Back in 2010, Diamond Foods, Inc. completed its acquisition of Kettle Foods, a premium potato chip manufacturer. Diamond paid approximately $616 million for Kettle Foods and $235 million, or nearly 40%, of the purchase price was allocated to “brand intangibles.” Such a high value leads to the question: How are such valuations determined and what are the drivers?
Whether it’s the name of an entire business or a single product, trade names can represent substantial value in business transactions and are recognized as a marketing-related intangible asset under ASC 805. ASC 805 states:
“Trademarks are words, names, symbols, or other devices used in trade to indicate the source of a product and to distinguish it from the products of others.”
Generally the relief from royalty method is used to determine the fair value of a trademark or trade name. The relief from royalty method seeks to measure the incremental net profitability generated by the owner of the subject intangible asset through the avoidance of royalty payments that would otherwise be required to enjoy the benefits of ownership of this asset.
Applying the relief from royalty method requires several steps:
- Determine the future use of the trademark. How will the acquired asset be used? Will it be phased out over time or is it a crucial part of the business? Do management’s expectations for the trademark differ from those of a market participant?
- Determine the expected stream of revenue related to the trademark. If there are multiple products or service lines, what are the projected revenues for each product line and its associated trademarks or product names? How long are the associated products or services expected to generate revenue? For some businesses this may be into perpetuity (e.g. Coca Cola), but for a trademark associated with certain technology or products, it may only be a few years.
- Determine an appropriate royalty rate to apply to the expected revenue stream. What would a market participant pay to license a similar trademark? What do the structure and terms of the transaction indicate about the value of the trademark? The presence of earn-out payments that are based on a percentage of revenue can serve as an indicator for the base royalty rate. Additionally, higher margin products generally demand higher royalty rates. Market data concerning royalty rates can be found in SEC filings, legal agreements, or by providers such as ktMINE and RoyaltySource. Royalty rates that are comparable to the subject transaction should be reflective of transactions in the relevant industry.
- Determine an appropriate discount rate to measure the present value of avoided royalty payments. The risks associated with a trademark may differ from the risk of the business as a whole. Identifying additional risks or benefits ensures a more accurate measurement of the fair value of the trademark.
The professionals at Mercer Capital are experienced in valuing trademarks and trade names in numerous industries. Please contact us to find out how we can help you measure the fair value of acquired intangible assets.
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