‘Goodwill’ is an intangible asset that is built up over time by the owner of a business. In general terms it’s the value given to its good name and reputation. Unlike tangible business assets such as property and machinery which, in comparison, are relatively straightforward to value, the calculation for goodwill introduces an element of complexity.
So what are the main methods of valuing goodwill in the UK?
Simple multiple approach
The simple multiple approach to calculating goodwill is typically suitable for smaller non-complex businesses, such as owner/managed companies. Goodwill is valued by using a multiplier - usually between one and five - against the figure for maintainable profits, before owners’ salaries have been deducted. The multiplier used is subjective, and based on factors such as levels of business growth and profitability in recent years.
Whole company approach
This is a common method of valuing a business, and involves valuation of the company as a whole, deducting the tangible and other intangible assets to arrive at a figure for goodwill. The basis for valuing a business in this way is the use of a multiple against sustainable profits.
If the resulting valuation is more than the adjusted net asset value, the difference is said to be goodwill. Should the value be less, there is likely to be little, if any, goodwill inherent in the business.
The turnover approach is commonly used for valuing professional practices such as those of accountants, solicitors and architects who charge fees, and where a profit-based approach is less appropriate.
Again, a multiplier is applied to the professional fees, and being subjective, can range from 0.5 to 2.5 depending on the type of clients in each practice, and levels of business growth.
As you can see, valuing goodwill is not a straightforward process and can be the subject of controversy when selling a business. In practice, the simplified example methods discussed above can be complicated by various elements within individual businesses, with high levels of subjectivity adding further capacity for contention.
If you’re thinking of selling your business, and would like more detailed information on how to value goodwill, our experts at Selling My Business will provide the guidance you need. Contact our team of experts today.