Selecting, Documenting, and Reporting the Intangible Asset Highest and Best Use Analysis in a Valuation Context

The following article was prepared by its authors. The opinions expressed in the article represent the authors’ and may not reflect the view and/or opinion of Vallit Advisors and its staff. Views/opinions are based on the specific facts and circumstances of each matter.

In the valuation of intangible assets, the highest and best use analysis may be part of the valuation analysis. Intangible asset appraisers may perform a highest and best use analysis in a valuation assignment. Such a highest and best use analysis may include the selection, documentation, and reporting of the highest and best use analysis conclusion. The highest and best use relied on in an intangible asset valuation analysis can affect the valuation conclusion. The appraiser should be aware of, and know how to perform, the highest and best use selection analysis. The appraiser should also be able to properly document the highest and best use selection analysis in their workpaper file. Finally, the appraiser should provide a highest and best use conclusion within their intangible asset valuation report.

Introduction

In the valuation of intangible assets (“IAs”), the highest and best use (“HABU”) analysis may be part of the valuation analysis. IA appraisers (“appraisers”) may perform a HABU analysis in a valuation assignment. The IA valuation can thus include the selection, documentation, and reporting of the HABU analysis conclusion.

The HABU relied on in an IA valuation analysis can affect the valuation conclusion. In an IA valuation analysis, the HABU may be explicitly concluded or implicitly concluded. 

For example, with an explicit conclusion, the appraiser clearly states the HABU conclusion (e.g., the subject IA’s HABU is based on a going-concern premise). 

For an implicit conclusion, the appraiser could perform a profit split of the IA owner’s business income, with a portion allocated to the subject IA. In this scenario, the value conclusion is implicitly based on a going-concern HABU, because the subject IA value is based on an allocation of business income.

IAs may be more valuable if analyzed on a “value in exchange” premise (i.e., to a different owner and/or in a different use) than on a “value in use” premise (i.e., to the current owner and/or in the current use). The appraiser may consider the facts and circumstances of the subject IA and the valuation assignment in their HABU analysis. That is, the appraiser should not default to a “value in use” premise, as part of going-concern.

For the IA valuation, the appraiser will normally select the HABU that would result in the highest net present value of the IA. However, if the IA valuation is part of a purchase price allocation assignment, the HABU will usually be “value in use,” as part of a going concern premise. This premise is typically used in a purchase price allocation-related assignment because the objective of the purchase price allocation is to allocate a purchase price for the entire going-concern business to the various transferred assets. 

As another example, if the subject IA was a gift from a parent to a child, then the purpose of the IA valuation assignment may be for federal gift tax return compliance. In this instance, the IA was transferred independently. Thus, the IA HABU would typically be based on a “value in exchange” premise of value. That is, a “value in use” as part of a going-concern premise may result in a higher value, but the subject IA was not gifted as part of a going-concern business.

Regardless of the assignment conditions, the IA HABU conclusion is an important part of the IA valuation assignment. Therefore, the appraiser may need to not only select the HABU, but document and report the HABU conclusion as well. 

This article summarizes the procedures of selecting, documenting, and reporting the HABU conclusion in an IA valuation context.

The next section of this discussion provides a general definition of the IA HABU.

Definition of HABU

The concept of HABU is traditionally part of the real property appraisal profession. Within this context, the Uniform Standards of Professional Appraisal Practice (“USPAP”) provides the following:

An appraiser must analyze the relevant legal, physical, and economic factors to the extent necessary to support the appraiser’s highest and best use conclusion(s).

The common considerations for selecting the HABU of in the real property appraisal profession relate to the subject property and are as follows:

1. HABU must be legally permissible,
2. HABU must be physically possible,
3. HABU must be financially feasible, and
4. HABU must be maximally productive.

The above considerations may also be applied to an IA valuation. An IA HABU analysis considers the transaction scenario for the IA that creates the most value to the IA owner. The transaction scenario may consider the following:

1. Would the IA be sold by itself, alongside other assets, or bundled in a going-concern business?
2. Would the IA be sold or licensed?
3. Would the IA be used in its’ current owner’s industry, a new industry, or both?

The following section of this discussion summarizes HABU as it relates to IA valuation.

HABU in Intangible Asset Valuation

For IA valuations, the HABU is (in part) determined by the (1) IA’s expected transaction scenarios and (2) subject IA’s function. 

An IA can sell (1) independently from other assets, (2) alongside related intangible assets, (3) bundled with other tangible and intangible assets, or (4) included within a going-concern business enterprise.

The HABU of an IA can affect the likely transaction scenario. Said another way, the likely transaction scenario may be affected by the following factors:

1. Does the IA have more value to its current owner, with its ongoing use?
2. Does the IA have more value for a new (i.e., different) owner with its ongoing use?
3. Does the IA have more value to a new owner with a different use?

The appraiser considers all alternative transaction types for IAs. That is, some IAs can either (or both) be licensed or sold in their entirety. As an example, trade secrets are IAs that are licensed regularly and are also sold in their entirety. When considering the HABU of a trade secret, the appraiser can consider a HABU to both:

1. use the trade secret for its current (or different) owner’s business (value in use, as part of a going-concern), and
2. license the trade secret to licensors in another geography or industry (value in exchange).

The following section of this discussion summarizes certain considerations when selecting the HABU of the IA in a valuation context.

HABU Selection

The first procedure in an IA valuation HABU analysis is the selection of the IA’s HABU. The selection of the HABU may be based on various factors and considerations. The following sections will summarize common factors and considerations that may affect the IA HABU selection.

Assignment-Specific Assumptions or Legal Instructions

One consideration in an IA valuation HABU analysis is whether the appraiser has been asked to make an assignment-specific assumption. The appraiser’s client (or counsel for the client) may ask the appraiser to assume one or multiple HABUs based on the facts and circumstances of the assignment.

Further, another consideration in an IA valuation HABU analysis is whether the appraiser has been given a specific legal instruction. The appraiser’s client (or counsel for the client) may instruct the appraiser to perform the IA valuation based on a specific HABU. Such a legal instruction often relates to statutory, regulatory, or other similar requirements. 

In the cases where assignment-specific assumptions are made, or legal instructions are given, the appraiser’s HABU conclusion may differ from what would otherwise have been concluded. These assignment-specific assumptions or legal instructions should be documented in the appraiser’s workpaper file and be included within the IA valuation report.

Ongoing Use

A second consideration in an IA valuation HABU analysis is the ongoing use of the IA. Many times, the ongoing use of the IA is the HABU. This consideration makes sense when one considers that an IA owner likely has an incentive to ensure that such an IA is being exploited in the most effective way possible. 

In instances where the ongoing use of the IA is as part of the current owner’s business operations, a “value in use” premise of value may be warranted. In instances where the current owner licenses use of the IA to unrelated licensees, a “value in exchange” premise may be warranted. 

In these instances, the appraiser might also consider both premises (i.e., the IA HABU may include a value in use and/or value in exchange).

Nature of the Industry

A third consideration in an IA valuation HABU analysis is the nature of the industry in which the IA is currently used or may be used. For some industries (e.g., technology start-ups), internally developed IAs are integral to business operations (and may be the most valuable company asset). When such IAs transfer, they typically transfer bundled in the sale of the entire business. 

For some industries (e.g., entertainment), IAs are more likely to be licensed from IA owners to third-party licensees. An example would be the use of a certain brand’s trademarks on products such as apparel. 

Lastly, for some industries (e.g., content publishers), IAs may be commonly operated by the owner as well as licensed to third-party licensees. An example would be the use of a customer (i.e., subscriber) list in a magazine’s operations as well as the renting of such a list to other content publishers. 

Appraisers can consider which IA HABU is most appropriate in the valuation analysis by considering the nature of the IA use within the IA owner’s industry.

Nature of the Intangible Asset

A fourth consideration in an IA valuation HABU analysis is the nature of the IA itself. Certain IAs have been internally developed by the IA owner for a specific use, only. An example would be specific company procedures or employee manuals. Such IAs typically sell with related IAs or bundled with the entire going-concern business.

By comparison, some IAs produce an identifiable income stream (e.g., royalties). An example would be commercial software (i.e., developed for sale or license). Such IAs may be sold or licensed and typically do so separate from the business.

Further, some IAs (e.g., licenses, permits, etc.) are often sold with other tangible and intangible assets. An example would be a “hospital certificate of need” which would often transfer with the related tangible property, in this case a medical facility. Such IAs do not necessarily have to be bundled in the sale of a going-concern business.

Appraisers can consider which IA HABU is most appropriate in the valuation analysis by considering the nature of the IA itself.

Analysis of Market Transactions

A fifth consideration in an IA valuation HABU analysis is the analysis of market transactions for IAs. That is, the appraiser may search for and analyze comparable uncontrolled IA transactions (“CUTs”). 

A CUT is a sale, license, or transfer between two independent parties acting at arm’s length. That is, intercompany licenses between subsidiaries of a company are not CUTs. Common sources of CUT data are RoyaltySource and ktMINE. 

For industries in which there are a meaningful number of CUTs of comparable IAs to the subject IA, the appraiser may determine if such CUTs are usually sales, licenses, or some other transfer. Moreover, the appraiser may determine if such CUTs are usually related to IAs by themselves, IAs bundles with other assets, or IAs bundled in the sale of a going-concern business. 

Based on these determinations, the appraiser then selects the subject IAs HABU. 

Functional Analysis

A sixth consideration in an IA valuation HABU analysis is the performance of a functional analysis related to the IA. In such a functional analysis, the appraiser researches the various functions of departments and other operating divisions within the IA owner business. This functional analysis assesses and compares the IA owner business to selected comparable (i.e., benchmark) businesses. 

As an example, the appraiser may gain an understanding about how an IA owner (1) schedules the pickup of products from the company’s warehouse, and (2) transports the products to the end-users. As part of the functional analysis, the appraiser may gain an understanding of the role that the subject IA plays in this (and other) IA owner business. 

Notably, the appraiser learns if the IA (1) is required before any other operations can proceed, (e.g., permit), (2) interacts with other assets (e.g., operating software), (3) is consumed in the process of providing products and services (e.g., supplier contract), (4) is added to the finished product or (e.g., trademark), (5) protects or enhances the value of a product or service (e.g., patent), and/or (6) creates income for the owner, (e.g., customer contract).

The functional analysis can also indicate if the IA is “defensive” in nature. IAs that are “defensive” in nature might not be actively used in business operations, but rather “defend” the use of other IAs (e.g., patents).

Moreover, the functional analysis helps the appraiser identify IAs that are owned for future use (i.e., not currently in use). For example, a film studio may own the rights to a movie script but may deliberately not put that movie into production for several years.

The appraiser may consider the functional analysis in their selection of the subject IA HABU in the valuation assignment.

HABU Documentation

The second procedure in the IA HABU analysis is the documentation of the appraiser’s HABU analysis considerations and selection.

The HABU documentation procedure should be sufficient to support that the appraiser made appropriate HABU considerations. The HABU documentation should both summarize the appraiser’s logic and allow another appraiser to re-create the appraiser’s HABU conclusion. 

The level of documentation required may depend on the IA being valued and/or the scope of the valuation assignment. Ultimately, the appraiser should document their HABU analysis considerations and selection within the appraiser’s workpaper file. 

HABU Reporting

The third and final procedure in the IA HABU analysis is to include (and state) the IA HABU conclusion within the appraiser’s valuation report. 

The HABU statement may not even need to use the words “highest and best use.” The appraiser may conclude the IA HABU by indicating the premise of value being relied on in the valuation. Moreover, if an assignment-specific assumption or legal instruction is relied on for the HABU analysis, the appraiser should mention this in the valuation report.

The amount of detail included within the valuation report’s HABU discussion may be based on the type of report being produced in the assignment (e.g., restricted appraisal report, appraisal report, etc.). Further, the amount of detail may depend on whether the HABU discussion is part of a written report or an oral report. 

Regardless, the goal of the HABU discussion in the valuation report is to ensure that the user of the report can understand the HABU conclusion upon which the valuation is based.

Summary and Conclusion

This article summarized the procedures of selecting, documenting, and reporting the HABU conclusion in an IA valuation context. 

The HABU relied on in an IA valuation analysis can affect the valuation conclusion. The appraiser should be aware of, and know how to perform, the HABU selection analysis. The appraiser should also be able to properly document the HABU selection analysis in their workpaper file. Finally, the appraiser should provide a HABU conclusion within their IA valuation report.

Connor J. Thurman is a Manager with Vallit Advisors, LLC. Connor has over 6 years of experience in business valuation, tangible and intangible asset appraisal, and various other litigation services. He has written numerous articles in professional and peer-reviewed journals covering a variety of topics in his areas of expertise and has presented on these topics via webinars and conferences. He is an Accredited Senior Appraiser (ASA) with the American Society of Appraisers and is Accredited in Business Valuation (ABV) with the American Institute of Certified Public Accountants.

Connor can be reached at 443-482-9500 Ext 114 or cthurman@vallitadvisors.com

Bryan Endres is an Analyst, with Vallit Advisors, LLC. Bryan assists with engagements involving business valuation, dispute advisory, and forensic accounting. He also assists the Senior Management in the development of analyses and report preparation for a variety of cases.

Bryan can be reached at 443-482-9500 Ext 108 or Bendres@vallitadvisors.com