What is Goodwill Worth When Buying or Selling a Business
The value of a business is very often far more than the value of its assets or even its net revenue.
There are certain intangibles that are unique to a business and from which value is derived. Intangible assets are commonly known as “goodwill”.
What is Goodwill: Because of its intangible nature, it is often difficult to pinpoint exactly what goodwill looks like, and what its true value is. The best way to define goodwill is that it is a reflection of the effort the business has put in over the years to establish itself and differentiate it from others in the marketplace. Goodwill is not a physical asset that can be sold off separately. Rather, it in as an asset that is unique to the business and inexorably tied to it.
There are a wide range of intangibles a business may possess that could be categorized as goodwill, some of the most common examples include:
- A business’ established brand and reputation;
- A strong and loyal customer or client base;
- Proprietary designs, formulas, technologies, processes, training systems, and other trade secrets;
- Exclusive customer mailing lists;
- Exclusive contracts with quality suppliers;
- Specialized tools, equipment, and industry knowledge;
- Loyal and highly skilled employees;
- Customized advertising and marketing materials;
- Unique advertising and marketing methods;
- Government permits and licensing that is difficult to obtain;
- A high-traffic location;
- Positioning for strong future growth potential.
What is Goodwill Worth: In a business sale, the overall value of goodwill is fairly straightforward; simply take the combined value of the business’ tangible assets (minus liabilities) and subtract that figure from the “fair market value” of the business. For example, if your business has a fair market value of $1 million and the net value of its physical assets is $600,000, then the value of its goodwill would be $400,000.
While the value of goodwill is fairly easy to ascertain from the sale price (that is presumably determined by fair market value), arriving at that figure is an entirely different matter. As we saw earlier, goodwill can (and usually does) encompass a wide range of factors, which can make it difficult to properly value. This can make it the subject of strong debate, especially when an owner wants to put a business up for sale.
Naturally, the owner who has put their heart and soul into a business for many years is often going to want to infer a goodwill that is higher than what it should be. Prospective buyers, on the other hand, will be much more skeptical regarding the true value of the various intangibles that make the business unique.
Goodwill is not some arbitrary figure that is pulled out of thin air, however. Under generally accepted accounting principles, it is supposed to be updated by management each year, and adjustments should be made (as needed) when conditions change. Ideally, the value of goodwill should be determined by an outside expert who understands the industry, is qualified to make accurate valuations, and can provide an objective assessment of the business.
Buying or Selling a Business? Speak with an Experienced Business Broker: Whatever side of a business sales transaction you are on, it makes good sense to work with a specialist who understands the buying and selling process. Business brokers, also known as business intermediaries, work closely with sellers and buyers. They help sellers by ensuring that their business is priced appropriately (not too high or not too low) based on a proper valuation of both tangible and intangible assets. They help buyers by ensuring that they are not overpaying for a business, and by ensuring that they are purchasing the right business to suit their passion, skills, and budget.