Using the Relief from Royalty Method to Value Trade Names

Presenters:

W. James Lloyd

Brian Burns

Using the Relief from Royalty

Method to Value Trade Names

Copyright © 2016 American Institute of CPAs (AICPA)

W. James Lloyd

Education & Credentials

• University of Tennessee

Bachelor of Science in Business

Administration

• Certified Public Accountant (CPA)

Licensed in Tennessee

• Accredited in Business Valuation (ABV)

• Accredited Senior Appraiser (ASA)

• Certified Fraud Examiner (CFE)

Experience

W. James (Jim) Lloyd is a Shareholder with PYA (Pershing Yoakley & Associates), a management consulting and accounting firm

specializing in the healthcare industry. Jim’s primary areas of expertise include valuation (entities, joint ventures, complex business

arrangements, and physician services agreements), transaction advisory, hospital-physician alignment, affiliations and alliances, and

litigation/expert testimony services.

Jim regularly assists clients with structuring business transactions and arrangements and has lead multiple projects involving trade

names and/or the “brand” value of organizations. He has broad healthcare industry experience that spans a wide range of provider

organizations such as ambulatory surgery centers, cancer centers, dialysis facilities, imaging centers, hospitals, long-term care

facilities, and physician practices. Other relevant industry experience includes managed care organizations, pharmaceutical

manufacturers, pharmacies, manufacturing, real estate, and wholesale distribution, among others. Additionally, he has substantial

litigation/expert testimony experience related to a broad range of disputes involving antitrust, diminution of value, fraud, intellectual

property, lost profits, marital dissolution, post and failed acquisition transactions, and shareholder oppression matters.

Jim has published multiple articles on valuation-related topics and is a frequent speaker at conferences and other venues across the

U.S.

Professional & Civic Organizations

• American Institute of CPAs - Past Chair, ABV Credential Committee

• American Society of Appraisers - Past Member, Board of Examiners

• Tennessee Society of CPAs – Past Member, Valuation and Litigation Services Committee

• American Health Lawyers Association – Past Member, Fair Market Value Affinity Group

• Helen Ross McNabb Foundation – Board of Directors

Shareholder, PYA (Pershing Yoakley & Associates)

865-673-0844 [email protected] 2220 Sutherland Avenue | Knoxville, TN 37919


Brian Burns, CPA/ABV/CFF, ASA, MAFF

Licenses & Certifications

• Certified Public Accountant, VA (CPA)

• Accredited in Business

Valuation (ABV)

• Certified in Financial Forensics (CFF)

• Accredited Senior Appraiser in Business

Valuation (ASA)

• Master Analyst in Financial Forensics

(MAFF)

Industry/Service Focus

• Valuation Services

• Commercial Matters

• Economic damages

• Business interruption

• Family Law

• Asset/income valuation and

classification

• Fraud and Forensics Accounting

Experience

Brian leads the DHG Forensics and Valuation practices in Virginia and serves clients across the Mid‐Atlantic region. He practices in

the areas of valuation and forensic accounting, including financial investigations and litigation support and consulting services. He

has been designated as an expert witness and qualified to testify by report, deposition, and/or trial testimony in various venues in

commercial and domestic matters. Brian frequently presents to professional and trade organizations and has presented at venues

such as the AICPA's National Forensic and Valuation Services conference, state CPA society conferences, and a national webinar.

Brian has also authored articles on forensics and valuation presented in various professional publications.

Brian assists businesses and individuals with valuation services in the areas of family law, financial reporting, stock‐based

compensation, litigation and shareholder disputes, transaction consulting, tax matters, and employee stock ownership plans. The

focus areas of his forensic accounting services include consulting services in commercial and family law matters such as

shareholder disputes, breach of contract, breach of warranties, misappropriation of trade secrets, post‐acquisition disputes, tortious

interference, statutory conspiracy, business interruption claims, employee embezzlement, investment scams, and fraud.

Brian has served both public and private businesses in industries including, but not limited to: real estate, construction, healthcare,

technology, food service, auto dealerships, manufacturing, distribution, government contracting, retail, insurance, and banking.

Professional & Civic Organizations

• AICPA, Business Valuation Committee and Former Task Force Member

• American Society of Appraisers, Former Richmond Chapter President

• VSCPA, Top 5 Under 35 Award, Past Recipient

• VSCPA, Annual BVFLS Former Conference Task Force Member

• Junior Achievement Worldwide, Past volunteer and presenter

Director, Forensics & Valuation

Dixon Hughes Goodman, LLP

804.474.1240 [email protected] 901 E. Cary Street, Suite 1000 | Richmond, VA 23219

Education

Virginia Tech

• Bachelor of Science, Finance, Magna

Cum Laude

Virginia Commonwealth University

• Post Baccalaureate Certificate in

Accounting


Agenda

Overview of Trade Names/Brands

Relief from Royalty Method

Case Study

Collaborative Approaches


Trade Name

Defined:

Simple Definition: “The name of a business.”

Legal Definition: “A name or mark that is used by a person (as an

individual proprietor or a corporation) to identify that person's

business or vocation and that may also be used as a trademark

or service mark.”

Like a trademark or service mark, a trade name is

protected by law against infringement.

Source: http://www.merriam-webster.com/dictionary/trade%20name


“Your brand is what people say about you

when you are not in the room.”Jeff Bezos

CEO, Amazon


Most Valuable Global Brands

Source: Interbrand™ Best Global Brands 2016


Characteristics of Valuable Trade Names

Customer loyalty

Revenue growth > competitors

Profit margins > competitors

Substantial on-going investments

Efforts to protect


Trade Names and Consumer Perceptions

Innovation



Prestige



Family Fun



Convenience



Quality


Why Value Trade Names?

Financial reporting

ASC 805 and ASC 958 (purchase price allocation)

Regulatory compliance

e.g., Stark Law and/or Anti-Kickback Statute for applicable

transactions within healthcare industry

Tax planning and/or compliance


Why Value Trade Names?

Evaluate effectiveness of advertising spend

Marketing/branding plan effective?

Brand value increasing?

Financial terms of license/royalty agreements

e.g., co-branding/affiliation arrangements, etc.

Evaluate competitive position

Relief from Royalty (RFR) Method


Valuation Approaches

Brand

Value

Income Approach

Based on the

economic benefits

anticipated to be

derived from the asset

Market Approach

Based on transaction

data involving

similar assets or

services

Cost ApproachBased on the

anticipated cost to

recreate, replace, or

replicate the asset


Valuing Brands/Trade Names

Brand

Value

Income Approach

Based on the

economic benefits

anticipated to be


Market Approach


data involving

similar assets or

services


anticipated cost to


replicate the asset

Difficult to apply -

Trade names

typically evolve over

long periods of time


Valuing Brands/Trade Names – Relief From

Royalty (RFR) Method

Brand

Value

Income Approach

Based on the

economic benefits

anticipated to be


Market Approach


data involving

similar assets or

services


anticipated cost to


replicate the asset

RFR Method

adopts a combination

of market and income

approaches


Relief from Royalty Method

Commonly used to value intellectual property assets –

such as trade names

Value is determined based on the theory of avoided cost

(i.e., not having to pay a license fee to use the asset)

Key considerations:

Appropriate royalty rate

Revenue projections

Discount rate


Royalty Rate

Typically developed from market data such as license

agreements for similar assets/services

Benchmark rates may need to be adjusted (up or down)

to fit the particular facts and circumstances

Common royalty rate data sources include:

RoyaltySource®

RoyaltyStat ®

ktMINE

Internet/Public domain


Royalty Research – Sample Output


Royalty Rate – Examples

Institution Royalty Rate*

University of the Pacific 7.5%

University of Tennessee 10.0%

Vanderbilt University 12.0%

Louisiana State University 13.0%

Brigham Young University 14.0%

Duke University 15.0%

University of Utah 16.0%

Source: The Collegiate Licensing Company - http://www.clc.com/

* The royalty rates listed above are current standard royalty rates set by the respective institutions for certain products, trademarks, and programs.


Royalty Rate Selection

Evaluate comparability

Industry/subject business, etc.

Nature of products/services

Geography

Exclusivity – exclusive arrangements may command higher rates

Evaluate profitability

Companies with strong trade names commonly have higher sales and

profitability as compared to competitors with less well-known brands

Stronger and more profitable brand names commonly will command

higher royalty rates


Qualitative Analysis

Qualitative factors to adjust benchmark royalty rates to

an appropriate level for the subject asset

Georgia-Pacific Factors1

Fifteen qualitative factors

Commonly used to help develop reasonable royalty rates

Evaluating brand/trade name strength

Comparison to competitors

Rankings, recognitions, awards, etc.

Net Promotor Score to assess customer loyalty2

1. Georgia-Pacific Corp. V. United States Plywood Corp.,318 F. Supp. 1116, 1119-20 (S.D.N.Y. 1970).

2. http://www.medallia.com/net-promoter-score/.


Other Key Considerations

Revenue projections

Anticipated future revenue to be generated from utilizing the

subject trade name/brand

Tax rate

Cash flows should be adjusted to an after-tax basis

Discount rate

Weighted average cost of capital (WACC)

Additional risk premium for intangible assets

Weighted average return on assets (WARA)

Case Study


Case Study - Background

Local Hospital (LH) is being acquired by Regional Health

System (RHS) as part of its expansion plan.

LH and RHS are both not-for-profit entities.

Assume that we have been engaged by RHS to assist

management with its purchase price allocation in

accordance with ASC 958 (Not-for-Profits Entities) and

ASC 820 (Fair Value Measurement).


Case Study - Background

LH has been operating under the same trade name for

20+ years and is one of only two hospitals in the area.

LH has a strong reputation and loyal customer base

within its primary and secondary markets.

LH’s trade name will be used by RHS post-transaction

(i.e., LH will be referred to as a subsidiary of RHS for an

indefinite period).

LH’s trade name is considered to be a separately

identifiable intangible asset.


Case Study – Key Considerations/Steps

Develop DCF model that approximates the purchase

price and determine internal rate of return (IRR) relevant

to the overall transaction.

Revenue projections from the purchase price DCF

model also will be utilized in the RFR model.

Determine economic life of trade name. This will

determine length of cash flow utilized in the RFR

analysis.



Research market data and develop range of

benchmark royalty rates for similar trade names.

Use qualitative analysis to adjust benchmark rates to an

appropriate level for LH’s trade name.

Select appropriate discount rate for LH’s trade name

(risk profile, WARA, etc.).

IRR based on purchase price and forecasted cash flows =

14%. Intangible asset risk premium of 2.0% based on

weighted average return on assets analysis (WARA).



Apply selected royalty rate to the projected revenues.

Adjust the projected royalty savings to an after-tax basis

using effective tax rate from DCF model.

Compute present value of projected after-tax royalty

savings.

Compute Tax Amortization Benefit (TAB) adjustment.



Prepare sensitivity analysis.

Based on range of royalty rates and discount rates.

Utilize collaborative approaches to test reasonableness

of conclusion.


Case Study - Example using RFR Method

FYE Terminal

12/31/2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Period

Total patient revenues $100,000 $102,000 $104,040 $106,121 $108,243 $110,408 $112,616 $114,869 $117,166 $119,509 $121,899 $124,337

Growth assumption 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0%

Royalty fees, based on royalty rate of 0.50% $510 $520 $531 $541 $552 $563 $574 $586 $598 $609 $622

Less: effective income tax expense 40.00% (204) (208) (212) (216) (221) (225) (230) (234) (239) (244) (249)

After-tax royalty fees $306 $312 $318 $325 $331 $338 $345 $351 $359 $366 $373

Terminal year value $2,664

Discount period (mid-year convention) 0.50 1.50 2.50 3.50 4.50 5.50 6.50 7.50 8.50 9.50 9.50

Present value factors at discount rate of 16.00% 0.929 0.800 0.690 0.595 0.513 0.442 0.381 0.329 0.283 0.244 0.244

Present value cash flows $284 $250 $220 $193 $170 $149 $131 $115 $102 $89 $650

Sum of Present Values:

Years 1 - 10 $1,704

Terminal Period 650

Total $2,354

Tax amortization benefit ("TAB") 469$

Total value including TAB $2,823 $2,823 15.00% 16.00% 17.00%

Rounded Value $2,823 0.25% 1,534$ 1,412$ 1,308$

0.50% 3,068$ 2,823$ 2,616$

Long-term growth rate of 2.00% 0.75% 4,603$ 4,235$ 3,924$

Royalty

rate

Year Ending December 31

Sensitivity Analysis - Value Indications

Discount Rate


Benchmark royalty rates can be like

finding a needle in a haystack.

Limitations on ability to appropriately

compare entities.

Small variations in selected royalty rate

can impact value significantly.

Qualitative factors can be difficult to

assess/estimate impact.

Corroborative methods and appraiser

judgment is key.

Additional Considerations


Valuing trade names is a bit of an art

and a science!

Total deal: $16 billion

Tradename: $448 million, or 2.8%

$160 billion deal in 2000.

Approximately $10 billion allocated to brand.

Impaired in 2003


Enterprise value less sum of (tangible assets + other

separately identified intangible assets) – is the balance

attributable/available for the trade name and goodwill

reasonable?

Percentage of purchase price based on SEC filings, etc.

25% Rule of Thumb

Assumes that a licensee would pay approximately 25% of its expected

profits generated from using the subject asset

Widely used for over fifty years

Determined to be fundamentally flawed by the Federal Circuit in: Uniloc

USA Inc. vs. Microsoft Corp., 632 F.3d 1292, 1315 (Fed. Cir. 2011)

Corroborative Approaches

PERSHING YOAKLEY & ASSOCIATES, P.C.

800.270.9629 | www.pyapc.com

Presentations & Public Speaking

Using the Relief from Royalty Method to Value Trade Names