Relief from Royalty (RFR) Method

Valuation Methods — Lesson 2 of 10

The Relief from Royalty method is the most widely applied technique for valuing intangible assets in professional practice. Its logic is elegant: if you own an intangible asset — a brand, a patent, a piece of proprietary technology — you are relieved of the obligation to pay a royalty to license it from someone else. The value of the asset is the present value of those avoided royalty payments.

RFR is favoured by valuers, auditors, and tax authorities because it anchors the valuation to observable market data — royalty rates from licensing agreements between unrelated parties. This market anchor makes RFR more defensible than methods that rely entirely on management projections, and it is the default method for brands, trade names, patents, and technology in most purchase price allocations.

This lesson walks through the method step by step, explains the key judgement areas, and provides a complete worked example.

The Five-Step Process

Every RFR valuation follows the same fundamental sequence, regardless of the asset being valued.

Step 1: Projecting Revenue

The revenue base must be directly attributable to the asset. This is more nuanced than it appears.

For a brand or trade name, the revenue base is typically total revenue generated under that brand. If a company operates multiple brands, only the revenue of the brand being valued is included.

For a patent, the revenue base is the revenue from products or services that are covered by the patent claims. If a product relies on multiple patents, the revenue must be apportioned — which introduces a layer of judgement. Our patent valuation guide sets out how claim breadth, remaining life and portfolio effects bear on that judgement.

For proprietary technology, the revenue base is the revenue from products or services that incorporate the technology. If the technology is one component of a larger product, a contribution analysis may be needed to isolate the relevant revenue.

The projection period should match the asset's estimated useful life. For a patent with 12 years remaining, the projection runs for 12 years. For a brand with an indefinite useful life, the projection includes an explicit forecast period (typically 5-10 years) plus a terminal value.

Step 2: Selecting the Royalty Rate

The royalty rate is the single most important input in an RFR valuation. A 1% change in the royalty rate applied to a $100 million revenue stream changes the annual royalty savings by $1 million — and the present value of the asset by $5-8 million over a typical useful life.

Sources of Royalty Rate Evidence

Illustrative Royalty Rate Ranges

Royalty Rates by Asset Type

These ranges are illustrative only, not benchmarks from a named dataset. The specific rate must be supported by comparable evidence relevant to the asset being valued.

Step 3: Calculating Royalty Savings

The royalty savings are calculated as:

After-tax royalty savings = Revenue x Royalty rate x (1 - Tax rate)

The tax adjustment is necessary because royalty payments would be tax-deductible expenses. By owning the asset rather than licensing it, the company avoids the royalty payment but also loses the tax deduction. The after-tax royalty savings reflect the net economic benefit.

Step 4: Selecting the Discount Rate

The discount rate converts future royalty savings into present value. It must reflect the risk of the specific cash flows being discounted — not the risk of the business as a whole.

For intangible assets, the discount rate is typically higher than the company's weighted average cost of capital (WACC) because intangible cash flows are generally riskier than the overall business cash flows. The specific premium depends on the asset type:

Step 5: Tax Amortisation Benefit

When an intangible asset is acquired (rather than internally generated), a buyer of the asset itself can typically amortise it for tax purposes. This creates a tax shield — a series of tax savings that has its own present value. The tax amortisation period, and whether relief is available at all, depend on the jurisdiction (for example, 15 years under US section 197) and on the deal: fair value assumes a hypothetical purchase of the asset on its own, so the TAB is a valuation assumption, not relief the actual buyer receives. After a UK share purchase, the buyer gets no relief on the price paid.

The tax shield depends on the asset's value, and that value includes the tax shield, so the TAB is calculated with a closed-form factor:

TAB factor = 1 / (1 − Tax rate × PV annuity factor ÷ Tax amortisation period)

Fair value including TAB = Pre-TAB value × TAB factor

The PV annuity factor is the present value of 1 a year over the tax amortisation period, at the asset's discount rate. The TAB typically adds roughly 10-20% to the pre-TAB value, depending on the tax rate, the tax amortisation period and the discount rate.

Worked Example: Patent Portfolio Valuation

Consider PharmaCo, which holds a portfolio of 5 granted patents covering a cardiovascular drug compound. The patents have a weighted average remaining life of 10 years. The drug generates annual revenue of $200 million.

RFR Calculation — PharmaCo Patent Portfolio

Each figure is calculated from unrounded values and then rounded to one decimal place, so a row's columns do not always reconcile exactly (for example, gross savings less tax). The total is the sum of the unrounded present values, $61.24 million.

Key assumptions:

• Revenue rises from $200 million to a $225 million peak in year 5 (5% growth in year 2, slowing to 1.4% by year 5), then declines as generic competition approaches patent expiry
• Royalty rate of 7% based on comparable pharmaceutical licensing agreements
• Tax rate of 25%
• Discount rate of 12% (WACC of 9% + 3% intangible asset risk premium), with each year's savings treated as received at the end of that year

Pre-TAB value: $61.2 million

Adding the Tax Amortisation Benefit, with a 25% tax rate, a 10-year tax amortisation period and the 12% discount rate: the PV annuity factor is 5.650, so the TAB factor is 1 / (1 − 0.25 × 5.650 ÷ 10) = 1.1645. The TAB is $10.1 million, a 16.4% uplift on the pre-TAB value.

Fair value including TAB: $71.3 million

Common Pitfalls

Three errors recur in RFR valuations conducted by non-specialists.

Using gross rather than after-tax savings. Royalty payments are tax-deductible. Failing to apply the tax adjustment overstates the value by the tax rate — typically 20-25%.

Applying an enterprise discount rate. The discount rate should reflect the risk of the intangible asset's cash flows, not the overall business. Using WACC without an intangible asset risk premium understates risk and overstates value.

Ignoring the revenue attribution. If a patent covers one product line that generates 40% of total revenue, the RFR should be applied to that 40%, not the entire revenue base.

What Comes Next

In Lesson 3: Multi-Period Excess Earnings, we examine the MPEEM — the method of choice when the asset being valued is the primary driver of the business's cash flows, particularly customer relationships in a purchase price allocation.

Tony Hillier is Chairman of Opagio with over 30 years of experience in structured finance, valuation, and due diligence across private equity and corporate transactions. Meet the team.