Chapter 11 Valuation of Debtor Company Intangible Assets

• Jurisdiction: United States

Chapter 11: Valuation of Debtor Company Intangible Assets

A. Structuring the Intangible Asset Valuation

Debtor company intangible assets may affect many issues in a bankruptcy. These issues include debtor company solvency, creditor collateral value, § 363 asset sales, fairness of debt/equity reorganizations, reasonableness of the plan of reorganization, and so on. Therefore, the debtor, the creditors, legal counsel, and other parties often retain an analyst to value the debtor company intangible assets. Structuring the valuation assignment is an important step for assuring the success of the debtor company intangible asset valuation.

Defining and Documenting the Valuation

The engagement documentation procedure should be performed before any quantitative or qualitative valuation analyses are prepared, before any valuation approaches, methods or procedures are performed, and before any data (i.e., owner/operator, industry or economy) are analyzed.

The assignment documentation specifies what it is that the analyst is trying to accomplish. In this definitional procedure, the analyst answers the question: What is it that I am setting out to do? The analyst typically documents the understanding of the client engagement assignment in writing. This is because an oral agreement between the parties can possibly lead to a misunderstanding.

Defining the Valuation Assignment

There are two fundamental components to the valuation assignment definition: the objective of the analysis and the purpose of the analysis.

Objective of the Valuation Analysis

The objective of the analysis describes what the intangible asset valuation is intended to do. The objective of the analysis should describe the following factors:

1. the specific intangible asset that is the subject of the valuation;
2. the ownership interest (or the bundle of legal rights) that is the subject of the valuation;
3. the standard of value (or the definition of value) that is being estimated; and
4. the "as of valuation date.

An example of an analysis objective statement is, "The objective of this valuation is to estimate the fair market value of the computer software source code owned and operated by Debtor Corporation in fee simple interest, as of December 31, 2016."

Purpose of the Valuation Analysis

The purpose of the analysis typically describes (1) who the audience for the valuation is (i.e., the party or parties who are expected to rely on the analysis and conclusion) and (2) what decisions (if any) will be influenced by the results of the valuation. The purpose of the analysis typically indicates the following: why the valuation is being performed; the intended use(s) of the valuation; and who (the intended user) is expected to (and permitted to) rely on the results of the valuation.

An example of a valuation purpose statement is, "The purpose of this analysis is to recommend a fair arm's-length royalty rate to be incorporated in the proposed license agreement, dated July 1, 2016, of the Debtor Company trademark and trade name between Debtor Company as licensor to Nu Corporation as licensee."

Selecting the Appropriate Standard of Value

One element in the analysis objective is the identification and explanation of the appropriate standard of value. The standard of value — or the definition of value — means: What type of value is being estimated? The alternative standards of value generally answer the question, "Value to whom?" The answer to that question is relevant to the analysis because the intangible asset may have different values to (and between) different parties.

The intangible asset description explains what property type — and what property rights — are being valued. The valuation date explains as of which calendar date the intangible asset value is valid. The standard of value explains to whom (i.e., to what parties) the value estimate applies.

The fair market value standard (or some conceptually equivalent standard of value) is often applied in bankruptcy-related intangible asset valuations. However, analysts should be aware of these numerous alternative standards of value, including fair value, market value, acquisition value, use value, user value, investment value (or investor value), owner value, insurable value, collateral value and ad valorem value.

The selection of the appropriate standard of value is influenced by the purpose (i.e., the intended use) of the analysis. The standard of value is typically selected by the client (or by the client's legal counsel) in order to accomplish the stated valuation purpose. The standard of value is presented to the analyst as part of the client's (or counsel's) engagement instructions.

Selecting the Appropriate Premise of Value

The analysis standard of value answers the question, "Value to whom?" The standard of value explains who are the assumed participants in the transactional analysis. In other words, the standard of value specifies which is the assumed transferor and who is the assumed transferee with regard to the assumed intangible asset transaction. The standard of value does not explain how the assumed transaction is to be consummated among (or between) the assumed participants. The selected standard of value does not explain the assumed conditions under which the assumed participants will consummate the sale, license or other transfer transaction. That question is answered by the selected premise of value.

The premise of value is the assumed set of sale, license or other transfer transac-tional circumstances under which the intangible asset is analyzed. For example, while the fair market value standard of value considers a hypothetical willing buyer and a hypothetical willing seller, in what marketplace will they meet? How will the intangible asset be sold between the willing buyer and the willing seller? Under what set of circumstances will the buyer and the seller enter into their fair market value transaction?

The premise of value is typically selected by the client or the legal counsel as part of the engagement understanding for the analyst. The client or counsel may select the engagement premise of value after consideration of the corresponding statutory authority, administrative rulings or judicial precedent. If not determined as an engagement instruction, the premise of value may be selected based on the intangible asset's highest and best use (HABU). The HABU is defined as the reasonably probable and legal use that is physically possible, appropriately supported, financially feasible and results in the highest value. There is a specific definition of HABU for fair value accounting purposes included in the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) topic 820. That GAAP definition of HABU is entirely consistent with the following discussion. The GAAP definition of HABU is not binding on bankruptcy valuations. However, the GAAP definition is widely accepted and there is no reason why it cannot apply for bankruptcy valuation purposes.

Highest and Best Use Analysis

The HABU is analyzed and selected using the following four criteria:

1. Legal permissibility. The HABU should be a lawful use and should comply with any applicable regulatory, licensing, fair trade, truth in advertising and other legal requirements.
2. Physical possibility. The HABU should be physically possible given the intangible asset physical, functional and technological attributes. The intangible asset itself is typically not going to be subject to physical restrictions. However, the intangible asset use may be subject to physical constraints. It is possible that there are physical limitations on the use of an FCC license, a hospital certification of need (CON), an oil refinery operating permit, an environmental permit, an Army Corps of Engineers water extraction permit, a product or service distribution agreement in an extreme climate location, etc.
3. Financial feasibility. The HABU will generate a positive rate of return on the intangible asset investment. Even though a particular use can be the "best" use among several unprofitable uses, it still may not be the HABU. The HABU should generate a positive economic return to the owner/operator. Otherwise, the owner/ operator will simply not operate or otherwise use the intangible asset.
4. Maximum profitability. Of all the remaining uses that are legally permissible, physically possible and financially feasible, the one use that results in the greatest value is the HABU.

Among all alternative uses, the use that yields the highest present value (after capital charges are considered for all relevant tangible and intangible contributory assets) represents the intangible asset HABU.

Alternative Premises of Value

Virtually any intangible asset may be analyzed under the following alternative premises of value:

1. Value in continued use as part of a going-concern business enterprise. The intangible asset is analyzed as part of a mass assemblage of assets, some of which may be tangible assets and some of which may be intangible assets. The intangible asset will transact in the marketplace that encompasses the sale of operating going-concern businesses.
2. Value in place, but not in current use in the production of income. The intangible asset is also analyzed as part of a mass assemblage of assets and as part of a going-concern business enterprise. The intangible asset will transact in the marketplace that encompasses the sale of nonoperating going-concern businesses. A nonoperating going-concern business is a business that is functional but not currently functioning. Examples include a business that is temporarily shut down because of a labor strike or the death of the business owner, a business that is fully assembled but that has not yet opened for business, and a business that is temporarily shut down pending a sale.
3. Value in exchange as part of an orderly disposition. The intangible asset will enjoy a normal period of exposure

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