets of the company.What other problems/issues beyond a PPA can you help acquirers navigate?As part of our full suite of services for acquirers, we can handle a number of different kinds of special projects that corporate finance departments may be looking to outsource, completely or partially. For example, our firm helps clients think through certain financial or strategic questions – what level of cash flow reinvestment will best balance competing shareholder interests? Or, what is the appropriate hurdle rate when evaluating internal projects vs. acquisitions for capital budgeting exercises? In other instances, we perform financial due diligence and quality of earnings analyses for transactions.ConclusionAs the “box score” of transactions, PPAs can be an important tool for acquirers and provide greater insight into the motivations and narrative behind a transaction by illustrating the value of various intangible components of a business beyond the collection of tangible assets and how those compare to the purchase price being paid. Our purchase price allocations can be more robust with fewer surprises when we have also worked with the clients before the close of the transaction on elements such as financial due diligence or contingent consideration estimates, or even broader corporate finance and PPA studies.Mercer Capital has extensive experience valuing intangible assets for purchase price allocations (ASC 805), impairment testing (ASC 350), and fresh-start accounting (ASC 852) and assisting buyers during financial due diligence. Call us – we would like to help.1 IRS Publication 535: Business Expenses, Ch. 9, Cat. No. 15065Z

In recent years, there’s been a great deal of interest in RIA acquisitions from a diverse group of buyers ranging from consolidators, other RIAs, banks, diversified financial services companies, and private equity. Due to the high margins, recurring revenue, low capital needs, and sticky client bases that RIAs often offer, these acquirers have been drawn to RIA acquisitions. Following these transactions, acquirors are generally required under accounting standards to perform what is known as a purchase price allocation, or PPA.A purchase price allocation is just that—the purchase price paid for the acquired business is allocated to the acquired tangible and separately-identifiable intangible assets. As noted in the following figure, the acquired assets are measured at fair value. The excess of the purchase price over the identified tangible and intangible assets is referred to as goodwill. Transaction structures involving RIAs can be complicated, often including deal term nuances and clauses that have significant impact on fair value. Purchase agreements may include balance sheet adjustments, client consent thresholds, earnouts, and specific requirements regarding the treatment of other existing documents like buy-sell agreements. Asset and wealth management firms are unique entities with value attributed to a number of different metrics (assets under management, management fee revenue, realized fees, profit margins, etc). It is important to understand how the characteristics of the asset management industry in general and those attributable to a specific firm influence the values of the assets acquired in these transactions. Because most investment managers are not asset intensive operations, the majority of value is typically allocated to intangible assets. Common intangible assets acquired in the purchase of private asset and wealth management firms include the existing customer relationships, tradename, non-competition agreements with executives, and the assembled workforce.Customer RelationshipsGenerally, the value of existing customer relationships is based on the revenue and profitability expected to be generated by the accounts, factoring in an expectation of annual account attrition. Attrition can be estimated using analysis of historical client data or prospective characteristics of the client base.Due to their long-term nature, relatively low attrition rates, and importance as a driver of revenue in the asset and wealth management industries, customer relationships often command a relatively high portion of the allocated value. We can see this in the public filings of RIA aggregator Focus Financial. Between 2017 and 2021, Focus completed 130 acquisitions of RIAs. Of the aggregate allocated consideration for these transactions, a full 51% was allocated to customer relationships. Most of the remainder (48%) was allocated to goodwill.TradenameThe deal terms we see employ a wide range of possible treatments for the tradename acquired in the transaction. The acquiror will need to decide whether to continue using the asset or wealth manager’s name into perpetuity or only use it during a transition period as the acquired firm’s services are brought under the acquirer’s name. This decision can depend on a number of factors, including the acquired firm’s reputation within a specific market, the acquirer’s desire to bring its services under a single name, and the ease of transitioning the asset/wealth manager’s existing client base. In any event, for most relatively successful small-to-medium sized RIAs, the tradename has some positive recognition among the customer base and in the local market, but typically lacks the “brand name” recognition that would give rise to significant tradename value.In general, the value of a tradename can be derived with reference to the royalty costs avoided through ownership of the name. A royalty rate is often estimated through comparison with comparable transactions and an analysis of the characteristics of the individual firm name. The present value of cost savings achieved by owning rather than licensing the name over the future period of use is a measure of the tradename value.Noncompetition AgreementsIn many asset and wealth management firms, a few top executives or portfolio managers account for a large portion of new client generation. Deals involving such firms will typically include non-competition and non-solicitation agreements that limit the potential damage to the company’s client and employee bases if such individuals were to leave.These agreements often prohibit the covered individuals from soliciting business from existing clients or recruiting current employees of the company. In the agreements we’ve observed, a restricted period of two to five years is common. In certain situations, the agreement may also restrict the individuals from starting or working for a competing firm within the same market. The value attributable to a non-competition agreement is derived from the expected impact competition from the covered individuals would have on the firm’s cash flow and the likelihood of those individuals competing absent the agreement. Factors driving the likelihood of competition include the age of the covered individual and whether or not the covered individual has other incentives not to compete aside from the legal agreement (for example, if the individual is a beneficiary of an earn-out agreement or received equity in the acquiror as part of the deal, the probability of competition may be significantly lessened).Assembled WorkforceIn general, the value of the assembled workforce is a function of the saved hiring and assembly costs associated with finding and training new talent. However, in relationship-based industries like asset and wealth management, getting a new portfolio manager or advisor up to speed can include months of networking and building a client base, in addition to learning the operations of the firm. The ability of employees to establish and maintain these client networks can be a key factor in a firm’s ability to find, retain, and grow its business. An existing employee base with market knowledge, strong client relationships, and an existing network may often command a higher value allocation to the assembled workforce. Unlike the intangible assets previously discussed, the value of a assembled workforce is valued as a component of valuing the other assets. Under current accounting standards, the assembled workforce value is not recognized or reported separately, but rather is included as an element of goodwill.GoodwillGoodwill arises in transactions as the difference between the price paid for a company and the value of its identifiable assets (tangible and intangible). Expectations of synergies, strategic market location, and access to a certain client group are common examples of goodwill value derived from the acquisition of an asset or wealth manager. The presence of these non-separable assets and characteristics in a transaction can contribute to the allocation of value to goodwill.EarnoutsIn the purchase price allocations we do for RIA acquirors, we frequently see earnouts structured into the deal as a mechanism for bridging the gap between the price the acquirer wants to pay and the price the seller wants to receive. Earnout payments can be based on asset retention, fee revenue growth, or generation of new revenue from additional clients, assets, or product offerings. Structuring a portion of the total purchase consideration as an earnout provides some downside protection for the acquirer, while rewarding the seller for meeting or exceeding growth expectations. Earnout arrangements represent a contingent liability for the acquiror that must be recorded at fair value on the acquisition date.ConclusionThe proper allocation of value to intangible assets and the calculation of asset fair values require both valuation expertise and knowledge of the subject industry. Mercer Capital brings these together in our extensive experience providing fair value and other valuation and transaction work for the investment management industry. If your company is involved in or is contemplating a transaction, call one of our professionals to discuss your valuation needs in confidence.

Did you miss Mercer Capital's 2021 Energy Purchase Price Allocation Study? If you did, before we move into 2022, take a look at the 2021 Study.This study researches and observes publicly available purchase price allocation data for three sub-sectors of the energy industry: (i) exploration & production; (ii) oilfield services; and (iii) midstream and downstream.  This study is unlike any other in terms of energy industry specificity and depth.The 2021 Energy Purchase Price Allocation Study provides a detailed analysis and overview of valuation and accounting trends in these sub-sectors of the energy space.  This study also enables key users and preparers of financial statements to better understand the asset mix, valuation methods, and useful life trends in the energy space as they pertain to business combinations under ASC 805 and GAAP fair value standards under ASC 820.  We utilized transactions that closed and reported their purchase allocation data in calendar year 2020.This study is a useful tool for management teams, investors, auditors, and even insurance underwriters as market participants grapple with ever-increasing market complexity.  It provides data and analytics for readers seeking to understand undergirding economics and deal rationale for individual transactions.  The study also assists in risk assessment and underwriting of assets involved in these sectors. Further, it helps readers to better comprehend financial statement impacts of business combinations.>> DOWNLOAD THE STUDY <<

There’s been a great deal of interest in RIA acquisitions in recent years from a diverse group of buyers ranging from consolidators, other RIAs, banks, diversified financial services companies, and private equity. These acquirers have been drawn to RIA acquisitions due to the high margins, recurring revenue, low capital needs, and sticky client bases that RIAs often offer. Following these transactions, acquirors are generally required under accounting standards to perform what is known as a purchase price allocation, or PPA.A purchase price allocation is just that—the purchase price paid for the acquired business is allocated to the acquired tangible and separately-identifiable intangible assets. As noted in the following figure, the acquired assets are measured at fair value. The excess of the purchase price over the identified tangible and intangible assets is referred to as goodwill.Transactions structures involving RIAs can be complicated, often including deal term nuances and clauses that have significant impact on fair value. Purchase agreements may include balance sheet adjustments, client consent thresholds, earnouts, and specific requirements regarding the treatment of other existing documents like buy-sell agreements. Asset and wealth management firms are unique entities with value attributed to a number of different metrics (assets under management, management fee revenue, realized fees, profit margins, etc). It is important to understand how the characteristics of the asset management industry in general and those attributable to a specific firm influence the values of the assets acquired in these transactions. Because most investment managers are not asset intensive operations, the majority of value is typically allocated to intangible assets. Common intangible assets acquired in the purchase of private asset and wealth management firms include the existing customer relationships, tradename, non-competition agreements with executives, and the assembled workforce. Customer RelationshipsGenerally, the value of existing customer relationships is based on the revenue and profitability expected to be generated by the accounts, factoring in an expectation of annual account attrition. Attrition can be estimated using analysis of historical client data or prospective characteristics of the client base.Due to their long-term nature, relatively low attrition rates, and importance as a driver of revenue in the asset and wealth management industries, customer relationships often command a relatively high portion of the allocated value. We can see this in the public filings of RIA aggregator Focus Financial. Between 2016 and 2020, Focus completed 106 acquisitions of RIAs. Of the aggregate allocated consideration for these transactions, a full 53% was allocated to customer relationships and 3% was allocated to other assets, with the remaining 44% comprising goodwill.Expand ChartTradenameThe deal terms we see employ a wide range of possible treatments for the tradename acquired in the transaction. The acquiror will need to decide whether to continue using the asset or wealth manager’s name into perpetuity or only use it during a transition period as the acquired firm’s services are brought under the acquirer’s name. This decision can depend on a number of factors, including the acquired firm’s reputation within a specific market, the acquirer’s desire to bring its services under a single name, and the ease of transitioning the asset/wealth manager’s existing client base. In any event, for most relatively successful small-to-medium sized RIAs, the tradename has some positive recognition among the customer base and in the local market, but typically lacks the “brand name” recognition that would give rise to significant tradename value.In general, the value of a tradename can be derived with reference to the royalty costs avoided through ownership of the name. A royalty rate is often estimated through comparison with comparable transactions and an analysis of the characteristics of the individual firm name. The present value of cost savings achieved by owning rather than licensing the name over the future period of use is a measure of the tradename value.Noncompetition AgreementsIn many asset and wealth management firms, a few top executives or portfolio managers account for a large portion of new client generation and are often being groomed for succession planning. Deals involving such firms will typically include non-competition and non-solicitation agreements that limit the potential damage to the company’s client and employee bases if such individuals were to leave.These agreements often prohibit the covered individuals from soliciting business from existing clients or recruiting current employees of the company. In the agreements we’ve observed, a restricted period of two to five years is common. In certain situations, the agreement may also restrict the individuals from starting or working for a competing firm within the same market. The value attributable to a non-competition agreement is derived from the expected impact competition from the covered individuals would have on the firm’s cash flow and the likelihood of those individuals competing absent the agreement. Factors driving the likelihood of competition include the age of the covered individual and whether or not the covered individual has other incentives not to compete aside from the legal agreement (for example, if the individual is a beneficiary of an earn-out agreement or received equity in the acquiror as part of the deal, the probability of competition may be significantly lessened).Assembled WorkforceIn general, the value of the assembled workforce is a function of the saved hiring and assembly costs associated with finding and training new talent. However, in relationship-based industries like asset and wealth management, getting a new portfolio manager or advisor up to speed can include months of networking and building a client base, in addition to learning the operations of the firm. Employees’ ability to establish and maintain these client networks can be a key factor in a firm’s ability to find, retain, and grow its business. An existing employee base with market knowledge, strong client relationships, and an existing network may often command a higher value allocation to the assembled workforce. Unlike the intangible assets previously discussed, the value of an assembled workforce is valued as a component of valuing the other assets. It is not recognized or reported separately, but rather is included as an element of goodwill.GoodwillGoodwill arises in transactions as the difference between the price paid for a company and the value of its identifiable assets (tangible and intangible). Expectations of synergies, strategic market location, and access to a certain client group are common examples of goodwill value derived from the acquisition of an asset or wealth manager. The presence of these non-separable assets and characteristics in a transaction can contribute to the allocation of value to goodwill.EarnoutsIn the purchase price allocations we do for RIA acquirors, we frequently see earnouts structured into the deal as a mechanism for bridging the gap between the price the acquirer wants to pay and the price the seller wants to receive. Earnout payments can be based on asset retention, fee revenue growth, or generation of new revenue from additional product offerings. Structuring a portion of the total purchase consideration as an earnout provides some downside protection for the acquirer, while rewarding the seller for continuity of performance or growth. Earnout arrangements represent a contingent liability that must be recorded at fair value on the acquisition date.ConclusionThe proper allocation of value to intangible assets and the calculation of asset fair values require both valuation expertise and knowledge of the subject industry. Mercer Capital brings these together in our extensive experience providing fair value and other valuation and transaction work for the investment management industry. If your company is involved in or is contemplating a transaction, call one of our professionals to discuss your valuation needs in confidence.

Have you downloaded Mercer Capital’s 2019 Energy Purchase Price Allocation Study yet?The study provides a detailed analysis and overview of valuation and accounting trends in these subsectors of the energy space.  It enables key users and preparers of financial statements to better understand the asset mix, valuation methods, and useful life trends in the energy space as they pertain to business combinations under ASC 805 and GAAP fair value standards under ASC 820. Download here.

Last week, Mercer Capital released its 2019 Energy Purchase Price Allocation Study.  In this post, we’ll be taking a deeper dive into the Exploration & Production transactions reviewed in the analysis.The E&P sector had the lowest average allocation to intangible assets, at just 2% of total purchase consideration.  In fact, only two of the eleven transactions analyzed had any intangible allocation at all.  Oasis Petroleum recorded a small ($1 million) intangible asset related to a non-compete agreement in connection with its acquisition of Forge Energy.  The major outlier was Concho Resources, which recorded over $2.2 billion of goodwill related to its acquisition of RSP Permian.Exploration & Production is not an intangible asset-driven business model.  These companies sell a commodity, so there is no real brand value leading to trademark or trade name allocations.  Bill Barrett and Fifth Creek rebranded as HighPoint Resources after their merger, and recently two E&P companies (Ovintiv, formerly Encana, and Battalion Oil Corporation, formerly Halcon Resources) changed names, the latter likely influenced by its emergence from bankruptcy.The commodity is generally sold at market hubs, so specific customer relationships have minimal value.  (To the extent the company has derivatives that result in above-market pricing realizations, that asset is captured separately.)And while E&P companies tout their technical prowess, few outside of the majors spend meaningfully on R&D or have protected intellectual property.  None of the transactions analyzed in this year’s study included allocations to Developed Technology or In Process Research & Development.Ultimately, the value of an E&P company is driven by its reserves, and purchase price allocations generally reflected that.  Based on the transactions reviewed in our analysis, ~90% of purchase consideration was allocated to reserves.Again, the outlier in the data is Concho’s acquisition of RSP Permian, in which over $2.2 billion was allocated to goodwill.  In its 2018 10-K filing, Concho rationalized the goodwill value as follows:Goodwill recognized is primarily attributable to the following factors: (i) operating and administrative synergies and (ii) net deferred tax liabilities arising from the differences between the purchase price allocated to RSP’s assets and liabilities based on fair value and the tax basis of these assets and liabilities. For the operating and administrative synergies, the total consideration for the RSP Acquisition included a control premium, which resulted in a higher value compared to the fair value of net assets acquired. There are also other qualitative assumptions of long-term factors that the RSP Acquisition creates for the Company’s stockholders, including additional potential for exploration and development opportunities and additional scale and efficiencies in basins in which the Company operates.Despite the headwinds faced by the E&P sector since the Concho / RSP transaction, Concho has indicated that this goodwill value has not been impaired.  The company’s most recent 10-Q indicates that quantitative impairment tests were performed as of July 1, August 29, and September 30, 2019.  (However, Concho did take an $81 million goodwill impairment charge related to certain New Mexico Shelf acreage that was divested in 2019.)In an environment of increasingly complex fair value reporting standards and burgeoning regulatory scrutiny, Mercer Capital helps clients resolve financial reporting valuation issues successfully. We have the capability to serve the full range of fair value valuation needs, providing valuation opinions that satisfy the scrutiny of auditors, the SEC, and other regulatory bodies. Contact our Energy Industry or Financial Reporting Valuation teams to discuss your valuation needs in confidence.

When performing a purchase price allocation for an oilfield services company, careful attention must be given to both the relevant accounting rules and the specific nuances of the oil and gas industry. Oilfield services companies can entail many unique characteristics that are not present in non-oilfield related businesses such as manufacturing, wholesale, non-energy related services, or retail.  Our senior professionals bring significant experience in performing purchase price allocations in the oilfield services area where knowledge of these characteristics is crucial to determining the proper allocation among the subject company’s assets.For the most part, current assets and current liabilities are relatively straight forward. The unique factors of an oilfield services company are found in the fixed assets and intangibles: specialized drilling and production equipment, service contracts, proprietary technology (patented, or unpatented), methods, or software, in-process research and development assets (IPR&D), etc.  In addition, the proper consideration of contributory asset charges in the appraisal of existing customer relationships or technology in the context of oilfield services companies requires a thorough understanding of how such contributory assets are utilized in generating the subject company’s expected operating results.  We will explore the unique factors in future entries. In this blog post, we discuss the guidelines for purchase price allocations that all companies must adhere.The unique factors of an oilfield services company are found in the fixed assets and intangibles.Reviewing a purchase price allocation report can be a daunting task if you don’t do it for a living – especially if you aren’t familiar with the rules and standards governing the allocation process and the valuation methods used to determine the fair value of intangible assets. While it can be tempting as a financial manager to leave this job to your auditor and valuation specialist, it is important to stay on top of the allocation process. Too often, managers find themselves struggling to answer eleventh-hour questions from auditors or being surprised by the effect on earnings from intangible asset amortization. This guide is intended to make the report review process easier while helping to avoid these unnecessary hassles.It should be noted that a review of the valuation methods and fair value accounting standards is beyond the scope of this guide. Grappling with these issues is the responsibility of the valuation specialist, and a purchase price allocation report should explain the valuation issues relevant to your particular acquisition. Instead, this guide focuses on providing an overview of the structure and content of a properly prepared purchase price allocation report.General GuidanceWhile every acquisition will present different circumstances that will impact the purchase price allocation process, there are a few general rules common to all properly prepared reports. From a qualitative standpoint, a purchase price allocation report should satisfy three conditions:The report should be well-documented. As a general rule, the reviewer of the purchase price allocation should be able to follow the allocation process step-by-step. Supporting documentation used by the valuation specialist in the determination of value should be clearly listed and the report narrative should be sufficiently detailed so that the methods used in the allocation can be understood.The report should demonstrate that the valuation specialist is knowledgeable of all relevant facts and circumstances pertaining to the acquisition. If a valuation specialist is not aware of pertinent facts related to the company or transaction, he or she will be unable to provide a reasonable purchase price allocation. If the report does not demonstrate this knowledge, the reviewer of the report will be unable to rely on the allocation.The report should make sense. A purchase price allocation report will not make sense if it describes an unsound valuation process or if it describes a reasonable valuation process in an abbreviated, ambiguous, or dense manner. Rather, the report should be written in clear language and reflect the economic reality of the acquisition (within the bounds of fair value accounting rules). This can be particularly daunting if the reviewer of the purchase price allocation report does not have significant experience in working with oilfield services industry participants.  The oilfield services industry is particularly strong in industry-specific terminology and jargon that can lead to a lack of understanding among purchase price allocation report reviewers that lack a deep industry background.Definition of AssignmentA purchase price allocation report should include a clear definition of the valuation assignment. For a purchase price allocation, the assignment definition should include:The definition of the valuation objective should specify the client, the acquired business, and the intangible assets to be valued.The purpose explains why the valuation specialist was retained. Typically, a purchase price allocation is completed to comply with GAAP financial reporting rules.Effective Date. The effective date of the purchase price allocation is typically the closing date of the acquisition.Standard of Value. The standard of value specifies the definition of value used in the purchase price allocation. If the valuation is being conducted for financial reporting purposes, the standard of value will generally be fair value as defined in ASC 820.Statement of Scope and Limitations. Most valuation standards of practice require such statements that clearly delineate the information relied upon and specify what the valuation does and does not purport to do.Background InformationThe purchase price allocation report should demonstrate that the valuation specialist has a thorough understanding of the acquired business, the intangible assets to be valued, the company’s historical financial performance, and the transaction giving rise to the purchase price allocation.Understanding of the BusinessThe purchase price allocation report should include a discussion related to the acquired company which demonstrates that the valuation specialist is knowledgeable of the company and has conducted sufficient due diligence for the valuation. The overview should also discuss any characteristics of the company that plays a material role in the valuation process. The description should almost always include discussion related to the history and structure of the company, the competitive environment, and key operational considerations.In the case of acquisitions within the oilfield services industry, the pertinent facts include a thorough understanding as to the demand for the subject company’s services across the various basins within the target market.  Unlike many other industries, oilfield services businesses may provide services that are specific to certain basins.  Therefore, expectations regarding the specific basins served may be of much greater importance than expectations for the overall oil and gas industry.Intangible AssetsThe discussion of the subject intangible assets should both provide an overview of all relevant technical guidance related to the particular asset and detail the characteristics of the assets that are significant to the valuation. The overview of guidance demonstrates the specialist is aware of all the relevant standards and acceptable valuation methods for a given asset.Upon reading this section, the reviewer of the purchase price allocation report should have a clear understanding of how the existence of the various intangible assets contribute to the value of the enterprise (how they impact cash flow, risk, and growth).Within the oilfield services industry, in particular, one may have to spend a significant amount of time in the determination of what intangible assets were acquired, what intangible assets should recognized as a separate asset from goodwill (based on the legal/contractual rights and separability considerations) and what intangible assets are likely to have a material value.  These can differ markedly across industries and such considerations can be somewhat unique in the oilfield services industry.Past PerformanceThe historical financial performance of the acquired company provides important context to the story of what the purchasing company plans to do with its new acquisition. While prospective cash flows are most relevant to the actual valuation of intangible assets, the acquired company’s historical performance is a useful tool to substantiate the reasonableness of stated expectations for future financial performance.The historical financial performance of the acquired company provides important context to the story.This does not mean that a company that has never historically made money cannot reasonably be expected to operate profitably in the future. It does mean that management must have a compelling growth or turn-around story (which the specialist would thoroughly explain in the company overview discussion in the report).Understanding an oilfield services company’s past financial performance requires knowledge of industry-specific trends that can impact activity levels, pricing for particular services, competing service providers, and profit margins.  The oilfield services industry is subject to potentially wide fluctuations in activity that can be driven by commodity prices and technological changes.  A thorough understanding of these dynamics is necessary in order to correctly interpret past performance among industry participants.Transaction OverviewTransaction structures can be complicated and specific deal terms often have a significant impact on value. Purchase agreements may specify various terms for initial purchase consideration, include or exclude specific assets and liabilities, specify various structures of earn-out consideration, contain embedded contractual obligations, or contain other unique terms. The valuation specialist must demonstrate a thorough understanding of the deal terms and discuss the specific terms that carry significant value implications.Determination of ValueThe purchase price allocation report should provide an adequate description of the valuation approaches and methods relevant to the project. In general, the report should outline the three approaches to valuation (the cost approach, the market approach, and the income approach), regardless of the approaches selected for use in the valuation. This demonstrates that the valuation specialist is aware of and considered each of the approaches in the ultimate selection of valuation methods appropriate for the given circumstances.Any of a number of valuation methods could be appropriate for a given intangible asset depending on the specific situation. While selection of the appropriate method is the responsibility of the valuation specialist, the reasoning should be documented in the report in such a way that a report reviewer can assess the valuation specialist’s judgment.In the closing discussion related to the valuation process, the report should provide some explanation of the overall reasonableness of the allocation. This part of the purchase price allocation report should include both a qualitative assessment and quantitative analysis for support. While this support will differ depending on circumstances, the report should adequately present how the valuation “hangs together.”Within the oilfield services industry determination as to the reasonableness of the indicated allocation of value (purchase price) is often a factor of whether the subject company’s services are subject to proprietary technology, the level of fixed assets required to provide the subject company’s services and the level of personal interaction with customers.  Based on such factors, the allocation of value might be reasonably expected to be skewed to particular types of assets, with higher, or lower, expected levels of goodwill.Keep in Mind, it’s Not a BlackboxA purchase price allocation is not intended to be a black box that is fed numbers and spits out an allocation. The fair value accounting rules and valuation guidance require that it be a reliable and auditable process so that users of financial statements can have a clear understanding of the actual economics of a particular acquisition. As a result, the allocation process should be sufficiently transparent that you are able to understand it without excessive effort, and the narrative of the report is a necessary component of this transparency.

This guest post first appeared on Mercer Capital’s Financial Reporting Blog on January 18, 2016.  When performing a purchase price allocation for an Exploration and Production (E&P) company, careful attention must be paid to both the accounting rules and the specialty nuances of the oil and gas industry. E&P companies are unique entities compared to traditional businesses such as manufacturing, wholesale, services or retail. As unique entities, the accounting rules have both universal rules to adhere as well as industry specific. Our senior professionals bring significant experience in performing purchase price allocations in the E&P area where these two principles collide. For the most part, current assets, current liabilities are straight forward. The unique factors of an E&P are found in the fixed assets and intangibles: producing, probable and possible reserves, raw acreage rights, gathering systems, drill rigs, pipe, working interests, royalty interests, contracts, hedges, etc. Different accounting methods like the full cost method or the successful efforts method can create comparability issues between two E&P’s that utilize opposite methods. We will explore the unique factors in future entries. In this blog post, we discuss the guidelines for purchase price allocations that all companies must adhere.Reviewing a purchase price allocation report can be a daunting task if you don’t do it for a living – especially if you aren’t familiar with the rules and standards.Reviewing a purchase price allocation report can be a daunting task if you don’t do it for a living – especially if you aren’t familiar with the rules and standards governing the allocation process and the valuation methods used to determine the fair value of intangible assets. While it can be tempting as a financial manager to leave this job to your auditor and valuation specialist, it is important to stay on top of the allocation process. Too often, managers find themselves struggling to answer eleventh-hour questions from auditors or being surprised by the effect on earnings from intangible asset amortization. This guide is intended to make the report review process easier while helping to avoid these unnecessary hassles.Please note that a review of the valuation methods and fair value accounting standards is beyond the scope of this guide. Grappling with these issues is the responsibility of the valuation specialist, and a purchase price allocation report should explain the valuation issues relevant to your particular acquisition. Instead, this guide focuses on providing an overview of the structure and content of a properly prepared purchase price allocation report.General RulesWhile every acquisition will present different circumstances that will impact the purchase price allocation process, there are a few general rules common to all properly prepared reports. From a qualitative standpoint, a purchase price allocation report should satisfy three conditions:The report should be well-documented. As a general rule, the reviewer of the purchase price allocation should be able to follow the allocation process step-by-step. Supporting documentation used by the valuation specialist in the determination of value should be clearly listed and the report narrative should be sufficiently detailed so that the methods used in the allocation can be understood.The report should demonstrate that the valuation specialist is knowledgeable of all relevant facts and circumstances pertaining to the acquisition. If a valuation specialist is not aware of pertinent facts related to the company or transaction, he or she will be unable to provide a reasonable purchase price allocation. If the report does not demonstrate this knowledge, the reviewer of the report will be unable to rely on the allocation.The report should make sense. A purchase price allocation report will not make sense if it describes an unsound valuation process or if it describes a reasonable valuation process in an abbreviated, ambiguous, or dense manner. Rather, the report should be written in clear language and reflect the economic reality of the acquisition (within the bounds of fair value accounting rules).Assignment DefinitionA purchase price allocation report should include a clear definition of the valuation assignment. For a purchase price allocation, the assignment definition should include:Objective. The definition of the valuation objective should specify the client, the acquired business, and the intangible assets to be valued.Purpose. The purpose explains why the valuation specialist was retained. Typically, a purchase price allocation is completed to comply with GAAP financial reporting rules.Effective Date. The effective date of the purchase price allocation is typically the closing date of the acquisition.Standard of Value. The standard of value specifies the definition of value used in the purchase price allocation. If the valuation is being conducted for financial reporting purposes, the standard of value will generally be fair value as defined in ASC 820.Statement of Scope and Limitations. Most valuation standards of practice require such statements that clearly delineate the information relied upon and specify what the valuation does and does not purport to do.Background InformationThe purchase price allocation report should demonstrate that the valuation specialist has a thorough understanding of the acquired business, the intangible assets to be valued, the company’s historical financial performance, and the transaction giving rise to the purchase price allocation.Company OverviewDiscussion related to the acquired company should demonstrate that the valuation specialist is knowledgeable of the company and has conducted sufficient due diligence for the valuation. The overview should also discuss any characteristics of the company that play a material role in the valuation process. The description should almost always include discussion related to the history and structure of the company, the competitive environment, and key operational considerations.Intangible AssetsThe intangible assets discussion should both provide an overview of all relevant technical guidance related to the particular asset and detail the characteristics of the asset that are significant to the valuation. The overview of guidance demonstrates the specialist is aware of all the relevant standards and acceptable valuation methods for a given asset.After reading this section, the reviewer of the purchase price allocation report should have a clear understanding of how the existence of the various intangible assets contribute to the value of the enterprise (how they impact cash flow, risk, and growth).Historical Financial PerformanceThe historical financial performance of the acquired company provides important context to the story of what the purchasing company plans to do with its new acquisition. While prospective cash flows are most relevant to the actual valuation of intangible assets, the acquired company’s historical performance is a useful tool to substantiate the reasonableness of stated expectations for future financial performance.This does not mean that a company that has never historically made money cannot reasonably be expected to operate profitably in the future. It does mean that management must have a compelling growth or turn-around story (which the specialist would thoroughly explain in the company overview discussion in the report).Transaction OverviewTransaction structures can be complicated and specific deal terms often have a significant impact on value. Purchase agreements may specify various terms for initial purchase consideration, include or exclude specific assets and liabilities, specify various structures of earn-out consideration, contain embedded contractual obligations, or contain other unique terms. The valuation specialist must demonstrate a thorough understanding of the deal terms and discuss the specific terms that carry significant value implications.Fair Value DeterminationThe report should provide adequate description of the valuation approaches and methods relevant to the purchase price allocation. In general, the report should outline the three approaches to valuation (the cost approach, the market approach, and the income approach), regardless of the approaches selected for use in the valuation. This demonstrates that the valuation specialist is aware of and considered each of the approaches in the ultimate selection of valuation methods appropriate for the given circumstances.The report should outline the three approaches to valuation, regardless of the approaches selected for use in the valuation.Depending on the situation, any of a number of valuation methods could be appropriate for a given intangible asset. While selection of the appropriate method is the responsibility of the valuation specialist, the reasoning should be documented in the report in such a way that a report reviewer can assess the valuation specialist’s judgment.At the closing of the discussion related to the valuation process, the report should provide some explanation of the overall reasonableness of the allocation. This discussion should include both a qualitative assessment and quantitative analysis for support. While this support will differ depending on circumstances, the report should adequately present how the valuation “hangs together.”Something to RememberA purchase price allocation is not intended to be a black box that is fed numbers and spits out an allocation. The fair value accounting rules and valuation guidance require that it be a reliable and auditable process so that users of financial statements can have a clear understanding of the actual economics of a particular acquisition. As a result, the allocation process should be sufficiently transparent that you are able to understand it without excessive effort, and the narrative of the report is a necessary component of this transparency.

FinTech M&A continues to be top of mind for the sector as larger players seek to grow and expand while founders and early investors look to monetize their investments.This theme was evident in several larger deals already announced in 2019 including Global Payments/Total System Services (TSYS), Fidelity National Information Services, Inc./Worldpay, Inc., and Fiserv, Inc./First Data Corporation.One important aspect of FinTech M&A is the purchase price allocation and the valuation estimates for goodwill and intangible assets as many FinTech companies have minimal physical assets and a high proportion of the purchase price is accounted for via goodwill and intangible assets.The majority of value creation for the acquirer and their shareholders will come from their investment in and future utilization of the intangibles of the FinTech target.To illustrate this point, consider that the median amount of goodwill and intangible assets was ~98% of the transaction price for FinTech transactions announced in 2018.Since such a large proportion of the transaction price paid for FinTech companies typically gets carried in the form of goodwill or intangibles on the acquirer’s balance sheet, the acquirer’s future earnings, tax expenses, and capitalization will often be impacted significantly from the depreciation and amortization expenses.When preparing valuation estimates for a purchase price allocation for a FinTech company, one key step for acquirers is identifying the intangible assets that will need to be valued.In our experience, the identifiable intangible assets for FinTech acquisitions often include the tradename, technology (both developed and in-development), noncompete agreements, and customer relationships.Additionally, there may be a need to consider the value of an earn-out arrangement if a portion of transaction consideration is contingent on future performance as this may need to be recorded as a contingent liability.Since the customer relationship intangible is often one of the more significant intangible assets to be recorded in FinTech acquisitions (both in $ amounts and as a % of the purchase price), we discuss how to value FinTech customer relationships in greater detail in the remainder of the article.Valuing Customer-Related AssetsFirms devote significant human and financial resources in developing, maintaining and upgrading customer relationships. In some instances, customer contracts give rise to identifiable intangible assets. More broadly, however, customer-related intangible assets consist of the information gleaned from repeat transactions, with or without underlying contracts. Firms can and do lease, sell, buy or otherwise trade such information, which are generally organized as customer lists.Since FinTech has some relatively varied niches including payments, digital lending, WealthTech, or InsurTech, the valuation of FinTech customer relationships can vary depending on the type of company and the niche that it operates in.While we do not delve into the key attributes to consider for each FinTech niche, we provide one illustration from the Payments niche.In the Payments industry, one key aspect to understand when evaluating customer relationships is where the company is in the payment loop and whether the company operates in a B2B (business-to-business) or B2C (business-to-consumer) model.This will drive who the customer is and the economics related to valuing the cash flows from the customer relationships.For example, merchant acquirers typically have contracts with the merchants themselves and the valuable customer relationship lies with the merchant and the dollar volume of transactions processed by the merchant over time, whereas the valuable relationship with other payments companies such as a prepaid or gift card company may lie with the end-user or consumer and their spending/card usage habits over time.Valuation ApproachesValuation involves three approaches: 1) the cost approach, 2) the market approach, and 3) the income approach. Customer relationships are typically valued based upon an income approach (i.e., a discounted cash flow method) where the cash flows that the customer relationships are expected to generate in the future are forecast and then discounted to the present at a market rate of return.Cost ApproachValuation under the cost approach requires estimation of the cost to replace the subject asset, as well as opportunity costs in the form of cash flows foregone as the replacement is sought or recreated. The cost approach may not be feasible when replacement or recreation periods are long. Therefore, the cost approach is used infrequently in valuing customer-related assets.Market ApproachUse of the market approach in valuing customer-related assets is generally untenable for FinTech companies because transactional data on sufficiently comparable assets are not likely to be available.Income ApproachUnder the income approach, customer-related assets are valued most commonly using the income approach. One method within the income approach that is often used to value FinTech customer relationships is the Multi-Period Excess Earnings Method (MPEEM).MPEEM involves the estimation of the cash flow stream attributable to a particular asset. The cash flow stream is discounted to the present to obtain an indication of fair value. The most common starting point in estimating future cash flows is the prospective financial information prepared by (or in close consultation with) the management of the subject business.The key valuation inputs are often estimates of the economic benefit of the customer relationship (i.e., the cash flow stream attributable to the relationships), customer attrition rate, and the discount rate.Three key attributes that are important when using these inputs to valuing customer relationships include:Repeat Patronage. The expectation of repeat patronage creates value for customer-related intangible assets. Contractual customer relationships formally codify the expectation of future transactions. Even in the absence of contracts, firms look to build on past interactions with customers to sell products and services in the future. Two aspects of repeat patronage are important in evaluating customer relationships. First, not all customer contact leads to an expectation of repeat patronage. The quality of interaction with walk-up retail customers, for instance, is generally considered inadequate to reliably lead to expectations of recurring business. Second, even in the presence of adequate information, not all expected repeat business may be attributable to customer-related intangible assets. Some firms operate in monopolistic or near-monopolistic industries where repeat patronage is directly attributable to a dearth of acceptable alternatives available to customers. In other cases, it may be more appropriate to attribute recurring business to the strength of the trade names, software platform, or brands.Attrition. Customer-related intangible assets create value over a finite period. Without efforts geared towards continual reinforcement, customer lists dwindle over time due to customer mortality, the ravages of competition, or the emergence of alternate products and services. The mechanics of present value mathematics further erode the economic benefits of sales to current customers in the distant future. Customer relationships are wasting assets whose economic value attrite with the passage of time.Other Assets.Customer-related intangible assets depend on the existence of other assets to provide value to the firm. Most assets, including fixed assets and intellectual property, are essential in creating products or providing services. The act of selling these products and services enable firms to develop relationships and collect information from customers. In turn, the value of these relationships depends on the firms’ ability to sell additional products and services in the future. Consequently, for firms to extract value from customer-related assets, a number of other assets need to be in place.ConclusionMercer Capital has experience providing valuation and advisory services to FinTech companies and their acquirers.We have valued customer-related and other intangible assets to the satisfaction of clients and their auditors within the FinTech industry across a multitude of niches (payments, wealth management, insurance, lending, and software).Most recently, we completed a purchase price allocation for a private equity firm that acquired a FinTech company in the Payments niche.Please contact us to explore how we can help you. Originally published in the Value Focus: FinTech Industry Newsletter, Mid Year 2019.

Due to the historical popularity of this post, we revisit it this week. The purpose of this post is to help you, the reader, understand how the characteristics of the asset management industry, in general, and those attributable to a specific firm, influence the values of the assets acquired in transactions between banks and asset managers. As banks of all sizes seek new ways to differentiate themselves in a competitive market, we see many banks contemplating the acquisition of an existing asset management firm as a way to expand and diversify the range of services they can offer to clients.  Following a transaction, the bank is required under accounting standards to allocate the purchase price to the various tangible and intangible assets acquired.  As noted in the following figure, the acquired assets are measured at fair value. Transaction structures between banks and asset managers can be complicated, often including deal term nuances and clauses that have significant impact on fair value.  Purchase agreements may include balance sheet adjustments, client consent thresholds, earnouts, and specific requirements regarding the treatment of other existing documents like buy-sell agreements.  Asset management firms are unique entities with value attributed to a number of different metrics (assets under management, management fee revenue, realized fee margin, etc.). It is important to understand how the characteristics of the asset management industry, in general, and those attributable to a specific firm, influence the values of the assets acquired in these transactions. Common intangible assets acquired in the purchase of a private asset manager include the trade name, existing customer relationships, non-competition agreements with executives, and the assembled workforce. Trade NameThe deal terms we see employ a wide range of possible treatments for the trade name acquired in the transaction.  The bank will need to make a decision about whether to continue using the asset manager’s name into perpetuity or only use it during a transition period as the asset manager’s services are brought under the bank’s name.  This decision can depend on a number of factors, including the asset manager’s reputation within a specific market, the bank’s desire to bring its services under a single name, and the ease of transitioning the asset manager’s existing client base.  However, if the bank plans immediately to take asset management services under its own name and discontinue use of the firm’s name, then the only value allocable to the tradename would be defensive.In general, the value of a trade name can be derived with reference to the royalty costs avoided through ownership of the name.  A royalty rate is often estimated through comparison with comparable transactions and an analysis of the characteristics of the individual firm name.  The present value of cost savings achieved by owning rather than licensing the name over the future period of use is a measure of the value of the trade name.Customer RelationshipsThe nature of relationships between clients and portfolio managers often gives rise an allocation to the existing customer relationships transferred in a transaction.  Generally, the value of existing customer relationships is based on the revenue and profitability expected to be generated by the accounts, factoring in an expectation of annual account attrition.  Attrition can be estimated using analysis of historical client data or prospective characteristics of the client base.  Many of the agreements we see include a clause that requires a certain percentage of clients to consent to transfer their accounts in order for the deal to close at the stated price.  If the asset manager secures less than the required amount of client consents, the purchase price may be adjusted downward or the deal may be terminated entirely.  Due to their long-term nature and importance as a driver of revenue in the asset management industry, customer relationships may command a relatively high portion of the allocated value.Non-Competition AgreementsIn many asset management firms, a few top executives or portfolio managers account for a large portion of new client generation and are often being groomed for succession planning.  Deals involving such firms will typically include non-competition and non-solicitation agreements that limit the potential damage to the company’s client and employee bases if such individuals were to leave.These agreements often prohibit the individuals from soliciting business from existing clients or recruiting current employees of the company.  In certain situations, the agreement may also restrict the individuals from starting or working for a competing firm within the same market.  The value attributable to a non-competition agreement is derived from the expected impact competition from the covered individuals would have on the firm’s cash flow and the likelihood of those individuals competing absent the agreement.  In the agreements we’ve observed, a restricted period of two to five years is common.Assembled WorkforceIn general, the value of the assembled workforce is a function of the saved hiring and assembly costs associated with finding and training new talent.  However, in a relationship-based industry like asset management, getting a new portfolio or investment manager up to speed can include months of networking and building a client base, in addition to learning the operations of the firm.  Employees’ ability to establish and maintain these client networks can be a key factor in a firm’s ability to find, retain, and grow its business.  An existing employee base with market knowledge, strong client relationships, and an existing network often may command a higher value allocation to the assembled workforce.  Unlike the intangible assets previously discussed, the assembled workforce is valued as a component of valuing the other assets.   It is not recognized or reported separately, but rather as an element of goodwill.GoodwillGoodwill arises in transactions as the difference between the price paid for a company and the value of its identifiable assets (tangible and intangible).  Expectations of synergies, strategic market location, and access to a certain client group are common examples of goodwill value derived from the acquisition of an asset manager.  The presence of these non-separable assets and characteristics in a transaction can contribute to the allocation of value to goodwill.EarnoutsIn the purchase price allocations we do for banks and asset managers, we frequently see an earnout structured into the deal as a mechanism for bridging the gap between the price the bank wants to pay and the price the asset manager wants to receive.  Earnout payments can be based on asset retention, fee revenue growth, or generation of new revenue from additional product offerings.  Structuring a portion of the total purchase consideration as an earnout provides some downside protection for the bank, while rewarding the asset management firm for continuity of performance or growth.  Earnout arrangements represent a contingent liability that must be recorded at fair value on the acquisition date.ConclusionThe proper allocation of value to intangible assets and the calculation of asset fair values require both valuation expertise and knowledge of the subject industry.  Mercer Capital brings these together in our extensive experience providing fair value and other valuation work for the asset management industry.  If your company is involved in or is contemplating a transaction, call one of our professionals to discuss your valuation needs in confidence.

On December 22, 2017, President Trump signed The Tax Cuts and Jobs Act, which resulted in sweeping changes to the U.S. tax code.The Act decreased the corporate tax rate to 21% from 35%, in addition to modifying specific provisions around interest, depreciation, carrybacks, and repatriation taxes.The change in tax rate will have the biggest impact on purchase accounting. In the energy industry, this will manifest itself in several ways.  This blog post explores some of the impacts to valuations performed under fair value accounting in ASC 805 and ASC 820.Cash Flows and ReturnsWhen we evaluate prospective financial information, a lower tax rate will result in higher after-tax earnings.The value of the tax shield created by depreciation and deductions will be influenced by both the lower corporate tax rate (which reduces the tax shield’s value) and accelerated depreciation of qualifying capital equipment purchases (which increases the tax shield’s value).  This could mean incentives for energy-oriented companies to (i) create a more modernized drilling rig fleet sooner that are best suited for today’s multi-frac lateral wells and (ii) accelerated plans to create more infrastructure and pipelines in active basins such as the Permian, Bakken and Eagle Ford.  In addition, it also could drive more refinery and LNG liquefaction plant development.  In most cases, a lower tax rate will increase cash flows, increasing the internal rate of return on acquisitions for a given purchase price.On the other hand, if lower tax rates drive higher purchase prices, internal rates of return may be unchanged.In terms of the weighted average cost of capital (WACC), the lower tax rate actually increases the after-tax cost of debt.Keeping other inputs constant, this modestly increases WACCs.Relief from RoyaltyUnder the relief from royalty method, after-tax royalties avoided increase as the tax rate falls.However, the tax amortization benefit (TAB) component of the intangible value also declines as a result of the lower tax rate, which serves to partially offset the increase in after-tax cash flows.Scenario AnalysisIn a scenario analysis used to value a noncompete agreement, a lower tax rate will again decrease the tax amortization benefit.Since both scenarios under the with and without approach will reflect the same tax rate, the impact of the new lower rate will be muted.As a result, the fair value of noncompete agreements may well be somewhat lower under the new tax rate.Cost ApproachThe cost approach, which is often used to value assets such as the assembled workforce or some technologies, the impact depends on whether a pre-tax or after-tax measurement basis is used.If fair value is measured on a pre-tax basis, the fair value of such assets is unaffected.If measured on an after-tax basis, costs avoided net of tax will be higher under lower tax rates, although this gain will be offset somewhat by the decrease in the TAB. Multi-Period Excess Earnings Method The impact of the tax rate on assets valued under the Multi-Period Excess Earnings Method (MPEEM) is more ambiguous since two key elements will be affected – the contributory asset charges and the tax rate used to derive after-tax cash flows.On the cash flow side of things, the lower tax rate will result in higher cash flow but a lower TAB.As far as contributory assets are concerned:Relief from royalty asset charges will increase under a lower tax rateWith and without scenario analysis with level payments charges will potentially decrease due to the lower base valueCost approach asset charges may increase or decrease depending on the net effect of taxes and TAB calculationsReserves & Goodwill The net impact of a lower tax rate on goodwill will vary by transaction.  Since reserves are typically viewed through a pre-tax lens, the value of reserves could be muted (all else held constant).  However, we note that if tax incentives increase CapEx and drilling plans, then more reserves could move up the category chain (P2 to P1 for example) and thus increase the fair value of reserves.  If the lower tax rate results in a higher transaction price, the aggregate increase in fair value will likely result in a larger allocation to goodwill.  This would apply more to intangible based energy companies.  Upstream companies typically do not book goodwill.  If, instead, the lower tax rate increases the projected IRR on a transaction, the impact on residual goodwill is harder to predict and will depend on the composition of the assets acquired.The changes to corporate taxes under the new bill are wide-ranging.In addition to the effect of lower rates discussed in this post, fair value specialists need to be alert to how other specific provisions of the bill may influence individual energy companies.Impact of Tax Rate Decrease on Valuation MethodCash Flows/Returns Higher after-tax cash flows/impact on returns depends on transaction priceTax Amortization Benefits DecreaseRelief from Royalty Method Increase (potential offset by decrease in TAB)Cost Approach (pre-tax) No ChangeCost Approach (post-tax) Increase (potential offset by decrease in TAB)With and Without Scenario Potentially lower (potential offset by decrease in TAB)MPEEM May Increase or Decrease (depends on magnitude of other changes)

The stakes for a business combination are high. Each party must negotiate a price and deal terms that promote its own interests but accommodate the counterparty’s expectations. Reaching an agreement can be a lengthy process and may require incorporating special provisions to help close the deal. Contingent consideration is a common example of such a provision.Measuring the fair value of contingent consideration (commonly referred to as an “earnout”) for financial reporting is a complex process – based on a number of variable inputs, unique risk profiles, and potentially complicated payoff structures.Valuation professionals must be well versed in the concepts of fair value, probability, and risk.Here’s what you need to know about what goes into that fair value measurement before it lands on your desk.How Does an Earnout Differ from Other Purchase Price Adjustments?While both purchase price adjustments and earnouts can affect the total consideration paid in a transaction, they differ substantially in terms of criteria and realization.Common purchase price adjustments include adjustments for working capital, client consents, and indebtedness.Purchase price adjustments, which are based on financial statement information, are observable and knowable at the closing date of the transaction, while earnouts are not.Earnouts, on the other hand, are payments based on performance that occurs subsequent to the measurement date. Although the eventual earnout payment cannot be known at the closing date, valuation specialists have developed techniques to enhance the reliability of fair value measurements.What Criteria Must Be Established in a Fair Value Measurement?The Purchase Agreement establishes the basic criteria, structure, and time frame for the earnout.Based on these characteristics, the valuation professional must determine several inputs for his or her modeling.Earnout Metric The Purchase Agreement will define one or more performance metrics for the earnout.A common example is EBITDA for the twelve-month period following the acquisition.The future outcome(s) of the relevant metrics are used to determine the future payout.For purposes of fair value measurement, valuation specialists may reference management projections, analyst expectations, and industry forecasts to model the expected payoff.VolatilitySince the actual value of the earnout metric cannot be known with certainty at the measurement date, the expected value is paired with an estimate of expected volatility. While there are several ways to estimate expected volatility, the estimate should be reasonable in the context of the volatility observed for similar companies, the subject company’s fundamentals, and the characteristics of the specific metric.Discount RateThe appropriate discount rate may be estimated through a bottom-up approach, where beta is built up using earnout-related factors, or through a top-down approach, which starts with the beta implied by the equity discount rate for the company overall.In the top-down approach, the valuation professional adjusts the company level beta up or downward for differences in risk between the metric and the company’s equity. The type of risk associated with the metric will affect the model that should be used to value the earnout.The two broad categories of risk are:Diversifiable. Diversifiable or “unsystematic” risk is specific to the subject company and can be reduced through diversification. For example, the risk associated with occurrence of a nonfinancial milestone such as patent approval is considered diversifiable.Non-Diversifiable. Non-diversifiable or “systematic” risk is related to the risk inherent in the market. For example, the risk associated with achieving a financial target such as revenue growth is considered non-diversifiable.Payoff StructureThe structure of the earnout reflects the provisions established in the Purchase Agreement.Questions that a valuation specialist may ask include:Is the underlying metric risk diversifiable (unsystematic) or not (systematic)?Is the payoff structure linear or non-linear?If multiple periods are involved, are the periods dependent on, or independent of, the other periods?The answers to these questions can help the valuation professional determine the structure of the payoff and whether a scenario based model or option pricing model is best suited to the fair value measurement of the earnout liability.TermThe term over which the metric is measured is established in the Purchase Agreement.The earnout may be determined after one period or over a multi-period time frame. Payments may be made throughout the earnout period, at the end of the earnout period, or at a later date. Additional time to payment may increase counterparty risk, or the risk that the Buyer will default on the earnout payment due.Credit Risk of the BuyerEarnouts typically represent a subordinate, unsecured liability for the Buyer.Thus, risk should be considered for the Buyer’s ability to meet the earnout obligation, commonly called counterparty credit risk or default risk. A valuation professional will look for any mitigating factors that could reduce or eliminate this risk, including:Guarantee by a bank or third partyEscrow account for full or partial funding of the earnoutEarnout structured as a note to increase its security rankingWhat Methods Are Used to Measure Fair Value?The two primary methods used to measure fair value are the scenario based method and the option pricing method. Selection of the method and model most appropriate for a given situation will depend on to the structure and risk profile of the subject earnout.Scenario Based MethodUnder the scenario based method, valuation specialists apply probability weights to the relevant metrics, and then discount the corresponding payouts at an appropriate rate. This method is most appropriate when the underlying metric for the earnout has a linear payoff structure or the underlying risk is diversifiable. Models within this method can effectively conform to any distribution assumption. This method is intuitive and is likely to mimic how the parties to the transaction thought about the earnout. However, these models can be perceived as unreliable since the inputs are qualitative in nature.Option Pricing MethodWhen applying the option pricing method, valuation specialists use models such as Black-Scholes to measure the fair value of a portfolio of financial instruments that replicate the potential payouts of the earnout structure. This method is best suited for earnouts with nonlinear payoff structures and metrics with non-diversifiable risk. A significant benefit to the method is that the use of historical data to estimate volatility, correlation, and the discount rate creates consistency among input assumptions. However, the complexity of the mathematics associated with the models is not well understood by those without financial expertise, rendering them much less intuitive.Understanding the DifferencesA simple example of an earnout that could be modeled with the scenario based method is as follows: a payment of 30% of the next fiscal year EBITDA. The payoff in this model is linear since it has a constant relationship with the relevant metric, meaning that a payout is due whether EBITDA is $1 million or $100 million (Example 1 below).In contrast, an earnout with a threshold or cap is better suited to an option pricing method. For example, a payment of 30% of the next fiscal year EBITDA only if EBITDA meets or exceeds $50 million. The payoff is the same as the linear scenario after EBITDA reaches the threshold; however, the payoff is $0 for any value of EBITDA below that.The second example can be modeled as a portfolio of options, where the threshold value of the metric ($50 million) acts as an effective strike price.What Guidance Exists Regarding Fair Value Measurement of Contingent Consideration?The measurement of contingent consideration has historically been a matter of considerable diversity in practice.While some common practices have generally been followed, new guidance clarifies best practices.A working group formed by The Appraisal Foundation issued a first exposure draft of new guidance regarding the measurement of contingent considerations in February 2017.This guidance details the methods described above and best practices for their application. The exposure draft endorses the risk-neutral valuation framework as the preferred basis for fair value measurements.A risk-neutral framework makes risk adjustments to the earnout metric to account for the unsystematic risk inherent in the metric. The guidance is expected to promote the consistency and reliability of fair value measurements.What Are the Implications of Fair Value on Financial Statements?Earnouts can act as a way to “bridge the gap” between what the Buyer wants to pay and what the Seller wants to receive. They can provide downside protection for the Buyer and upside potential for the Seller. These benefits contribute to the common use of earnout provisions in business combinations. However, the financial reporting consequences of an earnout may be counterintuitive once the transaction has closed and the Buyer becomes the owner of the acquired company.Subsequent to this point, if the relevant metric exceeds initial expectations, the Buyer will report a loss on its income statement associated with remeasuring the contingent liability at its new, higher value. In effect, if business goes well, the Buyer will report a loss. In contrast, if business goes poorly, the Buyer will report a gain upon remeasurement of the contingent liability at its new, lower fair value. Sophisticated deal makers understand the short-term implications for the Buyer’s financial statements but remain focused on the long-term goal.ConclusionThe uncertainty associated with contingent consideration means that the fair value of the earnout will rarely equal the amount that is actually paid out at the future payment date. While valuation professionals do not know what the future holds, they do have tools and techniques to reliably measure the fair value of the earnout liability as of the date of the transaction. While the nuances encountered in fair value measurement of earnouts can extend well beyond the scope of this article, we hope it provided some insight into what goes into the numbers before they reach your company’s accounting department.The inclusion of an earnout in a transaction negotiation can serve various purposes.Bridge the differences in Buyer and Seller expectationsServe as a form of alternative financing and defer a portion of the purchase priceProvide incentive for management to help the company meet post-transaction targetsShift and allocate risk between the various parties involvedThe motivation behind an earnout can influence management’s choice of earnout structure in order to achieve the intended purposes.Definition of Fair Value (ASC 820)“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.”Objective of Fair Value Measurement (ASC 820)“To estimate the price at which an orderly transaction would take place between market participants under the market conditions that exist at the measurement date.”

As banks of all sizes seek new ways to differentiate themselves in a competitive market, we see many banks contemplating the acquisition of an existing asset management firm as a way to expand and diversify the range of services they can offer to clients.  Following a transaction, the bank is required under accounting standards to allocate the purchase price to the various tangible and intangible assets acquired.  As noted in the following figure, the acquired assets are measured at fair value. Transaction structures between banks and asset managers can be complicated, often including deal term nuances and clauses that have significant impact on fair value.  Purchase agreements may include balance sheet adjustments, client consent thresholds, earnouts, and specific requirements regarding the treatment of other existing documents like buy-sell agreements.  Asset management firms are unique entities with value attributed to a number of different metrics (assets under management, management fee revenue, realized fee margin, etc.). It is important to understand how the characteristics of the asset management industry, in general, and those attributable to a specific firm, influence the values of the assets acquired in these transactions. Common intangible assets acquired in the purchase of a private asset manager include the trade name, existing customer relationships, non-competition agreements with executives, and the assembled workforce. Trade NameThe deal terms we see employ a wide range of possible treatments for the trade name acquired in the transaction.  The bank will need to make a decision about whether to continue using the asset manager’s name into perpetuity or only use it during a transition period as the asset manager’s services are brought under the bank’s name.  This decision can depend on a number of factors, including the asset manager’s reputation within a specific market, the bank’s desire to bring its services under a single name, and the ease of transitioning the asset manager’s existing client base.  However, if the bank plans immediately to take asset management services under its own name and discontinue use of the firm’s name, then the only value allocable to the tradename would be defensive.In general, the value of a trade name can be derived with reference to the royalty costs avoided through ownership of the name.  A royalty rate is often estimated through comparison with comparable transactions and an analysis of the characteristics of the individual firm name.  The present value of cost savings achieved by owning rather than licensing the name over the future period of use is a measure of the value of the trade name.Customer RelationshipsThe nature of relationships between clients and portfolio managers often gives rise an allocation to the existing customer relationships transferred in a transaction.  Generally, the value of existing customer relationships is based on the revenue and profitability expected to be generated by the accounts, factoring in an expectation of annual account attrition.  Attrition can be estimated using analysis of historical client data or prospective characteristics of the client base.  Many of the agreements we see include a clause that requires a certain percentage of clients to consent to transfer their accounts in order for the deal to close at the stated price.  If the asset manager secures less than the required amount of client consents, the purchase price may be adjusted downward or the deal may be terminated entirely.  Due to their long-term nature and importance as a driver of revenue in the asset management industry, customer relationships may command a relatively high portion of the allocated value.Non-Competition AgreementsIn many asset management firms, a few top executives or portfolio managers account for a large portion of new client generation and are often being groomed for succession planning.  Deals involving such firms will typically include non-competition and non-solicitation agreements that limit the potential damage to the company’s client and employee bases if such individuals were to leave.These agreements often prohibit the individuals from soliciting business from existing clients or recruiting current employees of the company.  In certain situations, the agreement may also restrict the individuals from starting or working for a competing firm within the same market.  The value attributable to a non-competition agreement is derived from the expected impact competition from the covered individuals would have on the firm’s cash flow and the likelihood of those individuals competing absent the agreement.  In the agreements we’ve observed, a restricted period of two to five years is common.Assembled WorkforceIn general, the value of the assembled workforce is a function of the saved hiring and assembly costs associated with finding and training new talent.  However, in a relationship-based industry like asset management, getting a new portfolio or investment manager up to speed can include months of networking and building a client base, in addition to learning the operations of the firm.  Employees’ ability to establish and maintain these client networks can be a key factor in a firm’s ability to find, retain, and grow its business.  An existing employee base with market knowledge, strong client relationships, and an existing network often may command a higher value allocation to the assembled workforce.  Unlike the intangible assets previously discussed, the assembled workforce is valued as a component of valuing the other assets.   It is not recognized or reported separately, but rather as an element of goodwill.GoodwillGoodwill arises in transactions as the difference between the price paid for a company and the value of its identifiable assets (tangible and intangible).  Expectations of synergies, strategic market location, and access to a certain client group are common examples of goodwill value derived from the acquisition of an asset manager.  The presence of these non-separable assets and characteristics in a transaction can contribute to the allocation of value to goodwill.EarnoutsIn the purchase price allocations we do for banks and asset managers, we frequently see an earnout structured into the deal as a mechanism for bridging the gap between the price the bank wants to pay and the price the asset manager wants to receive.  Earnout payments can be based on asset retention, fee revenue growth, or generation of new revenue from additional product offerings.  Structuring a portion of the total purchase consideration as an earnout provides some downside protection for the bank, while rewarding the asset management firm for continuity of performance or growth.  Earnout arrangements represent a contingent liability that must be recorded at fair value on the acquisition date.ConclusionThe proper allocation of value to intangible assets and the calculation of asset fair values require both valuation expertise and knowledge of the subject industry.  Mercer Capital brings these together in our extensive experience providing fair value and other valuation work for the asset management industry.  If your company is involved in or is contemplating a transaction, call one of our professionals to discuss your valuation needs in confidence.Mercer Capital's RIA Valuation Insights BlogThe RIA Valuation Insights Blog presents a weekly update on issues important to the Asset Management Industry. 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This guest post first appeared on Mercer Capital’s Financial Reporting Blog on January 18, 2016. When performing a purchase price allocation for an Exploration and Production (E&P) company, careful attention must be paid to both the accounting rules and the specialty nuances of the oil and gas industry. E&P companies are unique entities compared to traditional businesses such as manufacturing, wholesale, services or retail. As unique entities, the accounting rules have both universal rules to adhere as well as industry specific. Our senior professionals bring significant experience in performing purchase price allocations in the E&P area where these two principles collide. For the most part, current assets, current liabilities are straight forward. The unique factors of an E&P are found in the fixed assets and intangibles: producing, probable and possible reserves, raw acreage rights, gathering systems, drill rigs, pipe, working interests, royalty interests, contracts, hedges, etc. Different accounting methods like the full cost method or the successful efforts method can create comparability issues between two E&P’s that utilize opposite methods. We will explore the unique factors in future entries. In this blog post, we discuss the guidelines for purchase price allocations that all companies must adhere. Reviewing a purchase price allocation report can be a daunting task if you don’t do it for a living – especially if you aren’t familiar with the rules and standards governing the allocation process and the valuation methods used to determine the fair value of intangible assets. While it can be tempting as a financial manager to leave this job to your auditor and valuation specialist, it is important to stay on top of the allocation process. Too often, managers find themselves struggling to answer eleventh hour questions from auditors or being surprised by the effect on earnings from intangible asset amortization. This guide is intended to make the report review process easier while helping to avoid these unnecessary hassles. Please note that a review of the valuation methods and fair value accounting standards is beyond the scope of this guide. Grappling with these issues is the responsibility of the valuation specialist, and a purchase price allocation report should explain the valuation issues relevant to your particular acquisition. Instead, this guide focuses on providing an overview of the structure and content of a properly prepared purchase price allocation report.General RulesWhile every acquisition will present different circumstances that will impact the purchase price allocation process, there are a few general rules common to all properly prepared reports. From a qualitative standpoint, a purchase price allocation report should satisfy three conditions:The report should be well-documented. As a general rule, the reviewer of the purchase price allocation should be able to follow the allocation process step-by-step. Supporting documentation used by the valuation specialist in the determination of value should be clearly listed and the report narrative should be sufficiently detailed so that the methods used in the allocation can be understood.The report should demonstrate that the valuation specialist is knowledgeable of all relevant facts and circumstances pertaining to the acquisition. If a valuation specialist is not aware of pertinent facts related to the company or transaction, he or she will be unable to provide a reasonable purchase price allocation. If the report does not demonstrate this knowledge, the reviewer of the report will be unable to rely on the allocation.The report should make sense. A purchase price allocation report will not make sense if it describes an unsound valuation process or if it describes a reasonable valuation process in an abbreviated, ambiguous, or dense manner. Rather, the report should be written in clear language and reflect the economic reality of the acquisition (within the bounds of fair value accounting rules).Assignment DefinitionA purchase price allocation report should include a clear definition of the valuation assignment. For a purchase price allocation, the assignment definition should include:Objective. The definition of the valuation objective should specify the client, the acquired business, and the intangible assets to be valued.Purpose. The purpose explains why the valuation specialist was retained. Typically, a purchase price allocation is completed to comply with GAAP financial reporting rules.Effective Date. The effective date of the purchase price allocation is typically the closing date of the acquisition.Standard of Value. The standard of value specifies the definition of value used in the purchase price allocation. If the valuation is being conducted for financial reporting purposes, the standard of value will generally be fair value as defined in ASC 820.Statement of Scope and Limitations. Most valuation standards of practice require such statements that clearly delineate the information relied upon and specify what the valuation does and does not purport to do.Background InformationThe purchase price allocation report should demonstrate that the valuation specialist has a thorough understanding of the acquired business, the intangible assets to be valued, the company’s historical financial performance, and the transaction giving rise to the purchase price allocation.Company OverviewDiscussion related to the acquired company should demonstrate that the valuation specialist is knowledgeable of the company and has conducted sufficient due diligence for the valuation. The overview should also discuss any characteristics of the company that play a material role in the valuation process. The description should almost always include discussion related to the history and structure of the company, the competitive environment, and key operational considerations.Intangible AssetsThe intangible assets discussion should both provide an overview of all relevant technical guidance related to the particular asset and detail the characteristics of the asset that are significant to the valuation. The overview of guidance demonstrates the specialist is aware of all the relevant standards and acceptable valuation methods for a given asset.After reading this section, the reviewer of the purchase price allocation report should have a clear understanding of how the existence of the various intangible assets contribute to the value of the enterprise (how they impact cash flow, risk, and growth).Historical Financial PerformanceThe historical financial performance of the acquired company provides important context to the story of what the purchasing company plans to do with its new acquisition. While prospective cash flows are most relevant to the actual valuation of intangible assets, the acquired company’s historical performance is a useful tool to substantiate the reasonableness of stated expectations for future financial performance.This does not mean that a company that has never historically made money cannot reasonably be expected to operate profitably in the future. It does mean that management must have a compelling growth or turn-around story (which the specialist would thoroughly explain in the company overview discussion in the report).Transaction OverviewTransaction structures can be complicated and specific deal terms often have a significant impact on value. Purchase agreements may specify various terms for initial purchase consideration, include or exclude specific assets and liabilities, specify various structures of earn-out consideration, contain embedded contractual obligations, or contain other unique terms. The valuation specialist must demonstrate a thorough understanding of the deal terms and discuss the specific terms that carry significant value implications.Fair Value DeterminationThe report should provide adequate description of the valuation approaches and methods relevant to the purchase price allocation. In general, the report should outline the three approaches to valuation (the cost approach, the market approach, and the income approach), regardless of the approaches selected for use in the valuation. This demonstrates that the valuation specialist is aware of and considered each of the approaches in the ultimate selection of valuation methods appropriate for the given circumstances.Depending on the situation, any of a number of valuation methods could be appropriate for a given intangible asset. While selection of the appropriate method is the responsibility of the valuation specialist, the reasoning should be documented in the report in such a way that a report reviewer can assess the valuation specialist’s judgment.At the closing of the discussion related to the valuation process, the report should provide some explanation of the overall reasonableness of the allocation. This discussion should include both a qualitative assessment and quantitative analysis for support. While this support will differ depending on circumstances, the report should adequately present how the valuation “hangs together.”Something to RememberA purchase price allocation is not intended to be a black box that is fed numbers and spits out an allocation. The fair value accounting rules and valuation guidance require that it be a reliable and auditable process so that users of financial statements can have a clear understanding of the actual economics of a particular acquisition. As a result, the allocation process should be sufficiently transparent that you are able to understand it without excessive effort, and the narrative of the report is a necessary component of this transparency.