What’s in a Name? Determining the Value of a Trade Name

Coca-Cola, McDonald’s, and Burger King—all trade names that almost every American knows and recognizes. These trade names carry significant value, and when you buy their products, you know what you are buying. Trade names are part of the intangible nature of business and go beyond the physical. The name alone implies that customers prefer to buy a specific product over the competition.

The value of a trade name does not come from how a company operates or its overall margin and bottom line. It is driven by the customer and how they perceive the business. You can be the worst-run company in the world when it comes to operations and profit, but your name could have significant value due to any number of factors, including superior customer service, quality products, or product availability.

One example to demonstrate the value of a trade name is to use a convenience store. All convenience stores have the same basic formula, fuel sales and merchandise sales, and the products are similar across the board. Take, for instance, a local chain of convenience stores (Chain A). This chain owns several stores in an area, but every store is dirty, has a limited selection of products, and has horrible service. One might wonder who would buy food from a dirty convenience store when they can go down the street to a regional chain of convenience stores (Chain B) that are always clean, have more product availability, and helpful and friendly staff. In this case, the value of Chain B is much higher than Chain A. Even though Chain A may be very profitable, the value of Chain A’s name is lower in many people’s opinion than Chain B. Customers prefer to shop at select stores because they have the products they want, their stores are clean, and their people are helpful.

One item to keep in mind, though, is that not all trade names have value. For instance, say the only convenience store in a small town is bought out and the name is changed. The new convenience store suffers no change in business due to the name change. This would indicate that the old convenience store’s trade name had little to no value.

If the value of a trade name is derived from customer perception and other intangibles, how can one assign it a value? Ideally, there would be a market for trade names that could be used to determine value. In reality, markets are limited, and valuation specialists commonly apply a discounted cash flow approach called the “relief of royalty method.” This method’s focus starts with total gross sales. Why do valuation specialists use gross sales? Think back to the convenience store example. Customers stop and purchase items at Chain B because they perceive them as a higher quality convenience store. As a result, gross sales directed to Chain B is their vote of confidence and belief that Chain B is better than Chain A. Gross sales is also used over net sales, gross profit, or net income, as gross sales is less likely to be manipulated, and with different reporting requirements across industries and companies, provides the best comparable for assessment. For example, Company A could report bad debts as a reduction of gross sales, while Company B could report them as an operating expense, thereby impacting the calculated value of the trade name, but having no impact on the value as perceived by their customers.

Once projected gross revenue has been determined, a valuation specialist applies a royalty rate based on the company’s industry, adjusts this royalty for taxes, and calculates the present value of the royalties over the expected life of the trade name.

Thus, the value of a trade name varies based on the company, the perception of a company’s customers, and the company’s industry; but, the method of how to value a trade name is consistent across all companies and industries. The calculation itself is rather straight forward, but contains a few nuances and scenarios that must be considered and may be difficult to determine unless you have experience valuing this type of asset. This is where a trained valuation specialist, such as a Certified Public Accountant who holds the ABV designation is beneficial. These experts have experience and resources to properly value your trade name. Contact us to speak to a CPA/ABV at learnmore@boulaygroup.com or 952-893-9320.