Let’s start by saying that when valuing a business the core principle is that the business valuation must be based on what can be maintained by a reasonable competent operator.
The thing is that goodwill varies so much and is completely intangible.
The Local Pub Scenario – Goodwill
Your normal village local pub. It sits in a nice location, has a good regular customer base and trades pretty well. What is it’s goodwill value?
The pub could be run by a reasonably competent person who could reasonable expect to see the same level of sales.
In this case goodwill not only applies to the pub, but also to the surrounding area, the location, the length of the lease, whether the rentals are above or below market average etc. Because the pub cannot be picked up and moved then all of these factors take an influence.
Goodwill in this case is more than just about the business internally.
The London Restaurant – Goodwill
Take a top London restaurant. It is packed out every lunch and evening sitting. The staff operate on 14 shifts per week and the food is top notch. The business has a long lease at a surprisingly low rent.
All of these factors say that the level of goodwill must be pretty high, right?
Quite possibly. But if we add in the fact that this restaurant is run by Gordon Ramsey then what happens to the goodwill? The reason the restaurant is full is because of his connection, reputation and name. Take that away and what happens to the level of business?
This is about ‘inherent goodwill’ which is something that cannot be bought. It can mean that the level of goodwill anticipated, or what you think should exist, may not actually be as high as you think.
How To Calculate Goodwill
There are hundreds of factors that come into play when valuing a business or valuing goodwill. The key thing is that goodwill may be a balance sheet item, but it is only worth something to the buyer of that goodwill.
Understand ‘the seller is not selling what the buyer is buying‘ and it starts to make a little more sense.
If you want more information on valuing goodwill then speak with your accountant or contact Lime Consultancy direct and we will help you along.
Any comments on this post then please add them above, or contact us direct via the website here.
By Dave Farmer