The Goodwill question

Business valuations include an amount of money for “Goodwill” but what does that actually mean?

The perceived value of goodwill can make a massive difference to what a buyer is prepared to offer, but why is goodwill so difficult to quantify?

Here’s a definition of commercial goodwill:

The benefits that buyers obtain in an acquisition from its intangible assets – such as the company’s brand, established client relationships, operational and financial processes, trained and experienced workforce, industry know-how etc. 

And therein is the problem – unlike stock, IP or even employees, the benefit is intangible and its value is a matter of (informed) opinion.  In order to quantify that goodwill the benefit must be transferable and sustainable.  The value of the goodwill is a function of the degree to which it is sustainable and the effect it will have on the future earnings of the combined business post acquisition.

So let’s consider the questions of transferability and sustainability.  If elements of the commercial goodwill are held by the departing owner (usually relationships with key clients, sales or product development) then the goodwill is not held within the business.  As such it is not transferable and is only sustainable if the owner remains in the business post acquisition.

Result – the owner has to accept a lower price or has to stay on in the business, often tied in through an “earn out” clause in the sale agreement and usually tied to profit targets.

But there are some ways you can maximise the value of these intangible assets.  A few might include:

  • Demonstrating customer satisfaction – use your information to monitor attrition rates. Use project sign-off documents to provide you with evidence; conduct an annual survey of your customers perhaps?
  • Documenting of processes and procedures and keeping them updated, even if you’re not planning to have an accredited Quality Management system.
  • Using sales performance data to evidence that your projected revenues are realistic and achievable.
  • Evidencing the value of your company brand – use web analytics to monitor how many people are aware of your brand through your website, use customer order data to monitor brand loyalty by repeat business won and also recommendations from clients that lead to new business. If you advertise or use PR make sure to monitor the sales resulting from that source.  Include a field in your database or CRM system for Data Source so you can measure where your sales originate and build on that.

These are just a few examples of how build tangible value from your intangible assets.  When it comes to valuing your business it’s essential to have some real data to substantiate the value of goodwill.

You can find out more about growing a business by registering for our FREE Business Growth Workshop on 27th April.

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