What is goodwill?

July 30, 2018

I have met with a range of businesses in the last 6 months where the owner is critical to the ongoing success of the business. That might be because of their unique skills (specialist doctors), relationships with clients (accountants) or intimate knowledge of the whole business (basically any founder).

George, a business owner, works tirelessly in his business, often harder than many of his own employees. He is paid a reasonable salary that takes care of the family and personal affairs in the short term. In years’ when the business is profitable, he pays a dividend of 50% of profits and leaves the rest in the business as a reserve. The dividend is not used to build any wealth outside the business.

George knows the business intimately – from the staff, suppliers, equipment, customers and competitors. He is clearly the biggest asset and biggest risk to the success of the business.

Retirement age is looming and George has no exit plan. Most of his wealth is trapped in the business, which in turn is directly linked to his ongoing involvement.

George said to me “there is no goodwill in the business as it relies on me. While my heart beats, so too does the business”.

Such a comment would make most accountants / lawyers / succession planners salivate with an opportunity to help.

The point is that I am regularly asked to quantify goodwill.

Firstly, what is goodwill?

Think of it as a premium above the business assets and liabilities. It can represent the reputation, market position, intellectual property, brand, relationships with customers and so on. It might relate to the owner (personal goodwill) or the business more broadly (commercial goodwill). It can’t be separated from the rest of the business.

Goodwill is often the output of a business valuation, after identifying all other assets and liabilities used in the business.

So, how do you quantify it?

Goodwill is only quantified when a business is bought or sold, or a valuation is undertaken.

For example:

Business value $5,000,000
Made up of:
– Equipment $2,500,000
– Debtors $500,000
– Creditors ($200,000)
– Other liabilities ($100,000)
– Goodwill $2,300,000

Some of the goodwill might actually represent different things called intangible assets.

Can you value the intangible assets within goodwill. Absolutely, let’s talk about that next time.

Please to say George is getting support in his transition to retirement and importantly converting his biggest asset into cold hard cash.

Thanks for reading.

Lachie McColl
BV Specialist