How Is Brand Valuation Calculated?

Understanding How Is Brand Valuation Calculated?

The brand may be the most important asset of a company, and yet it is not shown on the balance sheet with a definite price tag attached. Calculating brand value is akin to asking a simple question: What is the value of a company’s name, reputation and customer loyalty in dollars and cents? It involves a combination of marketing intelligence, financial modelling and market information, and is used in mergers, licensing agreements and financial reporting – and can be the most hotly debated number in a seemingly simple deal. Learning the fundamental brand valuation techniques is very useful for junior and mid-level finance, marketing, or valuation advisory professionals, as they will be used in both interviews and in routine practice. In this article, I’ll take you through how financial brand valuation is actually done with real-life examples, typical traps and wisdom from real engagements. 

What Is Financial Brand Valuation and Why Is It Calculated?

Financial brand valuation is the method of determining a brand’s worth as an individual identifiable asset, apart from the whole goodwill of a business. As opposed to inventory or equipment, a brand is not a physical good, but rather something with more intangible value, provided via customer loyalty, pricing power, and the ability to charge a premium on products or to be more easily able to move into new markets than an unbranded competitor. This indirect relationship between the brand and the cash it ends up generating is why it’s tricky to do the math: Two companies can sell essentially the same product at vastly different prices in the market; the price difference is virtually all customer perception of the brand behind the product. These intangible attributes must therefore be put into some number that can be audited and tested by investors and counterparties in a transaction – an approach that must be structured and evidence-based rather than simply reputation-based. Part of the reason is that financial brand valuation has become a specialised discipline, nestled between traditional corporate finance and marketing analytics, to which financial modelling and understanding of the qualitative aspects of customer behaviour are equally necessary.

In the business world, brand valuations can be used in a variety of situations, such as when a company merges with another, is acquired by a parent company, is involved in a trademark dispute or is required to report on the value of its intangible assets in accordance with a business combination. While the use is different in each of these engagements, and therefore the degree of conservativeness or aggressiveness of the valuation number will vary, each of these parties is calculating brand value in some fashion. One of the first and most important lessons that professionals entering this field should learn is that the same brand could demand different methods of valuation depending on the objective of the valuation. Although both types of brand valuation may use the same underlying methodologies, a brand valuation undertaken for financial reporting will usually require more detailed documentation and adherence to accounting standards than a “firefight” valuation intended to support an internal strategic discussion. 

Which Brand Valuation Methods Are Most Widely Used? – How Is Brand Valuation Calculated?

There are a number of tried and tested methods for valuing a brand, based on different approaches to understanding the origin of a brand’s value. The cost approach values the brand based on the total investment in the development of the brand, which consists of all product research and development, promotional expenses and advertising expenditures, and the market approach involves determining a defensible multiple or price point from comparable brand transactions that are reasonably likely to have occurred in the same industry and with similar terms, a method that is effective in industries where brand sales are relatively frequent and terms are at least partially disclosed. The income approach, on the other hand, values the future economic benefit that the brand will provide, usually in the form of incremental revenue, the brand’s pricing leverage or cost savings that can be linked to the brand specifically and not to the business in general. A fourth, widely used, method lies between the market and income methods, and it is the estimation of the royalty that the company would have to pay the third party if it were to acquire the right to use a brand of comparable strength; this method is particularly appropriate if there are reliable licensing benchmark data available for the industry in question.

The table below outlines four frequently used methods, and the fundamental logic behind each method, as well as the primary limitation of each. Professionals embarking on their first brand valuation assignment will find this table to be useful. It’s not always the case that simply choosing any method that comes to mind for a situation is the right thing to do, and it’s quite common to be able to tell the difference between an analyst who knows a method works and one who does it without understanding the reason. The interviewer in this space often asks candidates to explain why one method is appropriate for the circumstances and not just give them the mechanics of the calculation. 

Table 1: Comparing Brand Valuation Methods – How Is Brand Valuation Calculated?

The relief-from-royalty method has proven to be one of the most commonly used of all brand valuation methods, especially when it comes to financial reporting, because it is a relatively easy-to-perform approach to estimating value based on available benchmarks from observable royalty rates from licensing deals in a similar or comparable industry. But the expert never uses only one of these techniques, and instead performs a few to compare across two or three methods to provide a cross-checked figure to present to auditors or counterparties that they can defend. What is most likely to be questioned (even if the underlying math is correct) is a valuation based on but not backed up by another valuation procedure, by a sceptical auditor or by opposing negotiators. 

What Are Five Key Steps in the Brand Value Calculation Process?

When valuing a brand, it is important for professionals to go through a specific process rather than jumping straight into a financial model without getting to know the true market standing of the brand. The five steps below are a typical process which brand and valuation experts follow from the early scoping stage to a defensible final figure.

First, be sure to have a clear purpose to guide the valuation, as a company’s valuation for financial reporting will vary significantly from a valuation performed to support a licensing negotiation or a litigation issue. Second, collect market and financial information about the brand’s performance, such as revenue growth, pricing compared to competitors and customer loyalty indicators; this information is integral to placing a value on the brand, not just because it is essential to the valuation, but also because it provides objective evidence of the brand’s performance instead of subjective perceptions, which often emerge as credibility issues later in the valuation. Third, choose a valuation approach (or combination of approaches) that is best suited to the information that is available and the purpose of the engagement; the income approach should be used when reliable predictions can be made, and the relief-from-royalty approach should be used when there are comparable licensing data. Fourth, use the correct discount rate for the brand and industry being valued, as adopting a discount rate from a different industry or brand could have an impact on the results – especially for brands in industries and markets with unusually volatile price swings relative to other markets. Fifth, test the valuation number to see how it holds up in the real world, e.g., similar transactions in recent history, or independent brand strength indices, to ensure that the valuation number is reasonable before making it public for stakeholders to review. One of the most common pitfalls of newer professionals wanting to get to work on creating a financial model is leaving the scoping step out of the process altogether, though the objective set at the beginning of the engagement should inform almost all of the decisions made thereafter, such as which data to focus on obtaining and how conservative the figure should be presented. It is better to go through the five steps one at a time than to rush to the momodellingo that early results on data characteristics and data use will indicate which later steps need particular focus. 

What Real-World Examples Show About Brand Valuation Methods?

Think about a small beer company that wants to use its leading brand in a new country, but doesn’t have the money to invest in setting up retail operations. The valuation team used the relief from royalty method, basing the royalty rate calculation on the royalty that the distributor would have to pay an unrelated third party for a similarly strong brand with a comparable level of market recognition, as this methodology was an appropriate option for the beverage industry given the degree of market recognition and reasonably well documented data on the industry’s benchmarks for licensing. The initial benchmark was drawn from a wider beverage industry database, but the negotiation was derailed when the distributor’s advisors pointed to the fact that the beverage brands in the database were much more well known in the target market than the client’s brand. A more limited and comparable group of regional licensing rates were used to revise the valuation downward, which resulted in a rate that both parties agreed was fair. The lesson for junior pros on similar engagements is that no matter what, the broad industry number is a good starting point, but it’s almost always in need of specificization and stress-testing to the actual level of recognition that exists in the brand’s region before either party will give it the benefit of the doubt.

A second example is a retail firm’s efforts to preserve the value of its brand in the face of a shareholder dispute following a proposed acquisition, where the accuracy of the underlying brand worth calculation was key to the structuring of the eventual settlement. The company’s initial was based on the cost approach, which added up marketing costs from the last ten years, yielding a relatively low value compared to what the marketing company would be willing to pay just for the brand. This was a flashpoint in the dispute and became the major issue. Independent valuation consultants, however, contended for a more income-centric valuation, based on the brand’s pricing premium over private-label options in the same product category, resulting in a significantly higher and more defensible valuation. This lesson is a financial brand valuation one I see repeated often and often: the cost approach is easy to determine, but can give a lowball valuation of the brand, as historical costs are often not correlated with current market strength. The final resolution of the dispute was achieved by a hybrid figure which combined both methods, the Tribunal itself pointing out that it would have been much less accurate to have relied solely on the cost aspect. 

What Are the Benefits and Challenges of Financial Brand Valuation?

A credible financial brand value approach provides genuine value for strategic decision-making. It provides companies with increased negotiating power in licensing and acquisition negotiations, as it provides a clear value methodology that is supported by a well-supported valuation rather than an arbitrary price. It also enables improved internal decision-making, providing marketing and finance leaders with the insight to know which of their brand investments are genuinely delivering a financial return – and that can make a difference to how future marketing budgets are spent across a company’s brand portfolio. Among professionals, having competence in this area creates a unique blend of financial skills and marketing expertise which has become more and more desired in corporate development, licensing and brand management positions – and few candidates have good financial skills combined with marketing skills, even if they possess one or the other. People who can seamlessly switch between a discounted cash flow model and a meeting of customer perception and brand positioning are the ones who seem to be indispensable on cross-functional teams for going through licensing, acquisition or brand portfolio.

But the challenges are great. Brand value is highly subjective – what is perceived as a high level of quality, trust and loyalty is a very difficult thing to measure and quantify and can therefore generate vastly different assessments of the same brand from two equally qualified valuation professionals. Comparable transaction data is not always available, as many brand licensing and acquisition transactions have confidentiality clauses, requiring the valuation professional to use limited or indirect market data. Consumer sentiment can also shift rapidly – in the wake of a public controversy, for example, or a shift in social attitudes – which can affect a brand’s value in ways not foreseen by a valuation done even a year before. The additional layer of complexity is added by cross-border brands, because perception of a brand’s value and recognition can differ significantly between markets, and so an average global valuation may be meaningless when considering licensing or expansion. To the new entrants to this space, the answer to these questions is to make explicit assumptions, triangulate with various techniques to establish a defensible range and re-evaluate valuations more often than appears to be needed in a connected, socially-driven marketplace in which brand perceptions evolve rapidly. It’s also one of the quickest ways for a young pro to get a quick sense of what works and what doesn’t when it comes to valuations, especially when hard, objective data is scarce, by looking back at previous valuations and comparing them to actual subsequent performance. 

How Is Brand Valuation Calculated? : Conclusion

Ultimately, the calculation of brand value is about attaching a quantifiable monetary value to the tangible evidence of customer trust and loyalty in the form of one or more of the accepted valuation models based on verifiable market and financial data. For professionals pursuing a career in finance, marketing, or valuation advisory, the salient point to take away is not to view every brand valuation as a routine calculation but rather a mix of financial rigour and market understanding, while always adapting to the context of the brand valuation engagements conducted. Learning how to value financial brands early and how to choose the appropriate valuation technique for the appropriate valuation context is one of the most visible ways for early-career professionals to establish a lasting reputation in this rapidly expanding field of corporate finance. Across most industries, brands have grown to a greater proportion of enterprise value, and calculating and arguing the value of brands with rigour will only continue to be a more important skill in a professional’s career.