Buying a small business. How do you value goodwill?
Discussion
I'm in talks with a sole trader who is selling his business. The business runs from home, where he also keeps his stock of equipment for hire. We've pretty much worked out the value of the stock and I know how much profit he makes annually, as well as the amount of hours he commits to the business every week. So far so good. But, he relies on his good name for repeat business and referrals and this is the part we're stuck on. How do you work out the value of goodwill? Is it based on a percentage of turnover? And if so, over how many years? It is assumed that his clients will become my clients, as there's no real reason for them to go elsewhere as long as I can continue to provide the level of service.
The way we did it years ago, was to agree on a figure and agree to pay it, but only if it was achieved over a set time frame.
We agreed to pay 60k if i remember correctly. Roughly 20k a year for three years only, on 5% of turnover. If we hit the 60k before time then happy days, if it went over the 3years due to drop in business then the previous owner lost out.
This meant he was keen to smooth over the transition, and ensure customers were happy with the new ownership.
But essentially, goodwill is worthless as the previous owner could start again tomorrow, and pinch all the customers back.
Get agreement written by solicitor, and signed by both parties.
All the best
We agreed to pay 60k if i remember correctly. Roughly 20k a year for three years only, on 5% of turnover. If we hit the 60k before time then happy days, if it went over the 3years due to drop in business then the previous owner lost out.
This meant he was keen to smooth over the transition, and ensure customers were happy with the new ownership.
But essentially, goodwill is worthless as the previous owner could start again tomorrow, and pinch all the customers back.
Get agreement written by solicitor, and signed by both parties.
All the best
BruceFlea said:
But essentially, goodwill is worthless as the previous owner could start again tomorrow, and pinch all the customers back.
Get agreement written by solicitor, and signed by both parties.
All the best
This.Get agreement written by solicitor, and signed by both parties.
All the best
Is goodwill really a thing these days?
Just dead money unless the business is a goldmine.
Lord Flashheart said:
I'm in talks with a sole trader who is selling his business. The business runs from home, where he also keeps his stock of equipment for hire. We've pretty much worked out the value of the stock and I know how much profit he makes annually, as well as the amount of hours he commits to the business every week. So far so good. But, he relies on his good name for repeat business and referrals and this is the part we're stuck on. How do you work out the value of goodwill? Is it based on a percentage of turnover? And if so, over how many years? It is assumed that his clients will become my clients, as there's no real reason for them to go elsewhere as long as I can continue to provide the level of service.
If it’s equipment hire then the frequency of hire and how those customers migrate to you will help you with the answer regarding goodwill. If repeat custom is very regular then it won’t take long for them to transition to you. However, if it’s very intermittent then whether he’ll do things such as transfer his website/email address/phone number to you an actively redirect anyone who still contacts him becomes an important part of the discussion.
Huge difference between customers getting rapidly transferred/seamlessly redirected to you vs a situation in which you’ve bought the business but customers contact the original trader only to told he’s no longer in business, has sold, etc…
Having recently been involved in business valuation, it can be either easy or very complicated! It depends on the size of the business, how long it has been running, turnover/profit levels and growth, work pipeline etc etc. having said all that you wouldn’t be a million miles away when you consider 1x turnover or 2x profit, allowing for inventory of equipment etc.
^^^ this was from employing a specialist business valuer. The detail used ebitda based on last three years, along with various multiples, but it still came out the same as the last years turnover! As always, protect yourself, do your research and get professional advice, at the very least from a good accountant. As has been mentioned earlier, watch for the potential of him setting up again and taking your new customers…. Whilst it can be largely prevented by the correct legal agreements, it still happens and would be expensive to take him to task.
Same thing. The value of a business is essentially its net worth (assets minus liabilities) plus whatever extra the buyer is willing to pay over and above the net worth I.e. the goodwill.
It’s the valuation of that goodwill which is the tricky part. There are numerous techniques that can be used but essentially it boils down to how much extra you are willing to pay.
It’s the valuation of that goodwill which is the tricky part. There are numerous techniques that can be used but essentially it boils down to how much extra you are willing to pay.
pomp1 said:
Pretty much ignore what a lot of the big agencies/ brokers are saying. They are listing agencies making money on signing up businesses to sell.
This is unfortunately true- to me ever long despair as someone who owns a business in this sector. Watching business owners being sold a dream that never appears constantly angers me. OP- you need to have a think about how risky that income will be when he leaves, and how many months/years you are willing to "forego" in profit in order to acquire the business.
Smaller businesses are highly risky, and therefore priced accordingly.
Thank you for for input with this. The business is basically a sole trader who is retiring, so the probability of starting up again is virtually zero, especially as there's £80k of stock he'd have to buy again. But nonetheless, I appreciate something must still be drawn up and signed.
I also know the chap well and he approached me as someone he'd like to take on the business. He likes to think that his last 25 years of hard work can be picked up and continued by someone he thinks has the attributes to keep it going, instead of simply selling his stock and folding up.
I also know the chap well and he approached me as someone he'd like to take on the business. He likes to think that his last 25 years of hard work can be picked up and continued by someone he thinks has the attributes to keep it going, instead of simply selling his stock and folding up.
Alternatively buy the Co on a net asset value basis only and structure a deal to pay the seller a small commission for each existing customer repeat order over time (max 3 years timeframe, declining £ value as time goes on). Its a bit of extra paperwork but the incentive is there for him to play nice and you not to get scammed.
PugwasHDJ80 said:
pomp1 said:
Pretty much ignore what a lot of the big agencies/ brokers are saying. They are listing agencies making money on signing up businesses to sell.
This is unfortunately true- to me ever long despair as someone who owns a business in this sector. Watching business owners being sold a dream that never appears constantly angers me. OP- you need to have a think about how risky that income will be when he leaves, and how many months/years you are willing to "forego" in profit in order to acquire the business.
Smaller businesses are highly risky, and therefore priced accordingly.
It’s usually a multiple of EBITDA. If you don’t or can’t use that. I’d be looking at his retention and churn rates. Then forecast the next three years of sales with no further marketing, and base it on something around that. But if the barrier to entry is low, then scale back appropriately.
And as someone else has mentioned, ensure there is water tight non-compete in the final contract for a period of at least two years.
And as someone else has mentioned, ensure there is water tight non-compete in the final contract for a period of at least two years.
Based on the fact you say it is a "small" business, if you can't do it effectively on a handshake forget about the notion of legally enforced contracts. The American saying of "the business goes up and down in the lift" is very true.
My limited experience of a buying a retiree's business was that even if they don't poach customers, outside of a potential core element, most customers are prone to wander off, I guess that's why so many earn outs exist.
If anyone knew how much it actually might cost to enforce a non compete clause against a determined adversary, in a small business context the fight that ensues will be massively inconvenient and disruptive.
So either be certain on the sellers "my word is my bond" and they do exist still or assume worst case that you're giving some unknown money, that way you won't get any benefit from.
My limited experience of a buying a retiree's business was that even if they don't poach customers, outside of a potential core element, most customers are prone to wander off, I guess that's why so many earn outs exist.
If anyone knew how much it actually might cost to enforce a non compete clause against a determined adversary, in a small business context the fight that ensues will be massively inconvenient and disruptive.
So either be certain on the sellers "my word is my bond" and they do exist still or assume worst case that you're giving some unknown money, that way you won't get any benefit from.
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