Look at your balance sheet and you'll see the vans and the stock. You won't see the years it took to build a name, or the customers who ring you first without shopping around. Yet when you sell, that's usually what most of the price is for.
That unseen part is goodwill. Buyers have their own ways of putting a figure on it, and the part that rests on you personally is the hardest part to sell.
What goodwill is
HMRC's guidance points to a 1901 House of Lords case as the leading authority. One of the judges called goodwill "the attractive force which brings in custom". In plain words, it's the value of your reputation and your connection with customers, and of whatever makes that connection last. A good location can be part of it, and so can an agreement that the seller won't compete.
Goodwill is tied to the business that created it. You can't sell it on its own, only with the business. It also moves, so a new contract or a bad review can change it quickly.
You won't find your own goodwill in your accounts. UK accounting standards don't allow a business to record goodwill it has built itself as an asset. HMRC's guidance makes the point that goodwill can exist even though it isn't shown on a balance sheet.
Goodwill is the price less the net assets
Buyers rarely value goodwill on its own. They value the whole business, usually on its adjusted profit, and goodwill is what's left once the net assets are taken off. Our guide to how to value a business explains how the whole figure is reached.
As a made-up example, a buyer agrees £1,200,000 for a printing business, before any cash and debt. The assets it's getting are worth this much at today's values.
| Made-up example | Value |
|---|---|
| Presses and equipment, at what they'd fetch today | £180,000 |
| Stock of paper and ink | £40,000 |
| Money owed by customers | £150,000 |
| Less money owed to suppliers | (£70,000) |
| Net assets | £300,000 |
| Goodwill (£1,200,000 less £300,000) | £900,000 |
Three quarters of the price here is paid for things that don't appear on the balance sheet. In a profitable business that doesn't need much equipment, goodwill can easily be most of the price. For a business with a lot of property or machinery and modest profit, the goodwill may be small, and the asset value acts more like a floor.
Once the buyer owns the business, their accounts show this figure as an asset. Under FRS 102, the main UK accounting standard, goodwill is the cost of the purchase less the fair value of the net assets acquired. It's then written off over its useful life, and if, exceptionally, that life can't be estimated reliably, over no more than 10 years. That yearly charge is the amortisation in EBITDA.
Other ways of putting a figure on it
HMRC's valuers mention other approaches. One works from the profit left after a fair return on the assets and a proper wage for the owner, sometimes called super profits. Some trades have their own rules of thumb, which HMRC calls a trade specific method. Each still starts with profit a buyer can rely on.
Personal goodwill and business goodwill
This is the distinction that matters most for an owner-run business. HMRC's guidance says goodwill that comes from the owner's personal skills won't transfer to a new owner. Its examples are a chef and a hairdresser. Its valuation manual goes further. If the business couldn't carry on without the owner, the goodwill is likely to be personal. If other people work in it, there's likely to be business goodwill too, but less of it, because profit that comes from the owner's own reputation and skill has to be left out.
Many owner-run businesses have some of each.
| Business goodwill | Personal goodwill |
|---|---|
| Customers who come because of the name, the location or the service | Customers who come because of you |
| Contracts held by the company that carry on after a sale | Work won through your own contacts, on a handshake |
| A team that delivers the work and knows the customers | Skills or know-how only you have |
| Written processes, systems and records | Knowledge that lives in your head |
A buyer will pay full value only for goodwill they're confident will stay. Where a good part of it is personal, expect them to tie more of the price to you staying on, through a handover period or an earn-out. They'll also ask you to agree not to compete or approach customers for a period. HMRC's guidance quotes a Court of Appeal judge describing that kind of promise as the means by which a buyer secures the goodwill they've paid for.
What builds goodwill
- Customers who come back, ideally on contracts or regular orders.
- A spread of customers, so losing one wouldn't hurt badly.
- A manager and team who deal with customers without you.
- A good reputation you can show, through reviews, referrals or inspection reports.
- Ways of working that are written down, so the next owner can follow them.
- A secure home for the business, such as a long lease or premises you'll let to the buyer.
- Records that prove all of this, such as sales by customer over several years.
Most of these take time. Moving customer relationships from you to a manager is the slowest of them, and the one that adds most.
What erodes it
- The business relying on you for sales, decisions or the work itself.
- One or two customers making up a large share of sales.
- Key staff leaving, or staff who could leave and take customers with them.
- A lease near its end with no right to renew, or premises you're about to lose.
- A poor inspection or a run of bad reviews.
- Profit that's falling, or records that can't show where it comes from.
- Word of the sale getting out before you're ready.
Goodwill in an asset sale and a share sale
How goodwill is handled depends on what's being sold. Our guide to share sales and asset sales covers the wider differences.
In an asset sale
The buyer buys the business and its assets from your company, and goodwill is one of them. The sale agreement lists it and gives it a share of the price, alongside equipment and stock. How the price is split matters, because it changes the tax for both sides, so agree the split with your accountant's input before you sign.
For you, the tax comes in two stages. Your company is taxed on its profit from selling the goodwill, and you're taxed again when you take the money out of the company. On the buyer's side, a company buying goodwill can only get Corporation Tax relief for it in limited cases, where it buys the goodwill as part of a business that includes qualifying intellectual property. Expect that to colour how a buyer wants the price divided.
If you're a sole trader or in a partnership, you own the goodwill directly. You're taxed on the gain when you sell it, and Business Asset Disposal Relief may reduce the tax if you meet the conditions.
In a share sale
The buyer buys your shares, and the company carries on owning everything it owned before, goodwill included. Nothing is priced separately. The goodwill is part of what makes the shares worth what the buyer pays, and you're taxed on your gain on the shares.
Protecting goodwill through the sale
Goodwill can drain away during a sale if you let it. Keep the circle small and have buyers sign a confidentiality agreement before they see anything detailed. Keep serving customers as if you weren't selling, because the buyer will be watching the monthly figures. Plan the handover with the buyer, including who introduces them to your main customers and when.
The restrictive covenants you give in the sale agreement are there to protect the goodwill the buyer has paid for. Expect them to cover the customers and the area the business serves, for a set period. Agree terms you can live with, because they'll bind you after the money has changed hands.
Before you agree heads of terms, be clear about how much of the price depends on goodwill that rests on you, and how the buyer proposes to pay for it. That's usually where the real negotiation is.