The Impact of Goodwill on a Business Valuation
Business value is not just tangible assets such as land, equipment, and cash flows, but rather a mixture of tangible and intangible assets. As a small business owner, an important intangible asset to know of is goodwill. It is important to know what goodwill is and how it impacts the value of your company. Often it is the largest part of the purchase price of a small business.
What is Goodwill?
Goodwill represents the portion of your business value that cannot be attributed to anything specific. When a business sells, the price is typically more than the value of its identified assets – this difference is generally goodwill. Goodwill is the difference between the purchase price of the business and the fair market value of the identified tangible and intangible assets.
Examples of Intangible Assets
- Copyrights, trademarks, patents
- Brand recognition, reputation
- Customer/Supplier relationships, contracts
- Websites, domain names
- Trade secrets, recipes
- Unique processes, software, databases, training
- Published articles, industry press
Case #1. Goodwill with Brand Recognition and Secret Recipes
Let’s suppose you own a small restaurant that you are selling. Assets included in the sale may be tables, chairs, and kitchen equipment. These assets only amount to a few thousand dollars, yet your business is worth much more than that. Any dollar amount above the value of these tangible assets is goodwill. Goodwill in this case comprises the brand, customer loyalty, recipes, etc. These intangible assets create real value for a company.
Case #2. Goodwill with a Website
Another example of goodwill is when someone sells a domain name. The website itself has little value, beyond the meager yearly registration fee. However, companies are willing to pay thousands, even millions of dollars for a memorable domain name. For example, in 2017, Walmart bought the website shoes.com for a whopping $9 million. While the additional intellectual property was included in the sale, almost the entirety of the purchase price was attributed to goodwill.
Case #3. Goodwill with a Customer Database
Suppose your company has a growing database that contains information about current and potential customers. This knowledge about your target market gives you a competitive advantage. The database includes email addresses, details of various business interactions, as well as marketing efforts. A database with proprietary information can aid future profits and recurring revenues. As such, this intangible value is part of goodwill.
Why Include Goodwill in a Valuation?
Goodwill has a major impact on the value of your company. Ultimately, goodwill can make a company more attractive to potential buyers. Although goodwill can be difficult to value, it is an important component when negotiating the potential buy or sale of a business.
Summary
When you are obtaining a business valuation, it is important to articulate the goodwill in your business. This will likely result in a higher valuation. We at Peak Business Valuation understand the importance of goodwill and are happy to answer any questions you may have. Reach out by scheduling a free consultation.
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