When a company is sold for an amount above and beyond the value attributable to the company’s net tangible assets and identifiable intangible assets, this premium is what is known as goodwill.
A tangible asset is an asset that can be physically seen or touched. Such items include cash, inventory, equipment and so forth. On the other hand, intangible assets are non-physical assets and include items such as customer lists, patents, trademarks, copyrights and goodwill.
Goodwill is different from the other intangible assets noted above in that goodwill is non-identifiable; in other words, goodwill cannot be separated from the company or business. Goodwill is further broken down into three categories: personal goodwill, individual goodwill and commercial goodwill.
a) Personal goodwill is the advantage the company has compared to its competitors and peers in the industry. It arises from a person’s unique abilities, reputation, skill set and relationship with business contacts that are not transferable upon sale of the company. Oftentimes, the person is the owner of the company and because this advantage is not transferable upon sale, no value is ascribed to the shares of the business. For example, a successful entertainer earns a substantial amount in revenues for his or her entertainment company year over year due to the entertainer’s ability to perform. If the entertainer decides to sell the company, the portion of revenues related to the entertainer is expected to disappear, and as such, does not have any economic value to the business.
b) Individual goodwill, on the other hand, is an advantage that does accrue to the business by way of employment of an individual who has the ability, reputation, skill set and relationship with business contacts. This individual can be the owner of the business or a manager of the business. Unlike personal goodwill, there is value to individual goodwill if it can be seen that the individual’s departure and subsequent competition with the company will create an economic detriment to the business. The value in individual goodwill is normally attributed to the value of the non-competition agreement in place with the individual.
c) Commercial goodwill is the goodwill associated with the company. Examples of commercial goodwill include the brand name and reputation that the company has developed over its course of operations – some are so strong that the brand name itself represents the entire product category (i.e., Band-Aid®).
Depending on the circumstances, when a company is sold for more than the net tangible assets it holds and its identifiable intangible assets, the premium received is classified as goodwill. As personal goodwill does not have any value to the purchaser of the company, the premium is generally comprised of individual and/or commercial goodwill.
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Partner - Advisory Services
Mike has over 25 years of experience providing accounting and business advisory services, with a focus on the Canadian insurance industry.
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Alex Wong is a partner at Smythe Advisory and is focused on being a trusted business advisor to his clients.
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Director of Valuation Services
Paul Woodhouse focuses on providing financial advisory and litigation support services to clients.
Gagandeep specializes in M&A advisory engagements, as well as business valuations in the contexts of management buyouts and succession planning.
Arthur’s mandate is to assist Smythe clients in Western Canada in preparing for and executing business divestitures or acquisitions.