According to the Oxford Dictionary, Goodwill is:
“The established reputation of a business regarded as a quantifiable asset and calculated as part of its value when it is sold.”
What does that mean when we talk about business? A business’ goodwill can be viewed somewhat as their reputation. Goodwill isn’t a tangible asset. Although it is an intangible asset, it can be incredibly valuable. A business with a higher amount of goodwill will reflect this in the sale price, as goodwill generally takes time to build and can strongly affect profitability.
The easiest way to explain how goodwill works is through an example. Here are three different businesses and how each of them has a different goodwill value – and more importantly, why that is the case:
- A bottle shop: You may have a favourite bottle shop. But think of why you frequent this one over others. The price and the staff come into play, but more often than not – it’s the location that is convenient. It’s nearby for a quick run to get another bottle of wine if needed, therefore their goodwill lies in their location. If the owner sells their bottle shop and a new owner begins, would you change shops? Probably not. That is why this is referred to as ‘locational goodwill’
- A hair salon: A hairdressing salon may also fall somewhat into the locational goodwill category, but unlike a bottle shop – there is one big difference… It’s a service business. In particular, a personal service business. The hair cut and colour you receive from your hairdresser may not be the same quality you receive elsewhere, therefore this is a business you may follow elsewhere if the owner decides to sell. This is referred to as ‘personal goodwill’
- A TV network: Whether you watch the news on one station or another, the likelihood of you changing each week is slim. They essentially report on the same news, however, you’ve always watched Channel 9, so why change now? This is defined as ‘brand goodwill’
When you’re buying a business, it is important to assess the type of goodwill attached to the business in question and ask yourself these questions:
- Is this goodwill associated with the business or the owner?
- If associated with the owner, how can it be transferred to me?
Goodwill is one of many variables that is assessed during the early stages of a business purchase. Here at Core Business Brokers, we are happy to break down the components that form the business sale price and explain why the goodwill is valued the way it is.
If you are looking to sell your business and wonder how valuable your goodwill component is, contact us today on (02) 9413 2977, or by email at [email protected]. Our experienced team of Business Brokers have years of experience both appraising and valuing businesses and would be more than happy to explain any questions you may have regarding goodwill.