Is Goodwill Good for Your business?

While the answer to this goodwill question is a resounding “yes”, one of the most perplexing questions a small business owner faces when he or she decides to sell their business is "what do I have to sell and what is it worth?" And if yours is a business services company with little equipment, inventory or fixed assets, this question will resonate even more.

Most owners are familiar with balance sheet assets such as:
• Cash and short term investments
• Accounts receivable
• Inventory
• Equipment and machinery
• Business real estate

But other valuable business assets may not appear on the company's balance sheet. Among them are such intangible assets as intellectual property…and business goodwill.
Then how do you value and monetize an asset that is not tangible, yet does contribute to income?

How do you monetize a sales process, know-how, customer lists, vendor agreements, training systems, technical process, distribution networks, and client relationships? How do you monetize your position in the marketplace and your ability to effectively serve your customers and drive additional income? And how do you monetize all of those proprietary methods and processes you use in order to conduct your business?

The answer is to properly value your business “goodwill”.
Owners may believe that the business has additional value simply because it is able to create new products and services, attract new customers, and acquire or merge with other businesses.

But to properly value and provide a rationale for a valuation which includes business goodwill, two most common valuation methods are the Capitalized Excess Earnings method and the Discounted Cash Flow method.

The Capitalized Excess Earnings method works as follows:
Estimate the fair market value of all identified business assets.
Determine a fair rate of return on these assets.
Subtract the return from the total business earnings. The difference is the excess earnings.
Capitalize the excess earnings to determine business goodwill.

Of course this is often more art than science when the correct choice of the capitalization rate is key and will determine the resulting value.

The Discounted Cash Flow business valuation method utilizes a time value of money concept which expresses a business market value as the present day value of future expected cash flows. Business goodwill is then estimated as the difference between the total business value and the fair market value of all identified and fixed business assets.

And remember, an evaluation of goodwill is called for not only when selling your company, but also when two businesses merge. This is when equity ownership needs to be allocated among the business owners. One way to do this is to allocate a portion of the assets being contributed as business goodwill.

And when seeking credit or a bank loan, the value of your business assets includes business goodwill and always will influence the lender’s decision.


Ken Stein, CFP®
Business Broker and Intermediary
www.linkedin.com/in/kennethsteincfp
www.gotoimpact.com www.reliancestrategies.com


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