• Achille Ekeu, MBA, CVA

Impact of Goodwill in Business Valuation


Goodwill is defined by the International Glossary of business Valuation Terms as "that intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factor not separately identified". There are three components that cause Goodwill to exist:

  • (a) The existence of assets in place and ready to use. This element is sometimes referred to the going-concern value element of goodwill.

  • (b) The second component of goodwill is the existence of excess economic income. This is the excess income generated by an enterprise that is not attributable to other tangible and intagible assets.

  • (c) The third component is the expectation of future events that are not directly related to the current operation of the business.

Accountants Definition of Goodwill

Under General Accepted Accounting Principles (GAAP), the goodwill that a business enterprise develops is rarely on the financial statements of the business. Goodwill is recorded on the books and records of the acquired business only if the acquisition qualifies under the purchase accounting rules. For accountants, goodwill represents the total value of the business enterprise (purchase price) less the fair market value of the business enterprise tangible real and personal assets.


Economists Definition of Goodwill

The economists interpretattion of goodwill is less global than the accountants interpretation. The economists define goodwill as the capitalization of all the economic income from a business enterprise that can not be associated with any other asset (tangible or intangible) of the business. Economic income could be net cash flow, before or after business debt service, net income before or after taxes; net operating income; and so forth. The important consideration is that in the economic income capitalization process, the capitalization rate used should be consistent with the definition of economic income used.


Reasons to Analyze the Goodwill Intangible

  1. Damage Analyses

  2. Business or Professional Practice Merger

  3. Business or Professional Practice Separation

  4. Solvency Test

  5. Insolvency Test

  6. Transfer Price

  7. Bankruptcy and Reorganization

  8. Conversion of a C Corporation to an S Corporation

  9. Business Enterprise Valuation

  10. Deprivation Analysis

  11. Ownership Allocation Litigation

  12. Ad Valorem Property Taxation


Common Valuation Methods

The cost approach, the market approach and the income approach methods are all applicable to the valuation and economic analysis of goodwill intangibles.

Cost Approach: Using this approach, the analyst estimates the amount of current cost required to recreate the elements of the subject goodwill intangible. The component build-up method is the most common method that consists of: (a) list all of the individual components of the subject goodwill, (b) estimate the amount of cost required to recreate each component.

Market Approach: There are two common market approach methods:

  • the first estimates the value of goodwill as the residual from the purchase price of the actual sale of the subject business enterprise.

  • the second method estimates the value of goodwill based upon an analysis of actual guideline sales transactions.

Goodwill intangibles are rarely sold totally separately from other assets, so guideline sales transactions usually involve the sale of going-concern businesses or professional practices.

Income Approach: The three most common income approach methods are:

  • Residual from busines enterprise value method

  • Capitalized excess economic income method

  • Present value of future economic events method

Each of these methods is based upon the concept of goodwill representing the expectation of some future economic benefit.


In Divorce Cases

Goodwill in divorce proceedings is handled differently depending on various jurisdictions. There are two different types of goodwill: Professional and Personal goodwill. The issue is whether or not personal goodwill should be included as marital assets to be divided among the two parties. In some jusridictions, courts always include goodwill as a divisible marital asset, regardless of the nature of the goodwill. Many states, however, differentiate between "enterprise goodwill" (entity goodwill), which is considered to be divisible marital asset, and "personal goodwill", which is not.


Conclusion

Goodwill is an intangible that needs to be identified , analyzed and valued using the appropriate methods.



Achille Ekeu, MBA, CVA


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