November 12, 2020
Customer relations are the single-most important asset class of enterprises. On average, 18% of enterprise value are attritubutable to customer relations.
Because of the need for financial statements to be both reliable and relevant, valuation practices must provide reasonably consistent and supportable fair value conclusions. Guidance regarding best practices surrounding certain specific valuation is helpful. The Appraisal Foundation has addressed the general topic of customer-related assets in an advisory piece titled “The valuation of customer-related assets”.
Customer-related assets include customer lists, order or production backlog, customer contracts and related relationships, and non-contractual customer relationships. The purpose of the Valuation Advisory is to outline best practices in the valuation of customer-related assets for financial reporting purposes.
A Customer Relationship is a relationship that exists between an entity and its customer if the entity has information about the customer and has regular contact with the customer, and the customer has the ability to make direct contact with the entity. Customer relationships meet the contractual-legal criterion if an entity has a practice of establishing contracts with its customers, regardless of whether a contract exists at the acquisition date. Customer relationships also may arise through means other than contracts, such as through regular contact by sales or service representatives.
The Advisory discusses various methods to value customer relationships, including the Multi-Period Excess Earnings Method (MPEEM or MEEM), the Distributor Method, the With-and-Without Method, and the Cost Savings Method. Moreover, the Advisory adresses critical issues like attrition rate calculation and useful life, pre-existing relationships, overlapping customers. In the appendix, the Advisory provides various case studies with business from various sectors.
The Valuation Advisory is a must-read for all professionals dealing with the valuation of customer-related assets. The full text can be read or downloaded here.
Other must-read papers in the context of customer valuation include: