Goodwill is a term bandied around by all of us, whether it is in a social or business context, but what exactly lies behind the word?
After all, we never hear about “badwill”, which is the word that one would think is the opposite of goodwill. Instead we refer to negative goodwill.
At it’s basic level from a technical definition, goodwill is the amount paid over and above the value of an asset at the point a transaction is concluded.
From a customer’s point of view it is a certain aspect of their shopping experience or service delivery that makes them want to return or recommend a business to others.
So we can easily state that a business with assets that are undisputedly worth £1m sells for £1.1m, has sold goodwill worth £100,000.
But if a buyer says they are unwilling to pay more than the £1m of assets does this mean the business has no goodwill?
Of course not. There is a book of loyal customers and a strong cashflow.
In the services sector, such as accountancy, there are no assets to speak of but a book of clients with recurring fees, and these are referred to as goodwill sale.
So why do people often get hung up on goodwill when selling their business or acquiring a business?
Is it time to stop using the term, and if so what should we refer to instead?
Let’s step back a little and examine why businesses are acquired, in a normal transaction with a willing buyer and a willing seller, not a distressed sale.
Essentially a business is bought because it has a reliable income stream that the buyer wishes to take advantage of and is willing to pay for.
The marketplace has established mechanisms for how much to pay for the privilege, because that’s what markets do.
Usually the price bears little resemblance to the value of the assets in the business, especially when it is a service business or one with a low asset base used to generate its profits.
But let’s consider a business that is iconic and a buyer who wishes to acquire a trophy or maybe an ordinary business where there are two or more buyers wanting to make the acquisition for strategic reasons.
Nothing like scarcity or competition to drive a price up!
In the first scenario the excess paid is not what people would ordinarily describe as goodwill, it is what one could argue is the value of the business and the iconic status is in truth its actual prized asset.
In the second scenario the excess has nothing to do with goodwill, it is how the bidders perceive the worth of the target business to themselves, probably for strategic reasons or maybe for IP that the business owns, which again takes us back to an asset.
So, if goodwill is to be redefined, what should it be termed and is there any reason to stop talking about goodwill but something else instead?
Perhaps any perceived excess worth over and above the apparent market value needs to be seen as a “premium”, which I think has a more precise terminology about it than goodwill.
But if I am correct what benefit might there in doing so?
I think the term “premium” might well focus the mind of a buyer as it is clearly shouting at them that they are paying over and above what might normally be expected.
Conversely, a seller who is holding out for a significant premium might do well to reflect on whether the asking price might not drive a potential suitor away, leaving them with nobody else in the room.
The only question is, if the name was changed would the accounting regulations follow suit?