Preface: Goodwill is never a fixed rate calculation with an accredited appraisal. Goodwill calculations are more multidimensional than discussing with college professors how to assess individual student’s relative EQ during a lecture on 10 A.D. history.
Profitability and Business Valuation: Appraisals Are a Prophecy of an Enterprise’s Future Cash Flow Value
Credit: Donald J. Sauder, CPA | CVA
Factor B is the business’s excess earnings that result in premium valuation from a rate of return on investment from the intangible assets cash flows of management decisions, employee activity, patents, processes, etc. Excess earnings are the net revenues above the ceiling of equity market rates of return on the tangible assets. For example, if a business produces substantial earnings above equity risk premium rate of return on tangible assets the business can appraise for a higher value, because it is a profitable investment grade asset. The key term is investment grade asset.
Economic and industry growth are also added to the goodwill equation with Factor C including the organizations ability to attract new customers and create more products, increase top-line sales volume, and strengthen cash flows. Of note is that recurring revenues have higher goodwill multiples than transactional revenues, i.e. a bicycle shop has a different economic and industry growth characteristic than a farmer’s market stand, or a car wash. Therefore the goodwill factors are for these reasons traditionally unique from industry to industry with an expert appraisal value.
Goodwill is never a fixed rate calculation with an accredited appraisal. Goodwill calculations are more multidimensional than discussing with college professors how to assess individual student’s relative EQ during a lecture on 10 A.D. history!
The Type of Goodwill Matters
Let’s look for a moment at the following picture of personal goodwill. Personal goodwill is from relationships developed between customers or suppliers and a business. The value that it adds for appraisal purposes is certainly controversial for many valuation analysts. One such legendary example of personal goodwill valuation is the Martin Ice Cream Co. v. Commissioner.
In Martin Ice Cream Co. v. Commissioner valuation negotiation with the Tax Court, the final ruling was that intangible assets encapsulated in the shareholder’s personal relationships with key suppliers and key customers were not assets of the shareholder’s corporation. Why? Because there was no corresponding employment contract or non-competition agreement between the selling shareholder and the corporate entity. In this case, the shareholder, Arnold Strassberg, had developed personal relationships with his customers over a duration of approximately twenty plus years. For the background, in 1974 the founder of Haagen-Dazs asked Mr. Strassberg to assist with his ice cream marketing expertise and relationships with supermarket owners and managers to introduce Haagen-Dazs ice cream products into supermarkets.
The tax court essentially ruled that the goodwill was not a corporate asset because while at the corporation, Mr. Strassberg was instrumental in the design of new ice cream packaging and marketing techniques; there were no legal contracts for his services on behalf of corporate operations.
This tax opinion, can reduce the value of a certain corporate stock appraisal because it is personal goodwill and not corporate goodwill, yet that value is still an asset. This area of tax law is best deferred to experts, because it is a double-edged sword in business appraisals depending on if you’re a buyer or a seller.