Your company might spend millions of dollars on advertising and marketing, but none of that matters if your potential customers are confused about who you are and what you’re selling. Is a particular product yours, or does it belong to a different company? What if consumers don’t even know your brand exists?
For consumers to buy your goods, first they must be able to recognize your brand and your products. Yet achieving brand recognition takes time, even for the most successful organizations, according to a recent LegalZoom article, “The Value of a Trademark: What It Can Do for Your Business.” And as author Lisa C. Johnson points out, maintaining your brand over time to ensure it stays relevant in the public eye is even harder.
Despite these challenges, raising awareness of your brand will help your company generate sales and turn casual window-shoppers into paying customers who may support your brand over their lifetime. That is why trademarks are so important.
How Can Your Trademark Create Value?
To understand why trademarks can be valuable, you need to understand what a trademark is. The Trademark Act of 1946 — more commonly known as the Lanham Act — governs trademarks, service marks, and unfair competition. This federal statute defines a trademark as “any word, name, symbol or device or any combination thereof adopted and used by a manufacturer or merchant to identify his goods and distinguish them from those manufactured by others.” For your trademark to be eligible for protection, it must meet two basic requirements: First, it must be used in commerce. And second, it must be distinctive. Only by ensuring it fulfills these two obligations, and by using it in trade regulated by the federal government, can you register your mark with the U.S. Patent and Trademark Office.
Once you have surmounted these hurdles, your company can achieve substantial earnings through the use of trademarks. A successful trademark can conjure images in the minds of potential consumers, working at the conscious and subconscious levels, and cutting across cultural and linguistic barriers. In other words, consumers are more likely to purchase from your company if you’re known for quality products and services.
Trademarks associated with those quality goods and services, when they are repeatedly kept front of mind through campaigns that target the consumers who have purchased and were satisfied with the goods and services, ultimately can deepen customer loyalty, the value of which is immeasurable. Even so, the value of your trademarks can be determined, and it can be substantial, especially for the many trademarks that are recognized around the world.
Why Should You Value Your Trademark?
A trademark valuation may be required — or preferable — for a variety of reasons. Here are just a few:
- To comply with the requirements set forth in ASC 805 Business Combinations. For purposes of a purchase price allocation, you must state your acquired assets at fair value on the opening balance sheet.
- To comply with transfer pricing tax regulations pertaining to intercompany transfers.
To use as collateral for debt financing.
- To establish a starting point for negotiations when you wish to sell or license your trademark.
- For litigation support purposes, such as calculating damages for certain legal proceedings.
How Can You Determine the Value of Your Trademark?
There are three common approaches to utilize when determining the value of your trademark.
The first of these, the cost approach, is based on the principle of substitution, which states that no sensible buyer would pay more for an asset than what a similar, equivalent asset would cost. In applying the cost approach to your trademark’s value, it is necessary first to determine replacement and/or reproduction costs, and then to consider allowances for applicable forms of depreciation and obsolescence. You must consider any costs that would be incurred in order to replicate the recognizability and reputation of your trademark — obviously, a difficult and subjective exercise. Because of these challenges, the cost approach is not typically used in valuing a trademark.
A second option is the market approach, sometimes referred to as the “sales comparison approach” because it estimates value based on the cost of similar assets recently sold to other market participants. Using this approach, you will need to adjust your estimate to compensate for the inherent distinctions among similar assets, such as each asset’s age, condition, and capacity and the dates of the comparable transactions. Yet the sale of trademarks is uncommon except as part of the larger purchase of a going concern, and when such a sale does occur, relevant information on the terms of the transaction is generally not made public. Consequently, the market approach is likewise not typically used in valuing a trademark.
Finally, the income approach estimates a trademark’s value based on the net economic benefit — operating income or cash flow — over the life of the asset, discounted to its present value using a rate of return that accounts for various factors such as the time value of money and investment risk. A variant of the income approach, often called the “relief from royalty” method, is perhaps the most common way to value a trademark. Using this method, your company leverages ownership of your trademark as opposed to simply licensing it, in order to avoid paying a royalty (usually expressed as a percentage of sales) for use of the trademark on your own products and services. The present value of the after-tax cost savings (the “royalty relief”) at an appropriate discount rate indicates the value of your trademark.
In choosing the relief from royalty method, you must first determine a reasonable royalty rate to apply in the valuation, using one of two general methods: The first entails searching for and then purchasing suitable public market evidence pertaining to trademarks in your industry. The second method, also known as the “pretax profit method,” assumes a portion of the pretax profitability margin (often in the 25% to 33% range) as a reasonable starting point in a negotiation to license the trademark. For example, if your company has a pretax margin of 10%, then a reasonable royalty rate for the trademark arguably would fall in the range of 2.5% to 3.3%.
Why Hire a Valuation Analyst?
The methodologies involved in valuing a trademark are anything but straightforward, and the complexities lie in the details, such as determining a reasonable discount rate and royalty rate. A great deal of research, thought, and experience are required to properly develop these assumptions. To value a trademark properly, therefore, you should always employ a qualified valuation analyst — the benefits of doing so far outweigh the costs.
A well-respected trademark that consumers can easily recognize serves as a trusted symbol of quality and assurance. It can be a valuable asset for your company, offering brand recognition, enhanced profit margins, and a guarantee of reliability. What’s more, a trademark valuation could entice a larger entity to take a closer look at your company — and perhaps seriously consider acquiring it.