Let’s assume there is a real estate brokerage firm located in the Phoenix metropolitan area that has been in business for the last 30 years and is organized as a regular corporation. The owner wishes to transfer the trade name from the corporation to his LLC and requests the assistance of a valuation firm. How is the value of a trade name determined?
A commonly used method to value trade names is the relief from royalty method. This method is used to estimate the present value of future savings that accrue to the owner of an intangible asset by virtue of not having to pay royalties (or license fees) for the use of the trade name. Royalties can be charged on gross revenue, net revenue, or some other measure of cash flows.
The first step is to obtain market royalty rates for comparable trade names. This usually results in a range of market royalty rates. After the royalty rate range is determined, an analysis of various factors is performed and adjustments are made for differences between the observed trade names in the market data and the subject company. Some of the factors to look at are:
- How long has the trade name been in use?
- How consistently has the trade name been used on related products and services?
- How specific is the name– is it general and can it be used on a broad range of products and services or is it very specific?
- How broadly geographically can the name be used – does it have national appeal or only local?
- What is the potential for the trade name to expand its use to different products, services, or industries?
- Does the name have positive or negative connotations and reputation among customers?
- What is the quality of the name – is it perceived as respected?
- How profitable is the business – both in absolute terms and relative to competing trade names?
- How expensive is it to promote the name and what are the various means of marketing/advertising?
- What is the market share and market potential for the company, both in absolute terms and relative to competing names?
- How well recognized is the name?
Let’s assume the market data indicates a royalty rate range from 3% – 8%. After analyzing the above factors, we selected a royalty rate of 3% for the subject trade name. If the brokerage firm is expected to generate annual net commission revenue of $10 million, the royalties saved by owning the trade name are $300,000 per year. Assuming a tax rate of 40%, a required rate of return on the trade name of 25%, and an annual growth rate of 3%, the value of the trade name is $818,000 (rounded).
Having a good understanding of the value of each of the tangible and intangible assets held by a company can help an owner feel confident that he is achieving full value for a transaction, including the value of a trade name and its related royalty rates.
Source: Valuing Intangible Assets by Robert F. Reilly and Robert P. Schweihs, © 1999