When in business, developing goodwill is one of the most difficult (and necessary) tasks. Business goodwill is the value of the business over the net assets or book value. This includes the brand name, customer relationships, reputations and other intangibles, which are all fundamental components of business success. Franchising, for instance takes advantage of the built-in goodwill a large company has established.
Now that we have an idea of what goodwill is… what is it? Well, it depends. Sometimes, it is the intangible value of a service or product. Sometimes goodwill is the intangible value of a business (the name, reputation). Goodwill can also be the intangible value of the members of the business. For example, Dan graduates and he partners with his classmate, Steve to start their own dental practice. It takes a few years, but eventually Dan & Steve’s Teeth Shop develops a following of loyal customers. All is going well until one day, Steve has an affair with Dan’s wife and Dan wants him gone. Steve doesn’t mind, but demands to be bought out of his half of the partnership. This is where goodwill comes in.
Since Dan has three patients for every patient Steve has, he might refuse Steve’s asking price on the basis that he (Dan) is more responsible for the success of the business and entitled to a bigger slice of the goodwill. Steve could argue that the goodwill is in the Teeth Shop brand name or that even though Dan works on more patients, he is clearly more responsible for the businesses success because he (Steve) came up with the catch phrase on the television commercials and built name recognition with his billboard idea. Meanwhile, Mrs. Dan decides to file for divorce under the pretense of abuse (Dan hit her with a rake, forcing her into the arms of another man). She wants a piece of Dan’s business and of course, some goodwill. So, how much money should she get? It depends.
As always, in any legal situation, consulting with a lawyer is recommended Most Canadian lawyers offer a free initial consultation and can advise you on your position on a goodwill dispute.
There are a couple ways to value goodwill- the market share method and the capitalization of excess earnings method. Market share, is what a willing buyer would pay for the business right now (what the business is worth plus goodwill). The capitalization of excess earnings method capitalizes excess earnings or the additional earnings beyond a “reasonable return” on the physical assets and the salary a similar professional could command in the same market for the same service.
Goodwill is difficult to quantify, because it is intangible. We know it’s “there” but putting accurate numbers to it is a challenge and eventually it comes down to what everyone can agree upon. In the example, if Steve and Dan agree on a 45/55 split they are right. If they agree upon a 30/70 split, they are also right. If an appraiser finds the business to have $30,000 in goodwill using the market method she is as right as an appraiser that finds the business to have $25,000 in goodwill using the capitalization of excess earnings method. It comes down to what everyone can agree on.
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