Rule of thumb: Goodwill is the “how” a company performs daily operations. It’s an intangible asset, often resembling the “opportunity” identified by a prospective buyer. Common examples of goodwill include:

  • Human capital (key executives, sales, operations, etc.)
  • Processes and procedures (including use of technology/software)
  • Stakeholder relations (customer concentration, key vendors, etc.)
  • Company leadership and culture (arguably the most valuable form of goodwill)

The impact of goodwill on a company’s valuation can be significant.

For example: Say a company is valued at $10 million. The real estate, equipment and the working capital are valued separately at $6 million, leaving $4 million allocated to goodwill. In other words, 40% of the company’s value is comprised of goodwill.

Note: This is an example, and the value of goodwill will vary depending on factors including the specific buyer, deal structure and terms of the deal, etc.

Not only can goodwill represent a significant portion of company value, but it’s often a key factor in a company receiving a premium or a discount on its sale price. Or, in other words, price multiples. For example, assume the sale of two companies in the same industry, and of similar size (in terms of revenues). But Company A sells at a seven multiple and Company B sells at a five multiple. Why is there a difference? Probably because Company A has better profitability. But why? Large in part due to goodwill – Company A exhibits:

  • Better leadership
  • Talented and engaged employees doing jobs they are well suited to perform
  • Sound processes and procedures to perform their daily functions in an efficient and effective manner
  • An established culture

It’s very likely that Company A is going to show stronger financial performance. This, plus the strength of their goodwill, is going to fetch a higher valuation.

Valuing the Company to determine the estimated goodwill is also a great KPI when measuring a company’s financial performance. We often use market multiples as a strategic planning tool. For example, if a company is valued at a multiple of 6x EBITDA, then in theory, every $1 of incremental EBITDA will result in $6 of incremental value. Pretty simple, until you put it into practice – does this mean revamping operations to improve efficiencies and margins? Does this mean better training to improve your people? Or investing in key employees? Many, many ways exist to drive value. But understanding your Company’s value to measure goodwill is best practice.