01What goodwill is
Goodwill is the value of a business above the value of its identifiable net assets. It reflects things such as customer relationships, reputation, location, systems, trained staff and the expectation of future profits. For a profitable owner-managed business, goodwill is often the largest part of what the business is worth.
Not all goodwill is the same. Some of it would pass to a buyer with the business. Some of it depends on a particular person and would leave if that person left.
02Business goodwill
Business goodwill, sometimes called enterprise or institutional goodwill, attaches to the business itself. It comes from features that would remain after a change of ownership, such as:
- An established brand and trading name
- Contracts and recurring customers that are not tied to one person
- A convenient or well-known location
- Documented systems, processes and know-how
- A management team and staff who would stay
03Personal goodwill
Personal goodwill depends on the skills, reputation and relationships of an individual, usually the owner. Clients may return because of who they deal with rather than the business they deal with. If that person stopped working, retired or set up elsewhere, some or all of those clients might follow them.
Personal goodwill is common in professional practices, consultancies, creative businesses and small trades where the owner is the main point of contact.
04Why the distinction matters
On a sale, a buyer will usually pay only for goodwill they expect to keep. Where much of the value is personal, a buyer may insist on the seller staying on, agreeing restrictive covenants or accepting part of the price as earn-out.
In divorce proceedings, questions can arise about whether a business is worth what a valuation says if the value depends on one spouse continuing to work in it. The way personal goodwill is treated is ultimately a matter for the court, but the valuer can explain how much value appears to depend on the individual.
In shareholder disputes and tax valuations, the distinction can affect the value of particular shareholdings and the assumptions a hypothetical buyer would make.
05How valuers tell them apart
There is no single formula. A valuer usually looks at the evidence about where customers, revenue and profit actually come from. Relevant questions include:
- What share of revenue comes from clients managed by the owner
- Whether clients have contracts with the business or with an individual
- How long staff have been with the business and whether they deal with clients directly
- Whether the business has a recognised brand or marketing presence of its own
- What happened to revenue when the owner was absent
- Whether restrictive covenants would be enforceable and effective
06The role of comparable evidence
Market evidence can help. Prices paid for similar businesses, the structure of those deals and the length of handover periods can show how buyers in the sector treat goodwill linked to an owner. Where most deals in a sector include long earn-outs, that is often a sign that buyers see significant personal goodwill.
07Reflecting personal goodwill in a valuation
Depending on the purpose and basis of value, a valuer may reflect personal goodwill by adjusting maintainable earnings, increasing the risk reflected in the multiple or discount rate, or assuming the owner continues under a service agreement at a market salary. The approach should be explained so that readers can see its effect on the conclusion.
08Reducing reliance on one person
Owners planning a sale can sometimes increase the transferable share of goodwill over time by introducing other people to key clients, documenting processes, building a brand that is not tied to their name and putting client relationships on a contractual footing. These steps take time, so they are best started well before a sale.
This guide is general information, not advice on any particular situation. The correct approach to a valuation depends on its purpose, the basis of value and the facts.
