The Tribune

By Simon Cooper
Res Socius

If you buy a business for sale that is an inactive shell, then its value is its depreciated assets - less a deduction if its reputation is shot (perhaps we should call that ‘bad will’ to be consistent). If, on the other hand, it is up and running, then it benefits from goodwill. In this article I explore this concept further.

Towards a Definition

If we like something, then we say we feel goodwill towards it. In fact, there’s a Christmas Carol in my memory that speaks of ‘men of goodwill’, although I can’t place my finger on it. Accountants refer to the likelihood of future turnover as goodwill, too. Presumably the general idea is that customers feel goodwill towards that business.

How It’s Calculated

Generally speaking, financial analysts treat turnover as net profit before tax, although it is a good idea to check this.

The problem lies in how the seller calculates that value. Take HP’s purchase of Autonomy that concealed stock purchases as marketing expenses (which are supposed to be discretionary) as one example. And then there is Starbucks UK, who pay no tax at all because they send their profits offshore as royalties (which a new owner might not be able to do).

Orders in progress are a special case of goodwill that is easier to confirm. However, many deals are based on trust and friendship, and the buyer could withdraw because of a perceived lack of that. Hence, at its best, future goodwill is a dodgy number, and at its worst an illusion that could disappear like morning mist.

More Pitfalls

It is very much a matter of ‘beware the buyer’ when assessing goodwill, especially when sellers set their prices at two (or even three) years of it. While audited books may help, equally true, auditors cannot report what they don’t know exists. A bookkeeping system like Xero churns out a useful set of ratios a buyer can compare with industry standards. However, the problem lies with small businesses that stick to questionable, hand-written ledgers under counters.

Future Goodwill

Sellers like to emphasise potential, almost as if you have to pay them for what they have not achieved themselves. This can be of some value in a rising market. At other times, the chances of winning lotteries could be better. In the end, buying a business is like any other investment. The likely returns must look good, although there is always an element of risk involved.

Seeking Closure

There is a body of argument in favour of starting up a business, instead of buying an existing one. In the former case there is usually no existing goodwill (unless you count on the promises of friends).

Moreover, it will take some time to get to profit, and that is an expense in terms of negative income. A fair price for a business for sale that is up and running is the purchase price of comparable assets in the same condition, plus the conservative value of existing goodwill.

NB: Simon Cooper is a founding partner of Res Socius, a firm authorised by the Bahamas Investment Authority to facilitate the sale and purchase of businesses and provide management consultancy services.

Contact 376-1256 or visit www.ressocius.com.