The value of a business usually includes Goodwill value. But what is Goodwill? What are the different characterizations of Goodwill? Let’s go Goodwill Hunting.
The International Glossary of Business Valuation Terms defines Goodwill as “that intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors not separately identified.”[i] Goodwill is the value of a company’s brand name, solid customer base, good customer relations, good employee relations, and any patents or proprietary technology. Goodwill is considered an intangible asset because it is not a physical asset like buildings or equipment.[ii] Goodwill, in general, is the value of the on-going business less the net value of the tangible assets. Rarely is the value of a business the Net Book Value of the assets.
To illustrate, let’s look at the Goodwill value of a brand name. Bobby decides she wants to start a fast food restaurant. Bobby purchases a tract of land on a busy street, builds a custom building, and equips the building for a restaurant. The total cost is $1 million dollars and Bobby’s Burgers is born. The book value of Bobby’s Burgers tangible assets is $1 million. Her grand opening brings three customers, her Mom and two cousins.
Bobby’s friend, Ray, also decides he wants to start a fast food restaurant. Ray purchases a tract of land on a busy street, builds a custom building, and equips the building for a restaurant. The total cost is $1 million dollars. Ray purchases a franchise license from McDonald’s Corporation for $45,000. The book value of Ray’s McDonald’s tangible assets is $1 million. The book value of Ray’s McDonald’s intangible assets is $45,000. Ray’s grand opening brings a thousand customers. The Goodwill value of the McDonald’s name is significant.
A business can also have Badwill, properly referred to as Negative Goodwill. Negative Goodwill exists where the value of the business is worth less than the Net Book Value of the assets. Back to Bobby’s Burgers. Bobby struggles with the restaurant for a year and continues to lose money. Bobby offers the business for sale at a price of $1 million (Net Book Value). Bobby has no buyers because no one wants her custom building, the shape of her hairdo with a hamburger on top, and used restaurant equipment. Bobby resorts to closing Bobby’s Burgers. She auctions the equipment and sells the real estate for the land value less the cost to raze the building. Bobby’s net proceeds from the liquidation of Bobby’s Burgers is $250,000. Bobby’s Negative Goodwill is $750,000.
Personal vs. Enterprise Goodwill
Goodwill can have two components, Personal Goodwill and Enterprise Goodwill. Personal Goodwill (also designated as individual, professional, or separate goodwill) is attributable to the individual. Enterprise Goodwill (also designated as practice, entity, business or commercial goodwill) is attributable to the business enterprise or the professional firm. Characterizing Goodwill as personal or enterprise is subjective to the parties involved. A business valuator, buyer, seller, divorcing party, tax professional, IRS agent, or judge, may each characterize the Goodwill of a business or professional practice differently. Factors to consider when characterizing Goodwill include the following:
- The name of the enterprise or practice – Charlottesville Family Law Group or Bull D. Dog and Associates.
- An enterprise logo.
- The focus of marketing materials – the enterprise or an individual.
- Website – does the practice use SEO techniques to bring new customers to the site?
- Advertising – promoting the enterprise or an individual.
- Sources of New Customers:
- Referrals and reputation, or Website and advertising.
- If the individual were to leave the business, would existing customers also leave?
- Location – is the enterprise conveniently located or must customers go out of their way.
- Size of the enterprise or practice – sole practitioner vs. a group of professionals.
- Special or unique qualifications of the professional or individual.
- Specialized or unique services offered by the enterprise.
- Income – does the individual realize income way above his peers?
- Do personal relationships exist between customers or suppliers and the individual?
- Do these relationships exist in the absence of formal contractual obligations?
- Does the individual’s personal reputation and perception in the industry provide an intangible benefit to the enterprise?
- Are the practices of the individual innovative or distinguishable in his or her industry?
- Concerning the above factors, is the owner/manager currently under any employment agreement or covenant not to compete with the business?
Characterizing Personal Goodwill from Enterprise Goodwill can be a very important issue in buy/sell negotiations, price allocation, determination of marital property, tax liability, and more.
In the movie, Good Will Hunting[v] starring Robin Williams, Matt Damon, and Ben Affleck, Will Hunting is a mathematical genius but has no will to apply his brilliance to his life. Will has huge Personal Goodwill potential but there is no Goodwill value until he applies his talents. Once an M.I.T. professor discovers Will’s genius, he is offered multiple positions with private companies and even the US National Security Agency. Instead, Will wants to continue as a janitor at M.I.T. and a construction worker. Will gets help from a psychologist, Robin Williams, to find direction in his life and to apply his Personal Goodwill potential. Through the goodwill of a persistent psychologist, Goodwill is found.
[i] International Glossary of Business Valuation Terms.
[ii] Investopedia, Goodwill, http://www.investopedia.com/terms/g/goodwill.asp#ixzz4r8i6vGlO.
[iii] Winter 2017: Recognizing Personal Goodwill – And Is Any Of .., http://www.bostonbar.org/in-the-community/public-service/news/2017/03/31/winter – (accessed August 29, 2017).
[iv] Martin Ice Cream Co. v. Commissioner, 110 T.C. 189 (1998).
[v] Good Will Hunting, Miramax Motion Pictures, 1997.