Page 3 - Asset Valuation

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Asset Valuation | Monday, May 16, 2016 | S3
at a discount rate that represents the risk of achieving the projected levels of cash flow.
While there are many valuation methods within these valuation approaches that can be used to value trademarks, several valua- tion methods commonly used are discussed below.
The relief-from-royalty method estimates the value of a trademark under the assumption that the company using the trademark does not own the trademark, but licenses the use of the trademark from the owner at a roy- alty rate negotiated on an arm’s length basis. The relief-from-royalty method has aspects of both the market approach (which is used to estimate an appropriate royalty rate) and the income approach (since the projected economic income is discounted to present value).
The first step in a relief-from-royalty calcu- lation is to estimate the appropriate royalty rate. Several databases are available that pres- ent information on arm’s length transactions in trademark licensing. The valuation analyst reviews the available data (on transactions in guideline trademarks) and considers the differences between the subject trademark and the guideline trademarks. An appropriate royalty rate is then determined. The selected royalty rate is then applied to the relevant revenue stream going forward, resulting in a measure of economic income generated by the trademark. The projected income stream is adjusted for income taxes and then dis- counted to present value, representing the estimated value of the trademark.
The selection of an appropriate royalty rate should consider differences between the subject trademark and the benchmark trade- marks that have been licensed in arm’s length transactions (also known as uncontrolled transactions). given the uniqueness of trade- marks, it is difficult to find a perfect match. Therefore, the valuation analyst should ana- lyze factors that differentiate the trademarks that can impact their value. These factors might include the age of the trademarks, the profitability of the underlying products, the market potential of the trademarks, the perceived quality of the trademarks, and the name recognition of the trademarks (note this is just a partial list of such factors). These and other factors can individually and collectively suggest that the appropriate royalty rate for the subject trademark should be higher, simi- lar to, or lower than the royalty rates of the benchmark trademarks.
The profit-split method estimates the value of a trademark in the context of the total eco- nomic income generated by the business unit allocated to all of the assets (including tan- gible assets, intangible assets, and intellec- tual property) used to generate the economic income. The profit-split method effectively allocates a portion of the economic income to each asset (including current assets, non- current assets, intangible assets, and other intellectual property) used to generate the economic income based on their values and required rates of return. The remaining income is then “split,” with a portion of the income attributed to the subject trademark. The profit-split percentage should be based on empirical financial data such as license agreements entered into by public companies, and not on rules of thumb.
From a legal perspective, trademarks have an indefinite life as long as the trademarks remain in use. However, from a valuation perspective, the pertinent measure of life is the trademark’s expected economic life.
amortization of the intangible asset through lower reported income and therefore lower income taxes. The key variables in this analy- sis are the estimated income tax rate and the discount rate. In cases where an income approach analysis is applied, a discount rate will already have been determined. In cases where only the cost approach and/or the market approach are applied, it is necessary to estimate an appropriate discount rate for the purpose of estimating the value of the amortization tax shield.
Management/Use of the Trademark: In the case of trademarks, it is also important to assess that the trademarks have been man- aged properly. The valuator should review fac- tors such as the ownership and historical use of the subject trademark. Many businesses have created separate holding companies to own and manage their intellectual property, in some cases to obtain tax benefits and main- tain independent control of the intellectual property assets. (The formation of a holding company might require valuation of the trade- mark for transfer purposes.) These holding companies are typically wholly owned sub- sidiaries. Such an ownership structure might indicate better intellectual property manage- ment. This could impact the assessment of the risk inherent in the subject trademark, and therefore impact the discount rate and the estimated value of the trademark.
Contribution of Other Assets: A final consideration in trademark valuation is that companies typically spend significant time and effort on products, which can signifi- cantly impact the value of the company’s trademark. For example, the value of the Apple trademark today is significantly greater than 30 years ago, and reflects the company’s investments in factors such as product and advertising.
Domain Names: Sometimes domain names of Internet websites are mistakenly conflated with trademarks. registering a domain name does not provide any trademark protection. And, the value of a domain name that is linked to a trademark might be embedded in the trademark value. In the case of a domain name that is not attached to a trademark, the valuation process is different from the valuation process for trademarks discussed in this article.
Reasonableness Check
After performing a trademark valuation, the result should be compared with other metrics for the company that owns the trade- mark in order to confirm that the results make sense in the real world. In addition, if the other assets owned by the company have also been valued, one can perform a weighted average return on assets analysis, which provides con- firmation that the asset values and discount rates for the different assets are consistent with one another.
Summary and Conclusion
Trademarks have become increasingly important assets for many businesses. This article has presented a general overview of certain quantitative and qualitative factors to consider when performing valuation analyses of trademarks.
The incremental income method estimates the value based on the additional economic income generated with the use of the trade- mark as opposed to without the trademark. This valuation method often utilizes projec- tions prepared by company management, which should be carefully considered by the valuation analyst.
Cost approach valuation methods include the reproduction cost method and the replace- ment cost method. The reproduction cost method estimates the cost of creating an exact replica of the subject trademark at cur- rent prices. The replacement cost method estimates the cost of creating a new trade- mark with equivalent utility. Cost components that should be considered include materi- als, labor, overhead costs, and profits for the trademark developer. For a trademark that generates a significant amount of cash flow, the cost approach will often underestimate value.
In some cases, it can be assumed that a company would not pay more for a trademark license than it would cost to develop a differ- ent trademark. In this case, the replacement cost method might be the appropriate valu- ation method.
These factors highlight the importance of the valuator obtaining a full understanding of the real world considerations regarding the subject trademark. depending on the specific facts and circumstances, the value of a trademark might be based best on its economic income (typically representing a higher value), a cost approach analysis (typi- cally representing a lower value), or in some cases the trademark might be determined to have little or no value.
Other Valuation Considerations
Discount Rates: one factor impacting trademark value using the methods above is the discount rate. The discount rate is the rate of return required by investors in the subject asset that considers the risk in achieving the projected levels of economic benefit. higher discount rates represent greater risk and therefore lower value (and vice versa). Trademarks, which represent intellectual property assets, are generally considered to be riskier than more tangible corporate assets. All corporate assets are considered to have some level of risk, and therefore generate a return commensurate with that level of risk. The safest assets are current assets such as working capital, which have a relatively low expected rate of return. The riskiest assets are intangible assets, with intellectual property generally occupying the higher risk end of this cat- egory. Therefore, the discount rate for a trademark will generally be greater than the discount rate for the company as a whole. In addition, the discount rate estimated for valuing a trademark should reflect other risk factors related to the asset (such as
the business risk of the industry in which the trademark is used). The risk assess- ment and its implications for the discount rate can have a meaningful impact on the estimated value.
In the case of trademarks, the estimation of the discount rate might consider factors such as how long the trademark has been in existence, it’s strength and perception in the marketplace, competitive threats and other risks, and opportunities for growth. The nature of the projected revenue and income stream for products using the subject trademark should also be considered. For example, if the assumed use of the trademark as reflected in the projections is only for exist- ing products that have been on the market for some time, this might represent a lower level of risk than a set of projections that includes expanded use of the trademark (perhaps for a new product line that has significant differ- ences with the prior product lines that used the trademark).
Remaining Useful Life: Another factor impacting trademark value is the expected life of the trademark (commonly called remaining useful life or rUl). From a legal perspective, trademarks have an indefinite life as long as the trademarks remain in use. however, from a valuation perspective, the pertinent measure of life is the trademark’s expected economic life. It is important to note that indefinite is not the same thing as infinite. Several factors can limit the eco- nomic life of a trademark, including industry stability, changing technology, changes in legislation, competition, and something as simple as changing tastes and fashion. The assumed economic life can have a significant impact on the valuation analysis. A trade- mark that is assumed to have an economic life of 10 years will be worth less than an otherwise identical analysis that assumes an indefinite life and utilizes a perpetual valu- ation model. It is of course very difficult to estimate the remaining economic life of a trademark. however, a reasonable estimate of a finite remaining life can result in a more accurate valuation than an analysis that assumes a perpetual life.
The rUl of a trademark can be a factor in the valuation methods discussed above. For example, in the income approach valuation methods, the rUl can determine the length of the projections period used to estimate the value of the trademark. In the relief from royalty method, a rUl analysis can be one of the factors used to compare the subject trademark with the benchmark trademarks.
For some valuation purposes (such as financial reporting purposes) it is appro- priate to add an additional factor called an amortization tax shield to the value of the subject trademark. The amortization tax shield accounts for the fact that an acquired intangible asset can typically be amortized over a 15 year period, during which the com- pany that owns the asset will benefit from the