In Search of Intangible Asset Value

Doing the Calculations

Whereas tangible assets are typically defined as items that can be seen, touched or physically measured ' such as buildings, equipment, machinery, furniture, fixtures, accounts receivable, cash, etc. ' intangible assets are those items that cannot be seen, touched, or physically measured. Examples of these include trade secrets, customer lists, goodwill, intellectual property and workforce. These intangible assets are less likely to appear on a business' balance sheet than are the tangible fixed assets. That is due, in part, to the fact that tangible assets are typically acquired for specific dollar amounts, at specific points in time, and are easily quantified. Conversely, intangible assets may be accumulated over time, with the costs being less apparent, and therefore more difficult to quantify.

To determine the intangible value incorporated in a business valuation, one may deduct from the business value, the net tangible asset value (owners' equity or partners' capital) that appears on the balance sheet of the enterprise as of the valuation date. Before doing so, however, care should be taken to ensure that there are no intangible assets recorded in the balance sheet in the first place. If there are ' for example, in cases where an entity had acquired another business and, as a result of the transaction, recorded goodwill ' then the recorded costs of those assets (goodwill in this example) should first be removed from the balance sheet, thus adjusting net equity. Additionally, it may be necessary to adjust the business' balance sheet for unrecorded tangible assets, such as accounts receivable, or to adjust certain assets to fair market value; for example, where an appraisal has been prepared of real property or equipment held by the enterprise. The residual amount (i.e., the difference between the business value and the adjusted net equity), necessarily represents value associated with intangible assets. An example of these balance sheet adjustments is illustrated on page 2.

Referencing the balance sheet, and assuming a value of $3 million has been placed on the business, the intangible value incorporated in the overall business valuation in this case would be $1 million ($3 million business value, less the tangible value or adjusted net equity of $2 million).

Once intangible value has been identified and quantified, the earnings incorporated in that value must be determined to complete the argument for avoidance of a double dip. One way to do that might be to consider first the required rate of return on tangible assets. This concept may be familiar from your encounters with the excess earnings valuation method, where excess earnings are derived by deducting a return (earnings) on tangible assets, from total earnings. You may recall that those excess earnings are capitalized to determine the value of intangible assets/goodwill. Considering this, one might identify a blended borrowing rate associated with the tangible fixed assets (many times used to collateralize debt). For example, if that rate is 6%, it is applied to the adjusted net equity value ($2 million in the example above), and $120,000 in earnings is found to represent the return on tangible assets. That amount is then deducted from total earnings ' say $370,000 ' and the difference ($250,000) then represents earnings that are incorporated in the intangible value. If you were limited in your duplication argument, by virtue of Keane, to earnings associated with intangible income-producing assets, then earnings of $250,000 would be off limits in this case for maintenance consideration (assuming the value of the business is distributed).

Conclusion

This is not to say that the award of maintenance based upon income generated from tangible income-producing assets, where those assets are distributed, does not constitute a double dip ' it clearly does. Rather, our example offers a means to make the argument within the confines of the flawed Keane holding and similar recent decisions.

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Michael J. Raymond is a partner at BST Valuation & Litigation Advisors LLC, with offices in New York City and Albany. He is a Certified Public Accountant, Accredited in Business Valuation and Certified in Financial Forensics. He has substantial experience in preparing, and testifying to, valuations of businesses, professional practices, professional licenses, academic degrees, stock options and intangible assets in the context of matrimonial matters.

It used to be that when faced with the question of “duplication” or “double dipping” in connection with assets that are distributed upon marital dissolution and income used as a basis for maintenance awards, one needed to look no further than the income that was capitalized in determining the value of the asset. In other words, it was typically held that income that forms the basis for the value of an asset is not also available for purposes of maintenance, lest you would effectively be distributing the same income stream twice. It did not matter whether the income was derived from a medical practice, a car dealership, a widget manufacturer, commercial real estate, or an enhanced earnings capacity.

Since 2004, however, with the troubling Court of Appeals decision in Keane v. Keane , 8 NY 3d 115 (NY 2004), the identification of income that is unavailable for purposes of maintenance awards (should one wish to avoid a distribution of an earnings stream more than once) has become more complex In Keane , the court distinguished between tangible and intangible income-producing assets, and decided that income associated with the former should not be off limits when considering a maintenance award. In other words, it allowed the “double dip” on income generated from “tangible” assets. Subsequent Appellate Division decisions have cited the Keane decision in allowing this overlapping award with respect to income produced by “tangible income producing properties,” which has been deemed to include service businesses (not just commercial real estate).

In light of these problematic decisions, it now seems that a first step to successfully arguing that business income should be excluded from consideration for maintenance is to demonstrate that the business value includes some intangible component.

Doing the Calculations

Whereas tangible assets are typically defined as items that can be seen, touched or physically measured ' such as buildings, equipment, machinery, furniture, fixtures, accounts receivable, cash, etc. ' intangible assets are those items that cannot be seen, touched, or physically measured. Examples of these include trade secrets, customer lists, goodwill, intellectual property and workforce. These intangible assets are less likely to appear on a business' balance sheet than are the tangible fixed assets. That is due, in part, to the fact that tangible assets are typically acquired for specific dollar amounts, at specific points in time, and are easily quantified. Conversely, intangible assets may be accumulated over time, with the costs being less apparent, and therefore more difficult to quantify.

To determine the intangible value incorporated in a business valuation, one may deduct from the business value, the net tangible asset value (owners' equity or partners' capital) that appears on the balance sheet of the enterprise as of the valuation date. Before doing so, however, care should be taken to ensure that there are no intangible assets recorded in the balance sheet in the first place. If there are ' for example, in cases where an entity had acquired another business and, as a result of the transaction, recorded goodwill ' then the recorded costs of those assets (goodwill in this example) should first be removed from the balance sheet, thus adjusting net equity. Additionally, it may be necessary to adjust the business' balance sheet for unrecorded tangible assets, such as accounts receivable, or to adjust certain assets to fair market value; for example, where an appraisal has been prepared of real property or equipment held by the enterprise. The residual amount (i.e., the difference between the business value and the adjusted net equity), necessarily represents value associated with intangible assets. An example of these balance sheet adjustments is illustrated on page 2.

Referencing the balance sheet, and assuming a value of $3 million has been placed on the business, the intangible value incorporated in the overall business valuation in this case would be $1 million ($3 million business value, less the tangible value or adjusted net equity of $2 million).

Once intangible value has been identified and quantified, the earnings incorporated in that value must be determined to complete the argument for avoidance of a double dip. One way to do that might be to consider first the required rate of return on tangible assets. This concept may be familiar from your encounters with the excess earnings valuation method, where excess earnings are derived by deducting a return (earnings) on tangible assets, from total earnings. You may recall that those excess earnings are capitalized to determine the value of intangible assets/goodwill. Considering this, one might identify a blended borrowing rate associated with the tangible fixed assets (many times used to collateralize debt). For example, if that rate is 6%, it is applied to the adjusted net equity value ($2 million in the example above), and $120,000 in earnings is found to represent the return on tangible assets. That amount is then deducted from total earnings ' say $370,000 ' and the difference ($250,000) then represents earnings that are incorporated in the intangible value. If you were limited in your duplication argument, by virtue of Keane, to earnings associated with intangible income-producing assets, then earnings of $250,000 would be off limits in this case for maintenance consideration (assuming the value of the business is distributed).

Conclusion

This is not to say that the award of maintenance based upon income generated from tangible income-producing assets, where those assets are distributed, does not constitute a double dip ' it clearly does. Rather, our example offers a means to make the argument within the confines of the flawed Keane holding and similar recent decisions.

[IMGCAP(1)]

Michael J. Raymond is a partner at BST Valuation & Litigation Advisors LLC, with offices in New York City and Albany. He is a Certified Public Accountant, Accredited in Business Valuation and Certified in Financial Forensics. He has substantial experience in preparing, and testifying to, valuations of businesses, professional practices, professional licenses, academic degrees, stock options and intangible assets in the context of matrimonial matters.