The most visible and recognizable intangible asset for a firm is its brand. A brand contains legal protections that trigger value. But knowing how to quantify the latter in view of the former can be perplexing to even the most experienced valuation professional.  According to intellectual property valuation expert Mike Pellegrino (Pellegrino & Associates), author of BVR’s Guide on Intellectual Property Valuation, there are some fundamental, underlying legal rights that provide brands monopoly protection and, ultimately, their value.

Perpetual life

A trademark, which is a protection on a brand, slogan, or logo, is generally the most valuable type of intellectual property (“IP”) because there is no statutory life associated with a trademark. If you maintain a trademark and continue to use it in the classes for which it is registered, you will just have to go through a registration process every 10 years to maintain it. And, as long as you do that, you will have perpetual ownership of that mark for the particular goods and services to which it applies. That perpetual life gives it a very long runway of economic-value creation opportunity that you do not get with some of the other assets.

Value creation

Trademarks and brands can create value for otherwise commodity products. For example, diamonds sold by Tiffany are made of the same substance—carbon—as diamonds sold by other stores. While a Tiffany diamond may cost quite a bit more, the price it commands does not necessarily relate to the intrinsic value of the asset, but there is a brand associated with that. A trademark creates value in several ways:

·         Reduced consumer search costs. By making it easier and quicker for consumers to buy a company’s product or service, the trademark reduces customer-acquisition costs on the part of that company.

·         Increased market penetration. Thanks to its brand, a company might be able to get greater market penetration, so its market share becomes disproportionately higher than its competitor’s, even if the pricing is the same.

·         Lowered sales and marketing expenditures. Let’s say two companies have competing products that cost the same and the companies have the same market share. If one company can get its product or service into the consumer’s hands for less cost than the consumer would otherwise have to spend because of that brand, then that is a value source.

·         Reduced risk of failure. You might have a greater chance of success or a reduced risk of failure, and that has a value-creating aspect. Why? Because it changes the risk profile associated with the investment, and that will ultimately affect the discount rate.

·         Increased revenue per unit. Through incremental revenues, the “brand” company can get a higher revenue per unit for a particular product or service. Table salt is nothing more than sodium chloride, but Morton Salt, for example, gets an 18% premium at a local grocer for its product. If you did a blind taste test on Morton Salt versus your local grocery store’s brand, you would probably find that they are indistinguishable.

Value can be fleeting

A disadvantage of trademarks and brands is that they can lose value instantly, especially in today’s connected world. Social networking sites such as Twitter and Facebook can disseminate information very efficiently. The bad news is that it is not always correct information. Even more, it may impair the trademark, even though the information might be incorrect.

For example, several years ago, a law firm issued a class-action suit against Yum! Brands (which owns KFC, Pizza Hut, and Taco Bell), making such claims as Yum products did not contain meat and had filler materials in them. This made a lot of splash in the headlines and the media, and people stopped buying this brand’s products for a while. Eventually, the lawsuit was dropped because independent scientific analysis showed that the product was composed primarily of meat—in fact, 88%—and that the rest was made up of seasonings. The basis for the lawsuit was basically unfounded but it still did damage to Yum in that case, even though there was not much mention of the suit in the press. Some brands might never recover.

Quantifying value

To quantify brand value, certain items of due diligence are worth noting:

·         See who owns it. Credible due diligence on a brand starts with figuring out who owns that title. As with patents and trademarks, it must be assigned and searchable. What if you discover that a client does not own a particular mark? If they don’t, you need to ask, “Why don’t they own it? Is there impairment there or might they not even be allowed to operate under that mark?”

·         Verify the history. The history and creation are important because they might help lay the groundwork for legal strength at some point if it is ever tested in court. There is a correlation between the strength of the brand or trademark and its value. Look at the trademark’s registration and understand the status of the trademark.

·         Check for look-alikes. Make sure no one else is using a similar trademark. That search provides a reasonable expectation of freedom to operate. Not searching is expensive. If a company is told that it must move away from a brand, then it has to design a new logo, reprint everything, get a new website, etc. It is a remarkably expensive process to fix that.

Building a credible forecast

The following tips can help build a credible forecast for brand valuation:

·         Toss out the yield-capitalization method. A brand value is volatile, and you are using a one-point predictor when you use a yield capitalization method. It represents an income perpetuity. Although trademarks may have a perpetual life associated with them at a legal level, that may not be the case from an economic level.

·         Look at the economic activity surrounding the brand and its associated time series. You have to spend a fair amount of time looking at such factors as marketing expenditures, marketing effectiveness, and analysis of earned media—especially for products that do not have a lot of technical differentiation. Earned media can have a direct relationship to the economic income attributable to an asset. The establishment of relationships of all those analyses together ultimately has to come into a free cash flow forecast.

·         Be prepared for a low or indeterminate value, especially if the relationships are indeterminate. In such a case, a brand may carry little value. Business owners do not like hearing that. They may believe they have a legitimate and viable brand but cannot show any sort of economic value creation attributable to it.

·         Focus only on the economic activity attributable to the brand. Also look at its associated allocated overhead.

·         Consider the discount rate. Discount rates for brands are unobservable in the market. There is no capital asset pricing model (CAPM) for brands. Conventional discount rates used by the profession developed using CAPM are not appropriate for brand valuation.

Bottom line

Credible brand valuation is difficult, and the values are volatile. The market failure rates for branded products can be very high and the value creation can be difficult to measure. Many brands are not as valuable as their owners think. Further, many companies do not want to pay for a credible brand valuation analysis because it is expensive. It is labor-intensive and will almost always be an income-based model, which requires specific product measurement and demand forecast. Bottom line: There are no shortcuts for building a credible forecast for brand valuation.

For more on the topic, check out Mike Pellegrino’s evergreen guide on Intellectual Property Valuation.

A mix of stakeholders participated in a full-day roundtable discussion at FASB headquarters in Norwalk, Conn., on November 15. The topic: the FASB’s Invitation to Comment (ITC) on moving from the current impairment model for goodwill to one of amortization or a hybrid approach. Other issues included whether other intangible assets should be subsumed into goodwill and whether there should be more disclosures about goodwill and intangible assets.

The valuation profession was well represented at the roundtable—and so were users of financial information (including investors), practitioners, preparers, academics, standard-setters, and regulators. Members of the valuation profession have serious concerns over going back to a model that treats goodwill as a wasting asset. Here are some key points that were made during the morning session of the roundtable:

·         Most users support impairment—there is definitely “news” in an impairment charge. That is, it is not solely a lagging indicator of company performance (academic studies support this), so the impairment process is “overwhelmingly” useful as a signal of what’s to come.

·         The acquisition of a business assumes a going-concern premise, so the concept of goodwill amortization is not compatible with this premise.

·         In practice, an acquired firm and its goodwill get integrated into an operating or reporting unit and it becomes nearly impossible to track goodwill back to the specific acquisition in order to evaluate performance. Added disclosures about future impairment charges should talk about the reason—whether it’s because of the acquisition or the legacy operations.

·         The higher up you go in terms of the level at which you test goodwill, the less meaningful it becomes. Testing at the entity level (versus an operating-unit level) could mask poor performance at lower levels.

·         Goodwill has different elements, some which may be wasting but others may not be (such as synergies, as one commenter pointed out—but that’s debatable). Different companies can have very different goodwill elements of variable magnitudes. Some commenters are inclined to let management decide the useful lives of the components, while others disagree because you’ll get a wide disparity in lives.

·         Increased disclosures will be helpful (such as what the primary intangible asset was that the acquirer wanted), but there’s a concern about information overload.

·         If a default useful life is used with amortization, it should be set at a minimum of 10 years and allow for management judgment (with disclosure) and also triggering events. A commenter from Japan said they use a combination of amortization and impairment and most companies choose 10 years or less for useful lives (20 years is the max).

·         There is a general agreement that it is important for global standards (IFRS) to converge. The IASB is also exploring whether to amend its approach to accounting for goodwill, but it is divided about the benefits of reintroducing goodwill amortization to IFRS standards. The IASB plans to release a Discussion Paper in early 2020 for a 180-day comment period to weigh stakeholder interest in amending IFRS 3, Business Combinations and IAS 36, Impairment of Assets.

·         Speaking of convergence, commenters from the M&A world had different experiences about the impact of accounting rules on deals. One said that, at the margin, different accounting rules may scuttle a deal. When using an EPS model, acquirers will pay more when impairment is used versus amortization (academic research backs this up). But another commenter said that, in his 20 years of M&A experience, he never saw that happen.

·         In response to a concern about what methodologies valuation experts use in valuing intangibles, it was stressed that there is a “very robust” body of knowledge and standards that all experts follow, such as The Appraisal Foundation’s financial reporting valuation advisories and AICPA guides, such as the upcoming guide on business combinations.

What’s next: The FASB has done an excellent job of laying out the issues and soliciting comments from a wide variety of stakeholders. But this is just the first step. Next, the comments will be processed, and a presentation will be made to the FASB board, which will decide on what action to take. Typically, an exposure draft would be issued and go through one or more revisions before rules are finalized. This entire process can take up to several years to complete.