When to Use MPEEM in Valuations
- Brandon Chicotsky
- Mar 2
- 10 min read
The Multi-Period Excess Earnings Method (MPEEM) is a valuation approach that isolates the value of a company’s primary intangible asset, such as customer relationships or proprietary technology. It’s especially useful in industries where intangible assets drive most of the enterprise value, like technology or service sectors. MPEEM is widely applied in purchase price allocations (ASC 805), mergers and acquisitions (M&A), and financial reporting.
Key Takeaways:
How It Works: MPEEM calculates the excess earnings generated by a key intangible asset by subtracting contributory asset charges (CAC) from total earnings.
Best Use Cases: Purchase price allocations, valuing key intangible assets, and financial audits.
Challenges: Requires detailed data, assumptions about attrition rates, discount rates, and asset useful life. It's complex and best suited for larger companies with sufficient historical and financial data.
Alternatives: Capitalized Excess Earnings Method (CEEM) is simpler but less precise, while the Market Approach uses comparable transactions for broader valuation.
MPEEM is ideal for precise valuations of intangible assets but demands expertise and detailed forecasting. It’s most effective when intangible assets dominate a company’s value.
1. Multi-Period Excess Earnings Method (MPEEM)
Intended Use
The Multi-Period Excess Earnings Method (MPEEM) focuses on isolating a company’s primary intangible asset - the one most responsible for driving revenue and profits. By deducting contributory charges for supporting assets, it determines the value of this key asset. This method is commonly applied in purchase price allocations (ASC 805 and IFRS 3) during mergers and acquisitions (M&A) and for financial reporting purposes. Unlike a general Discounted Cash Flow (DCF) analysis, which values an entire business, MPEEM hones in on a single asset. Paul Vogt, Managing Director at PCE Companies, explains:
"In essence, you're valuing what's left, the 'excess' earnings generated by your key intangible asset."
This approach is particularly relevant for businesses in service or technology sectors, where intangible assets - like customer relationships, patents, or proprietary technology - make up a significant portion of enterprise value. For example, in a consulting firm, the customer list might serve as the primary intangible asset, while items like office equipment and working capital are classified as supporting assets.
Complexity
MPEEM is not without its challenges. The method requires a detailed valuation of all supporting assets - such as working capital, fixed assets, and workforce - to calculate contributory charges. Khalid Ahmed of WallStreetMojo emphasizes:
"The complexity of its valuation method may hinder its implementation."
To implement MPEEM effectively, you need forward-looking financial data, 5–7 years of historical customer records, and assumptions aligned with market participants. A valuation expert must conduct statistical attrition analysis, calculate contributory asset charges (CAC), and ensure the internal rate of return (IRR) matches the chosen discount rate. Due to these complexities, MPEEM is typically reserved for valuing the primary intangible asset. Simpler methods, like Relief from Royalty, are often employed for secondary assets.
Applicability
MPEEM is most effective when intangible assets dominate a company’s business model. In today’s service and technology-driven economies, intangible assets can account for over 50% of a company’s total enterprise value. This makes MPEEM a go-to method for financial reporting and purchase price allocations, particularly for companies involved in acquisitions or preparing audited financial statements.
However, applying MPEEM to smaller, mid-market businesses can be tricky. These businesses often lack the historical data needed to estimate attrition rates accurately. Additionally, their assets may be so interconnected that separating earnings for specific assets becomes difficult. In such cases, MPEEM may serve as a reasonableness check alongside market-based approaches rather than as the primary valuation method. Despite its complexity, MPEEM is particularly well-suited for businesses where intangible assets are the main drivers of value.
Key Assumptions
The accuracy of MPEEM hinges on several critical assumptions. First, it relies on prospective financial projections, which can be prone to bias if management’s forecasts are overly optimistic. Estimating the attrition rate - the rate at which customers leave - requires extensive historical data, which can add another layer of difficulty. Determining contributory asset charges also involves subjective judgments about fair returns on supporting assets, and any miscalculations can significantly affect the valuation.
Another key factor is selecting an appropriate discount rate. The rate must reflect the higher specific risks tied to the intangible asset, which are often greater than the overall business risk. Finally, assumptions about the asset’s useful life are crucial. If the useful life is underestimated, the asset’s value might appear lower than it should be. Conversely, overly optimistic assumptions could inflate the valuation, leading to inaccurate results. These assumptions highlight the need for meticulous analysis when using MPEEM.
2. Capitalized Excess Earnings Method (CEEM)
Intended Use
CEEM, often called the Treasury Method, is designed to value overall business goodwill rather than focusing on a single intangible asset like MPEEM does. It works by separating earnings tied to tangible assets from those generated by intangible factors, offering a comprehensive view of goodwill[8][10]. Historically, CEEM was developed during Prohibition to estimate business value loss, and it continues to be relevant in situations like small business valuations, divorce settlements, and legal disputes where a straightforward approach is beneficial[3][10]. However, the IRS Revenue Ruling 68-609 restricts its use when more reliable market-based data is available for valuing intangible assets[10].
Complexity
While the CEEM formula itself is simple, applying it can be tricky due to the subjective nature of determining fair return rates for both tangible and intangible assets[8][10]. As ValuAdder explains:
"The idea is that the business owners, acting as investors in their own company, expect the return on the committed capital to be commensurable with the overall business risk."[8]
Unlike MPEEM, which relies on multi-period projections, CEEM typically uses historical or normalized earnings. This makes it more accessible for those without deep financial expertise but less precise for detailed financial reporting[3].
Applicability
CEEM is particularly useful for valuing small businesses and professional practices where detailed financial projections are unavailable, and a goodwill estimate is needed[8][3]. It can also act as a reasonableness check when compared to methods like Discounted Cash Flow (DCF)[3]. However, because it focuses on overall goodwill rather than isolating specific intangible assets, CEEM is less suitable for situations like mid-market M&A or ASC 805 allocations, where pinpointing individual asset values is crucial. In such cases, MPEEM is the better choice[1].
Key Assumptions
This method operates on the assumption that tangible assets should generate a normal market return, while excess earnings - those above this return - are attributed to intangible factors like goodwill[6][7]. It also assumes tangible and intangible assets produce earnings independently[10]. If the earnings fall short of the expected return on tangible assets, excess earnings turn negative, effectively indicating no goodwill[7]. Another critical aspect is the application of a higher capitalization rate to excess earnings, reflecting the increased risk associated with intangible earnings[6]. Small changes in this rate can significantly impact valuation; for example, raising the capitalization rate from 5% to 20% could nearly triple the goodwill value[9]. This sensitivity highlights the need for careful rate selection and limiting the capitalization period, typically to a range of 3 to 10 years[8].
3. Market Approach
Intended Use
The Market Approach determines a business's value by comparing it to similar companies that have recently sold or are publicly traded. Unlike MPEEM, which focuses on a single intangible asset, this method evaluates the entire enterprise. It’s often used in mergers and acquisitions, setting asking prices, or as a way to ensure internal valuations align with current market trends. As Adams Brown explains:
"The market approach examines transactions of similar companies to estimate the value of your business. The pricing multiples derived from these market transactions are applied to the subject company's metrics to derive its relative value." [11]
This approach provides a broad perspective but introduces additional layers of complexity when applied.
Complexity
Although the concept of the Market Approach is simple, its execution requires thoughtful analysis. Finding comparable companies and adjusting for differences in capital structure, size, or non-core assets can be challenging. The process relies heavily on external data sources like DealStats, BizComps, and PeerComps. For smaller businesses in the lower mid-market, the Guideline Company Transaction Method - which uses private sale data - is typically more relevant than the Guideline Public Company Method, as public companies tend to be much larger and operate with different financial structures.
Applicability
The Market Approach is most effective when there is ample transaction data available. It’s particularly useful for valuing an entire enterprise, making it less ideal than MPEEM for purchase price allocations under ASC 805. In industries where transactions are rarely reported or tightly held, this method may not be practical. Common pricing multiples used include Sales Price/Revenue, Sales Price/EBITDA, and Sales Price/Sellers Discretionary Earnings (SDE). These metrics set the foundation for understanding the assumptions behind this approach.
Key Assumptions
The Market Approach assumes that stock prices and transaction multiples accurately reflect value and that the subject company closely resembles its peers in industry, size, and growth. It relies on market efficiency to determine pricing, contrasting with MPEEM, which depends on cash flow forecasts and contributory asset charges. When valuing a minority interest in a private company, adjustments for lack of marketability and control are necessary. This method also assumes a going-concern value, factoring in future growth potential, unlike MPEEM, which accounts for customer attrition and the decline of existing customer relationships over time. By offering a market-based benchmark, the Market Approach can help validate MPEEM valuations with external evidence.
Advantages and Disadvantages
Each valuation method comes with its own set of strengths and challenges, making them suitable for specific scenarios. The Multi-Period Excess Earnings Method (MPEEM) stands out for its forward-looking approach and its ability to pinpoint the value of a primary asset. However, this precision comes with a trade-off: it’s a highly complex method. For example, it factors in customer attrition - commonly around 25% annually for customer relationships - making it a solid choice for ASC 805 purchase price allocations [1]. Paul Vogt, Managing Director at PCE Companies, highlights this complexity:
"The MPEEM can be complex because, although you are valuing your company's primary intangible asset, you must value all your company's other assets to determine their contributory charge" [5].
On the other hand, the Capitalized Excess Earnings Method (CEEM) is much simpler. Its single-period formula is easy to grasp, even for non-financial stakeholders like attorneys or judges. This makes it particularly useful for small professional practices where market data may not exist. However, CEEM's reliance on historical earnings rather than future projections can make it vulnerable to manipulation and less dependable for modern valuations [3].
The Market Approach brings objectivity to the table, relying on real transactions to reflect current market sentiment. It works well when comparable data is available, offering verifiable evidence of asset value. But it struggles with unique intangible assets, where finding comparable sales is difficult. Additionally, adjustments for differences in size, capital structure, or non-core assets can introduce subjectivity [2]. Below is a table summarizing the key points for each method:
Method | Primary Strength | Primary Weakness | Best Use Case |
MPEEM | Isolates primary asset value through contributory asset charges; accounts for attrition | Highly complex; sensitive to forecasting and discount rate assumptions | Primary intangible assets with finite lives (e.g., customer relationships, backlog) |
CEEM | Simple to calculate and explain to non-experts | Relies on historical data; viewed as outdated by many professionals | Small businesses or professional practices lacking market data |
Market Approach | Based on objective, verifiable market transactions | Often inapplicable for unique intangibles due to lack of comparable data | Assets with active trading markets or frequent comparable sales |
MPEEM is often the go-to when precision in valuing intangible assets is essential, but it comes with risks. Dwight Buracker, CPA and Partner at PBMares, cautions:
"Of the three methods, the income approach [including MPEEM] presents the highest risk that the outcome of the valuation model will be inappropriate" [12].
Given that intangible assets frequently account for over 50% of a company’s total value, the assumptions used in these methods - like discount rates and growth projections - require thorough sensitivity testing to ensure reliability [1].
Conclusion
Selecting the right valuation method depends on what your business requires. The Multi-Period Excess Earnings Method (MPEEM) shines when you need to pinpoint the value of a key intangible asset - like customer relationships, proprietary technology, or patents - especially when that asset produces measurable excess earnings [1][13]. It’s particularly favored for regulatory compliance, such as purchase price allocations under ASC 805, and for financial audits [1][5]. Plus, when comparable data is scarce, MPEEM offers distinct advantages for valuing proprietary assets [4][2].
One of MPEEM's standout features is its focus on "economic rent", achieved through Contributory Asset Charges. This ensures that supporting assets are neither undervalued nor overstated [4][5]. This precision makes it a critical tool during M&A negotiations and strategic planning. As FasterCapital explains:
"MPEEM is not just a tool for valuation professionals; it encapsulates a framework that aligns closely with the economic reality of how assets contribute to future profits" [4].
However, transparency is key when using this method. Paul Vogt, Managing Director at PCE Companies, underscores this point:
"Intangible asset valuation is not an exact science, and you must be transparent about the assumptions and methodologies used when presenting the value estimate" [1].
This transparency becomes even more crucial for smaller businesses. For companies with EBITA under $25 million, having specialized expertise is non-negotiable. God Bless Retirement (https://godblessretirement.com) offers NACVA-certified valuations - recognized by the IRS, banks, and courts. Their multidisciplinary team of CPAs, financial planners, and due diligence specialists helps uncover often-overlooked intangible assets while ensuring compliance with regulatory standards.
FAQs
What data do I need to use MPEEM credibly?
To apply the Multi-Period Excess Earnings Method (MPEEM) properly, you'll need three key components: projected future cash flows generated by the primary intangible asset, adjustments for contributory asset charges (costs tied to supporting assets), and a discount rate that accounts for the specific risks associated with the asset. These elements work together to ensure the method is implemented correctly and adheres to established valuation standards.
How do I determine the “primary” intangible asset for MPEEM?
The main intangible asset in the Multi-Period Excess Earnings Method (MPEEM) is usually the one that plays the biggest role in generating the company’s revenue and cash flow. For many service-based businesses, this often turns out to be customer relationships. Determining this key asset involves evaluating which intangible contributes the most to the company’s overall ability to generate income.
When should I use MPEEM vs. CEEM or the Market Approach?
When valuing intangible assets like customer relationships or proprietary technology, the Multi-Period Excess Earnings Method (MPEEM) is a reliable choice. This method focuses on isolating projected cash flows from these assets while factoring in contributory charges, making it ideal for assessing their standalone value.
If there’s solid comparable sales data available, the Market Approach can be a strong alternative. It uses market-based evidence to estimate value, offering a straightforward comparison to similar transactions.
For a more granular analysis, consider the Contributory Asset Excess Earnings Method (CEEM). This approach provides a detailed breakdown of contributory asset values, along with their associated charges, offering deeper insights into the financial contributions of each asset.
