How to calculate goodwill in the sale of your business

Among the long list of to-dos that go into selling your Sydney business, coming up with a sale price is arguably the most critical step. It can be a complicated process but coming up with a sale price is often based on a simple calculation:

The value of your physical (tangible) assets + the value of your business’ goodwill (intangible assets) – any liabilities.

Here, we’ll walk you through the main steps of calculating goodwill for the sale of your business.

Understanding goodwill

Every business will have a unique goodwill value but it is essentially the premium a buyer is willing to pay for your business over the fair market value of its tangible assets. Your business’ tangible assets include things like business equipment, stock, machinery, vehicles, and real property. Your goodwill premium is based on your business’ intangible assets including things like your:

• reputation;
• customer base and loyalty;
• brand recognition;
• physical location; and
• the continuing success of your business.

Another type of intangible value you should include in your overall calculations is the value of any patents, trademarks and logos your business owns.

3 helpful goodwill valuation methods

The type of business you have, your preferences and your buyer’s preferences will influence the valuation method you choose to calculate the value of your business’ goodwill. You can use a combination of different methods and you may even need to negotiate with a prospective buyer on which method you use. Plus, at the end of the day, the value of your business’ good will is what the marketplace or buyer is willing to pay.

Three of the most common methods for calculating goodwill include:

1. The return of investment (ROI) method

This method uses your business’ net profit to work out what a buyer’s return on investment would be. When you have the final score you can understand whether the value you attribute to goodwill yields the ROI you or your buyer is hoping for and reevaluate if necessary.
The formula is: ROI = (net annual profit/ideal selling price) x 100
For example, you have a selling price of $100,000 in mind and your business’ net profit was $25,000 last financial year.
The buyers ROI would be (25,000/100,000) x 100 = 25%

2. The cost of starting a business from scratch method

This method is handy if the price of your business comes out looking like a smart investment comparing to starting a similar one from scratch. Add up the cost of what it would cost you to start your business again from scratch in today’s market and compare that total to the cost of all your current assets. Presenting these comparable costs to a prospective buyer can be very persuasive.

3. The business asset valuation method

This method is the most pragmatic so we’ve stepped it out for you below.

Calculate goodwill in 3 steps using the business asset valuation method

1. Make a list

Like most jobs, start with taking stock of what you have to offer. List all your business’ intangible assets including, but not limited to, the list of common intangible assets listed above.

2. Determine fair market values

This step can get a bit tricky, but a good way to estimate the value of intangible assets is by researching industry benchmarks, looking at past sales records, and exploring current market conditions in your industry. A registered accountant, businesses broker or advisor would have access to a wide range of industry data to help with this valuation process. PLUS, a professional may also have clients who might be interested in buying your business.

3. Decide on the value of YOUR intangible assets

Once you have attributed a fair market value to each of your intangible assets, consider the unique features of your specific assets and decide whether each asset is worth more or less. Add up each adjusted value and the total number will be the value of your business’ goodwill.

How to maximise the value of your business’ goodwill

You want to show a buyer that your business’ tangible and intangible assets will deliver future maintainable profits. You can do this by showing:

• long-term customer contracts;
• a healthy sales pipeline;
• competent, well-trained and happy staff;
• a comprehensive business strategy and management structure;
• efficient inbuilt systems and processes; and
• a strong and well-executed brand.

By understanding the steps involved in calculating your business’ goodwill and considering the various ways of coming up with the right value, you can confidently navigate the intricacies of goodwill calculation and make informed decisions about the sale of your business. You might also want to consider engaging a financial or business professional for expert advice if you want help ensuring accuracy, fairness, and ultimate success in your business sale transaction.

Get in touch with our helpful and responsive team of experienced Sydney commercial lawyers today. The earlier you engage a specialised business sale lawyer in the sale of your business, the sooner you can have peace of mind that all aspects of the transaction are serving you and your interests.