UNLOCKING THE HIDDEN VALUE: UNDERSTANDING THE 3 TYPES OF GOODWILL FOR YOUR BUSINESS

AUTHOR

Bruce Coudrey

Goodwill is a key component of the purchase price in a business acquisition, representing the value of intangible assets such as the reputation and brand of the business. These intangible assets cannot be easily quantified, but they can have a significant impact on the value of a business. Understanding the different types of goodwill is crucial in accurately valuing a business and ensuring a fair price is paid.

In this article, we will explore the various types of goodwill and their impact on business valuation. Goodwill can be classified into several categories, including personal, commercial, and location goodwill. Personal goodwill refers to the value of a business that is tied to the personal relationships and reputation of the owner. Commercial goodwill attaches to the business itself, rather than to the owner, and is tied to the reputation and brand of the business. Location goodwill refers to the value of a business that is tied to its location. In addition to these three types of goodwill, there are several other types of goodwill that can impact the value of a business, such as intellectual property and industry goodwill.

Personal Goodwill: A Key Factor in Business Success

Personal goodwill exists in businesses where the owner has a personal following of customers or clients. This might include businesses such as hairdressers, mechanical repairers, restaurants, and professional practices. The risk with these businesses is that when they are sold, the customers may leave with the owner. As a result, values assigned to personal goodwill should be considered carefully, unless the vendor is willing to provide guarantees that the purchaser will retain the customers.

Personal goodwill can be difficult to value, as it relies on the personal relationships and reputation of the owner. It is important to put measures in place to protect the purchaser's interests. This can be through the vendor remaining for a period to assist in the transition, or by providing a restrictive covenant. A restrictive covenant is a legally enforceable agreement that limits the actions of one party, in this case the vendor, after the sale of the business. It might prohibit the vendor from competing with the business or from soliciting customers for a specified period.

A further way to protect the purchaser's interests is to have a clawback clause in the purchase agreement. A clawback clause allows for the adjustment of the purchase price if certain revenue thresholds are not met. For example, if the vendor guarantees that the business will maintain a certain level of revenue after the sale, and the business falls short of that threshold, the purchaser may be able to recoup some of the purchase price through the clawback clause.

It is also important to carefully evaluate the risks associated with personal goodwill when valuing a business. If the vendor is not willing to provide guarantees or put measures in place to protect the purchaser's interests, the value of personal goodwill may be lower. On the other hand, if the vendor is willing to take steps to ensure the retention of customers, the value of personal goodwill may be higher.

Personal goodwill can have a significant impact on the overall value of a business, especially in industries where personal relationships with customers are important.

Leveraging Commercial Goodwill for Business Success

Commercial goodwill attaches to the business itself, rather than to the owner. Examples of businesses with commercial goodwill include retailers, wholesalers, and manufacturers. A McDonald's franchise is a good example of a business with largely commercial (or corporate) goodwill - the nature of the business, through its marketing strategies, reputation, and products, has a loyal customer base that is not reliant on the owner. As a result, the value of the business is not as reliant on the owner and can be transferred to a new owner more easily.

Commercial goodwill is generally easier to value than personal goodwill, as it is tied to the reputation and brand of the business rather than the personal relationships of the owner. It can be difficult to quantify the value of commercial goodwill, as it is often made up of intangible assets such as the brand, reputation, and customer base of the business. However, there are several methods that can be used to estimate the value of commercial goodwill.

One method is the income approach, which values the business based on the future economic benefits it is expected to generate. This might include calculating the present value of future cash flows, using a discounted cash flow analysis. Another method is the market approach, which values the business based on comparable sales of similar businesses. This might involve looking at the sale prices of similar businesses in the same industry and using those as a benchmark for the value of the business being valued.

It is important to consider the value of commercial goodwill when valuing a business, as it can have a significant impact on the overall value of the business. In some cases, the value of the commercial goodwill may even exceed the value of the tangible assets of the business. It is important to carefully assess the value of commercial goodwill to ensure a fair price is paid in a business acquisition.

Location Goodwill: Maximising Business Potential in a Specific Area

Location goodwill refers to the value of a business that is tied to its’ location. This might include businesses such as convenience stores, motels, or childcare centres that rely on their location for success.

For example, a convenience store that has been located in the same spot for many years and has a strong reputation in the community may have significant location goodwill. On the other hand, a business with a shorter lease term or located in an area with declining commercial value may have less location goodwill. It is important to consider the value of location goodwill when valuing a business, as it can have a significant impact on the overall value of the business.

Location can be a key factor in the success of a business, and it is important to carefully assess the value of location. Some factors to consider when evaluating location goodwill include:

• Length of time remaining on the lease: A business with a longer lease term may have more location goodwill than a business with a shorter lease term. This is because the business has more security in its location and is less likely to be disrupted by a change in landlords or lease terms.

• Changes in regulations or the commercial value of the location: Changes in regulations or the commercial value of the location can impact the value of location goodwill. For example, if a business is located in an area that is experiencing rapid growth or development, the location goodwill may increase. On the other hand, if the area is experiencing decline or there are changes in regulations that negatively impact the business, the location goodwill may decrease.

• Difficulties with the landlord in transferring the lease: If there are difficulties with the landlord in transferring the lease, it may impact the value of location goodwill. For example, if the landlord is unwilling to transfer the lease to the purchaser, it may make the business less attractive and decrease the value of location goodwill.

Location goodwill can have a significant impact on the overall value of the business and should not be overlooked when valuing a business.

Other Types of Goodwill

In addition to personal, commercial, and location goodwill, there are several other types of goodwill that can impact the value of a business. These types of goodwill may not be as common as the three types mentioned above, but they can still have a significant impact on the value of a business.

Intellectual Property Goodwill: Protecting and Enhancing Business Value

Intellectual property goodwill refers to the value of a business's intangible assets related to intellectual property, such as patents, trademarks, and copyrights. These assets can be highly valuable, especially in industries where intellectual property is a key factor in the success of the business.

Industry Goodwill and How It Affects Your Business

Industry goodwill refers to the value of a business based on the overall health of the industry in which it operates. For example, a business in a growing industry may have more value than a similar business in a declining industry.

Maximising Business Potential Through Goodwill

Goodwill is a key component of the purchase price in a business acquisition, representing the value of intangible assets such as the reputation and brand of the business. There are several types of goodwill that can impact the value of a business, including personal, commercial, location, intellectual property, and industry goodwill. Understanding the different types of goodwill is crucial in accurately valuing a business and ensuring a fair price is paid.