The concept of “goodwill” in business valuation is often misunderstood, with many associating it with subjective perceptions of customer sentiment towards your business. However, in the context of business valuation, goodwill has a precise definition: it represents the difference between the total purchase price of a company and the fair market value of its assets.

To illustrate this concept, consider a hypothetical plumbing company with tangible assets (such as vans and tools) valued at $100,000. If the company were sold for $1,000,000, the acquirer would attribute $900,000 to goodwill ($1,000,000 – $100,000). This difference reflects the intangible value associated with the company’s brand, reputation, customer relationships, and other non-physical assets.

When a company is valued based solely on its fixed assets, it often indicates distress or a business on the brink of closure. Therefore, as a business owner, maximizing goodwill becomes crucial in increasing the overall value of your company, as it reflects how a buyer values your company.

Acquiring Goodwill

A notable example highlighting the importance of goodwill in valuation is Marriott’s acquisition of Starwood Hotels & Resorts Worldwide. Despite not owning many of the hotels bearing their names, both Marriott and Starwood license their names to operators and franchisees and derive substantial value from their brand reputation, customer loyalty programs, and operational expertise. In this case, Marriott’s acquisition of Starwood was driven by the desire for its popular loyalty program that had attracted more frequent travellers than Marriott’s program.

Similarly, companies like Uber derive their immense valuation not from tangible assets like cars but from the value they create for customers through their platforms and services. This emphasis on creating value for customers over accumulating hard assets is a strategic approach adopted by successful businesses to maximize their overall worth.

For business owners, understanding the distinction between tangible assets and goodwill is crucial. While tangible assets have their place, prioritizing the creation of goodwill through exceptional customer value propositions, brand-building, and innovation can significantly enhance the long-term value and sustainability of the business. Ultimately, focusing on what creates value for customers will drive success and maximize the value of the business beyond the sum of its tangible assets.

If you are looking for help calculating your business’ goodwill, contact us for a consultation.