Goodwill can increase your business' value
By Mark Wardell @MarkWardell | February 29, 2008
After working with business owners of all kinds for almost 15 years, I have learned that, pretty much universally, entrepreneurs have a difficult time understanding what it is that makes their businesses truly valuable. Value is an illusive measurement. Revenues, assets, profits, and so forth, are all fairly simple to read from financial statements. But value is a tough one. This is particularly the case when a business is sold. Why is it that two seemingly identical businesses sell for different amounts?
What makes it so difficult is that the most critical component of a business' value is its goodwill. If you aren't familiar with the term, goodwill describes the value of a company, over and above its liquidation value. In other words, goodwill is what forms the better part of the owner's "profit", when it's time to sell. There are essentially two types of goodwill; business goodwill and personal goodwill.
Business goodwill is the portion of a business' value associated with the business itself. It includes things like brand recognition, location, procedural manuals, market share and so forth. And since business goodwill is transferable from one owner to another, it is sellable.
On the other hand, personal goodwill is the portion of a business' value associated directly with its owner. Things like the owner's name, reputation, contacts, skills, and abilities. For many small-mid sized businesses, the majority of its value is tied up in personal goodwill. Unfortunately, personal goodwill only has value to the current owner, and is therefore unsellable.
Therefore, all things being equal, a company with a higher percentage of business goodwill will attract a higher price than one with a higher percentage of personal goodwill. From the buyer's perspective, a company with a large amount of business goodwill is worth the higher price because the customers are more likely to stay and the business is more likely to remain profitable, once it has changed hands.
So to answer your question, the surest way to rapidly increase the market value of your business is to transform as much of your personal goodwill into business goodwill as possible.
Recently, I developed a valuation tool that provides a business owner with a crystal clear picture of the goodwill components of their business. The objective of this tool is to show a business owner all the key components involved in achieving:
- A more solid, less owner-dependent operation
- A more secure investment opportunity for stakeholders
- A significant increase in market value
While I can't perform a complete diagnostic on your business in this column, I have created a "mini-diagnostic" below to help get you thinking in the right direction. As you answer the following questions, you'll develop a more accurate picture of the areas you'll need to work on to systematically increase your value. While the process requires a little work, I've yet to see one case where it wasn't well worth it! So give it a shot and let me know how it goes.
The more times you can answer "yes" to the following, the greater the net value of your company's goodwill. A score of 14 or more indicates a high goodwill value, while a score of 7 or less indicates a low goodwill value.
- Does your company have a 3-5 year Strategic Objective, outlining your overall goals?
- Does your company have a step-by-step plan for achieving your Strategic Objective?
- Does your company utilize Key Performance Indicators to track its ongoing success?
- Does your company have systems for recruiting, retaining, developing and managing the exiting of employees?
- Does your company have systems for collecting and addressing employee feedback and improvement ideas?
- Does your company have a Unique Market Position (why your business is unique in the eyes of your customers), and a Marketing Strategy for future growth?
- Are your employees dedicated to doing the best job possible, even when you are not present?
- Do you receive regular, current, and accurate financial reports?
- Do you know which are the most profitable products/ services you offer?
- Does your company have a Quality Assurance system?
- Does your company have systems for managing your Customer Service?
- Does your company have prospecting (lead generating) and sales (lead conversion) systems?
- Do you work less than 40 hours per week in your business?
- Do you regularly dedicate time to planning the future growth of your business?
- Are you responsible for less than 15% of your total sales?
- Do you track and analyze your customer satisfaction ratings?
- Are your financial reports and other Performance Indicators organized into a comprehensive, functional Analysis Manual (executive dashboard)?
- Could you (the owner) take a 6 month vacation without it significantly affecting your sales?
- Do your customers provide you with a steady stream of referral business?
- Have your profit margins increased steadily over the past three years?