The Goodwill Conundrum
Solving the puzzle of goodwill can be difficult
While most of us would say we know what goodwill is, few would be able to define it in a useful way for business valuation purposes. Yet forensic accountants must consider it in every valuation of a going concern. Understanding goodwill is important because however intangible it is, goodwill clearly contributes to the tangible value of a business, just as any other asset does.
A Common Definition
Usually, goodwill is defined as the characteristics of a business or individual that cause customers to return to that business or person. Profit above a reasonable return on other assets of a business is likely to stem from goodwill. Goodwill always is attached to the business or individual and cannot be sold separately. Many aspects of goodwill are challenging for forensic accountants, since it is often hard to isolate and quantify. There are also several different types of goodwill relating to different elements of a business, individual or professional practice, and identifying them can be difficult. As an example of how tricky goodwill can be, let’s look at some of the issues concerning the distinctions between professional and practice goodwill in a medical or other professional practice.
What Kind of Goodwill Is It?
Courts often won’t accept valuations of such professional practices as medical, law or accounting unless the forensic accountant has presented clear and convincing proof that a practice has professional goodwill. This can be difficult. A forensic accountant has to identify and separate the components of the professional practice that could be considered elements that create value. The forensic accountant should consider these and any other factors relating to the particular practice:
- Is the group a multiprofessional practice unit, such as a partnership, LLC, LLP or professional corporation?
- Do members of the practice work as a client or patient service team rather than as sole practitioners?
- Has the group practiced in the same area for years and maintained a long-term patient or client base?
- Is a skilled workforce in place?
Supporting the Value Conclusion
Forensic accountants often utilize the following approaches to quantify the value of practice goodwill:
1. Value the practice as a whole, combining net tangible asset value, identifiable intangible asset value and unidentifiable intangible asset value; and/or,
2. Calculate the value of an individual’s practice if he or she practiced alone, taking into consideration such factors as education, skill and experience.
Thus, under either method above, the calculated value of the whole company are attributable to identifiable tangible and intangible business/practice assets. To justify the business goodwill value he or she derives, the forensic accountant needs to independently, as much as possible, verify and identify quantify all of the tangible asset values reflected on the company’s financial statements, especially the Balance Sheet, in calculating values to arrive at a net amount. The remainder of the difference between the tangible assets and the whole company value would then represent the business/practice goodwill. Forensic accountants who do not identify and separate all elements of a business run the risk of weakening the credibility of their valuation and testimony in court.
An Insoluble Puzzle?
As you see from this example, determining the values of various types of goodwill is more puzzling than it might seem. Experience and expertise, however, can go a long way toward ensuring that goodwill is correctly considered in the valuation of your business. I would be glad to advise you on the goodwill value of your business or professional practice.