The Value of Goodwill

Small business buyers and sellers often ask, “What is good will?”

Goodwill is an accounting tool that assesses the value of a company’s reputation, its relationship with customers, its standing in the community and other intangible benefits.

The bulk of the value of the small business is goodwill rather than fixed assets.

By definition, goodwill is an intangible asset and that asset varies considerably in different circumstances. As opposed to tangible assets like plant and equipment, stock on hand, and contracts in place, if a business falters, intangible assets cannot be sold to recover debt.

In this particular climate of recession recovery, many banks are reluctant to loan based on goodwill and some have set a limit of 50% of the goodwill figure that will be included in loan calculations. For small businesses in the Busselton-Margaret River Region, this can be a problem.

Let’s say you want to sell your business for $600,000. You have $200,000 in assets and clear $250-300,000 per year. In someone else’s hands, that could drop to nothing. A prospective buyer, who is unable to obtain any more than $400,000 in a business loan, might decide it’s too hard and walk away.

Small business owners, who are retiring, looking to exit due to illness, burn-out and so on may be forced to simply close their doors if this tight lending continues.

Small businesses are often valued on a multiple of cash flow, and lenders provide debt financing based on the buyer’s ability to repay the debt.

Goodwill is defined by the value created by the cash flow of the business, less the tangible assets. Large businesses are valued on cash flow, public companies are valued on cash flow, and lender loan covenants are based on cash flow. Why not small business?

If you’re looking at a business to buy, you’ll want to pay as little as possible for goodwill. If, on the other hand, you are selling, goodwill is a fair way to recover all the blood, sweat and tears put in from the beginning to turn an idea into reality. Somewhere in between is what will be deemed a fair transaction.