When business owners hear the term goodwill, they often think it simply means having a good reputation. While reputation is certainly part of it, goodwill has a much broader meaning when it comes to valuing and selling a business.
Simply put, goodwill is the value of a business beyond its tangible assets. Equipment, inventory, furniture, vehicles, and real estate may all have measurable value. But a successful business often has additional value because of advantages it has built over time—advantages that would be difficult, expensive, or time-consuming for a new owner to recreate.
Those advantages are often what make an established, profitable business worth considerably more than the value of its physical assets alone.
Where Does Goodwill Come From?
Goodwill develops over time as a business establishes itself in the marketplace. A loyal customer base, recognizable name, experienced workforce, strong vendor relationships, efficient operating systems, recurring revenue, and a history of consistent earnings can all contribute to goodwill.
Consider two businesses with identical equipment and inventory. One has declining sales, inconsistent earnings, and frequent employee turnover. The other has loyal customers, recurring revenue, experienced employees, strong systems, and an excellent reputation.
Although their tangible assets may be nearly identical, most buyers would be willing to pay considerably more for the second business. Why? Because they are not simply buying equipment and inventory—they are buying an established operation with customers, employees, systems, relationships, and proven earning power.
That additional value is goodwill.
Goodwill Is Different From Book Value
A common misconception among business owners is that their company is worth only what appears on the balance sheet. In reality, financial statements rarely capture the full value of a successful operating business.
When a profitable business is sold, the purchase price often exceeds the value of its tangible assets. A portion of that difference may be attributed to goodwill, while other portions may be allocated to identifiable intangible assets depending on the transaction structure and applicable accounting and tax rules.
How the purchase price is allocated among these assets can have important tax and accounting implications for both the buyer and seller. For that reason, the final allocation should be determined with guidance from qualified accounting and tax professionals.
Building Goodwill Before You Sell
The good news for business owners is that goodwill is not necessarily fixed. Many of the factors that contribute to goodwill—and ultimately business value—can be strengthened well before a company is brought to market.
Building stronger customer relationships, creating recurring revenue, reducing dependence on the owner, documenting systems and procedures, retaining key employees, strengthening financial performance, and developing a recognizable brand can all make a business more attractive to prospective buyers.
These improvements can make the company easier to operate, reduce perceived risk for a buyer, and potentially increase its value when the time comes to sell.
Every business has tangible assets, but many of the qualities buyers value most cannot be seen on a balance sheet or measured with a tape measure. They are built over years of serving customers, developing relationships, establishing systems, and creating a business capable of producing consistent results.
Understanding goodwill—and actively building it—is an important part of maximizing the value of your business.
Copyright: Business Brokerage Press, Inc.
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