Valuing Personal Goodwill

Valuing Personal Goodwill

Personal goodwill is present to a greater or lesser extent, in most SME – but is less common in larger companies.

An Australian case stated “a business proprietor who has ‘know how’ and ability, and the personality to attract and hold customers, no doubt may be said to possess those customers’ goodwill. This will certainly be of value to him, and just as certainly will increase his profits, but it does not thereby become for the purpose of commercial law, ‘goodwill’. It is not a saleable asset. This is the test.”

With intangibles becoming an increasingly large proportion of business value the appraiser needs to carefully differentiate between enterprise / practice goodwill and personal goodwill.

For example, a restaurant may appear to have significant goodwill i.e. its value over and above the value of its tangible assets (plant, equipment, and stock). However, if a substantial portion of this goodwill is based on the skills, reputation, and experience of the owner / chef this may not be readily transferable.

The problems for the valuer is that he or she first has to identify the presence of personal goodwill and then quantify the value of it. A common approach is to value the business with or without the services of the owner/chef. The difference is the personal goodwill. It is highly probable that this “with/without” approach will involve subjective judgements – as do most valuations.

And there is more recognition now that personal goodwill may not be totally non-transferable and therefore of no value. Steps may be taken to mitigate the effects of a proprietor or key person leaving the business. We see this often with the sale / merger of accountancy practices where the purchaser comes in on a partnership basis or the exiting owner remains for a period on a consultancy basis.

Sometimes, of course, the present owner is the business. It is totally dependent upon his skills, experience, and relationships. Some years ago I was an expert witness in a Family Court case in Wellington. The subject business had an excellent track record of producing large profits over many years but was almost totally dependent upon the specialised knowledge and relationships of the owner. Four very experienced valuers agreed that the goodwill was in the range of $10,000 – $20,000.

One of the fundamentals of business appraisal is that value is the net present value of the future cashflows likely to be derived from ownership of the asset. Business valuation must be forward-looking and the presence of personal goodwill may endanger the sustainability of future cashflows.

Clyth MacLeod, Managing Director of Clyth MacLeod, Ltd., in New Zealand has over 40 year’s experience in business broking and business valuation. Clyth is also a director of Business Appraisals Ltd (business valuers), BizStats Ltd (a national database of business sales information) and Australasian Business Valuations Ltd (consultancy). The only business broker to be awarded a Life Membership by the Real Estate Institute of NZ and a Fellowship by the International Business Brokers Association he remains active in the industry and committed to leading a professional team.