What Is Goodwill in a Trade Business?

What is goodwill in a trade business?

Goodwill is the value of the business that is not in its tangible assets. Net tangible assets are the market value of the vehicles, plant, tools and stock, less what the business owes against them. In an illustrative case, if those come to $150,000 and the business as a whole is worth $520,000, the remaining $370,000 is goodwill.

It is a remainder, which is why a valuer does not treat it as a separate purchase. A buyer is not paying for a thing called goodwill. They are paying for earnings that continue, and goodwill is the label for the part of the price those earnings explain. In a trade business it usually comes from sources like these.

• Customers who return, and recurring maintenance or service agreements.
• A reputation with builders, strata managers, agents, councils or the local community.
• A trained team that can do the work without the owner.
• Systems for quoting, scheduling, job costing and follow-up.
• A brand, phone number, website and online reviews that bring in enquiries.
• Licences and approvals held by the business.

Do not expect to find goodwill in the accounts. Goodwill that an owner has built up over the years is generally not recorded on a balance sheet, while goodwill paid for in an earlier purchase may be. Either way, a figure in the accounts is not a valuation of goodwill today, and how it is recorded is a question for your accountant.

What is the difference between personal and business goodwill?

Business goodwill belongs to the business and would stay if the owner left. Personal goodwill belongs to the owner: it is the part of the value that depends on who they are, what they know and who knows them. Customers call the owner by name, the owner wins the work and the licence is the owner’s.

The split matters in trades because so many businesses grew around one capable person. An owner on the tools may feel the business is worth a great deal because customers love the work. A buyer asks what happens to those customers when the owner is gone. Who owns personal goodwill, and how it is treated for tax and in a contract, are questions for your tax adviser and lawyer.

How does a valuer separate the two?

There is no formula. A valuer looks for evidence of how much of the earnings depends on the owner and how much would continue. The questions are practical.

• Who quotes, who wins the work and who deals with each major customer?
• How long have the key customers dealt with the business, and are they under written agreements?
• What would happen to the work if the owner were away for a month?
• How do new enquiries arrive: through referrals to the owner, or through the website, reviews and a known business name?
• Who holds the licences, and could someone else hold them?
• Would the key staff stay, and do customers trust them?
• Is the owner willing to stay for a handover, and for how long?

The answers show up in two places in a valuation. The owner’s role is replaced with a market wage in the earnings, and the dependence that remains is reflected in the risk, and so in the multiple. A valuation may also express the result as a split of the goodwill. Our guide on valuing a business with owner dependency covers the first step in detail. The next example uses illustrative figures to show the idea of a split.

When is goodwill nil?

Goodwill is nil when the business does not earn more than it needs to. After a market wage for the owner’s work is deducted, the earnings have to be large enough to support a value above the net tangible assets. If they are not, the business is worth about its assets, and a buyer will not pay extra for goodwill.

A one-person business is the common example. If the owner’s market wage takes up almost all of the profit and the customers are personal to the owner, a buyer is buying vans, tools and perhaps a job. The value is then close to the value of the assets, and our guide to whether equipment adds to business value explains how those are treated.

Where is goodwill found in different trades?

The mix of business and personal goodwill differs between trades, and between businesses in the same trade. These are tendencies, not rules.

• Recurring service trades such as pest control, fire services and facilities maintenance tend to hold more of their goodwill in the business, through service cycles, routes and agreements that continue after a change of owner.
• Project trades such as building, concreting and earthmoving often depend on relationships with a small number of builders or head contractors, and those relationships are frequently held by the owner.
• Owner-operated service trades such as plumbing and electrical vary widely. A business with a booked-out team and maintenance accounts is a different case from one built on the owner’s own call-outs.

How do buyers and sellers deal with goodwill they cannot be sure of?

When it is unclear how much goodwill will stay, the parties can reflect that in the terms instead of the price. A handover period, in which the owner introduces customers and staff, lets the transfer happen over time. An earn-out ties part of the price to results after completion, so the seller is paid for goodwill only if it proves transferable. Vendor finance spreads the payment.

Each of these is a commercial and legal arrangement for your lawyer and tax adviser. Our guide to how to sell a trade business describes them in general terms, and buying a trade business looks at the same question from the buyer’s side.

Why does goodwill matter beyond a sale?

It is often the part of the value that people disagree about. In a shareholder transfer or a partnership exit, the assets are easy to agree and the goodwill is where the argument starts, especially when one party says the value is personal to them. In a dispute the same question can decide the outcome.

For capital gains tax, the value of goodwill and who owns it are matters your tax adviser will want a reasoned figure for. Our guide to business valuations for CGT explains where a valuation fits, and what follows from it is for your tax adviser.

How can an owner build goodwill that transfers?

By making the business less dependent on one person. The steps are practical, and they take months rather than weeks.

• Put key customers on written agreements and recurring service schedules.
• Build a team that customers know and trust, and give a lead hand real authority.
• Document how quoting, scheduling and job costing are done.
• Build a business name that customers and referrers look for, through reviews, a website and consistent branding.
• Hold licences and approvals in a way that does not depend on one person.

Our guides on recurring maintenance contracts and customer concentration look at two of these in detail. Goodwill analysis is part of every Independent Business Valuation, which is $1,995 + GST. See pricing or begin at our start page.