Can Brands Be Valued Using Relief from Royalty Method Only?

Guidance from AICPA’s 2024 Accounting and Valuation Guide—Business Combinations

There are various methods used to value intangible assets. The relief from royalty method is based on the premise that there are royalty savings if the acquiror acquires the asset instead of licensing it. The value of the asset is calculated as the present value of after-tax royalty savings over the economic life of the asset. This article delves into the available methods used to value brands.

When a company acquires another company, the acquiror may need to perform a purchase price allocation. In essence, the purchase price allocation (PPA) analysis apportions the purchase price to various tangible and intangible assets. This allocation is generally required to record the intangible assets on the acquiror’s balance sheet.

The first step in recording the intangible assets is identifying which intangible assets need to be valued. An intangible asset is identifiable if it meets either the separability criterion or the contractual-legal criterion.[i] This step involves discussions with management about various factors, including motivation behind the transaction, the importance of various intangible assets in the business, ownership of the intangibles, and the relative value of the intangible assets, among others. The intangibles that are recognized and valued also depend on whether the accounting alternative is selected by the company. Some customer relationships and non-compete agreements are not recorded if the accounting alternative is chosen.

The categories of intangibles that can be acquired include marketing-related intangible assets, customer-related intangible assets, artistic-related intangible assets, contract-based intangible assets, and technology-based intangible assets.[ii] Marketing-related intangible assets are primarily used in the marketing or promotion of products or services.[iii] Some examples include trademarks, domain names, non-competition agreements, among others. The term “brand” generally encompasses a group of complementary assets such as brand names, tradenames, and trademarks.[iv]

There are various methods used to value intangible assets, which can be categorized under three fundamental valuation approaches: income approach, market approach, and cost approach. Some of the commonly used methods are multi-period excess earning method (MPEEM), relief from royalty method (RFR), with and without method, distributor method, and replacement cost method. The MPEEM method is specific application of a discounted cash flow method where residual cash flows specific to the intangible asset are calculated by subtracting contributions of all other assets. These cash flows are then present valued over the economic life of the asset to derive the value of the intangible asset. The RFR method is based on the premise that there are royalty savings if the acquiror acquires the asset instead of licensing it. The value of the asset is calculated as the present value of after-tax royalty savings over the economic life of the asset.

Commonly, MPEEM was used for valuing primary assets in business, while the RFR method was used for valuing brands. However, the recent Accounting and Valuation Guide—Business Combinations[v] (guide) published in 2024, states that “Specific valuation methods, such as the MPEEM, are not required to be used for pivotal assets.”[vi] The guide further defines pivotal asset as “An asset that provides an owner or licensee with the ability to create a significant amount of the excess profit in the business unit or value chain. Pivotal assets’ functions are not available from alternative sources because they are unique or scarce assets. An iconic brand name is an example of a pivotal asset.”[vii] Regarding the use of any default method for brand or any other asset, the guide states that “The characteristics of the acquired intangible assets should drive the selection of the valuation technique as opposed to relying on defaults (such as defaulting to a RFR method to value a trade name, trademark, or brand).”[viii]

A brand can be valued by using multiple approaches and methods depending on the facts and circumstances. It can be valued using the income approach with methods like MPEEM and RFR, or the cost approach with the replacement cost method. Though a market approach might be applicable in some cases, it is rarely used to value the brand. When selecting a valuation technique to value a brand (or any other intangible asset), the AICPA guide emphasizes first the use of “substance over form.” Secondly, it may be helpful for the valuer to determine certain attributes of the intangible assets, such as relative importance of the asset (pivotal or routine), nature of the asset (relationship-based or intellectual property [IP]-based), and underline economics of the asset (licensed or owned). Furthermore, the valuer needs to consider if the rights reacquired.[ix]

Brand is considered an IP-based asset[x] and not a relationship-based asset. First, when considering the “substance over form” principle, if the royalty rates are readily available and the brand is routine, the use of the RFR method might be more appropriate.[xi] If the brand is owned and is a pivotal asset, it might be appropriate to use both MPEEM and RFR. One method can also be used as a corroboratory check for the other method. In this case, if the RFR method is used, then the royalty rate can be higher than the market royalty rate based on the brand’s strength, protection, competitive advantage, and other factors. If the brand is owned and is a routine asset, it can be measured using the RFR method using a market royalty rate, or the replacement cost method under the cost approach, or any other appropriate method. The replacement cost method might be appropriate if the brand is new, some trademarks have been registered recently, and the cost spent on the brand is available.

In addition to the above attributes, the choice of method can also depend on the following:

• Availability of inputs—The RFR method requires the use of a royalty rate. There might be some challenges in selecting comparable royalty rates. Firstly, the comparable royalty transactions might not be available. Secondly, comparable royalty transactions which are available may be dated and may not provide an accurate representation of the royalty rate as of the measurement date. Thirdly, the comparable royalty transactions might be bundled. This means that the licensing transaction includes licensing of other assets like knowhow and/or technology in addition to the brand. In such transactions, it might be hard to estimate a royalty rate only for the brand. Fourthly, the royalty rates might not be as a percentage of revenue but depend on other financial measures like net income. Furthermore, the guidance advises to avoid the use of “rule of thumb” where royalty rate is assumed to be 1/4 to 1/3 of the profit margin to determine royalty rates.[xii] Instead, the guide encourages the use of simulated royalty rates[xiii] if the market royalty data is not available.
• Availability of valuation methods for other intangible assets—It is generally not advised to use MPEEM for multiple intangible assets to avoid the issue of contributory asset cross charges. If a situation arises where MPEEM seems more appropriate for a customer relationship asset or any other asset, valuers can consider applying the RFR method to the brand.
• Availability of full projections—Sometimes, instead of full cash flows as required to apply a MPEEM method, estimates of only revenue might be available. In such cases, RFR might be applied.
• Sole pivotal asset—If the brand is the only pivotal asset, both the MPEEM or RFR method can be used, but if there are two pivotal assets, the method selected to value the brand needs to be based on the other intangible asset. For example, if the other pivotal asset is customer relationships, the valuer may choose the MPEEM method for customer relationships assets and the RFR method for the brand. Given relationship-based assets are not licensed, commonly they are not valued using the RFR method. If the brand is a solo pivotal asset, it might be valued using MPEEM, and RFR can be used to corroborate the value or vice versa.

In addition to choosing the right valuation technique, it is also important to consider selecting some other valuation assumptions. First, the economic life of the asset. The factors to consider determining the economic life of the brand might include the history of the brand, the age of the brand, marketing spend on branding activities, acquirors and market participant intention to keep or replace the brand, strength of the brand, and others. When using the MPEEM method for valuing the brand, consideration can be given to adding back any advertising and promotion expenses expected to be spent on branding activities. When using the RFR method, consideration can be given whether royalty rates are gross or net. If the rates are gross, the valuer might have to make adjustments to arrive at the net royalty rates. It is also important to consider revenue contributed by brands. If any products are white labeled, it might be appropriate to reduce some of these revenue streams.

Overall, the brand can be valued using any of the income, market, or cost approaches depending on the attributes of the brand, and other facts and circumstances. Whether the brand needs to be valued using the RFR method can depend on a combination of factors, including but not limited to, significance of brand to the business, the nature of the brand, its relative importance, whether it is owned or licensed, and availability of market and management data.

[i] Financial Accounting Standards Board (FASB), Accounting Standards Codification (ASC) Topic 805-Business Combinations, Subtopic 20 – Identifiable Assets and Liabilities, and Any Noncontrolling Interest, 25 Recognition, FASB ASC 805-20-25-30. Source: https://asc.fasb.org/1943274/2147479876/ .

[ii] FASB ASC 805-20-55-13.

[iii] FASB ASC 805-20-55-14.

[iv] FASB ASC 805-20-55-18.

[v] Accounting and Valuation Guide, Business Combinations, by Association of International Certified Professional Accountants (AICPA), published in 2024. This AICPA Accounting and Valuation Guide (AICPA guide) has been developed by the AICPA Business Combinations Task Force (task force).

[vi] AICPA guide paragraph 11.08.

[vii] AICPA guide, Glossary, page 525.

[viii] AICPA guide paragraph 13.03.

[ix] AICPA guide paragraphs 11.13–11.14.

[x] AICPA guide page 211.

[xi] AICPA guide paragraph 11.16.

[xii] AICPA guide paragraph 11.24.

[xiii] AICPA guide paragraphs 11.22–11.24.

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Meenal Aggarwal, CVA, is a certified business valuation professional specializing in the valuation of private stock, intangible assets, and complex securities. She has expertise in business and stock valuations (ASC 718, IRC 409a), purchase price allocations (ASC 805), goodwill impairment analysis (ASC 350), complex securities (ASC 815), convertible debt, and warrant valuations. Her valuations are used for financial reporting, tax reporting, and strategic purposes. She is the founder of Groots Valuation LLC and previously worked at Deloitte and PWC.

Ms. Aggarwal can be contacted at (201) 920-7214 or by e-mail to meenal@grootsvaluation.com.