Intro » Valuation and licensing of intangible assets (using brand as an example)

Valuation methodology for trade mark rights in the context of the valuation objective

The Polish economic area has not managed to create in the period of over 30 years of history of the free market system a real market of trading in intangible assets, in particular brands. The majority of brand valuations so far have had the character of tax optimisation processes and most often concerned transactions between related parties. This did not reflect any authoritative principles of free market trading in brands.
In view of the above, in the case of brands, it is also difficult to speak of principles for estimating their market value, in the absence of an active market for trading this type of asset. Thus, when estimating the value of brands for transactional or contribution purposes - formally considered to be associated with market conditions - no other valuation procedure can logically be identified than one that is primarily based on the principles of assessing the brand's contribution to the value of its user's business area.
The guiding principle is to include as many estimation methods as possible in the valuation process, especially for companies with complex/variable financial situations. In addition, this is particularly valid for cases of companies with start-up characteristics.
The thesis that most valuation methods are based on analytical models, based on assumptions about the potential of the brand itself, but in isolation from estimating the potential value of the entire business, should be taken as an important principle. Meanwhile, the MVA [Market Value Added] model is key, with MVA = VB - IC, where VB is the value of the business area involving the use of the brand; IC is the value of the capital invested in the business area [normally determined by balance sheet items]. Since, for the majority of cases, MVA is originally identified with the concept of goodwill [reputation or IP - intellectual Property, which subsequently is identified with intellectual capital] or the accounting term 'Goodwill', it is therefore only logical that the value of the brand should not materially 'go outside' the MVA value area, as it is a component of it. Most often, brand value is only a part of MVA. Thus, the validity of using, among other things, the MVA model in the estimation process must be kept in mind, and this is the main reason why in the whole process the value of the business area itself [equivalent for corporate brands to the enterprise value] is also estimated at the beginning. Also with regard to this valuation area, the legitimacy of using multivariate [at least several valuation methods] in the estimation process should be recognised in order to carry out an optimisation of the entire process and minimise the risk of overestimating or underestimating the value of both the business and its MVA and thus its components [including the brand or so-called customer relations (CR) or technology, depending on what is the subject of the valuation].

How to select the value of a business area

In principle, a positive IP value is a confirmation of the real possibility of attributing to the business value the positive impact of intangible assets such as brand, CR, technology, etc. Determining a company's ability to generate goodwill in the long term is therefore a kind of canon for determining the positive value of the main off-balance sheet intangible assets.
Admittedly, the valuation of a positive brand value [in practice, it is difficult to imagine a negative brand value] can be obtained by several methods independent of the revenue generated by the entity and, for example, only revenue [e.g. based on sectoral average ratios]. This means that, for example, potential negative revenues of the entity are attributed to management errors, which from a universal point of view do not negate the brand potential based on a different management style. This is merely an assumption. However, on such a basis, brands in every industry could be reduced to the same financial parameters and their potential would only be differentiated by the level of sales revenue generated, which nevertheless seems a simplification too far.
As a result, it should be assumed that in order to establish the development prospects of the brand and to demonstrate the possibility of shaping its potential in the long term, establishing the development prospects of the business and indicating that a stable and correct balance sheet structure is achievable for the company forms the basis of the analysis in question. This is because it is difficult to analyse with full economic sense the brand potential of an entity in respect of which, for example, the characteristic of current and hitherto systematic economic unprofitability [i.e. in simple terms the excess of the asset value over the income value of the company] is indicated. Therefore, in spite of everything, the sense of valuing a brand in the context of its market value nevertheless requires a description of the conditions and circumstances under which the goodwill of an entity can remain positive in the long term.
Thus, as part of the analysis, it is worth noting the following important factors:
a) The current economic and financial position of a company is not entirely shaped by strictly market factors, but sometimes by the effects of the development phase in which an economic project may be implemented.
b) As raised in the commentary, the determination of a company's development prospects - in view of the circumstances and its specifics - cannot be based on historical trends alone, but is in principle entirely a matter of accepting the speculative nature for the expected effects of the entity's investment intentions. The point, however, is that these speculative assumptions should not be arbitrary, but should be based at least on the valuation statistics of similar companies [if available].
c) If, as part of the procedure for valuing an entity, a financial plan was created for assessing its future business prospects, this plan was created in conjunction with the assumptions of the speculative models used as part of the valuation.
In summary, among the several results of the business area valuation for the analytical purposes of estimating the value of the brand, it would be advisable to consciously select a result that represents a weighted average of a possibly representative number of methods for estimating the value of the brand business that represented the most consistent range of valuation results.

Interpretation of the correlation of brand potential with customer relationship potential [CR]

The contemporary trend is to include the concept of customer relations [usually interpreted as contractor databases, CRM] within the IP components of companies. According to the model in question, the areas corresponding to the potential of a brand [or portfolio of brands] and CR co-create the potential of the MARKETING area within IP [possibly other components such as Internet domains, but these generally represent a trace value towards brands]. Other IP components are active within other areas such as MANAGEMENT, TECHNOLOGY and R&D. This interpretation requires a clear distinction between brand and CR potentials within the valuation.
A good comparative area for establishing brand and CR parity is the company's sales structure and measuring what proportion of customers cover a predictable proportion of sales. It is at most this proportion of customers that it makes sense to attribute the potential of CR to, as they perceive other elements in the business relationship with the company than the brand itself. The nature of these two quantities is derived from the type and specificity of the business [B2B or B2C], but especially in the case of the areas of industrial products and services [rather than FMCG] the role of CR cannot be overestimated.
In addition, it is important to consider what is meant by the term 'customer' in the specific case of a business area. In many cases, companies have direct customers and a significant proportion of customers who are simply trade intermediaries, distributing the products purchased from the company in their regional markets. It would therefore be difficult to put an equal sign between the incentives obliging both of these groups of customers to have business relations with the company and to posit that for both, the potential of CR is proportional to the value of their turnover with the manufacturer.
In conclusion, the proposed solution can be regarded as reasonable.

Level of estimation of operational parameters for brand valuation

The principle that the operating profitability of a brand user's business is adjusted upwards by the share of general and administrative expenses [G&A] in sales should be considered important when valuing the potential transaction value of a brand. This is based on the view that the potential buyer of the brand operates in the same industry and, once acquired, will no longer duplicate this cost area.
In specific cases, this type of adjustment is generally not taken into account in the valuation process on the basis of the circumstances. In view of this, the result of an income valuation will not be exaggeratedly different in plus from the results of several other estimation methods and often merits inclusion in the weighted average.
Therefore we come to the conclusion that the valuation of selected intangible assets such as the brand or CR requires, in order to ensure the application of prudent valuation principles, de facto valuation in turn:
- the value of the business area of the whole company;
- the value of the intellectual capital (IP);
- the value of the know-how zones comprising the IP [MARKETING, MANAGEMENT, TECHNOLOGY, R&D];
- the value of designated intangible assets within the aforementioned know-how zones.
Particularly in the case of the brand and/or CR, it is directly advisable to determine the impact on the value of the MARKETING know-how zone of both the brand and CR, and this regardless of which of these parameters is the direct purpose of the valuation. In addition - the methodology for brand valuation is far more differentiated than CRM valuation, and this provides an additional argument to link CRM valuation to the brand valuation procedure.

Valuation concept in terms of the time factor

In accordance with economic principles on valuations, the very procedure of estimating the value of assets in monetary units is always to establish their value in the perspective of the benefits that these assets can potentially bring to their owner in the future [i.e. the reference period of the valuation, taking into account the concept of the so-called residual value (RV)]. Any ex post data analysis is carried out with the sole purpose of minimising financial planning risks. If, therefore, the thesis is formulated that the valuation is based on historical data, it represents a kind of portentousness, since historical profits can no longer bring a tangible benefit to the contemporary user, except within the asset value of the company's infrastructure, thanks to them.
However, this is only one aspect of the valuation, usually a materially 'minority' one, since the main economic potential of businesses considered viable lies in their ability to create future profits rather than in the value of the assets. There is also the aspect of market analysis that can lead to the conclusion that ex ante business conditions may be different from those previously prevailing, resulting in, for example, the acceptance of greater risk of that business and thus more stringent profitability forecasts or acceptance of higher discount rates. In summary, therefore, the analysis of historical factors within the analysed business provides an overview of the planning area, but does not absolutely guarantee it 100% as a certainty. Therefore, the concept of valuation on an underlying basis always refers to the future benefits of the assets acquired, not to historical benefits. In particular, this applies to business operations.
The above does not contradict the thesis already made that weighted averages, illustrating ex post activity, should be included in the form of future financial effects. Indeed, it is first and foremost a question of the purpose of the valuation, i.e. the issue of to what extent the acceptance of speculative planning assumptions can be considered authoritative in estimating the current value of an economic entity and to what extent not - given precisely the purpose for which the estimation process is carried out.

The time factor (period of financial forecasts) in the case of intangible assets

In particular, in the aspect of valuing certain intangible assets, the issue of the life cycle of these assets additionally arises. E.g. trademark rights can be renewed indefinitely in 10-year cycles, but industrial or utility models and patents are only granted to creators for a specific period of time, in the range of 20-25 years. Therefore, logically, valuations of these assets should not automatically take into account the residual value. CR, according to some opinions, is clearly a time-limited component of IP, which can be argued against. Indeed, the measurement of the duration of a consumer's use of a GSM telephony subscription may be for a limited period of time [month, 1 year, 2-3 years], but only market statistics can give an answer as to how much on average such a subscription on a given network is rolled over for successive periods.
Topical periodicals and weblogs define the average lifecycle of an individual customer [B2C] for SaaS or e-commerce services at 20 years, which is practically almost equivalent to the value of a perpetual annuity [i.e. the residual value formula for revenue]. In the case of B2C, thinking about the life cycle of a corporate customer - with its long-term purchase history confirmed - is rather unwarranted. In practice, its potential loss in the foreseeable future will be offset by the acquisition of other customers. The preference for reducing the lifetime value of customers is in clear contradiction to the long-term revenue and income projections built for corporate valuation purposes. Of course, CR's potential can and does change over time, but this is a regularity for any valued intangible asset. Effective consideration of this principle relies solely on periodic verification valuations of assets at specified intervals; there are no other equally effective criteria.

CONCLUSIONS ON THE PRINCIPLES FOR LICENSING INTANGIBLES' COMPONENTS WITHIN BUSINESS PROJECTS:

In the context of the process that is the design of a know-how licensing scheme [as a business secret], it should be noted that:
a) Licensing terms should always take into account the payment capabilities of the licensee [LB], for only then do they make real sense. It is unacceptable that the selection of these conditions completely disregards these possibilities.
b) The so-called "benchmark" methodology, which is popular and promoted in Poland [based on a certain "Western fashion" and most often by foreign consulting companies or national counterparts uncritically imitating them] could still be applied at most in the case of very widespread markets, usually involving fast-moving products [FMCG], for which the level of operating profitability, e.g. in the EU and Poland, can be considered sufficiently transparent. This is due to the simple fact that there is simply no real active licensing market in Poland and therefore any databases are only built on transactions relating to Western markets [mostly the USA, by the way]. Thus, all "benchmarks" are usually derived from there and their representativeness for economic conditions in Poland is usually questionable, or at least controversial.
c) In the case of highly industrialised, high-tech products, on the other hand, the "benchmark" rule works even less well in practice, and with regard to the Polish market in particular, the payment capabilities of domestic licensees are most often significantly limited compared to their Western counterparts.
d) Realistic design of a procedure for licensing IP components to an external licensee [or licensees] therefore generally requires a good understanding of the economic and financial situation of this or these potential counterparties as well as being dependent on several other areas of decision-making [such as, among others the very reason and purpose of licensing, the choice of whether or not to license exclusively or non-exclusively, whether or not to include the possibility of sub-licensing, and others such as the capital intensity of the business, which is poorly represented in operating profitability indicators (because capital expenditure is not a category of operating expenses and depreciation does not reflect investment activity in a sufficiently representative manner)].
A final conclusion as to the nature of the analytical findings of the licensing model - in the case of a specific valuation, a licensing agreement may most often only have a hypothetical character, as, for example, there is no data that the principal is considering the use of this form of delegating the benefits arising from the use of the brand in business. At the same time, it is worth noting the pragmatism that characterises the determination of potential and realistic licensing terms in view of the characteristics of a specific asset and the financial performance of a specific entity. This pragmatism makes it possible to add a representative valuation model to the methodological palette, and it is this aspect that justifies the use of the licensing contract optimisation model as one of the brand valuation methods. And since this is the case, the thesis that the valuation value of the subject of licensing should, under the perpetual annuity formula, correspond to the value of the discounted royalties is justified. This allows the use of several methods within the income approach, thanks to which it is possible to establish adequate multipliers shaping the amount of licence fees related to differentiated bases, both revenue and income.
In specific cases, the alleged licensee may be a business structure under commercial law, so the basic principle indicates that in a licensing scheme the essential requirement is the feasibility of the licensee's ability to cover the royalties. Hence the criticism of databases, as these do not take into account the specific capabilities of a particular company, as they are usually sourced from foreign markets. In particular, it is worth considering which reference base for calculating royalties would be most reasonable under the circumstances. Popular sales has the negative feature that it does not take into account the capital intensity of the business at all, i.e. the scale of investment activity required. Good for foreign counterparties is rather not recommended for companies within the same capital groups. On the other hand, a better basis in this respect, in the form of e.g. POS [Profit On Sales], may prove critical for the licensor when the licensee generates not profits but losses for several seasons.
In these circumstances, a good solution is to set a minimum lump sum fee, which is a part of the licence fee for a given period [month, quarter or year] that the licensee should cover even despite the financial losses incurred. It is assumed in practice that such a lump sum fee should not exceed 30% of the total licence fee for the period in question, as envisaged in the business plan. The inclusion of a lump-sum fee is the licensor's prerogative; under Polish conditions this construction is rather very rare.

Usefulness of the licensing model for valuation purposes

Typically, the licensing model [or more precisely the LCOM - Licensing Contract Optimisation Model] is fully applicable in practice, as this procedure itself is used to justify and substantiate viable licensing principles. Thus, it either confirms or contradicts a certain valuation result, and this forces the analyst to revise the planning assumptions made.
In addition, it should be noted that the valuation author is often not fully aware of the final decisions of the principal, viz:
a) whether the brand will be licensed by an individual to a company;
b) whether the brand will be contributed to the company in kind;
c) whether the brand will be sold to another company.
Thus, the analytical principles adopted go out of their way to implement each of the aforementioned solutions.

Valuation and licensing of intangible assets (using brand as an example)

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