The Functional Analysis Strategies: Part 2

Intangible assets—like research and development know-how, trademarks, and trade secrets— are hard to value. This is because they lack a physical substance that can be easily or singularly appraised. You'll need to determine which entity performs the intangible development, enhancement, maintenance, protection, and exploitation functions, better known as the DEMPE functions; that way you'll understand which party owns the piece(s) of intangibles.

Risk equals reward, right? Well, transferring profits is no different. The entity that bears the liability will reap the profits. How do you know which entity bears the liability? The functional analysis, of course.

Risk comes in many forms. One type is the credit risk that the company takes on when extending credit to customers. Another type is market risk, where the company doesn’t have the capabilities to profit in the currently existing market. Imagine that a company faces inventory risk, where inventory expires or becomes obsolete, and who bears the cost?

“There are lots of different risk—market risk, operational risk, credit risk—the typical types of risks that you would be looking at in any business context,” Song explains. “And that’s important in a related-party context because you can actually indemnify all the related parties for lots of different types of risks.”

When you're doing a comparability analysis, it's really important that you understand the risk-reward relationship of the entity you're valuing or the comparable you're assigning to. This will determine how profits should be allocated.