Customer Relationship Valuation: Avoiding the Pitfalls of Shortcuts in Purchase Price Allocations

When it comes to business combinations under ASC 805, valuation reports can be quite a minefield. At first glance, assigning fair values to acquired assets and liabilities may feel like a compliance exercise. After all, there’s often no immediate impact to EBITDA. The reality is, the valuation methods and the assumptions used can have long-lasting consequences for credibility, audit readiness, and investor perception.

Key Takeaways

• Accurate valuation of intangible assets is important, as the chosen methods and assumptions can have significant, long-term impacts on a company's credibility and audit readiness. 
• Selecting an appropriate valuation model, such as the Multi-Period Excess Earnings Method (MPEEM) for customer relationships, is critical for accurately reflecting the true economic value of intangible assets. 
• Management's active participation and preparation of detailed, supportable data, like forecasts, contributory asset charges assumptions, and customer attrition rates, are essential for a high-quality valuation that withstands auditor scrutiny and conveys a clear strategic rationale to investors.

The Method Matters: Cap Earnings vs. MPEEM for Customer Relationships

One common misstep involves valuing customer relationship intangibles. A valuation specialist might opt for a capitalization of earnings-based approach for expedience or to keep fees low. Sometimes it’s chosen simply because management has not provided detailed revenue projections, making the more data-intensive Multi-Period Excess Earnings Method (MPEEM) seem out of reach.

The problem? The capitalization of earnings method assumes a business is in a mature, steady-state phase and will continue operations into perpetuity. As such, it does not reflect the variability in cash flows resulting from factors such as changes in existing customer relationships, organic growth, customer attrition, or evolving cost structures. In contrast, the MPEEM is specifically designed to capture the economic value of these relationships by modeling projected revenues, attrition rates, cost structures, and contributory asset charges (CAC) over time.

Choosing the wrong model can result in materially misstated intangible values — and that’s costly to fix when your audit team starts asking questions. Retrospective adjustments can also create credibility issues with investors, lenders, and regulators.

Why Investors Care About Intangible Assets in Purchase Price Allocation

It’s tempting to think purchase price allocation is just an accounting formality, but investors and analysts increasingly look beyond EBITDA to understand the quality and nature of the intangible assets acquired.

As discussed in The End of Accounting and the Path Forward for Investors and Managers (Baruch Lev and Feng Gu), today’s markets place significant weight on intangible assets — brands, customer relationships, proprietary processes — as indicators of long-term value creation.

A thoughtful allocation that accurately quantifies these intangibles tells a strategic story:

• Customer relationships → signal stability of revenues and potential for cross-selling.
• Technology assets → highlight competitive barriers and innovation pipelines.
• Trade names → provide clues about brand equity in the market.

Using an inappropriate valuation model may misallocate value and fail to convey the strategic rationale behind the acquisition effectively.

Management’s Role in Providing Accurate Valuation Assumptions

Another trap is the over-reliance on the valuation specialist without active engagement.

The quality of a valuation hinges on reasonable, supportable estimates — especially for assumptions like customer attrition rates and cost structures.

These inputs should come from management’s own operational insight and data, not default percentages borrowed from “market averages.” For example, attrition rates should be grounded in historical churn analyses, and cost structures on actual spending patterns for marketing and business development.

When management thoughtfully develops and documents these assumptions, they not only strengthen the valuation but also reduce friction in the audit process.

The Audit Perspective: Auditing the Specialist

Auditors are required to evaluate the competence, capabilities, and objectivity of any management specialist. They also must test the reasonableness of significant assumptions and the methods applied.

If the chosen valuation model doesn’t align with the nature of the asset — for example, using the capitalization of earnings approach for customer relationships — auditors will push back.

Inadequate support can lead to delays, additional fees, or even restatements. Proactive involvement by management, combined with an appropriately selected model, helps maintain a smoother audit and higher quality financial reporting.

Investor’s Quick Guide: Questions to Ask About Intangibles in a Deal

How much of the purchase price went to identifiable intangibles?
High allocation to customer relationships, technology, or brand can indicate durable competitive advantages.

Were the right models used for valuation?
Using MPEEM for customer relationships vs. capitalization of earnings shows care in isolating the true economic benefit of that asset.

What assumptions drive the value?
Look at attrition rates, cost structures, and revenue growth forecasts. Are they realistic given historical trends?

Are discount rates and IRR consistent with the deal’s risk profile?
A discount rate that reflects the acquirer’s capital structure instead of the target’s risk can distort fair value. Similarly, IRR can be misleading if used as a standalone decision metric rather than as a cross-check against the valuation models. Ask whether small shifts in the discount rate or return assumptions would materially change the outcome.

How do the intangibles tie back to the deal’s strategic rationale?
If the target was acquired for its loyal customer base, the valuation should reflect that.

Do the intangibles align with post-acquisition integration plans?
High brand value is great — but only if the acquirer plans to keep and leverage the brand.

Pro Tip: A well-supported intangible valuation is more than accounting rules; it’s an early window into whether management’s growth story will hold up in the years to come.

Bottom Line

Under ASC 805, valuation reports are more than a box-checking exercise. The right model not only supports compliance but also enhances the narrative of the deal for investors, analysts, and other stakeholders.

Management’s active participation in providing accurate data — and the valuation method fits the asset — is essential for both credibility and audit readiness.

Choosing convenience over correctness may seem like a small shortcut, but in valuation, shortcuts often lead to expensive detours.