What goodwill can be valued as part of a Purchase Price Allocation (PPA)?

When acquiring a business, understanding and accurately valuing its assets is extremely important. Purchase Price Allocation (PPA) helps to break down the purchase price and attributes values to specific tangible and intangible assets. Among these, goodwill – traditionally non-physical assets such as branding, technology, and customer relationships – often account for a significant portion of value.

In this article, we explore some of the sources of intangible value which are commonly identified as part of a PPA and their contribution to a business’s overall value.

Goodwill is a broad concept that encompasses various intangible assets contributing to a business’s overall value. Identifying and valuing these components during the PPA process is essential for reflecting the true worth of the acquired business and meeting reporting requirements. Each source of value is significant for different reasons, however we have outlined the main sources below.

Customer and contractual relationships

One of the main elements of goodwill assessed within a PPA is customer and contractual relationships. These relationships often play a key role in the valuation process, as they represent an important driver of revenue and profitability for the acquiring firm. This value can show in several ways:

Direct revenue contribution

If the target company has won significant contracts, these agreements can provide immediate financial benefits and provide revenue security (if multi-period contracts are agreed). For instance, a contract secured by the business with a reputable client might enhance not only revenue, but also the acquiring firm’s credibility within the industry and provide an acquirer with comfort that the target will generate value for multiple years beyond the acquisition.

Reputation and leverage

Even if there is only one major client of the target company, the association may well be with a well-known business or individual in the industry, and this can enhance the firm’s ability to attract additional clients. This reputational leverage can be of great importance for growth should the acquirer wish to take on more clients.

Steady revenue streams from smaller clients

Alternatively, the target company may have a broader customer base comprising of smaller, but consistent clients. While these clients individually could contribute less revenue, their collective stability reduces the risk of over-reliance on a single customer, offering a more diversified and, perhaps, secure income stream.

The diversity and quality of customer relationships can account for a substantial portion of goodwill, reflecting the importance of these relationships in an acquisition. It is important to note that there may be situations with long-standing clients whereby revenue is not contractually recurring, however the revenue does still repeat, which has value in itself.

Technology

A target may have developed innovative technology which drives the value of the company, though if this is internally developed, it will typically not be recorded as an asset on its balance sheet prior to acquisition. Innovating technology can provide significant advantages to an acquiring firm, especially if it offers unique solutions not yet available in the market or provides the firm with an edge over a competitor.

The value of technology in this case lies in its ability to enhance efficiency and provide a competitive edge. This is particularly true when:

A firm has developed a novel method or process that is not only innovative, but also incredibly effective. This can make the acquisition more attractive, as the technology represents a ready-made tool for improving operations or creating new revenue streams.

If the technology is safeguarded by patents or similar protections, its value is further enhanced. Patents establish barriers to entry, ensuring that competitors cannot replicate technology for a set period. This exclusivity gives the acquiring firm a distinct advantage in the market.

In some cases, technology can play a role in securing supply chains. For example, if manufacturers rely on specific parts from a single supplier, acquiring the supplier will help to secure the supply chain. This form of vertical integration can either complement the acquiring firm’s operations or directly strengthen its position within the same industry.

The ability to leverage unique, protected technology is often a key consideration in completing an acquisition and should create goodwill in the target, offering both operational benefits and a stronger competitive position.

Brands

Brands can be a substantial source of value, but this can vary dramatically by sector, particularly in SME businesses. The way in which the acquirer intends to use the brand name following the acquisition might also impact the value attributable to the asset.

If the intention is to retire or phase out the acquired company’s brand over time, the value of that brand may be minimal. In such cases, its importance to the acquisition is limited, as it won’t play a long-term role in the market.

However, if the acquirer intends to retain and continue using the target company’s brand, this suggests that there is distinct value in the brand itself. Established brands often carry customer recognition, loyalty, and trust, all of which can contribute to ongoing revenue and business growth opportunities.

Recipes, formulas and processes

Recipes, formula and processes underpin the products and services of a large number of companies and drive their competitive advantage – take Coca Cola’s famously guarded recipe as an example. A PPA will seek to understand how these assets go beyond simply detailing how raw inputs are mixed or made; they often include proprietary methods that outline key recipes essential to the target business’s offering.

Such intellectual property is valuable as it represents the unique knowledge that underpins the company’s products and differentiates them in the marketplace. Where applicable, by including recipes and formulation process in the PPA, their contribution to the business’s value is properly acknowledged.

The workforce

The workforce is a critical element and most businesses would agree that their employees contribute significantly to the value of the business. The workforce however cannot be recognised as a standalone asset under accounting standards applicable to UK-based entities – primarily because the assembled workforce does not have a single contract with the business nor would it be simply transferable to another business’s operations without disruption. As such, the workforce is not deemed to be an asset that can be recognised separately from the business.

The value of a skilled workforce lies in the know-how and expertise they bring to the business, with much intellectual capital being indirectly captured through the value of other intangibles e.g. technology. This knowledge and technical capability often enhance the firm’s operations and can make an acquisition more appealing. While it may not be accounted for as a separate asset, the contributions of experienced and capable staff are often reflected in the overall goodwill valuation.

Closing thoughts

Accounting standards have evolved to necessitate the breakdown of goodwill following an acquisition through a Purchase Price Allocation – the intangible assets of a business can come through a range of sources, including but not limited to, those mentioned in this blog. Specifically identifiable intangible assets form a substantial portion of the goodwill identified when making acquisitions and are important factors that drive value, with each component playing a unique role in shaping the future and potential profitability of the acquired company.

How can Price Bailey help?

At Price Bailey, we have a team of PPA experts that will work with you to conduct a PPA as we know it’s a crucial element of your financial reporting obligations and can be a key element of maintaining transparency and trust with external investors. If you have a question regarding PPA, please contact one of our Strategic Corporate Finance team using the form below.

We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.