Date September 2016
By The Numbers
- The emergence of brand acquisition, licensing, and management companies has created significant liquidity in the market, creating increasing opportunities for secured lending.
- current retail market conditions have resulted in an uptick in brand transactions.
- Brand acquirers are generally focusing on wholesale instead of retail, as licensing retail locations in the U.S. is generally not an option, and retail sales can be difficult to convert to wholesale.
Value approach: While secured lenders typically rely on Net Orderly Liquidation Value (“NOLV”), Fair Market Value (“FMV”) may also be given additional consideration by second secured or mezzanine lenders who would consider a strategic sale for an exit strategy. The appraised value of a brand is tied to revenue and a corresponding hypothetical royalty stream. Brand values are primarily developed utilizing some form of the relief from royalty method, a subset of the income approach. The relief from royalty method applies a discount to projected royalty cash flows commensurate with risk.
NOLV may vary significantly depending upon a company’s business model and brand-specific characteristics. It assumes that the brand is sold (generally in a 363 sale) as a stand-alone asset, separate from inventory or other company assets. Therefore, there is a period of disrupted cash flows as the hypothetical licensees need to resource and resell the branded product. This also results in potential loss of sales. For example, certain wholesale customers may never be regained and retail sales may be eliminated as the company-owned stores are closed. How the historic sales channels of the brand convert in this type of sale can vary significantly.
FMV is generally a more hypothetical exercise that contemplates the value of the brand to licensees within the context of the current company operations as a going-concern. Brand FMVs are generally more directly similar to traditional relief from royalty models.
Assessing brand collateral: Strong brand collateral is differentiated, meaning it is distinct from competitors’ products or services. As the product or service becomes more different, categorization becomes more challenging and draws fewer comparisons with its competition. An excellent example is Airstream, whose iconic RVs are a cult classic. Its products look distinct and, as a result, its brand is one of the most recognized on the road. This not only promotes sales but also improves profits as highly differentiated brands can charge a premium for their product or service.
Strong brand collateral also maintains a high level of consumer awareness, meaning it is recognized and correctly associated with a particular product or service by potential customers. Brands such as Apple and Disney are renowned worldwide as innovative and fun companies, and their products and services are uniquely sought after by consumers. This brand awareness contributes to sales and value.
Another important consideration is whether there is retailer and/or distributor support of the brand. Brands with strong relationships in this area are more resilient and better positioned to withstand downturns. Retailers and distributors will do more for brands that are highly integrated with their businesses such as co-op marketing, discounting or handling returns. Strong retailer support can often convey more brand value than a strong company-owned retail chain due to conversion considerations. Beyond that, it’s important to consider whether that advantage appears to be sustainable relative to the competition.
Given all of the above, the most important question is whether a third party will pay to either license or acquire the brand. In short, it must have value to another party. When valuing brands, appraisers typically utilize some form of the relief-from-royalty method, an income approach that uses market-based data (when available) to calculate the present value of hypothetical royalties an owner would otherwise be willing to pay to use the asset. The model considers what revenue could be generated from setting up a business (with no other assets) to license the brands. Differentiated brands with high consumer awareness and strong retail/distributor relationships as well as strong margins are typically the best collateral. It is important to note that the value of a brand to a financial buyer can often be materially different from the value of a brand to a strategic party or competitor, as they may value the brand based on other mandates or synergies that are not captured in the value of the cash flows generated by the brand.
Collateral monitoring has unique considerations: The value ascribed to brands by Gordon Brothers is a financial one; therefore, the financial performance of the company is the baseline for establishing value. Declines in sales and profitability have a direct impact on brand value. Gross margins, in particular, are relevant because they inform the hypothetical royalty rate that the brand would be able to command to licensees. Declines in margins reduce what the effective royalty rate could be, reducing value. Any existing license agreements where the company rents the brand out to other parties are of particular note here, and changes in those agreements are also key points to monitor as they represent strong evidence of how the brand could be licensed in a hypothetical transaction. Lastly, changes in interest rates are worth monitoring as changes in market conditions can have an impact on the return requirements investors would have for the brand.
Strong brands are durable: Brands can take time to ‘restart’ post-liquidation. While their value is more durable than hard assets from an obsolescence factor and they have longer economic lives, it can take time to generate cash flows on brands subsequent to acquisition. When executed successfully, brand transitions happen quickly and can occur in less than six months. For example, Sycamore Partners purchased women’s apparel and accessories retailer Coldwater Creek’s intellectual property out of bankruptcy and re-launched as Coldwater Creek Direct, a catalog and online-based business. The process took only five months from purchase to launch. By compressing this timeframe, Sycamore Partners was able to leverage existing consumer awareness and transition loyal customers to its new platform, capitalizing on brand value.
Opaque market underscores need for experience: Given the intangible nature of the asset, brands can be tricky to liquidate. Brands that are liquidated are generally bought out of Chapter 7 or 11 bankruptcy. The acquirer buys the trademarks along with any marketing assets, style guidelines, formulations, domains, mastheads, and other direct related assets and re-registers them for the appropriate jurisdictions. In practice, brands are often acquired as part of a pool of assets including inventory and other hard assets in these transactions. Because this market is not as robust and established as it is for other hard assets, it is important for lenders to choose appraisal firms that have a strong history of buying and licensing brands. Gordon Brothers brings decades of acquisition and brand building experience to our appraisal methodology.