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Goodwill is a Good Thing


As suggested earlier, there are multiple interpretations of goodwill which extend beyond the SBA’s formulaic definition of “Selling Price Less Book Value of Acquired (Tangible)Assets”. Although there is some consistency between new GAAP rules on goodwill accounting, the IRS’ “residual method” and this “formula” method, the general shortcoming with the line of thinking put forth by the SBA to restrict or monitor goodwill-based lending is that goodwill should NOT be considered a negative feature or outcome or the reason why businesses default on their loans To the contrary, only successful firms will generate the profits needed to foster the presence of substantial goodwill (however defined). In fact, the more profitable (successful) a firm becomes, the greater the firm’s goodwill value becomes (all other things equal). The more profitable an asset-heavy manufacturing firm becomes, the greater the portion of value that is attributed to goodwill – is this a bad thing? In short, “goodwill” is a “good thing”.

As mentioned in my previous writings, at least one-half of the Top 30 Lowest Default NAICS codes (based on SBA-published data) are businesses which are comprised primarily of goodwill or other intangible assets, e.g. professional practices, internet firms, service firms, merchant wholesalers, etc (between 55% and 95% intangible asset value).

Goodwill and/or other intangible assets are present in every business and they should not be “discriminated” against given their direct relationship to profitability and financial and operational performance. It is a feature of our modern “service and information economy” that “hard assets” are less and less important as time progresses.

In fact, even those businesses considered to be “hard asset heavy” will feature goodwill values of at least 45% and often much higher (more profitable, more goodwill – get the idea). Actual statistics related to real world business acquisitions are provided next in order to “document” this fact.

Approximate Goodwill Estimates By SIC Code***

SIC Code/Source Description Goodwill* as Percent of Price
SIC 5983/Pratt’s Fuel Oil Dealers**
80.7%
SIC 5085/Bizcomps Industrial Supply Distribution
47.5%
SIC 7537/Pratt’s Transmission Repair
56.3%
SIC 5912/Bizcomps Restaurants
52.8%
SIC 3499/Bizcomps Metal Fabrication
56.9%
SIC 5712/Pratt’s Retail Furniture Stores
73.4%
SIC 3599/Bizcomps Machine Shops
56.0%
SIC 8021/Pratt’s Dentists
78.2%
SIC 8082/Pratt’s Home Healthcare
95.6%
 
Range of Goodwill Value from Diverse Industries
48% to 96%
Median
57%
Mean
67%

*Goodwill is considered a proxy for all intangible assets, similar to the SBA perspective.
**Pratt’s Stats “asset sale” transactions may include accounts receivable and, rarely, assumed liabilities. Adjustments have been made to reflect their presence to the fullest extent possible. Bizcomps transactions are always reported as pure “asset sales”, but the price and corresponding multiples exclude the impact of inventory (the total price figure has been adjusted to reflect inventory before calculating the goodwill percentage). ***It should be noted that the fixed asset figures utilized by Bizcomps and Pratt’s Stats may be reflective of either book value or fair market value. Due to the tendency to utilize book values for such reporting and based on the fact that FMV is typically greater than BV due to accelerated depreciation methods, the fixed asset values used to generate the corresponding goodwill percentages may be somewhat understated (actual goodwill values may be somewhat lower than stated).

The “bottom line” interpretation of a goodwill cap (or any maneuver which seeks to reduce lending associated with intangible assets) is that it represents punishment against those firms which are highly profitable and/or hard asset-poor – irrespective of debt service ratios, credit records, business plans, character, etc. For these reasons (and many others), I commend the decision to delay the goodwill cap implementation.

Did You Know That the New SBA Goodwill Restriction* May or Will.....................

  1. Decrease the number and value of 7(a) loans as well as the number of 7(a) lenders across the nation (ceteris paribus)?
  2. Create layers of misunderstanding, misinterpretation and/or misapplication of “the rules”, which in turn may compromise the integrity of a given lender’s loan guaranty?
  3. Increase loan closing costs via the need for BOTH fixed asset AND inventory valuations (by certified appraisers) in order to “justify” (maximize) the potential loan amount and to sustain the loan guaranty within the new rules?
  4. Create an increasingly common situation requiring a total of 4 (FOUR) MANDATORY CERTIFIED APPRAISALS for one given transaction (real estate, fixed assets, inventory and going concern/business) while simultaneously increasing total transaction costs?
  5. Allow for a maximum 7(a) loan of only $60,000 for a home healthcare business which is generating over $900K in normalized profits and growing at more than 30% per annum and employing over 150 workers (due to minimal hard assets worth only $30K and the 50% goodwill threshold)?
  6. Potentially increase the average default and charge-off rates due to the elimination of loans to high cash flow (and low default/charge-off rates)  businesses such as professional practices (e.g. dentists, vets and insurance agents), various merchant wholesalers, translation and interpretation services and even painting contractors. Roughly 15 of the top 30 “Best Industry Performers” during the 2000 to 2005 timeframe were comprised of these types of businesses. 
  7. Harm professional practices and franchises, in particular. Of the 893 professional practices valued by one large national appraisal firm, 91% of the transaction price was considered goodwill.  Of the 651 franchises, 86% of the transaction price was considered goodwill.
  8. Generate a cottage industry of professionals who attempt to creatively but legally “work around the restriction” in order to serve their clientele?
  9. Nearly eliminate the financing of professional practices, internet-based firms, home healthcare providers and many other profitable, growth-oriented companies which happen to have only minimal fixed or hard assets?
  10. Possibly lead to increased litigation among buyers and sellers due to increased reliance on “second position” seller financing with full or partial standby status?
  11. Possibly cultivate a negative perception among borrowers that the “new” SBA programs are not what they were intended to be?
  12. Increase unemployment and decrease income among lenders, loan brokers, business brokers and business appraisers?
  13. Penalize those companies which are maximizing sales and profits per dollar of fixed assets and inventory?
  14. Be opposed by approximately 99.9% of industry professionals for a variety of different reasons (most of which are self-preserving to be sure)?
  15. Negatively impact GDP and employment levels as the business owners delay their decision to sell and maintain their “status quo” rather than parting from the company and letting the “new blood” implement their typically more aggressive growth plans (including the hiring of new employees).
  16. Reduce small business values, small business sales and IRS tax collections?
  17. Possibly shift and increase the tax burden on the seller to a point which greatly reduces the appeal of such financing? For example, customer lists, non-compete, customer base and policies/procedures could be used to bolster the loan amount – all of these accounts are all associated with ordinary income taxation to the seller (not capital gains) in an asset sale.
  18. Reduce the money creation process (and the availability of other funds for other borrowers over time) associated with loans and our fractional deposit banking system, i.e. it will NOT stimulate the economy?

*The planned SBA restriction originally called for limiting the amount of “goodwill” financing to 50% of the total loan amount or a maximum of $250,000.  This list represents potential outcomes based on the author’s review and analysis prior to the implementation of the SOP 50-10(5)(B) version that raised the goodwill cap to $500,000 and facilitated PLP lending in cases with higher goodwill values (based on a combined minimum “equity” investment by the buyer and seller combined). Even with the new “B” rules, the general impact of the goodwill cap remains and the preceding list is still relevant.

Goodwill Transactions
Over the last 10 years, a large and successful business appraisal firm (Gulf Coast Financial) has been compiling data associated with all of their engagements as well as obtaining additional transaction data from their clients.  Soon to be published, this database shows over 4,000 arm’s length transactions, all of which were financed by SBA lenders.  Here is a summary of the transaction detail:

Average Sales $1,332,604
Average Available Cash Flow $190,447
Average Transaction Price $708,260
Average Goodwill $529,862

As you can see above, total goodwill as a percentage of the total purchase price averages approximately 75%.  Keep in mind, “tangible” assets in an asset sale can be severely overstated.  If the SBA requires “depreciated value” or an equipment appraisal, I would certainly agree that the average small business transaction would equal 80% to 90% goodwill.  Here are a few other facts from our database:

  • Of the 893 professional practices, 91% of the transaction price was considered goodwill;
  • Of the 651 franchises, 86% of the transaction price was considered goodwill;
  • Approximately 25% of the businesses in our database sold for more than $1 million.  The average transaction price was $1,562,000.  The average goodwill for this group of transactions was $1,188,111 or 76%.
  • The percentage of transactions in our database that had goodwill less than $250,000 = 27%.

Goodwill-Related Definitions
from the International Glossary of BV Terms

Excess Earnings—that amount of anticipated economic benefits
that exceeds an appropriate rate of return on the value of a selected
asset base (often net tangible assets) used to generate those anticipated
economic benefits.
Excess Earnings Method—a specific way of determining a value
indication of a business, business ownership interest, or security
determined as the sum of a) the value of the assets derived by capitalizing
excess earnings and b) the value of the selected asset base.
Also frequently used to value intangible assets.
Going Concern Value—the value of a business enterprise that is
expected to continue to operate into the future. The intangible elements
of Going Concern Value result from factors such as having a
trained work force, an operational plant, and the necessary licenses,
systems, and procedures in place.
Goodwill—that intangible asset arising as a result of name, reputation,
customer loyalty, location, products, and similar factors not separately
identified.
Goodwill Value—the value attributable to goodwill.
Intangible Assets—nonphysical assets such as franchises, trademarks,
patents, copyrights, goodwill, equities, mineral rights, securities,
and contracts (as distinguished from physical assets) that grant rights and privileges and have value for the owner.

Definitions of Goodwill on the Web

  • good will: (accounting) an intangible asset valued according to the advantage or reputation a business has acquired (over and above its tangible ...
  • good will: the friendly hope that something will succeed
  • grace: a disposition to kindness and compassion; "the victor's grace in treating the vanquished"
    wordnet.princeton.edu/perl/webwn
  • The Goodwill was a post-hardcore band from Long Island, New York formed in 2001. They released two full length albums- 'That Was A Moment' on ...
    en.wikipedia.org/wiki/The_Goodwill
  • Goodwill is an accounting term used to reflect the portion of the market value of a business entity not directly attributable to its assets and ...
    en.wikipedia.org/wiki/Goodwill_(accounting)
  • Difference between the purchase price of a company and its net worth (assets less liabilities).
    ir.airberlin.com/glossar.php
  • Goodwill is the difference between the buying price of a company and the net value of the subsidiary after reevaluation.
    www.alstom.com/_looks/alstomV2/frontofficeScripts/index.php
  • Intangible asset that quantifies the price that a buyer of a company has paid for the reputation, know-how and market position of the acquired company. Goodwill is the excess of the amount paid over the fair value of the net assets acquired at the purchase date.
    adidas-group.corporate-publications.com/index2.php
  • The difference between the price which is paid for a business and the value of its assets.
    www.nottingham.ac.uk/business/cmbor/Glossary.html
  • An invisible asset created by a good reputation for work well done.
    www.choice.com.au/viewArticle.aspx
  • An intangible asset that represents the value of a corporation's name, customer service, employee morale, and other such factors that are anticipated to translate into higher earning power. ...
    lion1234.dreyfus.com/cgi/inet/invest_glosry.trn
  • An intangible asset which provides a competitive advantage, such as a strong brand, reputation, or high employee morale. ...
    www.btplc.com/Sharesandperformance/Usefulinfoandlinks/
    Glossary/Glossary.htm
  • Premium paid in the acquisition of an entity over the fair value of its identifiable tangible and intangible assets less liabilities assumed
    www.startheregoplaces.com/glossary/
  • An intangible asset that adds value to a company's worth. For example, the reputation of its products, services, or personnel.
    hul.co.in/investor/investor_services_glossary.asp
  • An intangible, salable asset arising from the reputation of a business; the expectation of continued public patronage; including other intangible assets like trade name and going concern value. When a business is sold, the sales price often reflects its goodwill value.
    nvfh.com/glossary_g.cgi
  • Goodwill arises when a company buys another business at a price greater than the book value....more on Goodwill
    moneyterms.co.uk/d/
  • An account that can be found in the assets portion of a company's balance sheet. Goodwill can often arise when one company is purchased by ...
    ir.telecomegypt.com.eg/Glossary.asp
  • an intangible asset that attaches to the successful operation of a business. Favorable factors such as location, product superiority, service ...
    cfdccariboo.com/glossary.htm
  • The accounting treatment of an intangible asset such as the takeover premium in a merger or acquisition.
    globaledge.msu.edu/resourcedesk/glossary.asp
  • Goodwill is based on a company's reputation and relationships with customers, vendors and the community and its participation in trade-related ...
    www.business-law-and-litigation.com/PracticeAreas/Glossary.asp
  • Businesses usually have a base of customers who know them and people who identify them with a particular location. For example, a restaurant that has been in the same spot for 25 years has business goodwill in the form of regular customers and identification with that location. ...
    www.castlecoalition.org/index.php
  • An intangible asset, based on the ability of a business to earn profit above the ‘norm’, (these above-average earnings are also known as ‘super profit’)
    www.smartaccountingsoftware.com/acctterm.aspx
  • The difference between the market value of an institution's assets and the higher amount paid at the time the institution is purchased or merged into another institution. ...
    www.ncbuy.com/credit/glossary.html
  • Excess over the purchase price for a subsidiary and the share in its equity after winding up the hidden reserves attributable to the purchaser on the date of acquisition.
    gb2006.uniqagroup.com/eReport.asp
  • An intangible business asset which includes a cultivated reputation and therefore the attraction and confidence of repeat customers and connections. Sales of businesses often include a section of the purchase price for "goodwill".
    www.trumanlaw.com/docs/dictionary/g.html
  • An elusive, ill-defined concept that has at least three definitions: 1. The amount by which the purchase price of an entity exceeds its book value, based on the precept that no one pays for nothing, so that if more than book value is paid it must have been for something intangible, all tangible ...
    www.direitocultural.com.br/arquivos/dicion%E1rio_PI_engli.doc
  • The value of customer lists, trade reputation, etc., which is assumed to go with a company and its name, particularly when trying to arrive at the sale price for the company. In accounting terms it is the amount a purchaser pays over the book value.
    www.smallbiz.ca/glossaryg/
  • The part of the price, not accounted for by the net value of tangible assets, that covers extra qualities of the business such as the name, reputations and customer loyalty.
    www.businesswings.co.uk/articles/Glossary-Of-Business-Terms
  • The value of the name and reputation of a person or company, which will generate better future earnings, based on that reputation.
    www.peakagents.ca/glossary/g5.htm
  • The total purchase price of a business minus it's liabilities
    www.moneymatters101.com/tax/taxdef/taxdefg.asp

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