Transcript Understanding Goodwill and When to Appraise the Loss

Understanding Goodwill and
When to Appraise the Loss
Presented to the 1st Joint Luncheon
IRWA – Chapter 1 and
The Los Angeles Chapter of the ASA
by
Dave Girbovan, ASA and
Vanita Spaulding, CFA, ASA
Today’s Discussion
• Intangible assets valued in Purchase Price
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Allocation Studies
The Micro and Macro Approach
Goodwill can be narrowly or broadly defined
The basics of the Aklilu case
When lost goodwill is appraised.
The effects of relocation on specific intangible
assets.
Purchase Price Allocation Studies
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Purpose – To allocate the premium paid for a
company in excess of the tangible assets to
specific categories of intangible assets.
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Provides additional amortization resulting in
tax savings.
Historical Example
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MegaHuge Conglomerate acquires the assets
of PalTron for $100 million.
The current assets and fixed assets have a
value of $60 million.
The company was not allowed to amortize the
residual of $40 million if booked as goodwill.
Significant tax savings result when a portion of
the premium is allocated to identified,
amortizable, intangible assets.
Two Phases of the Study
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Macro Approach – An income approach
resulting in the acquisition price.
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Micro Approach – All intangible assets are
value and assigned a useful remaining life.
Categories of Intangible Assets
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Trademarks
Trade Names
Proprietary Technology
Internally Created Software
Assembled Work Force
Favorable Contracts
Advertising Programs
Distribution Networks
Training Materials
Customer Lists
Going Concern Value
Licenses and Certifications
Favorable Leases
Goodwill
Broad and Narrow Definitions of
Goodwill
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Goodwill narrowly defined in purchase price
allocation studies.
Goodwill in eminent domain is broadly
defined.
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Marketable licenses (Liquor) are separated.
Favorable leases are separated.
Everything else is included in goodwill.
Broad Definition of Goodwill
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Although goodwill is broadly defined in
eminent domain, considering the components
is useful to:
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Determine if and why a business may have
goodwill,
Where a business may need to relocate so that
goodwill can be preserved, and
Analyze how a relocation may affect goodwill
Methods to Value Intangibles
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Income Approach
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Market Approach
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Preferable
Value based on income potential
Rarely used
Cost Approach – Cost to Create
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Represents a sunk cost
Cost to Create Method
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By acquiring an operating company one can
avoid the costs to create those assets and the
costs represent their value.
An investor would pay no more for an asset
than the cost to create the asset.
Cost to Create Method
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Examples
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Assembled work force
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Going concern value
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Cost to hire, train and orient employees
Can avoid start up losses
Key Point
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The actual sale of the company established that
intangible asset exists
As confirmed by the macro approach, the business
is expected to be profitable.
Cost to Create Method
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Drawbacks
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Method does not incorporate economic benefits of
the intangibles.
Information regarding the trend of the economic
benefits is lacking.
Duration of the benefits not considered.
Sunk costs.
Inglewood Redevelopment Agency v.
Aklilu, Cal.App 2 Dist., 2007
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Facts
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Auto Inn Lube and Oil was started in 1997 by Elias Aklilu
Believed it would take 3 to 5 years to be successful.
Construction of the Marketplace at Hollywood Park
disrupted the business from 1999 to 2002.
In 2003 the Marketplace was largely completed, traffic
returned to normal, and the business became profitable.
Complaint filed in October 2004.
The Aklilu Case
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Valuation Approaches
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Both appraisers agreed no goodwill using historic
statements and traditional approaches.
Chris Pedersen for the business owner used a cost
to create method. The adjusted historic losses were
added to arrive at goodwill of $238,761.
Chris Pedersen qualitatively established goodwill,
citing a fine location, outstanding exposure,
excellent parking and access, and no competition.
The business had a “very promising future”.
The Aklilu Case
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Issue on Appeal – Is the cost to create method
valid to appraise lost business goodwill?
The Appellate Court said yes.
Adopted a point of view from Muller case that
Code Section 1263.510 should be liberally
construed.
The Aklilu Case
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Discussion Points
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The business’s past was not indicative of its future
Historic losses are sunk costs
Goodwill was qualitatively established
A dangerous precedent
What method has more typically been used to
appraise goodwill under these circumstances?
Distinction from Redevelopment Agency of the
city of San Diego v. Ahmad Mesdaq.
The Effects of Relocation on
Goodwill
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Can examine each category of intangible
assets to determine how goodwill may be
affected.
Also helps to establish primary and secondary
relocation areas
Primary relocation area is where the most goodwill
may be preserved
 Secondary relocation area may preserve some
goodwill.
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When to Appraise the Loss
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Possibilities
Before relocation
 After relocation
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Often do not have a choice
Not always better off waiting
Must recognize appraising lost business
goodwill is somewhat subjective.
Examining Goodwill Before and
After Relocation
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If appraising goodwill in the after condition
prior to an actual relocation, the before
condition model is alter to reflect the
anticipated effects of relocation on the
business.
If appraising goodwill in the after condition
after the actual relocation, the appraiser must
be careful to consider changes not attributable
to relocation.
Examples of When to Appraise the
Loss
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Some agencies have given the business owner
the choice on when lost business goodwill is
appraised.
Value loss before example.
Value loss after example.