Attributes of an Effective Intangible-Asset Valuation Report

<p>Intangible-asset valuation (and related economic analysis) reports are often prepared within
a corporate bankruptcy. Intangible-asset valuations are often relevant to controversies
involving (1) the solvency or insolvency of the debtor corporation; (2) the
identification of license, spinoff or joint venture opportunities; (3) the assessment
of DIP financing collateral; (4) the value of secured creditors' interests;
and (5) the analysis of proposed reorganization plans, among others. Of course,
every bankruptcy financial advisor attempts to make every intangible asset valuation
report clear, convincing and cogent, particularly when valuation is likely to
be controversial.
</p><p>First, this discussion summarizes the common attributes of the effective intangible-asset
valuation report. Second, this discussion summarizes common errors to avoid
in the preparation of the intangible-asset valuation report. Finally, this discussion
summarizes the basic quality control procedures that bankruptcy financial advisors
should perform before issuing the written intangible-asset valuation opinion
report. Each topic is discussed from a bankruptcy negotiation and/or litigation
support perspective.
</p><p><b>Valuation Reports Within a Bankruptcy Controversy </b>
</p><p>Bankruptcy-related controversies regarding intangible-asset value are often
decided by a judicial finder of fact. In this litigation environment, an effective
intangible-asset valuation report should be both well-written and well-organized.
In addition, an effective intangible-asset valuation report should satisfy (1)
all of the analyst's professional standards and (2) all of the client's engagement
requirements.
</p><p>This discussion reviews the attributes of an effective intangible-asset valuation
report within the bankruptcy context. However, this discussion of effective
valuation report attributes also applies to intangible-asset valuation reports
that are (1) prepared for any controversy/dispute purpose and/or (2) subject
to a contrarian review.
</p><p><b>Effective Intangible-Asset Valuation Report Attributes </b>

</p><p>A clear, convincing and cogent intangible-asset valuation report should demonstrate
several effective writing attributes. These attributes include:
</p><p><i>1. Thoroughness</i>. The written report should include (a) all relevant
quantitative/qualitative data and (b) all relevant quantitative/qualitative
analyses that affect the intangible asset value conclusion. The valuation report
should disclose (a) the purpose and objective of the valuation and (b) the analyst's
client. In addition, the valuation report should adequately describe (a) the
subject intangible asset, (b) the bundle of legal rights subject to analysis,
(c) the owner and operator (if different) of the subject intangible asset, (d)
the valuation assignment standard of value, premise of value, valuation date,
etc. and (e) any contracts, agreements or licenses that may affect the ownership,
use or transferability of the subject intangible asset.
</p><p><i>2. Objectivity</i>. The written report should discuss both the positive
and the negative factors affecting the subject intangible-asset value. Although
the analyst's client will presumably have an interest in the subject intangible-asset
value conclusion, the analyst should remain unbiased and objective. Accordingly,
the intangible-asset valuation report should manifest that objectivity by presenting
an impartial discussion of all relevant facts and factors affecting the subject
intangible asset.
</p><p><i>3. Understandability</i>. The judicial or other reader of the intangible-asset
valuation should be able to follow and understand (a) the data analyzed, (b)
the analyses performed and (c) the value conclusions reached. The valuation
report should be written in a clear and concise style. The narrative should
avoid technical jargon whenever possible. When technical appraisal or economic
jargon is necessary, it should be adequately defined. Any empirical data and/or
analytical assumptions presented in the report should be adequately described
so that the valuation report readers can understand them.
</p><p><i>4. Coherence</i>. The valuation report content should logically flow from
the empirical data presented to the final value conclusion. Also, the intangible-asset
valuation report conclusions and analyses should be internally consistent. The
valuation report should present a narrative story that logically leads the report
reader from the initial description of the valuation assignment to the analyst's
value conclusion.
</p><p><i>5. Documentation</i>. The intangible-asset valuation report should adequately
document (a) each valuation approach, method and procedure performed and (b)
each value indication reached. An adequate level of documentation generally
implies (a) the presentation of all quantitative and qualitative analyses and
(b) the identification of all empirical data sources relied on. That way, a
finder of fact (or another analyst) can (a) recreate the particular procedures
performed and (b) reach a similar value conclusion.
</p><p><i>6. Composition</i>. The analyst should follow all of the report composition
guidelines below with respect to the intangible-asset valuation report:
</p><blockquote>
<p>a. Stick to the point; avoid discussion of extraneous topics not related
to the subject valuation. <br>

b. Make the report prose coherent; clearly link related ideas; distinguish
unrelated ideas. <br>
c. Support the report statements with specific evidence; use facts and statistics
to support statements and conclusions. <br>
d. Use lists to display facts; use charts, graphs, tables and diagrams to
display data. <br>
e. Make the point of view consistent; maintain consistent verb tenses; make
verbs consistent in mood and voice. <br>
f. Untangle the grammatical structure; straighten out the logical connections.
<br>
g. Use a variety of sentence structures; use a variety of sentence openings.
<br>

h. Avoid wordy sentences; eliminate redundancies; avoid the unnecessary repetition
of words. <br>
i. Eliminate pretentious language; simplify sentence structure; reduce clauses
to phrases and phrases to single words. <br>
j. Use the active voice (unless there is a good reason to select the passive
voice). </p>
</blockquote>
<p><b>Common Errors in Intangible-Asset Valuation Reports </b>
</p><p>Within the bankruptcy litigation context, it is very common for two (or more)
intangible-asset valuations to be prepared by two (or more) analysts. This can
occur, for example, when the debtor and creditors disagree on the valuation
approach/method, analytical assumption or value conclusion. Differences among
the parties in interest to the bankruptcy may require the court to judicially
determine the intangible-asset value based on two (or more) different valuation
reports.
</p><p>Courts (and other finders of fact) may appropriately disregard an intangible-asset
valuation report that has obvious deficiencies. Before issuing the final written
report, the analyst should review the intangible-asset valuation report for
one or more of the following common errors.
</p><p><i>1. Failure to follow the defined standard of value</i>. Generally accepted
valuation terminology is used in most valuation reports to inform the report
reader as to how the intangible asset value was concluded. The stated standard
of value—or definition of value—is an important disclosure in any
valuation report. This statement of the defined standard of value is because
the subject's value can vary significantly depending on which definition of
value is selected for the valuation engagement (<i>e.g.</i>, fair value vs.
fair market value vs. investment value vs. use value, etc.).

</p><p>One of the common errors in an intangible-asset valuation report is the analyst's
failure to consistently follow the standard of value defined in the report.
This error may cause the finder of fact to assign little or no weight to the
intangible asset valuation report. Therefore, analysts should (a) carefully
define the selected standard of value in the report and (b) ensure that the
defined standard is applied consistently throughout the valuation report.
</p><p><i>2. Analytical internal inconsistencies</i>. All of the valuation data, analyses,
calculations and conclusions should be internally consistent throughout the
report. Some common examples of analytical internal inconsistencies include:
</p><blockquote>
<p>•Application of the selected valuation pricing multiples to the wrong
economic income measure (<i>e.g.</i>, applying an after-tax pricing multiple
to a pre-tax measure of intangible asset royalty income). <br>
•Failure to match the selected direct capitalization rate or present
value yield capitalization rate to the corresponding economic income measure
(<i>e.g.</i>, applying a net cash-flow discount rate to an incremental or
residual income measure based on net income). <br>
• Failure to use a consistent expected growth rate throughout the various
valuation methods (<i>e.g.</i>, using a different growth rate in an excess
earnings analysis than the rate used in a profit-split analysis). <br>

•Comparison of current intangible-asset operating data to comparative
data for a different time period without making appropriate adjustments (<i>e.g.</i>,
for changes in market conditions or for changes in the owner/operator's accounting
methods). <br>
•Normalizing the financial statements for the intangible asset owner/operator
without normalizing the corresponding financial data for the selected guideline
companies (<i>i.e.</i>, companies with/ without guideline intangible assets).
<br>
•Use of inconsistent extraordinary assumptions or hypothetical conditions
(<i>e.g.</i>, estimating the intangible asset income assuming the existence
of contributory tangible and intangible assets<br>
—but without allowing for a capital charge or economic rent on those
contributory assets). <br>

•Failure to perform (or to report on the performance of) a highest and
best-use analysis with regard to the subject intangible asset. </p>
</blockquote>
<p><i>3. Arithmetic errors in the analysis</i>. One of the easiest valuation errors
to prevent is one of the most common valuation report errors. All mathematical
calculations should be reviewed for accuracy, and all mathematical rounding
conventions should be reviewed for consistency. An obvious (and easily correctable)
mathematical error may make the finder of fact question the reliability of an
otherwise well-supported intangible asset valuation report.
</p><p><i>4. Insufficient support for selected valuation variables</i>. Inadequately
documented valuation reports are an easy target for contrarian analysts during
the bankruptcy litigation. Depending on the professional reporting standards
applicable to the subject report, intangible-asset valuation reports should
adequately document (a) the data used, (b) the procedures performed and (c)
the value conclusions reached. The data used in quantitative analyses should
be able to be traced to the intangible asset owner/operator financial statements
or to other empirical data sources. In addition, the finder of fact/report reader
should be able to trade the value conclusions presented in the report schedules
and exhibits to the value conclusions presented in the report narrative.
</p><p><i>5. Reliance on industry or other rules of thumb</i>. Industry or other rules
of thumb are not generally accepted as an intangible-asset valuation method.
Transactional rules of thumb (<i>e.g.</i>, dollars per line of code for computer
software or dollars per cable TV subscriber/customer relationship) may be used
to provide confirmatory evidence of a more rigorous valuation analysis. In other
words, analysts may sometime use rules of thumb as a "sanity check"
on their value indications. However, values indicated by rules of thumb should
not be assigned significant weight in actually reaching the intangible asset
value conclusion.
</p><p><i>6. Insufficient data and inadequate market research</i>. Some intangible
asset analysts cut corners either (a) because of engagement fees and time budget
constraints or (b) because of their lack of familiarity with publicly available
sale/license/royalty rate transactional data sources. The intangible-asset valuation
report should make it clear to the finder of fact that the analyst considered
all relevant data that may significantly affect the value conclusion.
</p><p>7. <i>Inadequate due diligence procedures</i>. Some examples of inadequate
due-diligence procedures in the preparation of the intangible asset valuation
report include:

</p><blockquote>
<p>a. failure to consider all three generally accepted intangible asset value
approaches, <br>
b. failure to review relevant contractual or other documentation regarding
the subject intangible, <br>
c. failure to inquire about recent sales and/or licenses involving the subject
intangible, <br>
d. failure to consider the highest and best use of the subject intangible,
<br>
e. failure to consider the owner/ operator's actual use of the subject intangible,
and <br>
f. failure to consider the specific bundle of legal rights encompassed in
the subject intangible-asset analysis. </p>

</blockquote>
<p><b>Summary and Conclusion </b>
</p><p>Particularly within a bankruptcy litigation context, the intangible-asset valuation
report should be clear, convincing and cogent. The objectives of such a valuation
report are to (1) educate the finder of fact and (2) persuade the finder of
fact as to the concluded value for the subject intangible asset. In addition,
intangible-asset valuation reports must comply with any applicable valuation
professional standards.
</p><p>When the analyst invests the time and effort to prepare a well-written and
well-documented valuation report, that report should be able to (1) withstand
a contrarian review and challenge and (2) convince the finder of fact of the
concluded intangible-asset value. Also, with the appropriate analyst investment
of time and effort, the same results will occur with regard to bankruptcy-related
effective intangible asset analysis reports that conclude a fair royalty rate,
an arm's-length transfer price, an RUL estimate, a lost profits/economic damages
conclusion or a transactional fairness assessment.