When I do post-mortem reviews with business owners about business sales that have fallen over, one of the most common points of failure is a dispute over the value of Goodwill.
It is fair to say that establishing a reasonable value for your business is fairly straightforward – in most cases it is a defined multiple of the EBITDA. However, when this number doesn’t match up with what the current owner(s) want they resort to Goodwill to create the necessary “padding” to create the total value they want.
As the current owner, you’ll unconsciously factor in how difficult it was in the beginning and how much sacrifice was necessary to weather the difficult times. The owners must realise, however, that others will evaluate your business from a much narrower point of view … it’s ability to return an investment over a fixed period of time with an acceptable margin of risk.
This doesn’t mean that a prospective buyer fails to appreciate your efforts in building the business.
But goodwill is the single most difficult portion of your business to value. Your reputation and relationships with your customers, vendors and the community, along with your participation in trade-related activities, all contribute to goodwill. In fact, your customer list is probably among your business’s most valuable assets. In fact … sales of some businesses are based on this alone.
One of the key factors that causes sales to fall over is greed, or ignorance, with respect to Goodwill.
This is because the factors used to increase/decrease the EBITDA multiple have already been assessed and the judgement has been made. Therefore you can’t have those contributions to the business valuation TWICE.
Some examples are:
- The quality of your current clients;
- The duration of your current contracts;
- The level of current revenues that are annuity-based;
- The reputation of the business in the industry/sector it trades in;
- The strength (or lack of strength) of your competitors;
- How much of the effort has already been completed that is needed to yield a great return on a product/service.
Some factors that legitimately contribute to Goodwill, and are not likely to be reflected in the EBITDA:
- Brand recognition;
- Product recognition;
- Intellectual Property that has yet to be fully commercialised;
- Intellectual Property that has real licensing potential;
- Intellectual Property that can be OEM’d into the product set of a major global player.
As a rough guide, if the Goodwill value is more than 20% of the total business value then you’re double-dipping on Goodwill factors and will have trouble justifying the price.
Remember that in the final analysis, your company is worth only what someone will pay for it.
Generally, a potential buyer’s offer will be influenced by how soon they expect to see a return on their initial investment. As a guide, anything longer than 5 years is too long … therefore you’re trying to get a higher price than the business can actually deliver to the new owners.
Feel free to contact us if you want to understand more about business Goodwill as part of selling your business.