Ask a banker, buyer, seller, accountant, lawyer, businessperson, or investor what goodwill is and you get some interesting answers. Some might say goodwill is the result of a business being in business for a length of time, having a good reputation, having steady customers with reliable systems and people in place. (I guess that would beg the question as to whether a bad reputation, w/ poor management, would reduce the value of a business. Would that be negative good will? Yes, but oddly enough there are times when it wouldn’t impact value. More on this later.)
Some say Goodwill is the intangible assets. Perhaps copyrights, patterns, records, files, names, phone numbers, location, intuitional knowledge, etc. Again, not a bad definition. But how the heck do you put a value to that?
Others might suggest that a ‘going concern’ has goodwill because the day the business is purchased it has customers coming through the door. That the blood, sweat, time, good luck and/or foresight, along with perhaps operating losses that it takes to get a company up and running don’t need to be incurred. And, anyone that has started a business knows how trying this is.
Frankly, I’d have to say all these definitions give a good understanding as to what goodwill is. The problem arises when you have to put a number to it. The first step is to determine the value of the hard tangible assets of the business. The assets being the ‘stuff’ that is used in the operation of the business. Add up this value as if it were all to be instantly acquired, at its current used value, and dropped off in a new but identical location. This would be asset value. Now add the good will.
However, adding the goodwill value has to be approached indirectly. But once done it is easy to place a number on it. Let’s start by saying ‘the value of the business, less tangible assets, equals goodwill’. Let’s say a business is valued based on the cash flow it produces. Whether this is based on historical or projected cash flow. Whether valued using a gross or net multiplier or perhaps some other formula (see article in issue III) at this point makes no difference.
So using the returns (cash flow) the value of the business is determined to be, say, $ 500,000. Now you subtract the value of the assets, in this case let’s say $350,000. This leaves you with $150,000 in goodwill. So you take all the subjective definitions of goodwill and it explains why $150,000 in good will is real, legitimate and valuable. Why it makes sense to buy a business and pay for goodwill vs. starting a business from scratch. With startups you may not be able to draw a salary or pay expenses from day one.
You reduce the risk of starting your new enterprise, by buying a going concern The statistics regarding the number of start-ups that fail in the first three years is horrible. If you’re selling a business we would love to value it, to make sure you receive the extra value (called goodwill) over the assets that you so well deserve.
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By Scott Balfour