Holly founded ExitPromise.com as well as StartupPromise.com and so far has answered more than 3,000 questions asked by business owners about starting, growing and selling a business.
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Business goodwill is defined as an intangible asset that increases a business’s value above and beyond its current market value.
Business goodwill arises when one company is acquired by another at a premium, above market or book value price.
Goodwill can be attributed to a number of factors, including the company’s well-known brand name, outstanding customer relations, a solid customer base, any patents or unique technology, proprietary processes, trade secrets, licenses, custom software systems, training programs, proprietary databases, published articles, or any of a number of other intangible assets not recorded as such on the company’s books.
Types of Goodwill
Generally, goodwill is evaluated by a business’s ability to generate superior income. For the purposes of small business valuation, two types of goodwill are common: institutional goodwill and professional practice goodwill.
Institutional goodwill – applies to the business and its position in the market, as well as how it is able to serve its customers.
Professional practice goodwill- applies to professional services, such as doctors, lawyers, architects, CPAs, and engineers. Professional practice goodwill is separated into two components: practitioner goodwill (the skill, reputation, and reliability of the practitioner), and practice goodwill (the reputation, location, and operating procedures of the practice).
Accounting for Business Goodwill
Business Goodwill is recorded generally only if it is acquired as a part of an acquisition or purchase. In this case, goodwill (calculated by subtracting the fair market value from the purchase price) is recorded on the balance sheet in the assets section as a non-current asset. Until 2001, it was required that business goodwill be amortized. Today, companies can elect to not amortize goodwill, but must instead undergo annual impairment tests.
Because business goodwill is subjective, it can be difficult to determine what the dollar amount of a company’s goodwill is. It is not uncommon for the acquiring company to overvalue or undervalue goodwill. An overvaluation of goodwill is bad news for shareholders, particularly if and when the acquiring company needs to write down goodwill. In this case, share values are likely to drop also.
Although goodwill is difficult to price, it is an important component that makes a company more valuable than its tangible assets would suggest. It is also a very important aspect of the negotiations when buying or selling a business because of the possible tax implications for both parties.
Companies can overvalue goodwill in an acquisition as the valuation of intangible assets is subjective and can be difficult to measure. Discuss?
Hi Janes,
You are correct, goodwill can be easily overvalued — and undervalued as well.
Depending on the buyer, one may value certain intangible assets baked into the business’ business model and another may not.
So finding a buyer who values the business’ goodwill should be the business broker’s goal.
I’m selling a subchapter S retail apparel business as an asset sale
on term. I’m not sure if deposit and down payment is made to me or to the business name. Not sure how to divide for tax purposes
the assets: it consists of inventory, fixtures & equipment and goodwill/trademark…can have a non compete or not…buyer doesn’t care; as she knows I am retiring.If doing an asset sale do I have to know basis for tax purposes?
Peggy: BEFORE You sell anything, be sure to talk with your tax advisor? Don’t have one? Call us!
If you are selling the assets of an S-Corporation, then you personally don’t own any of the individual assets. They are owned by the corporation. You determine gain or loss at the corporate level, but it is taxed as a pass-through to the shareholder(s). Yes, you MUST know the basis of the assets. This should be in your corporation’s records. Be aware that you may sell “goodwill” which likely has ZERO basis.
thank you
I’m going through a small business dissolution with my business partner. He is planning to continue in a similar business under a different name, same location. Can I ask for payment of goodwill? Can I prohibit him from continuing in a similar business that we owned together? We have no partnership agreement.
Hi Victoria:
As in life, the rules are what we make them to be. You can ask for whatever you want as long as it does not violate any laws.
My only concern is that you are asking for a “payment of goodwill” and at the same time hoping he doesn’t run a similar business. These are contradictory. Why would someone pay you for the “goodwill” of a business when they cannot earn money from that investment? If you are telling him he cannot continue the business, then there is no goodwill–just the opposite is true!