Goodwill is essential to an acquisition because it increases a company’s overall value. It involves intangible assets, such as brand recognition, reputation and intellectual property, that set your business apart from competitors. If you are interested in selling your company, determining goodwill before negotiating prices with buyers is important.
Highlighting your company’s goodwill helps attract more potential buyers and enables you to set an asking price higher than the value of your tangible assets.
Reputation: Once a company establishes a good reputation in its industry, it attracts more customers and increases revenue.
Customer relationships: A company’s customer base can hold significant value. Successful companies often have a loyal consumer base.
Brand: A well-known business has a valuable brand name and logo. For example, Coca-Cola’s brand name and logo are highly valuable because of how well consumers recognize it.
Intellectual property: Intellectual property consists of a company’s processes, patents and proprietary technology.
Employee relationships: An engaged and loyal workforce contributes to a business’s overall reputation.
Community relations: Community relationships are another factor that contributes to a company’s public standing.
Goodwill gradually generates value, making it a long-term asset. Companies typically review their goodwill annually because it’s a key performance indicator (KPI) that helps them gauge their competitive advantage. It significantly impacts a company’s overall value because it contributes to its earning potential beyond physical assets. This means that a company with high goodwill is technically more valuable than one with only substantial physical assets.
What Is Goodwill in a Business Sale?
In a business sale, goodwill is the value a company gains when it purchases your company for more than the value of your identifiable assets.
Why Goodwill Matters When Selling Your Business
If you want to sell your business or merge with another company, goodwill is one of the most important considerations you should focus on.
Significance of Goodwill in Mergers and Acquisitions Transactions
Goodwill plays a significant part in mergers and acquisitions (M&A) transactions because it provides a fuller picture of a company’s total value. Company balance sheets only list tangible assets such as inventory and buildings, while goodwill takes a company’s intangible aspects into account to determine its overall worth. It’s a key consideration for stakeholders and investors when evaluating a potential business purchase, and it can significantly enhance buyer interest.
Goodwill and Competitive Advantage
Goodwill builds trust in potential buyers because it shows them how acquiring your tangible assets can increase their success. Goodwill creates a competitive advantage for your company in the following ways:
Brand recognition and customer loyalty: A positive reputation and strong brand cause more customers to choose your company over others. This attracts potential buyers because they can see your company’s potential growth and profitability.
Price potential: Strong goodwill typically enables companies to charge higher prices for their goods or services because their brand has a higher perceived value.
Consumer trust and advocacy: High goodwill helps generate organic marketing because it increases word-of-mouth. Consumers are more likely to recommend your company’s products to services to others when they have positive experiences and trust you. Potential buyers recognize this as an advantage because it can enhance their marketing efforts.
Ability to attract top talent: A positive reputation helps attract the industry’s top talent. Potential buyers often view a company’s strong goodwill as an opportunity to build a skilled workforce.
Market entry advantages: A strong brand can act as a barrier for competitors trying to enter the same market, giving your company and your buyer an advantage in market recognition.
Amazon acquiring Whole Foods is an example of a successful M&A outcome. Whole Foods had established a strong brand and customer loyalty, which accounted for a significant portion of its selling price when Amazon bought it.
What Is the Cost Basis of Goodwill?
The cost basis of goodwill is the amount a company pays you in an acquisition that exceeds your tangible assets’ liabilities and assets. It’s the difference between your company’s tangible value and the amount another company pays to acquire it.
How to Calculate Goodwill
Determining a company’s goodwill can be challenging because it involves subjective values. An acquiring company must be careful to avoid overvaluing goodwill in their negotiations, and a seller must be careful not to undervalue their goodwill.
Businesses may use the following approaches to calculate goodwill:
Cost-based approach: The cost-based approach is the most straightforward goodwill calculation method. With this method, you can calculate goodwill by subtracting the fair value of your net assets from the total selling price. First, add the consideration transferred, non-controlling interest and fair value of previous equity interests together. Next, subtract your net identifiable assets from the sum.
Market-based approach: The market-based approach compares your company’s acquisition price to comparable companies’ market values. Purchasers use this method to determine how much excess value they can attribute to goodwill. This approach requires careful analysis. The individual performing the calculation must carefully analyze similar companies to ensure they are truly comparable. They must also consider differences in market conditions.
Income-based approach: An income-based approach estimates future revenue, discount rate and the expected life span of excess revenue.
Valuation Methods
Companies also use the following methods to calculate goodwill:
Average profit method: The average profit method multiplies a company’s average profit during a set period by a pre-established number of years of purchase.
Super profit method: The super profit method determines a company’s profit that exceeds a normal rate of return and multiplies it by the predetermined number of years of purchase.
Capitalization method: The capitalization method capitalizes a company’s average profit. With this method, you would divide profit by a normal rate of return and subtract all net tangible assets from the sum.
How Goodwill Is Recorded and Adjusted
Goodwill is listed on a balance sheet under intangible assets as a non-current asset. Unlike other intangible assets, you do not amortize goodwill over its useful life.
Instead, you must periodically test it for impairment. Under International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP), you must document an impairment loss if the fair value falls below the carrying amount. You should adjust goodwill in the following scenarios:
Significant business operation changes: Significant changes such as profitability decline or changed market conditions may require a goodwill reevaluation.
Acquisition date adjustments: Goodwill adjustments may be necessary if new information about your company’s fair value arises after the acquisition date.
Goodwill Tax Implications
When you sell your business, goodwill assets typically fall under long-term capital gains for tax purposes. This is an advantage because the tax rates on long-term capital gain investments are lower than those on short-term capital gains assets.
Goodwill can be challenging to quantify, but tax authorities strive to tax business sales and acquisitions fairly.
You can enjoy significant tax savings on goodwill, but you must keep the following nuances in mind when calculating goodwill tax:
Duration: To qualify for lower rates, you must have the goodwill for over a year. Otherwise, it could be taxed higher as a short-term capital gain.
Location: Some states impose additional capital gains taxes, which can increase your tax liability depending on your location.
Depreciation: If your goodwill has previously depreciated, tax authorities may tax a portion of your capital gains as ordinary income.
How to Maximize Goodwill Tax Advantages When Selling Your Business
You can maximize goodwill tax advantages with the installment sale method. This method extends the tax on your capital gains, such as goodwill, over several years, reducing your overall tax liability. Rather than receiving your full sale price right away, you can recognize the gain of your sale in proportion to the payments you receive.
If you choose the installment sale method, you will report a portion of your gain each year based on incoming payments for that year. You are eligible for this method if you meet the following criteria:
Payment installments: You must receive at least one payment on your sale after the tax year in which you make the sale.
Clearly stated goodwill amounts: You must clearly state the amounts you allot to goodwill in the sale agreement.
Readily identifiable goodwill: Ensure your goodwill is easily identifiable. Tax authorities only apply the installment approach to specific assets.
Consulting with a tax professional is essential when handling taxes after a business sale. Tax professionals have the knowledge and experience to help you gain the most advantages from your deal.
How to Maximize Goodwill for a Business Sale
Maximizing goodwill is one of the most proactive ways to make a profit off selling your business. The following tips can help you prepare for your sale.
Enhance Goodwill Before Selling
You can enhance your company’s goodwill with the following tips:
Build a strong brand reputation: Enhance your marketing strategies to build a strong brand reputation. You can increase brand awareness through strategies such as social media marketing, content marketing, search engine optimization (SEO) and influencer partnerships.
Work toward consistent revenue growth: You can work toward consistent revenue growth by exploring untapped markets, diversifying your target audience and boosting your competitive advantage.
Cultivate loyal customer relationships: Providing excellent customer service and personalizing communication are some of the best ways to cultivate customer relationships.
Maintain operational efficiency: Establishing efficient processes and operations can significantly boost your goodwill and attract more potential buyers. You can start increasing efficiency now by streamlining processes, leveraging automation technology, fostering team collaboration and boosting productivity through employee training.
Document your company’s achievements: Document company achievements such as high customer satisfaction ratings, employee satisfaction ratings, positive testimonials, service initiatives and customer retention rates.
Document Company Achievements
Document company achievements, such as the following, to show potential buyers how valuable your business is:
High customer satisfaction ratings
Excellent customer retention rates
Positive testimonials
Service initiatives
Loyalty programs
Innovative product or service launches
High customer conversion rates
Product patents
Industry-leading technology advancements
Positive public relations and media coverage
Industry awards and recognition
High employee satisfaction ratings and retention rates
Positive employee feedback
Professional development initiatives for employees
Low employee turnover rates
Philanthropic activities or community outreach programs
Sustainability efforts and initiatives
When possible, it’s important to quantify your company’s achievements so potential buyers can understand the full impact. Key metrics such as satisfaction scores, community impact statistics and customer conversion rates can provide a clear picture of your company’s goodwill.
Showcase the Value of Your Goodwill to Potential Buyers
After documenting your company’s achievements and reputation, it’s essential to highlight the value of these advantages. Consider how each of your intangible assets can benefit potential buyers in the following ways:
Superior product quality: Explain how your technology or processes contribute to product quality and stand out from competitors.
Efficiency: If operational efficiency is a significant part of your goodwill, let potential buyers know how much your systems and processes can help them reduce costs and boost revenue.
Company culture and employee expertise: Highlight your key employees’ qualifications and expertise. You can also showcase how your company’s culture fosters productivity and employee retention. Emphasizing strong leadership and team collaboration efforts is an excellent approach.
Projected future growth: Potential buyers want to know what they can do with your company’s intangible assets and how much growth to expect. Present current market share data and projected growth, and identify new market opportunities for potential expansion.
Financial stability: Demonstrate consistent cash flow and profitability with detailed financial statements. Highlighting your company’s ability to withstand economic fluctuations is also important.
Synergy: Emphasize the potential for future synergies if you plan to merge with another company. Focus on how your processes, technology and workforce can complement a potential buyer’s for enhanced operations and increased revenue.
Work With a Knowledgeable M&A Firm
A professional M&A firm can help you determine your company’s goodwill and set a reasonable asking price. M&A brokers can also connect you with ideal buyers who are looking for what you have to offer.
Maximize Your Company’s Sale Value With Synergy Business Brokers
Goodwill is a vital consideration when selling your business because it can increase profits on your sale. Navigating Goodwill can be challenging due to the subjectiveness of intangible assets, but Synergy Business Brokers helps simplify the process.
As an experienced Mergers & Acquisitions firm, we match companies with potential buyers in their industry, negotiating the best asking price. Our experts can review your company’s goodwill, handling complexities and tax implications so you can sell your business with confidence. We require no upfront cost, collecting payment only if we make a sale.
You can depend on Synergy Business Brokers to market your company to potential buyers in your industry with professionalism and confidentiality. Submit a confidential seller registration form to learn more about how we can help you sell your business.
