One of the key assets of any business, particularly when it’s being sold, is goodwill. As a business owner, you will have put a lot of work into building your business’s goodwill, so it’s important that its value is included in the sale price. A problem often occurs however, when you need to attribute part of the selling price to its goodwill, after all, how do you put a dollar figure on something so intangible as goodwill?
What is goodwill?
There are no definitive definitions of goodwill, however in plain terms, it is the component of the selling price that cannot be attributed to the business’s other assets. Goodwill cannot exist separate from a business and is essentially, the public’s 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. If your business is running at a healthy profit, it is generally assumed that it has some goodwill; if it runs with a small amount of profit or at a loss, it is often assumed that it has low or no goodwill.
For a buyer, goodwill is a vital part of buying a business, so the greater your business’s goodwill, the higher its asking price. It’s important to note that once contracts have been signed for the sale of your business, you must maintain its goodwill until completion of the sale. Just as you can’t sell any of your business’s assets once contracts have been signed, you must not reduce or damage its goodwill, because it is an asset of the business.
How do you value your business’s goodwill?
Some people take a broad view of goodwill, deciding that their net profits or excess business income is due to their business’s goodwill. This is a fair assumption, but because goodwill is composed of many different factors, it 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), quality of your clients (high value clients increase your business’s goodwill), the reputation of your business, brand name, patents, trademarks and logos, and the continuing success of your business.
To ensure an equitable costing of your business’s goodwill, you should always consult a qualified accountant, however one of the simplest methods that is often used to value the goodwill of a small business is the Goodwill Method.
Simple 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 risk - the higher the multiple applied, so a business that has steadily increased its customer base and profits over the past 3 to 5 years will have a higher multiple than one that is showing declining profits over the same time frame.
Let’s look at a simple example using this method, where you have no employees, pre-tax profits of $100,000 (after paying yourself a $50,000 salary) and your business assets total $30,000. Using a multiple of 1, your business valuation is $180,000 with goodwill accounting for $150,000. As you can appreciate, the multiple you choose can make a significant difference to the valuation of goodwill within your business.
In general, goodwill can be quite a subjective valuation, however 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 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 with the buyer.
Therefore, a thorough business assessment needs to be conducted by a licensed business broker or your accountant to establish what that multiple may be, according to a business’s risk factors and likelihood of continued success in producing a certain profit level.
Interested in selling your business? Verified Businesses are the leading Business Brokers on the Sunshine Coast, so why not contact our friendly team to book a consultation? You can also explore our Sellers Toolkit for everything you need to know about selling your business on the Sunshine Coast.