What's Goodwill Got to Do With It?

The other day an attorney friend said in his best Scrooge-like voice, “I don’t like goodwill.” Because we were discussing business sales, I knew he wasn’t referring to the happy, peaceful, holiday goodwill. He meant business goodwill except he called it “blue-sky”. Contrary to popular belief, the word blue-sky is not synonymous with goodwill. Goodwill has more than one meaning especially at this time of year, but blue-sky isn’t one of them.

 My attorney friend was confusing something of no value (blue-sky) with a sale-able asset (goodwill). While some owners do have blue-sky dreams, the buyer purchases goodwill and tangible assets when a business is transferred in an asset sale. 

According to Merriam-Webster’s dictionary, Goodwill is: 

1)     a kindly feeling of approval and support; benevolent interest or concern; 

2)     the favor or advantage that a business has acquired especially through its brands and its good reputation; 

3)     the value of projected earnings increases of a business especially as part of its purchase price; 

4)     the excess of the purchase price of a company over its book value which represents the value of goodwill as an intangible asset for accounting purposes.

And Blue-Sky is: 

1)     having little or no value

2)     not grounded in the realities of the present

3)     a law providing for the regulation of the sale of securities such as stock

According to  Barron’s Dictionary of Finance and Investment Terms , blue-sky laws are those passed by various states to protect investors against securities fraud. The term is said to have originated with a judge who asserted that a particular stock offering had as much value as a patch of blue sky. 

Goodwill is the value of a well-respected business name, good customer relationships, high employee morale and other factors that have created its higher earning power. While there is no market or liquidation value for goodwill, accounting principles require that it be written off over time, generally 15 years

While my attorney friend frowned and grumbled, he listened when I said, “Let me tell you a true story of a business owner who hired me to sell his service business. A professional valuation report determined that the company would likely sell for $1,200,000. There was only $200,000 of fixed or hard assets meaning there was $1,000,000 of goodwill. And the business did sell for that price.”

“Why would the buyer purchase a company with $1,000,000 of ‘air’?”,  my friend asked incredulously.

 I laughed, “It’s not air. It’s goodwill. Goodwill is an asset, which is created when the company has developed a solid reputation, strong revenue and profit performance and has multiple of earnings that provide a value in excess of its tangible assets. While some owners do have blue-sky dreams before selling a business, buyers will only purchase value not blue-sky.”

Assets are only as valuable as the income they generate. Goodwill means that the company utilizes its tangible assets very efficiently to generate earnings. The company has value as a ‘going-concern’. If a company is only worth the equivalent of its tangible assets, it is likely a poor performing business. Buyers want to buy profitable, going-concern businesses.

“Okay”, my friend said, “I understand what you are saying but I still don’t like it.  How does goodwill benefit the new owner?”

I explained that the Internal Revenue Service recognizes goodwill an asset in a business sale. Both the buyer and the seller must agree to the asset allocation.  The purchaser of business goodwill can amortize the asset over 15 years thus providing a tax benefit to the new business owner. 

Additionally, the seller of goodwill gets the benefit of using the capital gain tax rate on the business value allocated to goodwill. Equipment and vehicles, for example, have depreciation recapture and the seller pays the normal income tax rate upon sale. 

This time of year, goodwill means peace, kindness, charity, and benevolence. Goodwill is what we are wishing to others when we say “Happy Holidays”. It is the kindly feeling of happiness, approval, generosity, and supportiveness that we offer to friends, family, and acquaintances. It is intangible but it has value.

So here’s wishing you Happy Holidays and Much Goodwill in the New Year!

Join me on January 17, 2017 from 11:00 am to 1:00 pm for the no-cost workshop “Selling Out: Is Your Business Ready?” I’ll be discussing ways to maximize business value, find qualified buyers, manage negotiation, and due diligence and obtain the right resources. Register at idresources@zionsbank.com or call 208-501-7573 to reserve your seat to this complimentary workshop sponsored by Zions Bank Business Resource Center.