Business Valuation – Goodwill 

 Buyers will look at four primary issues when considering the purchase of a business.  Suitability or fit, affordability, risk, and return.   Suitability and affordability are individual to each buyer and do not directly affect price determination when pricing a business for sale.  There is no question that a highly motivated buyer may pay more for a business, but pricing should not be set at a level that only that one “special” buyer might pay.   As brokers, we can only look at pricing based on what a normal market might assess on a risk vs. return basis, taking into account any market data that may be available on businesses of a similar type.

 Most business transactions in the small market are “Asset Sales” comprised of hard assets (equipment, vehicles, stock etc..) and in certain cases goodwill. Putting a market or  “on-going concern” value on working assets in generally not difficult as there are a number of qualified  CPPA’s (Certified Personal Property Appraisers) that can value these assets.  The market price of the assets will often set the “Floor Price” for the business.  If the business is under-performing, the end price of those assets might very well be discounted …. with the floor price falling anywhere between “market” value and  liquidation value.  The Broker’s job is to assess a value, if any, for goodwill in addition to the liquidation value of those hard assets.

It is a common mistake among sellers to assume that there is a finite amount of goodwill attached to their business simply because of the years that they may have put into the business (sweat equity).    Unfortunately, buyers will not pay goodwill expressly on this basis.   If the recent earnings are weak then it is difficult to find price support for goodwill, regardless of past performance.   In some cases there may be an argument for some level of goodwill if the business has a new product, technology or service that has yet to be fully developed and marketed, however this form of goodwill is most often tied to a future performance-based payout, commonly referred to as an "earn-out".

The amount of goodwill that a prudent buyer might pay over and above the value of the hard assets is dependent on any number of factors, but is generally tied to the level and sustainability of current earnings, or anticipation of future  earnings in a  range sufficient to justify that goodwill.   Put another way, buyers will look at the earnings potential, and first determine if those earnings provide a reasonable return on the investment in hard assets.  If those earnings provide a return in excess of that, some level of goodwill can be considered.

 

 

Patrick S. Preston, Agent

Business Brokerage Specialist