Goodwill, simply stated, is the difference that exists between a business’s tangible assets and the purchase price. Goodwill can also be looked at as encapsulating all the hard work that the seller has put into the business while building it. That stated some do confuse goodwill value with the going-concern value, and this should clearly be avoided. The going-concern value deals with the concept that the business will continue to operate instead of being liquidated. Going-concern value is built around the idea that the business has ongoing value and is not ready for liquidation.
What is Goodwill?
The M&A Dictionary deems goodwill as an intangible and fixed asset, one that can be carried on “as an asset on the balance sheet, such as a recognizable company or product name or strong reputation. When one company pays more than the net book value for another, the former is typically paying for goodwill.”
In other words, goodwill is not one-dimensional in nature, but instead, encompasses a range of worth that includes such variables as reputation and long-term relationships. This often denotes a deeper value and indicates potential hidden strength within the business. For example, a strong reputation and a plethora of long-term clients and business relationships can imbue a business with both enhanced stability and longevity.
Some Prime Examples
Determining goodwill can be a complex process as it is necessary to include an array of diverse factors. Factors used in determining goodwill can range from having a loyal customer base and a strong reputation to the overall health of the local economy, being in a recession-resistant industry and having a good location. Other key factors such as strong management, skilled employees and low employee turnover are further examples of goodwill.
Other examples of goodwill can be a little more concrete in nature. A business with technologically advanced equipment, a custom-built factory, royalty agreements, and effective advertising campaigns can also have high levels of goodwill. Copyrights, patents, trade secrets, proprietary designs, and name recognition can all be powerful company assets that can be entered into the overall equation.
Changing Rules Regarding Goodwill
In the past, many companies were built largely around hard assets such as machinery. But today’s industry titans are increasingly built around intellectual property, an array of patents and trademarks and even brand names. Accountants have had to adjust to this new reality when determining value.
New rules and standards were created by the Federal Accounting Standards Board (FASB) in 2001. Under these new rules and standards, goodwill may not be written off. Now, both public and private companies must include their intangible assets and this, not surprisingly, includes goodwill. Importantly, goodwill must be valued by an outside expert.
Ultimately, goodwill is more complicated today than in the past. Working with an experienced business broker is an excellent way to demystify the goodwill process and help to determine the true value of any business.Read More
You may hear the word “goodwill” thrown around a lot, but what does it really mean? When it comes to selling a business, the term refers to all the effort that the seller put into a business over the year. Goodwill can be thought of as the difference between the various tangible assets that a business has and the overall purchase price.
The M&A Dictionary defines goodwill in the following way, “An intangible fixed asset that is carried as an asset on the balance sheet, such as a recognizable company or product name or strong reputation. When one company pays more than the net book value for another, the former is typically paying for goodwill. Goodwill is often viewed as an approximation of the value of a company’s brand names, reputation, or long-term relationships that cannot otherwise be represented financially.”
Goodwill vs. Going-Concern
Now, it is important not to confuse goodwill value with “going-concern value,” as the two are definitely not the same. Going-concern value is typically defined by experts, as the fact that the business will continue to operate in a manner that is consistent with its intended purpose as opposed to failing or being liquidated. For most business owners, their goodwill value is seen as good service, products and reputation, all of which, of course, matters greatly.
Below is a list of some of the items that can be listed under the term “goodwill.” As you will notice, the list is surprisingly diverse.
42 Examples of Goodwill Items
- Phantom Assets
- Local Economy
- Industry Ratios
- Custom-Built Factory
- Loyal Customer Base
- Supplier List
- Delivery Systems
- Experienced Design Staff
- Growing Industry
- Recession Resistant Industry
- Low Employee Turnover
- Skilled Employees
- Trade Secrets
- Mailing List
- Royalty Agreements
- Technologically Advanced Equipment
- Advertising Campaigns
- Advertising Materials
- Computer Databases
- Computer Designs
- Credit Files
- Engineering Drawings
- Favorable Financing
- Government Programs
- Training Procedures
- Proprietary Designs
- Systems and Procedures
- Employee Manual
- Name Recognition
As you can tell, goodwill, as it pertains to a business, is not an easily defined term. It is also very important to keep in mind that what it is and how it is represented on a company’s financial statements are two different things.
Here is an example: a company sells for $2 million dollars but has only $1 million in tangible assets. The balance of $1 million dollars was considered goodwill and therefore it can be amortized by the acquirer over a 15-year period. All of this was especially impactful on public companies as an acquisition could negatively impact earnings which, in turn, negatively impacted stock price, so public companies were often reluctant to acquire firms in which goodwill was a large part of the purchase price. On the flip side of the coin, purchasers of non-public firms received a tax break due to amortization.
The Federal Accounting Standards Board (FASB) created new rules and standards pertaining to goodwill and those rules and standards were implemented on July 1, 2001. Upon the implementation of these rules and standards, goodwill may not have to be written off, unless the it is carried at a value that is in excess of its real value. Now, the standards require companies to have intangible assets, which include goodwill, valued by an outside expert on an annual basis. These new rules work to define the difference between goodwill and other intangible assets as well as how they are to be treated in terms of accounting and tax reporting.
Before you buy a business or put a business up for sale, it is a good idea to talk to the professionals. The bottom line is that goodwill can still represent all the hard work a seller put into a business; however, that hard work must be accounted for differently than in years past and with more detail.Read More
How much goodwill do you have in your business?
The term “goodwill” is often thrown around in conversation as though it is a subjective description of how much your customers like your business.
In fact, when it comes to valuing your business, there is nothing subjective about the definition of goodwill. It is defined as the difference between what someone is willing to pay for your company minus the value of your hard assets.
Let’s imagine you own a HVAC company and the main physical assets in your company are the five vans you own and some tools with a total value of around $100,000. If you sold your HVAC company for $1,000,000, the acquirer would have paid $900,000 in goodwill ($1,000,000 – $100,000).
When a company sells for the value of its fixed assets, it is often a distressed business one step away from closing down. One way to think about your job description as an owner is to maximize the difference between what your business is worth to a buyer and the value of your fixed assets.
Marriott buys more than bricks and mortar
For an example of the difference between valuing a business for its hard assets vs. its goodwill, take a look at the recent acquisition of Starwood Hotels & Resorts Worldwide by Marriott. Neither Starwood nor Marriott own many of the hotels that bear their name. Instead, they license the name to operators, franchisees and the owners of the bricks and mortar.
So why would Marriott cough up $13 billion for Starwood if they don’t even own the hotels they run? In part, Marriott wanted to get its hands on the Starwood Preferred Guest program, a loyalty scheme which has proven more popular than Marriott’s program for frequent travellers.
Similarly, Uber is worth something north of $50 billion because more than one million people per day hail a ride using Uber, not because they own a whole bunch of cars.
Chasing hard assets at the expense of goodwill
Many owners focus on building their stockpile of hard assets, not understanding the concept of goodwill.
Accumulating hard assets like land and machines and equipment is fine, but the savvy owner, looking to maximize her value, focuses less on the tangible assets and more on what those assets allow her to create for customers. There is nothing wrong with owning hard assets unless they take away from capital you could be investing in creating goodwill. Then the opportunity cost may exceed the value of owning the stuff.
Arguably both Uber and Starwood would be a shadow of the companies they are today had they pursued a strategy of accumulating hard assets. Would Uber ever have made it out of San Francisco if they had to buy a Lincoln Town Car every time they wanted to add a driver to their network?
In your case, focus on what creates value for customers and you will maximize the value of your business far beyond the value of your hard assets.Read More