Selling Goodwill: What is goodwill?
"Goodwill in financial statements arises when a company is purchased for more than the book value of the company. The difference between the purchase price and the sum of the fair value of the net assets is by definition the value of the "goodwill" of the purchased company. The acquiring company must recognize goodwill as an asset on its financial statements and present it as a separate line item on the balance sheet, according to the current purchase accounting method. In this sense, goodwill serves as the balancing sum that allows one firm to provide accounting information regarding its purchase of another firm for a price substantially different from its book value. Goodwill can be negative, arising where the net assets at the date of acquisition, fairly valued, exceed the cost of acquisition." www.ventureline.com - M&A glossary
If a business sells for 200K and there are only 100K worth of tangible assets the goodwill is approximately 100K.
Goodwill includes the name, likeness, reputation, relationships, market position, market dominance etc. - it is an asset that can be sold, but it is intangible - it cannot be seen or touched.
So how does one arrive at a value when selling goodwill?
The valuation approaches for small businesses, with the most weight, are based on the earnings of the business. So to a large degree the value of goodwill is determined by the ROI that the goodwill can generate for it's owner.
Personal versus Business Goodwill
Both sellers and buyers need to know the difference between personal goodwill and business goodwill. (in the M&A sense not tax sense)
For many small business's the owner is the business. All of the relationships, agreements and know-how depends on the owner. The two cannot be separated. I refer to this a personal goodwill.
In a business where there are systems, policies and procedures in place the goodwill is transferred to the owner to the business itself. The vendors and customers have relationships with the business not the owners. The owner's knowledge is transferred to the business, in the form of training and delegation, and the business would be able to continue without the owner.
Sellers Which of the above describes your business? What would happen if, heaven forbid, you were hit by a bus? Would your knowledge die with you? Do your customers know you or your business?
If you feel that your goodwill is mostly personal goodwill, and you would like to sell then changes should be made. Some business are unsaleable when the owner cannot extracted from the equation. Other businesses may need to grow before they can be sold. Business's with more "business goodwill" will sell for more money than business's with "personal goodwill".
Buyers In due diligence buyers should spend some time investigating the owner's role in the business. What is the business's training like. What procedures or policies are in writing? How open is the owner to training? Will the owner stay on for an extended period of time?
Buying a business where there is a lot of personal good will can be more risky and that level of risk is usually reflected in the selling price.
More information on selling goodwill and business pricing here
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