When you get to know about brands, you generally hear what big brands like Coca-Cola or Disney are worth…
How do they arrive at these valuations?
Let’s take the case of Kirkland – Costco’s generic brand. Costco developed that brand to provide its customers with the same quality as premium brands, without the premium of a brand name. Now that brand itself is worth $75B. Wow! $75 billion dollars. That is more than the yearly budget of the state of Ohio!
Let’s discuss your everyday Main street type of brand names. Jim’s Barber Shop, or Kristie’s Bakery. What are they worth? Or are they worth anything?
Assume there is a wonderful cake shop on Main Street since 1979. Teeny Cakes. They bake the simplest cake in 50 miles radius. I mean, their cakes are the go-to for any milestone celebration sort of first birthday or 25th anniversary.
Say Teeny just invested 50k in developing your new brand image with fancy logos, vision statements, marketing material, etc. Can she sell it for 50k to a possible buyer?
What if Teeny wants to retire someday, she has been doing this for 40+ years. Can Teeny sell or license her brand to enjoy some passive income during her retirement?
I will assist you to understand the type of cash flow an honest brand can provide. The rule of thumb I give you here applies to all or any sorts of intangibles or property. Be patents, or trademarks, or copyrights, or domain names, etc.
A brand only has value when customers buy from Teeny due to her brand’s reputation for quality and consistency. Or put differently, would Teeny’s income suffer if the brand were changed to mention Dolly’s Cakes?
If the sales suffer then Teeny Cakes as a brand may have worth. If you don’t think the revenue would suffer without the name Teeny Cakes, then Teeny Cakes as a brand does not have value and should not be ready to generate passive income for her.
Is the business profitable? If yes, then it’s going to have worth, if not, the brand does not have a worth or minimal value.
Whatever is that the business’s operating profit (or EBIT), you will assume that that brand can bring you royalties that are about 25% of that operating profit. So if the business is bringing Teeny an operating profit of 10%, then it could support a royalty of 2.5% on revenue.
Therefore, if Teeny Cakes’ annual revenue is $1M, then Teeny could be ready to dictate an annual royalty of $25000.
This is just an easy rule of thumb. This rule is employed as a start line for determining royalty rates for many years. I share rules of thumb with you to assist you to estimate a solid ballpark useful. But it is not a substitute for a full valuation or analysis.
This rule was rejected in court in 2011 because they were determining damages just supported by this rule of thumb. They did not support this rule of thumb with further analysis.
If Teeny decided to sell the brand and not await the yearly cash flow then she could be ready to get 3-5x on her yearly cash flow. So, take 4x as average.
$25000 times 4x = $100,000
If you employ this rule of thumb for negotiations or as a start line backed by further analysis, you will be on strong grounds.
I hope that provides you with a good understanding of how brands and royalty payments are valued.