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What is goodwill and how is it normally valued?

Updated: Aug 25, 2020

This is a question we've been asked frequently recently so we thought it was worthy of a blog entry of its own. One of the key assets of any business, particularly when it’s being sold, is its goodwill. As a business owner over the years you will have put a lot of work into building up your business’s goodwill - so it’s important that its value is included within the sale price. However, a common problem often occurs when you need to attribute part of the selling price to goodwill because how do you put a monetary figure on something so intangible as goodwill?


What is goodwill?


There are no real definitive definition of goodwill. However in general it’s the component of the selling price that cannot be attributed to the business’s other assets. Goodwill cannot exist separate from a business and essentially it’s the value attached to the public’s (and ultimately the buyers) perception of your business.


This perception can be generated by a combination of IP, brand awareness and the skills and reputation of the business owners. Therefore if your business is running at a healthy profit it is generally assumed that it has some goodwill. Conversely if it runs with a small amount of profit (or indeed at a loss) it is often assumed that it has low or no goodwill.


For any buyer goodwill is a key part of buying a business so the greater your business’s perceived goodwill the higher its asking price.


So how is goodwill usually valued?


Some sellers will take a broad view of goodwill deciding that their net profits or surplus income is solely due to their business’s goodwill. This is a fair assumption but because goodwill is composed of many different factors it generally isn’t the only way it can be measured.


For example - goodwill can be composed of your business’s position in the marketplace, its physical location (the better the location the lower the risk to the buyer), the quality of your client book (high value clients increase your business’s goodwill), the reputation of your business, its brand name and brand image, and its social media presence and followers and other social channels - as well as things like any patents, trademarks and logos etc that you have. To ensure an equitable costing of your business’s goodwill ultimately you should always consult a qualified accountant.


That said one of the simplest methods that is often used to value the goodwill of a small business is the Goodwill Method.


This is where a multiple is applied to the business’s sustainable profits. The greater the business’s profits, margins and growth prospect, and the lower the risks - the higher the goodwill multiple that’s generally applied. So a business that has steadily increased its customer base and profits over the past 3 to 5 years will tend to have a higher perceived multiple to a buyer than one that is showing declining profits over the same time frame. This is why we always suggest that a seller provides at least three years accounts so that average profits over a number of recent years should be evident to any buyer.


Ultimately though goodwill can be quite a subjective valuation as it depends on the buyers view of the goodwill value they are purchasing. But by using different multiples based on the comparative analysis of past sales it can give you an idea of the likely range that the asking price of your business should be set within. It’s also important to note that since the physical or tangible assets of a business can be given a costing based on their purchase price, age and serviceability - it is often the value of the business’s goodwill that is harder to establish and what is invariably most negotiated over with a buyer.


Therefore for any reliable goodwill value an assessment often needs to be conducted your accountant to establish what that multiple may be.





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