19 June, 2019 / IN Business valuations / by Tony Carter
How exactly do you work out a business valuation? Did you know that a business’s value is measured by a number of factors. These include its ability to generate profit or a return on an investment. However ‘goodwill’ is also an influencing factor and a harder one to calculate.
A business valuation is usually measured by its ability to generate profit for its owners or a return on an investment. Typical components of a business are its plant and equipment plus its working capital and its goodwill. The plant & equipment and working capital are relatively easy to define. Equipment can be seen and touched on the workshop floor. Working capital can be seen in your bank account and in the money customers owe you.
Goodwill and its value are more difficult to define. One way to think about goodwill is that it is the profit generated by the owners putting the optimum combinations of plant and equipment, operated by the right people, in the right place and at the right time.
Common types of goodwill in a Business Valuation
- Enterprise goodwill – the business’s reputation, market position and products generate customer loyalty
- Personal goodwill – a business owner has a personal following that generates customer loyalty, e.g. hairdressers or medical practitioners
- Location goodwill – a business derives extra profit from its location, e.g. a retailer with high pedestrian traffic, or from special qualities of a business’s premises such as a childcare centre with a specialised fitout
- Distribution rights –a business has the right to trade in a particular product or set of products in a particular territory, for instance the right to sell Harry Potter books in Australia. N.B. Franchise rights are similar to distribution rights but not the same
- Intellectual property – the value of any patents (such as new medicines and drugs), copyrights (e.g. books or software) and trademarks (e.g. logos, branding and distinctive packaging).
It can be critical to identify and value the different types of goodwill separately. Failure to do so can be costly.
Business Valuation Case Study
We had this scenario play out in a recent family law valuation, where a construction company was generating great profits for its owners. On the face of it, the company was worth a substantial sum. However, our valuation process revealed that the company had minimal plant and equipment, no website and no sales department.
The main reason for the company’s success was the husband’s relationships with customers and the time he had spent cultivating these. This value belonged more to the personal goodwill of the husband rather than the enterprise goodwill of the business. We recommended a reduction of the company’s value in the asset pool accordingly.
In this case, the distinction between enterprise and personal goodwill was critical to achieving an equitable settlement. There is a big difference between calculating a simple valuation and detailed valuation. An experienced valuer will ask the right questions to determine where the value of a business lies. A true valuation is based on commercial realities and is not just a formula on a page.
Business Valuation questions to ask
- Is everything required to run the business on the table? Can it be transferred to you?
- If you want to maximise the price for which you can sell your business, have you made sure you have arranged the business such that the value is in the enterprise, not you?
If you are not able to confidently answer these questions, contact Tony Carter at Lambourne Partners Business Valuations on 02 4969 6600 or firstname.lastname@example.org for an obligation free chat about how we can help you work through the issues.
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