When adopting the Capitalisation of Earnings Methodology, it is not uncommon for the calculation to deviate from the business’ net operational business assets. In circumstances where the value calculated under the Capitalisation of Earnings Methodology exceeds the net operational assets of the business, the excess or premium is typically referred to as the Goodwill component.
In many small businesses, Goodwill can represent a significant amount of a business’ value, however its intangible nature can lead to disagreement between parties.
When determining the Goodwill of a business, it is important to understand the different types of Goodwill that may exist in a business. Common types of Goodwill will include:
Where the owners of the business have personal followings of clients such as professional services firms, this is typically attributable to Personal Goodwill. The risk (which is typically built into any earnings multiple) is that when businesses are sold or key personnel exit the business, there is a risk that clients may also leave.
Values which are attributable to Personal Goodwill should be carefully considered by a valuer and have regard to the existence of restrictive covenants or guarantees that a vendor is willing to provide.
Corporate Goodwill will generally attach to the business independent of its owners and arises from having an established brand or reputation, key product lines or a loyal customer base.
Corporate Goodwill commonly exists with businesses in the wholesale and manufacturing industry where reliance on key business owners is less critical to client retention and the operations of the business.
Where businesses operate from strategically located premises, Goodwill can sometimes be attributable to Location Goodwill.
Businesses which possess Location Goodwill may include Aged Care Facilities, Motels and Childcare Centres, however when attributing some or all of the Goodwill of a business to its location, a valuer should have regard to the following risk factors that may have an effect on this assessment:
- Length of time remaining under the current lease and the existence of options;
- Any identifiable deterioration of the commercial value of the location such as a permanent diversion of traffic flows;
- Any changes in regulations requiring an upgrade of the premises; or
- Any difficulties posed by the landlord in effecting a transfer of the lease.
The different types of Goodwill extend beyond those listed above and it is crucial that valuers properly consider the characteristics of the business being valued when undertaking their assessment.
For any specific or general business valuation queries, please get in touch with one of our qualified and experienced experts.