Brand names and trademarks are an important type of business intangible assets. Most successful businesses have these valuable assets in one form or another. Think of business trade names or product and service trademarks used to distinguish business offerings in the competitive market place.
As a business builds customer following, the value of its brand names grows. Existing customers prefer products they know – and often identify them by name. New referrals often come to the business to check out a product – because they were given its name.
Yet, the accounting balance sheet does not show that brand names have any value. If the business owners did not acquire them from a third party, the brand name is not listed at all!
But when it comes to valuing the business, brand names and trademarks quickly surface as the major value contributors. So how can you determine what these assets are worth?
You have 3 ways or approaches to measure the value of any business asset: Cost, Market, and Income. Let’s see how each can help in valuing business brand names.
Market valuation approach
Valuation using market based methods relies on comparison with sales of similar assets. The trouble is there just isn’t enough sales to compare against. Brand names and trademarks rarely sell by themselves, rather the entire business changes hands.
Cost valuation approach
You can estimate the costs of designing a similar product, its manufacturing and distributions facilities. But how much will it cost to develop the same customer recognition and loyalty? The answer is at best speculative – which makes the cost approach hard to apply.
Income valuation approach
This leaves you with the income based valuation methods. The idea is this: if you can attribute income to the brand name, then its value can be measured. You can do this using a number of well-known discounting or capitalization business valuation methods.
Looking at the income generated by the brand name product seems like a good choice. However, many other business assets also contribute to this income: production facilities, sales, marketing and customer support efforts.
What you need is a way of isolating that part of business income that is due to the brand name itself. There are a couple of ways to do this:
- Incremental income method
- Royalty income method
Incremental income valuation method
Brand name products tend to sell in higher volume and at a higher price than their generic counterparts. You can observe this “income lift” effect of a brand name by estimating two key factors:
- Incremental sales volume increase of a brand name product when compared to generic products.
- Incremental price increase that a brand name product commands in its market.
Together, these two factors are responsible for the additional income that can be attributed to the brand name directly.
Royalty income valuation method
Valuable Brand names can be licensed to another party. Such a licensing arrangement brings income in the form of royalty payments. Royalty rates are highly negotiable but in general are set as a percentage of expected sales. For example, if the licensee projects $1,000,000 in sales using the licensed brand name for products, then the licensor may collect 5% or $50,000.
Hence, you can value the brand name based on the expected royalty income. This requires accurate sales forecasts and agreement on a suitable royalty rate. Once these two parameters are determined, you can calculate the brand name value by discounting the income stream at an appropriate discount rate.
An alternative: relief from royalty valuation method
If you need to determine the brand name value but have no plans to license it to anyone, you can use an alternative method. This method is called relief from royalty.
The basic idea is to assume that, if the brand name were to be acquired, you would need to make adequate royalty payments. Since the business already owns the brand name, it avoids the costs of royalty payments.
Being relieved from this financial burden generates additional income that flows to your bottom line. The present value of this extra income is the value of the brand name.