An organisation’s brand encompasses all that it outwardly displays to the world. So why are brands often under-valued and deprived of investment?
A dedicated strategy
Brands take careful strategy and years of focussed effort to create. Brands encapsulate all that distinguishes an organisation’s products and services from its competitors and may consist of unique recognisable logos, names, trademarks, online presence, etc.
The marketing of products and/or services is one of the most important aspects of any business. A lot of time and hard work goes into establishing a brand, conducting market research and developing relationships with manufacturers, distributors and customers. Brand awareness can be the difference between being recognised or disappearing in a competitive market.
Often taking years to develop, it’s important to have a strategy in place to ensure that the importance and value of each brand is maintained, remains relevant to its intended audience and is not eroded. Here are a few examples of exploiting the potential of a brand portfolio:
- Advertising – continued investment in a brand can help ensure that a brand increases its value through use. It’s important to re-energise brands (as required) to enable the achievement of commercial value through prolonged, consistent and extensive advertising.
- Pricing – depending on your brand strategy, when a brand is successfully developed, customers should be willing to pay a premium for that branded product or service. It’s often best not to compete on price where the fundamental value of a brand lies in its premium image.
- Brand strategy – as discussed above, a brand strategy should be established for the portfolio of brands. For example, a key brand with high levels of market perception could be used as the ‘parent’ brand for a series of sub-brands.
- Licensing – consider licensing brand/s to third-parties which may be better placed to exploit the brand in certain markets. The terms of licensing arrangements should be agreed up front and renewed at regular intervals.
Identification and recognition
Once developed, brands should be nurtured as a primary source of revenue and profit. However, it is often misunderstood when a brand can be recognised in a company’s financial statements. This can only occur post a transaction, when the value of an acquired brand is identified, valued and recorded on the acquirer’s balance sheet, therefore crystallising a brands’ value for future exploitation.
This does not mean however, that a brand does not have importance or financial value prior to a transaction. The creation of brands can enhance and generate cash flow at any point in time, however, for financial reporting purposes the formal identification, valuation and recognition of brands in an acquirer’s financial statements will occur at the completion of a successful transaction.
There are strict criteria that must be satisfied in order to qualify as a brand and to be recognised and recorded on an entity’s balance sheet. These include considerations around elements such as: identifiable, separable, controllable, generation of (probable) future economic benefits; materiality and reliability of measurement.
Further to this, it’s important to regularly review brand ownership, and/or ensure compliance with any brands under licence arrangements with third parties.
Brands are often under-valued and the impact of a strong brand on an entity’s profitability can be crucial. It’s important to remember that brands not only generate revenue, they can also deliver a premium price for the relevant products and services.
The value of a brand relates to the long-term effect to an entity, should that brand be lost or damaged. Therefore, the income approach is typically adopted to determine the value of a brand.
The income approach estimates the value of an asset (i.e. brand) based on the income that the asset can be expected to generate in the future. This approach is typically applied through a discounted cash flow (DCF) method or capitalisation of earnings method.
The relief from royalty method (which is a form of the DCF approach) is commonly used in the valuation of brands, patents, licences and franchises. The relief from royalty method is derived from the economic theory of deprival value, whereby it is assumed that the business does not own the intangible assets under consideration and therefore has to pay a royalty to the owner of the intangible asset for its use. The value of the intangible asset under this method is the capitalised value of the royalties that the company is “relieved” from paying as a result of ownership of the asset (after deducting the costs associated with maintaining the licensing arrangements). The cash flows attributable to the intangible asset are typically discounted to their present value.
The key elements of the application of the relief from royalty method are discussed below:
- Revenue projections – relates specifically to the brand and incorporate future expected growth;
- Royalty rate – determined based on the hypothetical royalty rate that would be paid if the intangible asset was licensed from an independent third-party owner, inclusive of costs associated with maintenance of the brand. In arriving at an appropriate royalty rate assumption consideration should be given to:
- research licensing transactions with comparable assets;
- qualitative factors such as the brand strength, nature and characteristics of the brand, reputation, market share, relevance/ importance, etc.;
- analyse operating margins;
- Expected time horizon for the brand –determined by the length of cash flow and whether the brand has a finite expiry or is expected to continue into perpetuity.
- Taxation – determined based on the prevailing corporate tax rate applicable to the cash flows.
- Discount rate –an appropriately derived risk-adjusted discount rate, typically a weighted average cost of capital (which is a weighted average of the rate of return on each class of capital).
The fair market value of the brand is the net present value of the prospective stream of hypothetical royalty savings that would be generated over the expected useful life of the brand.
As a cross-check, there is a rule of thumb that suggests the royalty rate used in the relief from royalty method should be around or no more than 30 per cent of the EBITA margin derived from the operations, reflecting the assumption that there should be a sufficient residual return after paying the notional royalty.
Brands enhance the value and reputation of a business, so it’s vitally important to preserve and protect the brands. It takes years to create a reputable brand, however brand damage can have irreversible negative impacts relatively quickly.
From a formal perspective, protection can be obtained by registering (and renewing) brands as trade marks in all countries in which the company operates, or intends to operate. It’s also suggested to establish branding guidelines which specify the layout, font, content, rules and restrictions associated with each brand. Thereby ensuring that brands are consistently represented in selected markets.
From a financial reporting perspective, it’s important to continually enhance the value of brands recognised and recorded on an entity’s balance sheet. Brand values will be subject to impairment testing annually, therefore a careful brand strategy that includes protection and growth will help ensure that brand value is not eroded and/or subsequently impaired.
Do you have a brand that requires identification and valuation? We would be happy to assist and have valuable experience in the valuation of brands and other intangible assets. Further, we liaise with clients and their auditors in regard to the valuation and protection of the reported value of brands for financial reporting and impairment testing purposes. Brands are an integral part of any business and we are skilled at understanding how to capture and recognise this unique value.
Nicole Vignaroli MAppFin, BBus, BA, F.Fin, Aff.CA
Partner – Corporate Finance
Ph: +61 3 9258 6701