Goodwill Valuation

Valuing goodwill

ɡʊdˈwɪl/ – goodwill

Old English: godes willan “virtuous, pious, upright,” also “state of wishing well to another.

Defining goodwill

Valuing goodwill? You first need to define goodwill. It is an elusive concept.

According to the Hon. Justice G T Pagone, goodwill is as difficult to hunt for (and value) as Lewis Carroll’s mythical Snarks1. The definition is certainly slippery and interpretations differ between accountants and lawyers. According to the accountants’ goodwill is:

“an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised.”, International Financial Reporting Standards:

According to the lawyers (and the ATO):

“Goodwill is inseparable from the conduct of a business. It may derive from identifiable assets of a business, but it is an indivisible item of property, and it is an asset that is legally distinct from the sources – including other assets of the business – that have created the goodwill.”, High Court of Australia in FCT v Murry

Simply put: goodwill cannot be divided and separated. Goodwill is attached to the business. Goodwill is distinctive from the sources that created the goodwill.

Calculating goodwill

Goodwill is commonly referred to and calculated as the value of the business (or price in a transaction) over and above the value of the tangible assets of the company. Where the tangible assets are items that have a value on the balance sheet, such as work in progress and stock.

Watch out! This inferred residual value, the “rump” end of the valuation, might not just be goodwill. This residual value is the value of all intangible assets. Goodwill is just one example of an intangible asset.

To muddy matters, there exist identifiable and unidentifiable intangible assets. Those intangible assets that can be individually identified and separately recognised aren’t included in goodwill. Identifiable intangible assets include intellectual property such as copyrights, patents, trademarks and brand names.

Goodwill is the residual balance after all identifiable intangible assets have been deducted. Valuing goodwill therefore first requires that the identifiable intangible assets be valued.

Sources of Goodwill

Often from an accounting perspective, goodwill is classified into three key areas:

• Personal goodwill. The skills, abilities, reputation, character and personality possessed by the business owners and key people working in the business. If the owners and the key people no longer operate in the business then the value of the goodwill in the business must diminish. Which is why in transactions owners and key individuals are encouraged (and employment contracts signed) to stay on in the business.
• Site goodwill. The goodwill attached to the location. Site goodwill may exist if the premises are in a favourable location and or because customers have been going to that same location over several years. The site goodwill cannot be transferred to another property. Site goodwill is commonly attached to the property value – avoid double counting!
• Name goodwill. This relates to the name or reputation attached to a business. The name which attracts customers.

Wayne Lonergan considers the following business qualities and characteristics as goodwill: the quality of the management team, know-how, marketing & management expertise, distribution network, economies of scale, technical skills, location qualities, carry-over of any advertising effect, and synergies related to the combination of the purchased business and the existing business and consumer loyalty.

If goodwill can be separated into components then by definition it can’t be goodwill! The above must then be sources and not components of goodwill.

Summary

To value goodwill, you first need to identify and define goodwill. It is a slippery fellow. To arrive at goodwill you need to eliminate both tangible assets and identifiable intangible assets.

1. G.T.Pagone (2011) Goodwill and its relationship to land 2. International Financial Reporting Standards (I Save & Exit FRS) 3 – business combinations 3. Commissioner of Taxation v Murry [1998] HCA 42 4. FCT v Krakos Investments Pty Ltd (1995) 61 FCR 498; 32 ATR 7 5. Lonergan, W (1995) Goodwill and bad ideas

Simon is a CA Business Valuation specialist in Brisbane, Chartered Accountant and a Certified Fraud Examiner. Simon specialises in providing business valuation services. Prior to founding Lotus Amity, he was a Corporate Finance and Forensic Accounting partner with BDO Australia. Simon provides valuation services in disputes, for raising finance, for restructuring, transactions and for tax purposes.