The Tangible Impact of Intangibles
Intangibles (such as franchises, trademarks, trade names, licenses, recipes, patents, goodwill, client lists, noncompete agreements, business books and records, work force, permits and copy-rights) can be considered assets if they are transferrable to another party by the subject. In many cases, licenses are given in which an asset purchase would not allow a transfer, whereas a corporate ownership change could retain that right. In the first instance there would be no value, whereas in the second there would be a possible assignment of worth.
There has been more discussion of this issue since 1993 when intangibles were allowed to be depreciated by a new provision in the Internal Revenue Code, referred to as §197. The 15-year straight line amortization of these intangibles does not apply to that which is created by the ongoing business, but rather that which is purchased in an exchange of the business from one party to another.
Acquiring the inventory of a manufacturer, licensee or owner of the intangible rights may or may not empower the possessor with the ability to transfer certain intangible parts of the product. Consider the following scenarios:
1. Finished products where the manufacturer has failed and the seller is a lien holder of the inventory who will have to convert the last of those finished items into dollars.The lienholder will not be able to transfer warranties as the manufacturer has failed and there will be no one to honor them. If this is the case, an intangible has been created. This will be a loss of value due to the manufacturer’s demise for warranty support.
2. The value of a manufacturer’s inventory in which a bulk sale is made of the inventory as of a specific point in time; and the manufacturer will continue to make more of the same proprietary products after the sale.In this hypothetical sale, no rights of manufacture, trade name, trademark or license agreements are included, but rather the sale is only for the inventory items. This situation requires an assignment of value that considers a deduction for those rights that are not transferred. For some generic type items, this may be of little or no consequence, whereas, for other areas in which there is a requirement for the continuation of supplying a customer base, use of a trade name, or other such things, the effect is possibly profound.
For example, assume there is an inventory of new motors used to manufacture a special down hole pump. The motors are purchased outside and appear to be standard. However, perhaps these motors are specially wound for these particular pumps and no one else can use them. This also must be a consideration for the finished product. If the company stops manufacturing these pumps or sells the inventory without support, there are no return privileges, warranties or guarantees or back-up for the finished product and, therefore, those pumps are going to be discounted dramatically in order to sell them to another party who has knowledge of these facts.
The opposite would be true using an example of the manufacturing of lawn mowers or trucks that have standard off-the-shelf engines staged to produce the finished product. Even if the company stopped manufacturing its proprietary items, the Briggs and Stratton, Wisconsin, Cummins or Detroit engines could still be acquired, supported and, in all probability, sold under warranty.
The Fair Market Value or liquidation value for the pumps as a proprietary product would be far different as a percentage of cost than the lawn mower or truck example.
3. The transfer of ownership of only one or a few stores of an enterprise that has a network or national operation which is not affected by that particular sale. Many refer to this as the trade name or private label issue. Some department stores or tool and appliance stores have experienced this situation in which there was a return policy to any of their outlets through the chain. Under the transfer of ownership scenario, the balance of the chain would not be required to honor returns or warranties for any reason. Therefore, as part of that sale, there would have to be an identifying process to allow for that protection. In any event, this type of inventory would be subject to balances in such things as sizes, colors, patterns, models, etc. If no more could be purchased, then this would have an effect on the value of the remaining portion that was offered. This would not necessarily be the same for inventory that would be referred to as "national brands" in which warranties, return privileges, or additional purchases could be made by another supplier outside of the subject; an exception to this would be a license or supplier agreement that would not be granted to the new owner.
4. An inventory owned by a manufacturer that provided a private label for another in which a transfer of ownership did not allow the transfer of the identifying mark.This occurs when outside manufacturers are supplying under contract a proprietary product. This type of inventory, many times, can be affected by too much quantity, limited style or size, or other factors associated with a one-time sale. However, the issue is still the value measurement of assets in which there must be a separation of intangibles due to the lack of transferability of a certain attribute of an asset.
The above examples illustrate some of the problems associated with the measurement of inventories where certain scenarios are imposed. Remember, Fair Market Value assumes a willing buyer and a willing seller, and how that buyer is affected by the limitations imposed will affect the assumed price to be paid and, consequently, the overall value. By that same logic, liquidation concepts used in bankruptcy are also affected. The appraiser must deal in probability rather than possibility as it relates to product line or intangible transfers under any concept of value.
The appraiser must be ready to address these issues if the scope of the project requires that type of measurement. Even under level of trade issues, consideration must be for the most likely buyer or candidate due to the imposed restrictions. In many cases, the only purchaser is a second source buyer because of a one-time purchase of the inventory that may be affected. Even if the buyer were to use the inventory as a foundation or base for continuing the business of retail sales, manufacturing, wholesaling or distributing, there is a real world and a real value implication imposed on that type of inventory.
A sale to another party is the exchange of title. A sale or transfer of title by its very nature is not the implication of a compelled seller, unless the concept of value imposes that consideration. If both seller and buyer are willing, regardless of the exchange, liquidation value is replaced by Fair Market Value. This understanding is defended by most appraisers, documents and published definitions. Unless there is an exchange of the enterprise in which intangibles are also exchanged, there is a different impact on the value of those assets. If one considers the value to the current owner, there is certainly a difference from that measurement when there is a transfer to another owner without all the "bundle of rights." If one were to still continue the business without all of those rights, there is the effect of that loss of rights on the value that is being assigned.
It is this foregoing area of proper depreciation in which confusion surfaces, which could impact inventory. Inventory is typically measured at cost to the owner as that is the party being taxed (if the valuation is for an assignment for allocation under IRS regulations or for ad valoremtax). Regardless, cost must be deducted for any depreciation factors implied by law and its interpretation. This is understood as an adjustment for the unique characteristics of particular assets. Differences in value may occur under various laws throughout various states or even counties, depending upon a law or code. On new inventory, one should start with replacement cost at the current level of trade. That is the comparative measurement to which all purchases of inventory express value after depreciation (if any) have been taken. The expression of that value would certainly be different to the enterprise that includes fixtures, equipment, leasehold improvements or real estate and all business rights, as compared to a sale in exchange (buyer and seller) of that same mentioned inventory at a given point in time. Perhaps this insight may allow an understanding of an appraiser’s opinion of value in which two sides of an issue indicate values that seem to be unreasonably different. Both appraisals may be correct even though the assumptions are different.