Welcome to the June 2024 edition of MW Insights.
It has been too long since our last edition as we have been busy writing reports instead of newsletters.
With that in mind, we have decided to revisit some of our previous articles.
Presenting from the ‘MW Archives’, an article written by one of our co-founders, the well-respected Russell Munday:
Goodwill – Commercial or Personal?
The issue of separating personal and commercial goodwill often arises in valuing professional service businesses such as medical, dental, accounting, or law practices, as well as other small privately owned companies that depend extensively on the personal skills, knowledge and effort of one individual.
Generally, courts do not recognise personal goodwill where value is defined as fair market value in a notional market context.
The key to understanding where goodwill fits in the context of business valuation is to first consider the concept of intangible value. Intangible value represents the difference between the fair market value of a business (FMV) and the going concern value (value-in-use) of business’ net tangible operating assets.
Intangible value can be further subdivided into two groups: identifiable intangible assets such as patents, copyrights, licenses, or quotas, and non-identifiable intangible assets representing goodwill. “NTOA” represents the going concern value of net tangible operating assets and identifiable intangible assets.
Goodwill, as a non-identifiable intangible asset, is typically categorised as either commercial, personal, or individual goodwill.
Commercial goodwill represents transferable non-identifiable intangible assets, which represent value accruing to a business. Although, commercial goodwill cannot be separated from the business itself, it is easily transferred with the business when the business is sold. Examples of commercial goodwill include:
- product / service – market share, recognition by existing and potential buyers
- location – strategic importance of physical location to the business; (possibility of double counting – real estate appraisal may already include some or all)
- other opportunities available only to the business but not separable from the business – good employee relations
- individual goodwill
Personal goodwill represents personal characteristics, skills, knowledge, reputation and efforts of a specific person employed by a business. The profits derived from personal goodwill typically terminate at the time the person responsible for those profits loses interest in, is unwilling, or unable to participate in the business. Since, personal goodwill cannot be transferred to another person and personal services cannot be sold upon the sale of a business. Courts generally consider personal goodwill to be excluded from the fair market value of a business determined in a notional market context. Value-to-owner includes personal goodwill and represents value that is over and above the fair market value of a business. The value-to-owner concept of value may apply in Family Law matters.
i.e.; Value-to-owner = FMV + Personal goodwill
Individual goodwill includes abilities, business contacts, good name, and reputation of individuals employed by a business. In contrast to personal goodwill, individual goodwill does not negatively impact the profitability of a business when an individual is unable or unwilling to further contribute individual goodwill because the business is able to find suitable replacement. However, competition from departing employees who provided individual goodwill has the potential to negatively affect profits of a business. Restrictive trade agreements in open market transactions generally represent the commercial value of individual goodwill.
Commercial goodwill is generally valued as a residual calculated as the difference between fair market value and tangible asset backing of the valued business.
i.e.; Commercial goodwill = FMV – NTOA
In some cases, a high degree of dependence on one key individual will demand very low multiples resulting in low FMV and require valuation of a business purely on asset basis
As always, you can reach out at any time on (03) 9816 9122 or email us at advice@mwforensic.com.au
Regards,
The MW Forensic Team.
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