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For vendors and purchasers of businesses, goodwill can be difficult to understand. This is understandably so, as it is the legal term used for fundamentally intangible assets rather than identifiable assets.

For people who are in the process of selling or purchasing a business, understanding goodwill and other business assets can help navigate the sale of business process. It is also essential to understand what goodwill means on a practical level, as it can affect the purchase price or the tax consideration of the transaction. 

This article will explore the meaning of goodwill in more detail and provide examples of determining its value as an intangible asset.

What is Goodwill?

Goodwill is an intangible but invaluable asset of a business, as it is a necessary element for a business to continue operation. 

There is no definitive description. However, in legal terms, it is considered a kind of intangible personal property. Usually, it cannot exist separately from the business it is in connection to. Therefore, people often describe it as a business’s ‘capital infrastructure’.

Goodwill is often divided into ‘local’ and ‘personal’. While local goodwill is based on physical location, personal goodwill depends on the business owners’ skills, reputation, and customer base. Therefore, while location is key to running a successful business, a high level of personal goodwill is needed to ensure your business has good value. 

What Are Some Examples of Goodwill?

Not all of the assets listed below will be relevant to every sale of business transaction. However, it can take the following forms:

  • brand identity: creating and maintaining a brand associated with a company’s brand name can strengthen a business’s reputation and client base;
  • network of customers: a solid customer base is essential to the success of any business;
  • good reputation amongst customers: satisfied customers are more likely to recommend the business to others in the community;
  • expected growth and sales prospects: this is crucial as it helps the buyer with budgeting and financial projections; or
  • good reputation in the market: this is crucial to maintaining a successful and profitable business.

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Advantages of Goodwill 

From the purchaser’s perspective, you should consider what benefit you can obtain and commercially exploit from the goodwill. This advantage can include benefits the purchaser will receive from pre-existing client relationships. Additionally, it could include the business’ reputation in a particular industry developed from well-developed advertising campaigns in the past. Although these are elements that the purchaser will not understand immediately, they are invaluable to a buyer that intends to continue operating the business.

Goodwill may not count as an asset for business purchases solely relating to the acquisition of plant, equipment and stock. 

For example, suppose you wanted to start operating a new takeaway chicken shop. You have found the perfect location where the current business runs a kebab store. Goodwill may not then be a factor in the sale of business transaction. This is because the likely assets you will be purchasing from the kebab store owner are limited to the equipment (stove, ovens, refrigerators, etc.) or fittings (counters, display cabinets, tabletops, etc.). Technically you will not operate the kebab store, so there may be little goodwill to transfer to your new takeaway chicken shop. 

Why is Goodwill Important?

It is paramount as it is an asset that takes time and effort to generate.

For a vendor, it is vital in a sale of business transaction as it rewards them for their time and effort. For a purchaser, it is significant as it places you in a competitive position within the market. That is because the vendor has already established the groundwork for the business, and you can continue operating by maintaining it. For instance, this could include ensuring that your employees reach the same standard of customer service as before. It could also include keeping up any advertising campaigns the business had undertaken previously.

How Do You Determine the Commercial Value of Goodwill?

Determining the value of goodwill is unfortunately not straightforward as it is ultimately a commercial consideration. That means it is often subject to negotiations throughout the sale of business transactions.

If you are a purchaser in the transaction, you must complete your due diligence to determine value on the business’ goodwill. This due diligence may involve analysing customer reception and understanding how the vendor has operated the business in practice.

For vendors, knowing this present value is vital so that you can gain monetary consideration for establishing your business. However, it should be taken into consideration with other net assets.

Key Takeaways

Goodwill is an essential aspect of the sale of business process, as it can significantly affect a business’ value. You need to analyse it properly to attain a fair market value for your business. However, it can be difficult to grasp. If you need help with understanding this concept, our experienced sale of business lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.

Frequently Asked Questions

What are some examples of goodwill?

Goodwill can take the form of a brand identity, customer network or good reputation amongst customers, among others.

Why is goodwill important?

Goodwill is important as it is a business asset that represents considerable time and effort. Therefore, it must be considered when valuing a business during a sale of business transaction.

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