Technical Information Paper 3

The Valuation of Intangible Assets

Cover design
Copyright © 2012 International Valuation Standards Council.

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Technical Information Papers

The principal objective of an IVSC Technical Information Paper (TIP) is to reduce diversity of practice by
identifying commonly accepted processes and procedures and discussing their use. A TIP is designed to
be of assistance to professional valuers and informed users of valuations alike. A TIP will do one or more
of the following:

• provide information on the characteristics of different types of asset that are relevant to their value,

• provide information on appropriate valuation methods and their application,

• assist the consistent application of an International Valuation Standard (IVS) by dealing with
matters identified in the Standard in greater detail,

• provide information that is helpful to valuation professionals in exercising the judgements they are
required to make during the valuation process in specific situations.

A TIP does not:

• provide valuation training or instruction,

• direct that a particular approach or method should or should not be used in any specific situation.

The contents of a TIP are not intended to be mandatory. Responsibility for choosing the most appropriate
valuation methods is the responsibility of the valuer based on the facts of each valuation task.

The guidance in this paper presumes that the reader is familiar with the International Valuation Standards
(IVSs). Of particular relevance to the application of this TIP are the concepts and principles discussed in
the IVS Framework and the provisions of IVS 210 Intangible Assets.

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Contents

Paragraphs Page

1 Introduction 1.1–1.4 #

2 Definitions 2.1 #

3 Identifying the Asset 3.1–3.13 #

4 Valuation Approaches and Methods 4.1–4.4 #

5 Market Approach 5.1–5.8 #

6 Income Approach 6.1 #

Prospective Financial Information 6.2–6.11 #

Valuation Methods 6.12–6.15 #

Relief-from-royalty Method 6.16–6.23 #

Premium Profits Method 6.24–6.30 #

Excess Earnings Method 6.31–6.42 #

Greenfield Method 6.43–6.44 #

7 Cost Approach 7.1–7.7 #

8 Other Considerations #
Discount Rates 8.1 #

Remaining Useful Life 8.4 #

Illustrative Examples #

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1 Introduction

1.1 The objective of this TIP is to provide guidance on the principal recognised approaches and
methods that are used for valuing intangible assets. The guidance in this TIP should be
read in conjunction with the International Valuation Standards. IVS 210 Intangible Assets
sets out:

• matters that must be considered when developing a scope of work for a valuation of
intangible assets, and

• matters that are to be considered when reporting a valuation of intangible assets.

1.2 The Commentary to IVS 210 provides a high level overview of different types of intangible
assets and the principal valuation approaches and methods that are used. This TIP
examines the matters discussed in the Commentary in greater detail and gives examples of
how these are applied in practice.

1.3 Valuations of intangible assets are required for different purposes including, but not limited
to:
• acquisitions, mergers and sales of businesses or parts of businesses,
• purchases and sales of intangible assets,

• reporting to tax authorities,

• litigation and insolvency proceedings, and

• financial reporting.

1.4 This TIP provides guidance on appropriate valuation procedures, approaches and methods
for the valuation of intangible assets generally. It does not examine any specific statutory or
regulatory requirements that may apply to the valuation of intangible assets for particular
purposes in specific jurisdictions, eg for taxation or financial reporting. Where a valuation is
required for inclusion in a financial statement the provisions of IVS 300 Valuations for
Financial Reporting apply. IVS 300 also contains guidance on the principal valuation
requirements under the International Financial Reporting Standards (IFRSs).

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2 Definitions

2.1 The following defined words and terms have particular relevance to the valuation of
intangible assets and appear in this TIP. Other words and terms that are also defined in the
IVS Glossary may be used but are not listed below in the interests of brevity.

Contributory Assets Any tangible or intangible assets used in the generation of the cash
flows associated with the intangible asset being valued.
Contributory Asset A charge to reflect a fair return on or return of contributory assets
Charge used in the generation of the cash flows associated with the intangible
asset being valued.
Cost Approach A valuation approach based on the economic principle that a buyer
will pay no more for an asset than the cost to obtain an asset of equal
utility, whether by purchase or by construction.
Discounted Cash Flow A method within the income approach in which a discount rate is
Method applied to future expected income streams.
Excess Earnings That amount of anticipated economic benefits that exceeds an
appropriate rate of return on the value of a selected asset base (often
net tangible assets) used to generate those anticipated economic
benefits.
Excess Earnings Method A method of estimating the economic benefits of an intangible asset
by identifying the cash flows associated with the use of the asset and
deducting a charge reflecting a fair return for the use of contributory
assets.
Going Concern A business enterprise that is expected to continue operations for the
foreseeable future.

Goodwill Any future economic benefit arising from a business, an interest in a

business or from the use of a group of assets which is not separable.
Greenfield Method A method of valuing an intangible asset that deducts the cost of
buying or creating contributory assets from the cash flows associated
with the use of that asset.
Income Approach A valuation approach that provides an indication of value by
converting future cash flows to a single current capital value.
Intangible Asset A non-monetary asset that manifests itself by its economic properties.
It does not have physical substance but grants rights and economic
benefits to its owner.
Market Approach A valuation approach which provides an indication of value by
comparing the subject asset with identical or similar assets for which
price information is available.
Multi-Period Excess A method of estimating the economic benefits of an intangible asset
Earnings Method over multiple time periods by identifying the cash flows associated
with the use of the asset and deducting a periodic charge reflecting a
fair return for the use of contributory assets.
Premium Profits Method A method that indicates the value of an intangible asset by comparing
an estimate of the profits or cash flows that would be earned by a
business using the asset with those that would be earned by a
business that does not use the asset.

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Prospective Financial Forecast financial data used to estimate cash flows in a discounted
Information cash flow model.
Relief-from-royalty A method that estimates the value of an intangible asset by reference
Method to the value of the hypothetical royalty payments that are saved
through owning the asset, as compared with licensing it from a third
party.
Royalty A payment made for the use of an asset, especially an intangible
asset or a natural resource.
Tax Amortisation Benefit Tax relief available on amortisation of the capitalised asset.
Weighted Average Cost A discount rate determined by the weighted average, at market value,
of Capital of the cost of all financing sources in a business enterprise’s capital
structure.

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3 Identifying the Asset

3.1 IVS 210 requires the intangible asset being valued to be identified by reference to its type
and the nature of the right or interest in that asset. The Commentary to IVS 210 explains
the distinction between intangible assets that are identifiable and goodwill, which is an
unidentifiable intangible asset. In summary, an intangible asset is identifiable if it is
separable from the entity or if it arises from a contractual or other legal right.

3.2 The Commentary to IVS 210 describes four principal classes of identifiable intangible asset
to assist in compliance with the requirement to clearly define the asset to be valued and the
nature of the right or interest being valued. These are:

• marketing related,

• customer or supplier related,

• technology related, and

• artistic related.

A more comprehensive discussion of each of these classes of assets and the type of right
or interest typically found is provided below.

3.3 Marketing-related intangible assets are used primarily in the marketing or promotion of
products or services. Examples include, but are not limited to:

• trademarks, trade names, service marks, collective marks and certification marks,

• trade dress (unique colour, shape or package design),

• newspaper mastheads,

• internet domain names, or

• non-compete agreements.

The word “brand” is often used to describe marketing-related assets. It is a generic

description that typically refers to a group of complementary assets that can be separately
identified and therefore distinguished from goodwill. The rights to marketing-related assets
such as trademarks, trade names or trade dress often are protected by registration under
statute.

3.4 Customer- or supplier-related intangible assets arise from relationships with or

knowledge of customers or suppliers. Examples include, but are not limited to:

• advertising, construction, management, service or supply agreements,

• licensing and royalty agreements,

• servicing contracts,

• order books,
• employment contracts,

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 • use rights, such as drilling, water, air, timber cutting and airport landing slots,

• franchise agreements,

• customer relationships, or

• customer lists.

As can be seen from this list, the rights to assets arising from customer or supplier
relationships often arise from contracts, although considerable value can attach to non-
contractual assets such as customer relationships and customer lists.

3.5 Technology-related intangible assets arise from contractual or non-contractual rights to

use a specific technology or formula, such as:

• patents and design patents,

• a distinct design of machine or tool used for a specific process,

• a formula or recipe used in the making of a product,

• computer software, or

• a design or distinct type of product.

The rights to technology-related intangible assets are often legally protected, but may also
be granted by contract or be implicitly protected by proprietary know-how (trade secrets).

3.6 Artistic-related intangible assets arise from the right to benefits such as royalties from
artistic works such as:

• plays and other performed works,

• books, newspapers and other literary works,

• films, television and other visual media,

• music, including lyrics (either published or performed), or

• photographs, illustrations, drawings and paintings.

Frequently the rights to artistic-related intangible assets are the subject of statutory
protection (copyright laws) but can also be granted by contract.

3.7 Statutory protection of intangible assets through rights such as trademarks, copyright and
patents, collectively known as intellectual property, is primarily under the laws of the specific
country or state where the intellectual property has been protected. However, protection is
often extended by various international treaties in which participating states agree to
mutually recognise intellectual property rights. The foremost of these is the World Trade
Organisation (WTO) Agreement on Trade Related Property Rights which aims to harmonise
the intellectual property laws of member states. Compliance with this agreement is a
requirement for any state wishing to join the WTO. There are, however, other treaties that
are specific to certain types of asset that may differ from the WTO or involve different
states.

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3.8 There are also differences between states in the way in which the treaties are applied or
enforced. Where an intangible asset is international in its use, or potential use, and the
rights are dependent upon statutory protection, expert legal advice may be required on the
effective geographic extent as well as on the fields of use of the rights in that asset.

3.9 Contractual ownership rights may be recorded in a formal legal agreement or recorded by
an exchange of correspondence. Where rights are granted by a contract or agreement the
terms of the agreement are essential to the definition of the rights to be valued. Some
agreements may be of limited life or contain a restriction on transfer which could have a
fundamental effect on the value.

3.10 Some intangible assets grant privileges without the existence of actual ownership rights, eg
customer relationships or trade secrets. These intangibles do not necessarily have an
underlying contract, yet a company or individual can be the owner of such intangibles and
derive economic benefit from them.

3.11 Although it may at times be appropriate and possible to value an identifiable intangible
asset on a stand-alone basis, it may be either impossible or impractical in other cases to
value an intangible asset other than assessing it in conjunction with other tangible or
intangible assets. The valuer should document clearly in the valuation report whether an
intangible asset has been valued on a stand-alone basis or in conjunction with other assets.
If the latter is the case, the valuer should explain why it is necessary to aggregate the
subject asset with other asset(s) for valuation purposes and describe clearly the asset(s)
with which the subject asset has been aggregated.

3.12 Goodwill is an unidentifiable intangible asset because it is not separable from the business
to which it relates. Although goodwill is not separable and is therefore unidentifiable in its
entirety, some elements that contribute to goodwill can be identified. These may include
but are not limited to:

• company-specific synergies arising from a combination of two or more businesses,

eg reductions in operating costs, economies of scale or product mix dynamics,

• opportunities to expand the business into different markets,

• the benefit of an assembled workforce, as distinct from any intellectual property

developed by members of that workforce,

• the benefit to be derived from future customers, or

• the benefit of an established network.

3.13 In general terms, the value of goodwill is any residual amount remaining after the value of
all identifiable tangible, intangible and monetary assets less liabilities and potential liabilities
have been deducted from the total value of a business.

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4 Valuation Approaches and Methods

4.1 All three of the principal valuation approaches described in the IVS Framework, the market
approach, the income approach and the cost approach, can be applied to the valuation of
intangible assets. The main methods within each approach are discussed in this section.
There are additional valuation methods such as real option theory, which are not discussed
in this TIP as they are not widely used, although they may be appropriate for the valuation
of certain types of intangible asset under certain circumstances.

4.2 Understanding the nature and attributes of the subject intangible asset and the nature and
characteristics of the market for that asset is generally critical to determining the most
appropriate valuation approach. Sufficient data may be available so that the required
parameters to apply a secondary method can be deduced from the value for the intangible
asset calculated under the primary method. This is sometimes called ‘reverse engineering’.
For instance:

• if an intangible asset is valued using relief-from-royalty or premium profits as the

primary method, the implied multiples of, say, revenues and contribution after
marketing charges could be deduced and compared with those from identified
comparable market transactions, or

• if an intangible asset is valued using multi-period excess earnings or replacement

cost as the primary method, implied royalty rates could be deduced that would have
applied if relief-from-royalty were used; such rates could then be considered for
reasonableness.

4.3 The Commentary to IVS 210 observes that the heterogeneous nature of many intangible
assets means that there is often a greater need to consider the use of multiple methods and
approaches than for other asset classes.

4.4 Regardless of the valuation method applied, a sensitivity analysis can be an important part
of performing cross checks or reasonableness checks on the value of the asset and its
application should be considered if appropriate.

5 Market Approach

5.1 The market approach provides an indication of value by comparing the subject asset with
identical or similar assets for which price information is available.

5.2 The required inputs for applying the market approach to intangible assets are:

• prices and/or valuation multiples in respect of identical or similar intangible assets,

and

• adjustments as required to such transaction prices or valuation multiples, to reflect

the differentiating characteristics or attributes of the subject asset and the assets
involved in the transactions.

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5.3 A valuation multiple is often determined by dividing the transaction price of an asset by a
financial parameter, such as historic or prospective revenue or profit at a given level.
Valuation multiples may also be calculated by reference to a key non-financial operating
parameter, eg to establish a price per unit of sale.

5.4 Because most intangible assets are heterogeneous it is rarely possible to find transactional
data for an identical asset that can be used as a benchmark for the value of the subject
asset. It is more likely that any market evidence will be in respect of similar rather than
identical assets. Where transactional evidence is available an exercise should be
undertaken to identify any differences between the subject asset and the asset that is being
used as a benchmark and how these affect the relative values. Differences can include:

• geographical coverage,

• functionality,

• market share,

• markets accessed (for example one asset may be in the business-to-business

market and the other in the business-to-consumer market), or

• the date of the benchmark transaction and the valuation date.

5.5 The objective of this exercise should be to determine whether the identified factors would
result in the price in the benchmark transaction being higher or lower than the price in a
hypothetical transaction involving the subject asset. If possible, any increase or decrease
should be quantified – if this is not possible, as much qualitative information as available
should be documented, such as whether the factor is likely to have a material impact on
value as compared with the asset transacted.

5.6 Care should also be taken to establish the circumstances of the transaction that is being
considered as a benchmark. The price paid may have been with a related party, the seller
may have been under pressure to sell or the buyer motivated to pay a higher price because
of synergies that only it could exploit.

5.7 It is often the case that full information on a transaction may not be in the public domain, is
difficult or impossible to obtain or may be subject to confidentiality. The valuer may not
know the detailed terms, for example whether warranties and indemnities were given by the
seller, whether incentives were involved, or the impact of tax planning on the transaction.
Caution is required before relying on transactions where full information is not available.

5.8 Even where transactions can be identified and information regarding prices paid is
available, it can be difficult to determine the appropriate adjustments to the prices or the
valuation multiples necessary to reflect the differentiating characteristics or attributes of the
subject intangible asset as compared to those of the assets involved in the transactions.
Because the difficulties described may restrict the appropriateness of the market approach
this method is often only used as a cross check.

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6 Income Approach

6.1 Valuation methods under the income approach determine the value of an intangible asset
by reference to the present value of future income, cash flows or cost savings that could be
reasonably expected to be achieved by a market participant owning the asset.

Prospective Financial Information

6.2 All the intangible asset valuation methods under the income approach require prospective
financial information (PFI) for some of their inputs. The income stream will relate to
financial parameters such as revenues, operating profit, cash flow or some other measure.
Estimates of these financial parameters are critical to derive a credible valuation.

6.3 PFI should be estimated with respect to factors, such as:

• revenues anticipated through use of the asset or asset group and the forecast
share of the market,

• historic profit margins achieved and any variations from those margins anticipated
taking account of market expectations,

• tax charges on income derived from the asset or asset group,

• working capital, capital expenditure requirements or replenishment costs of the

business using the asset, and

• growth rates after the explicit forecast period appropriate to the asset’s expected
life reflecting the industry involved, the economies involved and market
expectations.

6.4 The assumptions behind these inputs should be documented in the valuation report
together with their source.

6.5 The forecast period needs to be assessed consistently with the expected remaining useful
life of the subject intangible asset. As the life of an intangible asset may be finite or
indefinite, forecast cash flows may be for a finite period or may run into perpetuity.

6.6 PFI obtained from different sources should be benchmarked to assess its appropriateness
for use in the valuation. Benchmarking is the process of performing consistency checks on
the PFI assumptions. When performing valuations to establish market value this will
include comparing the inputs with data derived from the market to assess and improve their
accuracy and reliability.

6.7 For PFI being used to determine the market value of intangible assets, growth rates,
margins, tax rates, working capital and capital expenditure, benchmarking should include a
comparison with the corresponding data from market participants, where possible.

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6.8 Other factors affecting PFI inputs may include the economic and political outlook and
related government policy. Matters such as currency exchange rates, inflation and interest
rates may affect intangible assets that operate in different economic environments quite
differently. Consideration should be given to how such factors affect the specific market
and industry in which the subject asset is being valued.

6.9 When cash flows are forecast into perpetuity, specific consideration should be given to the
growth rates used. These should not exceed the long-term average growth rates for the
products, industries, country or countries involved, unless a higher growth rate can be
justified.

6.10 When using PFI to determine the value of an intangible asset, a sensitivity analysis of the
resulting asset value should be performed to assess the impact of possible variations in the
underlying assumptions. Those elements of PFI to which the resulting asset value is most
sensitive should be reviewed to ensure that the assumptions underlying them are as robust
as possible with all available relevant factors being reflected.

6.11 Where the PFI is to be used as an input into a valuation method that uses discounting
techniques, care should be taken to select a discount rate that is consistent with the cash
flow forecasts.1

Valuation Methods

6.12 There are various methods used for valuing intangible assets that fall under the income
approach. The most common are discussed in this paper, ie:

• relief-from-royalty method, sometimes known as royalty savings method,

• premium profits method, sometimes known as the incremental income method,

• excess earnings method, and

• greenfield method.

6.13 Each of these methods involve the discounting of forecast cash flows attributable to the
subject asset based on PFI using either discounted cash flow techniques or, in certain
limited cases, the application of a valuation multiple.

6.14 In addition to capitalising the future expected income flows, or alternatively cost savings that
may be derived from use of the asset, it may be appropriate to take account of any tax relief
that would be available on amortisation of the capitalised asset in a transaction. Such an
adjustment, known as the tax amortisation benefit (TAB), reflects the fact that the income
derivable from an asset includes not only the income directly achievable from its use but
also the reduction in tax payable by a purchaser of the asset. The benefit is highly

1
See IVSC TIP 1 Discounted Cash Flow.

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 dependent on the ability to amortise the intangible asset in the relevant tax jurisdiction,
thereby providing a tax shield, as well as the assumptions for relevant tax rates and
amortisation conventions.

6.15 If estimating the market value, an adjustment to the cash flows for tax amortisation should
be made only if this benefit would be available to a purchaser of the asset in the market
under the relevant tax regime. When performing a valuation of an asset on a basis other
than market value, a TAB adjustment should be made if amortisation would be consistent
with the basis of valuation and the approach adopted. Thus, if an entity-specific valuation is
being performed, a TAB adjustment should be included only if tax amortisation is available
to the specific entity concerned under the application of an income approach.

Relief-from-royalty Method

6.16 The relief-from-royalty, or royalty savings, method estimates the value of an intangible asset
by reference to the value of the hypothetical royalty payments that would be saved through
owning the asset, as compared with licensing the asset from a third party. It involves
estimating the total royalty payments that would need to be made over the asset’s useful
life, by a hypothetical licensee to a hypothetical licensor. Where appropriate, the royalty
payments over the life of the asset are adjusted for tax and discounted to present value.

6.17 Some or all of the following valuation inputs are required in the relief-from-royalty method:

• an estimate of the hypothetical royalty rate that would be paid if the asset were
licensed from a third party,

• projections for the financial parameter, eg revenues that the royalty rate would be
applied to over the life of the intangible asset together with an estimate of the life of
the intangible asset,
• rate at which tax relief would be obtainable on hypothetical royalty payments,

• the cost of marketing and any other costs that would be borne by a licensee in
utilising the asset, and
• an appropriate discount rate or capitalisation rate to convert the asset’s hypothetical
royalty payments to a present value.

6.18 Royalty rates are typically applied as a percentage of the revenues expected to be
generated when using the asset. In some cases, royalty payments may include an upfront
lump sum in addition to periodic amounts based on revenues or some other financial
parameter.

6.19 Two methods can be used to derive the hypothetical royalty rate. The first is based on
market royalty rates for identical or similar assets. Royalty rates may be obtained by
reference to any existing or previous arrangements in which the subject asset was licensed
or by reference to licensing arrangements for other identical or similar assets. A prerequisite
for this method is the existence of comparable intangible assets that are licensed at arm’s

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 length on a regular basis. A cross check using a profit splits method is often useful to
ensure that the outcome is economically feasible.

6.20 The second method used in the absence of market royalty rates for identical or similar
assets is based on a split of profits that would hypothetically be paid in an arm’s length
transaction by a willing licensee to a willing licensor for the rights to use the subject
intangible asset. A reasonable percentage split is determined having regard to the facts of
the case, eg the respective investment that would be required by the licensor and licensee
in order for the asset to generate the anticipated profit. A cross check can be made by
reference to royalty rates for any broadly analogous asset.

6.21 Any royalty information obtained should be adjusted to reflect the differences between the
comparable royalty arrangement and the subject asset. Factors to benchmark when
comparing the subject asset and other royalty agreements include:
• specific licensor or licensee factors that might impact the royalty rate such as their
being related parties,

• exclusivity terms,
• whether the licensor or licensee has responsibility for certain costs, such as
marketing and advertising,

• licence inception date and period of effect,

• duration of licence, or

• differentiating characteristics such as market position, geographical coverage,

functionality, whether they are used in connection with business-to-business or
business-to-consumer products, etc.

6.22 Reasonableness checks should also be performed in respect of the selected royalty rate.
One such check compares the total profit at a particular level, such as gross or operating
profit, and how much of that profit would accrue to each of the licensee and licensor if a
selected royalty rate were used in determination of the licence fee. The reasonableness of
such a profit split can then be reviewed.

6.23 If the resulting profit split is significantly different from the ranges indicated by market
observation then:

• this may be due to specific factors – for instance, the subject asset may be more or
less complex and, hence, expected to earn a higher or lower than normal return for
the licensor,

• it may be necessary to reconsider whether the selected royalty rate is appropriate,

or

• depending on the basis of valuation being adopted, a royalty rate might be

appropriate that is different from that adopted by market participants.

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 The above are indications of potential shortcomings. There may be other reasons for
deviations and respective adjustments require professional judgement.

Premium Profits Method

6.24 The premium profits, or incremental income, method indicates the value of an intangible
asset by comparing an estimate of the profits or cash flows that would be earned by a
business using the asset with those that would be earned by a business that does not use
the asset. The forecast incremental profits or cash flows achievable through use of the
asset are then computed. Forecast periodic amounts are brought to a present value
through use of either a suitable discount factor or suitable capitalisation multiple.

6.25 The key inputs in the premium profits method of valuation are:

• forecast periodic profit, cost savings or cash flows expected to be generated by a

market participant using the intangible asset,

• forecast periodic profit, cost savings or cash flows expected to be generated by a

market participant not using the intangible asset, and
• an appropriate capitalisation multiple or discount rate to capitalise forecast periodic
profit or cash flows.

6.26 Forecasts of the cash flows achievable both with and without the subject intangible asset
should be made by reference to:

• activities of the owning entity,

• any entities using similar or identical intangible assets for which information is
available publicly,

• any proprietary databases of the valuer, and

• other research as available.

6.27 Where the PFI is obtained from the owning entity it should be tested or benchmarked
against other data in the market. Depending on the basis of valuation required,
adjustments may be required in respect of entity-specific factors in the forecasts.

6.28 Care should be taken when applying this approach to ensure that the cash flow forecast
excluding the use of the subject intangible asset is not representative because it is
influenced by another intangible asset. An example could be where the profits from another
business being used for comparison are reliant on an ‘own-name’ brand rather than no
brand. In such cases, the identified premium profit and resulting value attributable to the
intangible subject asset would be understated.

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6.29 The method can be used to value both intangible assets whose use will save costs and
those whose use will generate additional profit. Examples of where different profits may be
generated with or without an asset include:

• a beverage being sold by the same entity under both a branded and non-branded
label, and
• a non-compete agreement creating different projected cash flows.

6.30 Account also needs to be taken of any differences in the level of investment that may exist
between an apparently comparable brand and the subject. A branded product may produce
higher gross profits than an unbranded product due to higher selling price. However, sales
of the branded product may require advertising and marketing expenses that the unbranded
product does not. Similarly, a new manufacturing technology may reduce manufacturing
costs, but require the purchase of additional machinery. The return on and of the cost of
the additional machinery needs to be considered in the valuation of the technology.

Excess Earnings Method

6.31 The excess earnings method determines the value of an intangible asset as the present
value of the cash flows attributable to the subject intangible asset after excluding the
proportion of the cash flows that are attributable to other assets. It is a method that is often
used for valuations where there is a requirement for the acquirer to allocate the overall price
paid for a business between tangible assets, identifiable intangible assets and goodwill, eg
for financial reporting or tax purposes.

6.32 The excess earnings method can either be applied using several periods of forecast cash
flows – the “multi-period excess earnings method” or using a single period of forecast cash
flows – the “single-period excess earnings method”. In practice, because an intangible
asset will normally bring monetary benefits over more than one period, the multi-period
excess earnings method is more commonly used.

6.33 The inputs that should be considered when applying the excess earnings method include,
but are not limited to:

• forecast cash flows obtainable from the business to which the subject intangible asset
contributes to cash flows – this will involve allocating both income and expenses
appropriately to the pertinent business or group of assets of the entity that includes all
the income derivable from the subject intangible asset,

• contributory asset charges in respect of all other assets in such business(es), including
other intangible assets (see paras 6.37–6.41 below),
• an appropriate discount rate to enable expected cash flows attributable to the subject
intangible asset alone to be brought to a present value, and

• if appropriate and applicable, the TAB.

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6.34 The method is frequently used in practice to value in-process research and development
(IPR&D) projects which may be difficult to value by other methods. As each IPR&D project
is likely to be unique, it is unlikely that there will be data available from market transactions
of similar assets so a comparison approach is unlikely to be possible. The nature of an
IPR&D project is that additional development time and costs are anticipated prior to the
asset generating cash flows (or cost savings). A discounted cash flow exercise, such as
multi-period excess earnings, can be adapted to reflect these costs prior to the asset
generating cash flows (or cost savings).

6.35 The method is also frequently used in practice to value customer relationships or customer
contracts. Again, there are rarely market transactions in similar assets for which price
information is available so a comparison valuation method is unlikely to be possible. Also, it
is difficult to apply relief-from-royalty to such assets as these assets are not leased in the
market and so there is no data available on which to base royalty rates. Similarly, it is not
possible to apply the premium profits method as it would be difficult to find a comparable
business that did not have customer relationships.

6.36 The forecast cash flows are brought to a present value by application of a suitable discount
rate or, in simple cases with an indefinite remaining useful life, a capitalisation rate.

6.37 Typically, the types of intangible assets that are valued using the excess earnings method
are those that contribute to cash flows in combination with other assets in a group. While it
is important to assess the cash flows in the context of the business, the excess earnings
method is generally applied at a level of cash flows below that of the business. The method
first involves forecasting the total cash flows expected to arise from the business or group of
assets that use the subject intangible asset. From this forecast of cash flows, a deduction
is made in respect of the contributions to the cash flows that are made by assets, tangible,
intangible and financial, other than the subject intangible asset. This is referred to as the
application of contributory asset charges (CACs) or “economic rent”.

6.38 The underlying principles of the CAC calculation are that:

• CACs should be made for all the current and future tangible, intangible and
financial assets that contribute to the generation of the cash flow, and

• if an asset for which a CAC is required is involved in more than one line of
business, its CAC should be allocated to the different lines of business involved.

6.39 With some exceptions, CACs are generally computed as a fair return on and of the value of
the contributory asset.

• The appropriate return on a contributory asset is the investment return a typical

prudent investor would require on the asset. This is the return that an investor
would require if computed with respect to the market value of the asset.
• The return of a contributory asset is a recovery of the original investment in respect
of assets that deteriorate over time. The rate of economic depreciation, or

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 obsolescence, may differ from the depreciation, or amortisation, pattern used for
financial reporting or tax purposes. See IVS 300 Valuations for Financial Reporting
para G9.

6.40 If cash flows are forecast on a post-tax basis, CACs should be determined on a post-tax
basis. If cash flows are forecast on a pre-tax basis, CACs should be determined on a pre-
tax basis. In practice, it is more common to value intangible assets on a post-tax basis.

6.41 Assets for which CACs are typically assessed include working capital, fixed assets,
intangible assets other than the subject intangible asset, and any workforce in place.
Precautions should be taken to ensure that there is no double counting between charges in
the profit and loss account and the CACs, and similarly that no CACs are omitted.
Consideration also needs to be given as to whether income attributable to goodwill needs to
be excluded from the base cash flows for the intangible asset, in order to avoid
overvaluation.

6.42 The Appraisal Foundation’s publication The Identification of Contributory Assets and
Calculation of Economic Rents contains a detailed examination of this topic. Although this
references US accounting and tax requirements, the valuation methods it discusses have
wider application.

Greenfield Method

6.43 The greenfield method is conceptually similar to the excess earnings method in that it
identifies the incremental or “excess” cash flow associated with the subject asset.
However, instead of subtracting a CAC from the cash flow to reflect the contribution of
contributory assets, the greenfield method assumes that the owner of the subject asset
would have to build or buy the contributory assets. An amount representing that initial
investment is therefore deducted from the cash flow.

6.44 Because the cash flows used in the greenfield method can be used to explicitly model the
initial start-up costs of buying or creating the contributory assets, it can be a useful indicator
of the value of the going concern in cases where the PFI reflects an established business.
The greenfield method is most commonly used as one of the methods to estimate the value
of franchise-based intangible assets.

7 Cost approach

7.1 The cost approach is based on the economic principle that a buyer will pay no more for an
asset than the cost to obtain an asset of equal utility, whether by purchase or by
construction. Due to most intangible assets being heterogeneous there will rarely be any
transactions involving identical or even similar assets (see para 5.4) and therefore the cost
approach considers the cost that a buyer would incur in constructing or creating an
equivalent asset.

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7.2 The cost approach determines the value of an intangible asset by comparing it with the cost
of creating an asset of equal utility or service potential. Often a newly created intangible
asset will have a greater utility than the subject asset. Where this is the case an adjustment
is required to the cost of creating the new asset to reflect the inferior utility of the subject
asset. This adjustment is generally known as an obsolescence or depreciation adjustment.

7.3 The cost approach can only be applied to the valuation of intangible assets when it is
possible to reasonably estimate either the reproduction or replacement cost of the subject
asset. In this context:

• the reproduction cost is the cost that would be incurred in replicating the asset. It
would reflect the time, investment and processes involved in creating the subject
asset, at costs prevailing at the valuation date. It is most appropriate for recently
created intangible assets,

• the replacement cost is the cost of creating a modern equivalent asset that offers
the same utility or functionality as the subject asset. Due to changes that have
occurred in the market, eg because of changing consumer tastes or technological
changes, the processes involved in creating the subject asset may no longer be
appropriate. Replacement cost is most appropriate for well-established assets
where a potential buyer may have options for creating an equivalent alternative that
do not involve replicating the processes involved in creating the subject asset.

7.4 The cost approach is mainly used for those intangible assets that have no identifiable
income streams or other economic benefits. Examples of intangible assets to which the
cost approach is typically applied include:

• self-developed (proprietary) software,

• websites, and

• the benefit of an assembled workforce (see para 6.41) .

7.5 The costs that should be considered, where appropriate, in applying the cost approach to
value an intangible asset include:

• the labour costs and any material costs involved in creating the asset,

• the cost of any advertising or other promotion required to create an asset of

equivalent utility,

• the cost of any management time involved in project oversight,

• legal, licensing and patent registration fees,

• the opportunity cost, ie the cost of any opportunities for alternative investment that
would be foregone in order to develop an equivalent asset, and

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 • the profit that would reasonably be expected by a developer of the asset having
regard to the risks involved.

7.6 It may also be appropriate to consider the impact of tax deductibility for the costs incurred in
researching or developing an intangible asset.

7.7 If the costs are based on creating a modern equivalent asset, deductions may need to be
made from this cost to reflect any functional or economic obsolescence affecting the subject
asset. This could arise where:

• a new equivalent would be developed using technology or know-how that was not
available when the subject asset was created, or

• if the subject asset has a shorter remaining economic life than a new equivalent.

8 Other Considerations

Discount rates

8.1 The various methods that fall under the income approach described in Section 6 of this TIP
involve the use of discounting techniques. The heterogeneous character of most intangible
assets means that it will seldom be possible to obtain reliable market data on discount rates
for comparable individual assets. However, it may be possible to use rates from the market
as reasonableness cross checks of results from application of the build-up method.

8.2 If the subject intangible asset is the principal asset of the business it is common practice to
estimate the discount rate for an intangible asset by reference to the weighted average cost
of capital (WACC) applicable to that business. However, the WACC rate may not be
appropriate if the subject intangible asset has a distinct risk profile from the rest of the
assets and liabilities utilised in the business or if there is other evidence that indicates an
alternative discount rate.

8.3 Because of the limitations on deriving an appropriate discount rate from market data the
Capital Asset Pricing Model is commonly used for valuing intangible assets.

Remaining Useful Life

8.4 An important consideration in the valuation of an intangible asset is the remaining useful life
of the asset. This may be a finite period limited by either contract or typical life cycles in the
sector; other assets may have an indefinite life. Estimating the remaining useful life of an
asset will include consideration of legal, technological or functional and economic factors.
For example, an asset comprising a drug patent may have a remaining legal life of five
years before expiry of the patent, but a competitor drug with improved efficacy may be
expected to reach the market in three years. This might cause the remaining useful life of
the patent to be assessed as only three years, although consideration should be given as to
whether the know-how would have value beyond that date for production of a generic drug.

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ILLUSTRATIVE EXAMPLES

The following examples illustrate how various methods referred to in this TIP can be applied.
Simple inputs and calculations have been used to illustrate the basic principles involved. The three
illustrative examples share the same set of facts, but are not intended to interrelate, ie the
assumptions made in one example are not necessarily consistent with those made in another.
Accordingly, these examples should not be taken as a comprehensive example of how different
assets within the same business should be valued as part of the same assignment.

Scenario

A valuer has been engaged to value intangible assets belonging to a company that distributes food
products (“the Company”). The required valuation basis is market value as defined in the IVS
Framework.

Revenue is forecast to grow at 4% per annum over the forecast period. Management expects
revenue of CU2 200,000,000 in the first year and to maintain a constant EBITDA margin of 20%
each year. Depreciation is estimated at 2.5% of revenue. A long-term tax rate assumption of 23%
has been assumed over the forecast period. As at the transaction date, the valuer determined an
appropriate post-tax discount rate (base WACC) to be 8.5%.

Identifiable assets acquired as a part of a business combination are recognised separately if the
following criteria are met:

• it is separately identifiable,

• it is controlled by an entity, and

• it is a probable source of economic benefits.

On this basis, and following discussion with management, the valuer identified the following
intangible assets in the Company as at the transaction date:

1. A registered brand that is applied to all food products distributed by the Company.

2. A non-compete agreement with the founder of the Company which disallows his establishment
of a rival company after the sale of this Company.

3. A distribution agreement with a key customer.

Management advises that all of the Company’s revenue is generated from sales under the
registered brand, and considers brand awareness to be relatively strong. Having regard to royalty
rates identified from comparable transactions, the valuer believes an appropriate pre-tax royalty rate
to apply to this Company is 5%. Based on discussions with management, the brand is expected to
generate economic benefits for four years, after which a re-branding is anticipated. No advertising
or marketing expenses are expected to be required to support the brand.

2
CU = currency unit.

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The non-compete agreement is for a period of four years. Management estimate that without the
non-compete agreement in place the Company’s earning potential (EBIT) would be only 80% of that
forecast for the first year, increasing up to 95% of forecast EBIT for the fourth year. In addition,
management considers there to be a 75% probability that the value derived from these premium
profits will be achieved. The valuer considers an additional 2% risk premium should be added to the
base WACC.

The Company has a four-year distribution agreement in place with one key customer that
represents approximately 10% of the total revenue (at the same overall margin). Given the nature
of the Company, a total pre-tax contributory asset charge of 11% is considered appropriate to apply
to the pre-tax earnings on this distribution agreement. The valuer considers an additional 1% risk
premium should be added to the base WACC.

Illustrations

The following illustrations show the application of the following methods to value different assets
using the information provided in the above scenario:

1. Relief-from-royalty method – used to value the registered brand.

2. Premium profits method – used to value the non-compete agreement.

3. Multi-period excess earning method – used to value the distribution agreement.

1. Relief from royalty from royalty

CU m
Year 1 2 3 4
Revenue 200.0 208.0 216.3 225.0
Pre-tax royalty payment 10.0 10.4 10.8 11.2
Tax -2.3 -2.4 -2.5 -2.6
Relief from royalty 7.7 8.0 8.3 8.7

3
Discount period 1.0 2.0 3.0 4.0
Discount factor 0.913 0.834 0.762 0.695
Present value 7.0 6.7 6.3 6.0
Fair value before TAB 26.0

Key assumptions
WACC 8.5%
Risk premium 1.0%
Discount rate 9.5%
Comparable royalty rate (pre-tax) 5.0%
Tax 23.0%

3
For simplicity the cash flows in this example are assumed to be received at the end of each year. In practice the cash flows
from an intangible asset would often be due more frequently. This can be reflected by either introducing shorter discount
periods or adopting a mid-year discount date as an average.

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2. Premium profits
CU m
Year 1 2 3 4
EBIT with non-compete agreement 35.0 36.4 37.9 39.4
EBIT without non-compete agreement 28.0 30.9 34.1 37.4
Premium pre-tax profit 7.0 5.5 3.8 2.0
Tax -1.6 -1.3 -0.9 -0.5
Premium post-tax profit 5.4 4.2 2.9 1.5

Discount period 1.0 2.0 3.0 4.0

Discount factor 0.905 0.819 0.741 0.671
Present value 4.9 3.4 2.2 1.0
Sum of present value before TAB 11.5
Probability of competition and success 75.0%
Fair value before TAB 8.6

Key assumptions
WACC 8.5%
Risk premium 2.0%
Discount rate 10.5%
Tax 23.0%

3. Multi-period excess earnings

CU m
Year 1 2 3 4
EBIT 3.5 3.6 3.8 3.9
Pre-tax CAC -0.4 -0.4 -0.4 -0.4
Pre-tax profit after CAC 3.1 3.2 3.4 3.5
Tax -0.7 -0.7 -0.8 -0.8
Excess earnings 2.4 2.5 2.6 2.7

Discount period 1.0 2.0 3.0 4.0

Discount factor 0.913 0.834 0.762 0.695
Present value 2.2 2.1 2.0 1.9
Fair value before TAB 8.2

Key assumptions
WACC 8.5%
Risk premium 1.0%
Discount rate 9.5%
% of total sale and EBIT attributed 10.0%
Pre-tax contributory asset charges (CAC) 11.0%
Tax 23.0%

22