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Goodwill

Goodwill is the part of a purchase price above the value of a business's identifiable assets, less its liabilities. It reflects things like reputation, customer relationships and trained staff.
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Definition

Goodwill is the amount a buyer pays for a business above the fair value of its identifiable net assets, such as equipment, stock and money owed by customers, less the liabilities taken on. It represents what those assets alone do not capture: reputation, customer relationships, trained staff, systems, location and brand. In the buyer's accounts it is usually recorded as an intangible asset. Its accounting and tax treatment varies by country and by how the deal is structured.

Worked example

Saltmarsh Bakery is a fictional Australian business sold for A$900,000 in an asset sale.

  • Ovens and shop fit-out have a fair value of A$250,000.
  • Stock is worth A$50,000.
  • No other assets or liabilities transfer.

Goodwill is A$900,000 minus A$300,000, which is A$600,000.

Asset sale versus share sale

In an asset sale you buy selected assets of a business; in a share sale (a stock sale in the US) you buy the company itself, with its full history. The choice shapes risk, tax and what needs consent.

Why buyers care

In many profitable small businesses, particularly service businesses, goodwill is the largest part of what you pay for, and it is the part that can walk away. If customers are loyal to the owner rather than the business, or the reputation rests on one person's skill, goodwill can shrink soon after completion. Handover plans, restrictive covenants on the seller and deferred payments are the usual ways to protect it.

Goodwill also shapes financing. Lenders who rely on security over physical assets have little to lend against when most of the price is goodwill, so the deal depends more on cash flow, seller finance or your own equity.

How the price is split between goodwill and other assets can affect tax for both you and the seller. Take advice from a qualified accountant before agreeing the allocation.

Restrictive covenants

Restrictive covenants are promises that limit what a seller can do after a sale, such as competing with the business or approaching its customers and staff.

Seller finance

Seller finance is when the seller lends the buyer part of the purchase price, to be repaid with interest after completion. It is also called vendor finance or a seller note.

Related terms

  • Asset sale versus share sale

    In an asset sale you buy selected assets of a business; in a share sale (a stock sale in the US) you buy the company itself, with its full history. The choice shapes risk, tax and what needs consent.

  • Key person risk

    Key person risk is the risk that a business loses value if one individual leaves or stops performing. In small businesses that person is often the owner.

  • Restrictive covenants

    Restrictive covenants are promises that limit what a seller can do after a sale, such as competing with the business or approaching its customers and staff.

  • Depreciation and amortisation

    Depreciation and amortisation spread the cost of long-lived assets over the years they are used. They reduce profit without any cash leaving the business in that year.

  • Senior debt

    Senior debt is borrowing that ranks first for repayment and is usually secured on the business's assets. It is typically the cheapest part of acquisition finance and carries the strictest conditions.

Guides

  • Owner dependence and how to test it

    In many small businesses the owner is the salesperson, the expert and the person every decision waits for. This guide explains why that lowers value and sets out practical tests you can run, from reading the listing to the last weeks of diligence.

    9 minutes to read

  • How small businesses are valued

    Most small businesses are valued as a multiple of their earnings. This guide explains how the earnings basis is chosen, why size and quality move the multiple, and why an asking price is not a sale price.

    11 minutes to read

  • Financing an acquisition: deposits, lenders, seller finance and earn-outs

    Most business purchases combine the buyer's own money with a loan and often some deferred payment to the seller. This guide explains each layer, outlines government-backed lending by country and shows how lenders test whether a deal can carry its debt.

    11 minutes to read

Red flags

  • The owner does the selling or holds key relationships

    When the owner wins the work and keeps the important relationships, part of the revenue may leave with them. Test how much of that revenue would stay without them before you agree a price.

    Severity: price it inOperations and people

  • Key staff not tied in

    If the people who hold the business together have no written terms, no notice periods and no reason to stay, a sale is the moment they are most likely to leave. Find out who matters and what keeps them.

    Severity: fixableOperations and people

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