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How should you value goodwill?

How to value goodwill

Goodwill is notoriously hard to value. Here's how you can get the most out of it.

What is goodwill?

Goodwill is considered an intangible within the business.

Effectively, it is the “markup” on the physical assets of the business which helps to create the ultimate valuation of the business.

An example of goodwill is:

There are two "types" of goodwill:

1. Purchased goodwill

This is the difference between the actual value of the business and the purchased value of the business

2. Inherent goodwill

The best way to think about this is as internally generated goodwill. That is, it comes from the age, location, and overall reputation of the business. Sometimes, a business can have negative goodwill when the value of the business is less than its assets.

Methods of valuing goodwill

Essentially valuing goodwill comes from two methods:

  • Deciding what you believe the business to be valued at and then deducting the physical value of the assets to arrive at a goodwill figure.
  • Calculating the value of the business via several business valuation techniques (for example, multiple valuation, Discounted Cash Flow) and then deducting the physical value of the assets to arrive at a goodwill figure.

No matter the method, we recommend getting a professional valuation to give you an alternative of the value for your business.

Goodwill comparison

Below we compare two type of businesses and outline their goodwill and goodwill as a percentage of the business value.

Capital light businesses (such as software companies and service businesses) will always have a higher proportion of goodwill when compared to businesses that are asset heavy such as trucking businesses or machinery businesses.

Example of valuing goodwill

In most cases the, a buyer will consider what is the “reproduction value of the assets” when they look at buying the business. For example, if you are selling a trucking business with the value of all the trucks at $10 million and you are asking $25 million for them, (meaning your goodwill is relatively high at $15 million) a buyer may elect to simply go out and purchase all the trucks and setup in competition.

Businesses with high assets (such as plant hire companies, trucks, etc) typically have a lower goodwill value then a service based business.

How do I get a high value for my goodwill?

The key drivers of goodwill are varied, but essentially, a buyer will want to see what future maintainable profit is being delivered from the assets of the business, both tangible and intangible.

The most notable items are:

  • Customers being on long term contracts
  • A clear strategy within the business
  • Well trained staff and a set management structure
  • Intellectual property and inbuilt systems and processes in place
  • Ensuring a strong brand within the business
  • Sales pipeline through use of sales reps, publications or online

The quality of goodwill is crucial

The quality of goodwill can be pivotal in determining how risky your business is to buy. For example:

  • Quality and quantity of clients. Showing that you are able to retain clients long term, as well as show a volume of clients that you are able to attract can significantly de-risk your business to any potential buyer.
  • Age of the business. If your business is mature and has successful years behind it, a potential buyer may be comforted by that fact. As such, the value, and therefore the goodwill of your business is higher.
  • Location of the business. The location can significantly change the value of your business. For example, for some businesses, if you are in an accessible, central location such as the CBD, this will attract better value.

Valuing goodwill isn't an easy task

There are a lot of moving parts when it comes to valuing goodwill. While some goodwill items are easy to find, you'll quickly discover that you're just chipping away at the tip of the iceberg. At Nash Advisory, we can help you:

  • Discover where your goodwill lies
  • Increase the value of your goodwill
  • Put future strategies in place to ensure you get a confident buyer

Get in touch with Nash Advisory to discuss how to go about valuing goodwill. We'll even provide you a free business valuation with $5,000.