Good Will Agreement: Everything You Need to Know
A good will agreement is an agreement between a business and other party. It outlines the difference between the company's asking price and fair market value.3 min read
2. Valuating Goodwill
3. Business Assets
A good will agreement is an agreement between a business and at least one other party, asserting that the business has goodwill, a business asset that outlines the difference between the asking price for a company and its fair market value.
Goodwill Law and Legal Definition
Goodwill is a business asset that can be sold and bought with the business. This marketplace advantage includes customer loyalty and patronage, usually built and developed through continuous interactions with a business over a period of time. When a business owner chooses to sell the company, the goodwill is sold with it, although the value of goodwill is more subjective.
As an attribute of a business, goodwill is something that can be acquired by any owner who maintains a company that is competitive and offers services or goods. Within a sales contract, goodwill can be sold as part of the business. The purchase of a company's goodwill is subject to the same laws as any other type of purchase handled through a contract, according to local contract laws.
Since a contract transfers ownership of a business and that company's goodwill, the person selling the business is legally allowed to compete with the business, unless a non-compete clause is specifically included in the agreement.
The two main methods for valuing the goodwill of a business are:
- The residuum approach, which calculates the difference between the fair market value of a company's assets and the agreed-upon purchase price of that business
- The excess profits approach, which presents the value of all projected excess earnings in the future, over the standard earnings for a business that is similar to the one being acquired.
Using the excess profits approach to value a company's goodwill can be imprecise because future earnings are so uncertain.
In other words, goodwill is an intangible asset of a business. If a buyer is interested in the business, any amount over the calculated book value of that business would be considered goodwill. Some of the factors that might help one business stand out and become more dominant in its industry include:
- Management talent
These factors can make the business more appealing to a potential buyer.
When a business owner is able to command a higher price for that business, this is a direct result of goodwill. As the sale is finalized, the new business owner will outline the price paid less the book value of the company as goodwill on any financial documents and statements.
In addition to goodwill, selling a business can involve several other intangible business assets. Examples include:
- Licensing agreements
These examples are identifiable, which means it is easier to assign a value to them. Examples of intangible assets include:
- Brand names
- Special skills
- Market position
- Operating methods
- Customer lists
- Knowledge of innovative technology
These factors tend to be factored into the overall goodwill value, although it is difficult to assign an exact dollar amount to each. They do add value because they can help assure a potential buyer that the business will remain successful.
Goodwill is certainly a valuable asset, but because it is intangible, it is not included on the financial documents of a business. In accounting procedures, a company might assign a value of $1 for goodwill. Although many businesses could be sold for higher values based on their reputations, the goodwill of a business isn't usually valued until the process of acquisition begins. During this process, the price of the business will determine the value of the goodwill. For example, if a business had $100,000 in assets and was purchased for $150,000, the buyer of that business would record a goodwill value of $50,000.
When valuing a business, the first step is assessing how much equity it holds in tangible assets that are easier to value. Examples include:
- Real estate
After assessing these values, the next step is adding a value for intangible assets. This addition is often referred to as a “blue sky amount” and could include goodwill, non-compete clauses, trade names, and patent rights. In the sales of small businesses, most financial experts recommend keeping the blue sky addition to less than the company's net income in one year. For a public company, the goodwill amount can depend on the current stock conditions. Share prices determine the purchase prices for businesses, so stock prices could jump around during the acquisition process.
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