Goodwill – what is it and who owns it?
What is it? When a company changes hands, the price paid consists of two basic elements: the net book value of its assets (“NBV”) and the premium over its NBV the purchaser is willing to pay to secure its business, often known as goodwill.
In reality, the value of goodwill is derived from a number of factors including among other things:
• Relative market dominance
• The quality and distribution of a customer or client base
• The strength of any branding
• The level of recurring income
It is underwritten by the perceived value of the future cash flows which will accrue to the purchaser.
Therefore, the higher the amount of goodwill in a transaction, the greater the risk to the purchaser as a greater element of the purchase price is not secured by hard assets. The ridiculously over-inflated values and subsequent collapses of the dot.com era serve as a salutary reminder of what can happen when too much is paid for “goodwill”.
Who owns it?
Goodwill can be personal to the owner of a business or it can attach to the company itself. In certain situations, some goodwill may even attach to the business premises. Why is this important? If judged personal, there is little or no value to goodwill in the corporate context. If attaching to the company, it enhances its value to the benefit of its shareholders. What factors indicate the presence of personal goodwill? Examples include, marketing which emphasises individuals rather than the company, strong personal relationships with key customers, the absence of non-compete clauses in employment contracts, the lack of a management infrastructure, reliance of the company on one or two individuals.
Apart from the obvious impact on the sales value of a business, the distinction between personal and corporate goodwill can be of critical importance to the owner of a business seeking to incorporate and wishing to maximise the goodwill element of any pre-incorporation valuation. Goodwill valuations in this context are attracting the increasingly sceptical attention of HMRC which will often proceed from the position that substantially all goodwill on incorporation is personal unless there is hard evidence to show otherwise.
Goodwill to some men!