Business Value Drivers

3 08 2012

Business value drivers are those aspects of a business that can and do add value.

Today’s business environment is not just about survival, it’s about focusing on and creating sustainable value. But, which elements of a business are capable of creating value? Equally important which elements of a business are capable of destroying value? Proper business planning is the process of uncovering and identifying what creates and drives value.

ImageStart by using the SWOT Analysis – Strengths, Weaknesses, Opportunities and Threats – this will help you identify the “value drivers” for your business. With this approach, you can focus on key value drivers.

There are many Value Drivers that have been identified in businesses. But, typically no more than 8-12 are critical in any given business; here are the most common 8.

 

 

Financial History:  

Are your books accurate and up to date? Over the last few years are there patterns of growth or decline? If in decline, are there good reasons for the decline?  Accurate and current financials are important to determine how the company fares in its industry and amongst competitors.  A comparison to industry ratios can identify strengths and weaknesses in the business.

 

Management Depth:

Can the company operate without the owner, for more than a week or two? Is there any cross-trained management to fill in if you were gone?  What is the average age of management?  Will they retire soon? What levels of experience and education do they possess? Having a good management team can add value to the business.

Customer Diversity:

Do you have one or two major customers that account for more than 25% of your gross sales?  What would happen to the value of your company if you lost one? Are most of your customers considered “blue chip”? A good overview and a rating analysis of the customer base can be beneficial not only for added value but is crucial for where, how and when you advertise, not to mention a much better understanding of your accounts receivable and aging.

 

Owner Involvement:

Are you the ‘rainmaker’ in the business? Does everything from sales to

production revolve around you and your decisions? How difficult would you be to replace? The more the business depends on you, the owner, the more likely the value will be lowered.  One of the things I see the most is that over the years, the business owner and number one sales person, is now an office manager.  Maybe it’s time to get back out in the field with your sales people or provide on-going sales training.

Competition:

Does your company compete in a clearly defined market niche which is

defensible? Or, have your products or services become a commodity that is becoming more difficult to defend?

Customer Satisfaction:  

Are your customer relationships based on great products and service, or lowest price? How long and what type of history have they had with you? Are they satisfied or loyal? Do you have systems in place to identify your customers and communicate.

Loyal Employees:

Outside of ownership, are there people in place who you can rely on and are

capable of doing their job day in and day out? Are they considered knowledgeable for your industry? Again, what levels of experience and education do they possess?

What is the average length of employment amongst your staff? A responsible business buyer will be looking for opportunities where the current staff, especially management, will remain in place, following the current owner’s exit from the business. Having key employee contracts, non-competes, but more importantly a loyal, dedicated staff that is committed to the company’s success regardless of ownership change will be highly valuable to a prospective buyer and thus reflected in a business valuation.

 

Proprietary Technology:

Has your company developed a unique application, tool or technology as part of its

Ongoing operations? Does it give you a competitive advantage? If so, this proprietary innovation or intellectual property can be positioned as a key value driver for your business. Technologies or processes do not have to be patented to carry value but privacy and confidentiality must be maintained. It is critical that non-compete and confidentiality agreements be strictly adhered to and enforced by the company, before and after a transfer of ownership. The benefits, application and purpose of your proprietary technology should be explained to a business valuation consultant.

Intangibles (intellectual property) and human resources (who go home at night) can be protected and leveraged through a combination of business strategies and legal protections. Business strategies include incentive compensation plans to recognize, reward and retain high performing employees. Legal protections include requiring key employees to sign non-compete agreements, registering Trademarks and Copyrights, and taking steps to protect proprietary information/trade secrets such as recipes and formulas. Contracts with key players, including partners, customers and suppliers, are also important.

In conclusion, it’s easy to be distracted by all the demands competing for the business owner’s time and attention. To maximize the value and profitability of your company, you need to focus on the key value drivers – which may be intangibles and employees – in addition to having up-to-date equipment and systems.

Advertisements




EBITDA Can Be Misleading

7 04 2015

EBITDA, otherwise known as earnings before interest, taxes, depreciation, and amortization, has become the buzz word of the century, touted by many as the measure of company performance and indicator of value. Not so fast, it is only one of the methods used to measure performance. It is exactly what it is, and should be used as one indicator of earnings for comparison purposes. By itself, EBITDA does not measure how healthy a Company is.

Understanding the amount of asset depreciation is of limited value in determining the present viability of a company; instead, it is a measure of what the company has spent, in the past, on capital expenditures. If you are trying to evaluate the health of the company, depreciation and amortization are “non-cash” items and are irrelevant. Calculating the company’s future capital expenditures is much more meaningful. The assets purchased in the past, can be a measure of calculating needed purchases in the future, and the future is what is important.
EBITDA is only one indicator of how much debt the company can service after it is acquired, but is not a measure of the company’s health. EBITDA does not address working capital requirements, which are critical to a company’s health. Again, EBITDA is only one method for evaluating a company’s performance.
EBITDA is very appealing when it comes to valuing a company, as the multiples represent a fast and convenient way to determine value, but again, it is only one method. There does not exist, a quick convenient method to value a business. No two businesses are alike, not even in the franchising world. EBIT, EBITDA, Adjusted EBITDA, Sellers Discretionary Cash are all backward looking.

The value of a business is a function of its expected future performance. EBITDA is a historic measure. Particularly in the current economic environment, future EBITDA may be significantly lower than historic EBITDA.

While the value of every business can be expressed as an EBITDA multiple, EBITDA multiples do not determine value.
EBITDA measures the flow of earnings but offers no insight into the balance sheet. Business value, however, must take into consideration a variety of other factors, such as whether the business has adequate working capital, whether there has been deferred maintenance on capital equipment, how much investment is necessary to add the next increment of capacity, or what contingent liabilities might result in future economic costs. A wise investor will not neglect these points.

EBITDA may not represent the actual profitability of the company. Large companies with stockholders and investors strive to show as much profit as they can. Smaller, privately owned companies with no investors and just family shareholders strive to show the least amount of profit. Between these two psychologies, are a myriad of other companies doing a little of both. The key to determine value is to determine which earnings are the most representative of the subject company for comparison purposes.

All businesses are not similar—each has its own unique set of strengths, weaknesses, opportunities and threats, none of which is captured in EBITDA multiples. The multiples used to value a company must be based an assessment of future risk from research on what challenges the company will face in the future, its cash needs, capital expenditures and working capital needed for growth.

This article is not meant to discredit EBITDA, it is meant to convey that it is only one of many measures of earnings and is not, by itself, a sole method of measuring a company’s performance or a quick way to value a business. If you replaced EBITDA in this article with EBIT, Adjusted EBITDA, Sellers Discretionary Cash, it would still be the same.





What Factors Enhance Value and Acquisition Success

18 08 2014

Business value and acquisition success are about measuring risk. Less risk increases value and makes the company more attractive to potential buyers. The following are significant factors when measuring risk.

Motivated Realistic Sellerunnamed (6)

Sellers go through many emotional stages before they are realistic and motivated to sell. I have witnessed many successful business sales and some spectacular failures where intermediaries were involved. Both were the fault of the intermediary.  The intermediary that does not recognize an unmotivated and unrealistic seller will fail. That said, the rest of this article will assume a motivated and realistic seller as you can’t enhance value and acquisition success without this.

Organized up-to-date professional financials

In-house quick books financials are useless as many accountants make changes at the end of the year.  There should be no item on the financials that the seller cannot explain and provide backup. This is where a professional appraisal will be the best

Management

The Company has capable management that handles the day-to-day operations of the business in the Sellers absence. A marketing person or sales force does marketing and generation of new business. In other words, a buyer with reasonable skills can replace the Owner.

Is the Company’s management efficient?   Are they motivated and ready for the challenges of the future?  Many companies have employees that grew up with the business, but now the company has outgrown them.  They do not have the education or expertise to take the company to the next level.

How many of the key managers are relatives?  If all or most of the key managers are relatives, and will be gone after the company sells, there is no management.  The average age of the managers is important. Are they close to retirement age? Many managers, after years on the job and close to retirement do not want the perceived changes by new ownership.

Employees

Will the key employees stay if the Company is sold?  Key employees having a long-term relationship with the owner may feel like they are starting over and have to prove themselves again and their tenure will not be rewarded. When this is the case, many employees feel that employment with a larger competitor would be more lucrative.

Like management, age is important as well as skills and education to meet future challenges. Many companies are highly technical and require special education and skills that are not available in the area or may be scarce in the industry.  However, depending on the Company, can they outsource or use virtual offices in any part of the country?

Are employee and management salaries competitive and considered fair market or is a significant salary increase due?

Many companies have employees performing jobs such that accidents and injuries are common in the industry and face significant liability. If this is the case, have the employees been trained sufficiently in safety procedures?  Is safety an on-going program for the employees?

 Diversity of Accounts

Having some large prestigious accounts may be flattering, but if you lose one or two, is the company out of business?  If ownership changes, will these accounts stay with the company?

Competition

How strong is competition? What is the level of ease of entry into this industry? Are technological changes going to give a major competitor with more cash a significant advantage?

Predictability

What has the historical financial picture shown? What would it tell a buyer as to what he or she can expect in the future?  Based on industry and economic forecasts, is the past performance of the company feasible in the future?

Marketability

How hard would it be to sell this company? How many buyers would be interested in this type of business?  Does the company have a unique niche? What is the future of its customer base?  Do they manufacture sewing machines or medical equipment?

Future Outlook

In business appraisal, value has its basis in “anticipated future benefits” (earnings).  What the company will do in the future is what its value is based on.  The risk factors mentioned in this article are the key to the projections that have to be made in the appraisal process and are all critical points that the appraiser must consider.

Acquisitions are successful when there is the assumption of economic benefits (earnings) in the future. The likelihood of these economic benefits occurring is based on perceived risk.  The lower the risk, the more confident a buyer is in the assumptions, and the more attractive is the company.





Just what is Normalizing?

22 10 2012

Image

 

Just what is Normalizing?

 By: George D. Abraham

CEO & Chief Appraiser

Business Evaluation Systems

 The International Glossary of Business Valuations Terms defines “Normalized Earnings” as “the economic benefits adjusted for non-recurring, non-economic, or other unusual items to eliminate anomalies and/or facilitate comparisons.”  There are very few industries where a company’s earnings will remain constant and therefore a business appraiser needs to “normalize” past earnings in order to accurately predict future income potential.

As closely held businesses are controlled by one or just a few individuals, the valuation analyst should consider whether the economic benefits being paid to its owners are above, below or at market levels. Sometimes the analyst can easily identify which items require normalization and at other times the analyst is left to his or her own analysis to identify the income normalization issues. These are adjustments that eliminate one-time gains or losses, other unusual items, non-recurring business elements, expenses of non-operating assets, and the like.

 

Examples of common items that are normalized in the valuation of a closely held business are:

  • Related party rent. In many cases the owner personally owns the real estate and possibly      machinery and equipment and leases them back to the company.  The appraiser must determine if   these leases are at fair market and adjust if it is not.
  • Owner and related party compensation

            Business owners will sometimes compensate themselves with the remaining profits left over after    all other expenses have been paid.  Here, the analyst must determine whether that compensation        is at fair market level.

            Other compensation can be to non working or overpaid relatives, which may include insurance,       auto expenses cell phones, etc.

  • Nonrecurring or extraordinary items such as nonrecurring legal fees associated with litigation,          additions to expand the building the company operates from, hunting leases, costs associated with           the owner’s boat and repairs from hurricanes or floods. Other nonrecurring items are lawsuit          settlements, insurance proceeds, and changes in accounting methods, discontinued operations and             gains or losses  from the sale of assets.

 

  • Non-Operating Assets. In many instances there may be assets that are not directly related to the        production of earnings, such as the owner’s boat and Jeeps and tractors for the hunting lease.     These assets would also be adjusted out of the balance sheet and in some cases excess cash.

 

  • Discretionary Adjustments such as prerequisites, insurances, automobile, employee benefits,           etc.  Also, items that would normally be considered personal, but are nonetheless paid for         through the business such as personal credit cards, owners home landscaping. 

            Some industries such as construction will have their workers build a new home for the owner or      rental homes when business is slow.  Another example is auto repair and body work companies     where labor is working on the owner’s race car.

  • Comparability Adjustments. The appraiser may adjust the subject company’s financial                              statements to facilitate a comparison between the subject company and other businesses in the                      same industry. These adjustments are intended to eliminate differences between the way that                        published industry data is presented and the way that the subject company’s data is presented in                   its financial statements.

            Internal Comparability adjustments may need to be made.  Many times appraisers must annualize   the current year using in-house financials. In many companies, the CPA adjusts the income and expenses on the in-house financials at the end of the year for tax purposes. Many times these  adjustments relocate expenses (or income) to other areas of the financials so the appraiser must  make sure that the current in-house financials categorize income and expenses the same as the 4  or 5 prior years prepared by the company’s CPA.  Also the appraiser must account for seasonal    differences whereby the remaining months may not reflect the same level of revenues, labor or  inventory levels.   

                When the appraiser makes normalizing adjustments, certain clients and related parties may object.    Valuation professionals generally should provide detailed explanations of their adjustments and,

            whenever possible, support them with authoritative references, thus greatly minimizing potential      confusion and arguments between the parties.

 





Goodwill, Blue Sky, Pie in the Sky, all the same!

3 08 2012

 

 

 

Wait a minute there is a huge difference.  Assume for instance you are a famous scientist that just made a machine that would make pure gold and the cost of the machine was $20,000. How much would someone pay for this machine. I am willing to bet it would be more than $20,000. But how much more, is the Appraisers dilemma.  Well the first thing to decide is how much production is it capable of and secondly how long will the machines run. All machines need maintenance and surely as sophisticated as this one is, what will that cost?

 

 Where will we get the parts, are they available and how expensive would they be? Who is qualified to repair this machine? Is the inventor the only one who could fix it? How long will this genius be around and what will he charge for consulting or repair?  Oh no, what if this ability to make pure gold is illegal and if not how 

 

long before Uncle Sam decides you are ruining the economy and passes 

 

laws to stop your production? But wait, maybe they would want to buy 

 

it. Oh my God, how much more would Exxon pay? Forget Exxon, what about 

 

Germany, no wait, the Chinese or Russians? However, the Saudi’s have 

 

all the cash. Hmmmmm

 

 I wonder what the value of this machine is now.  I would bet millions or even billions. What do we call this increase in value? Is this blue sky?  Is this increase in value really real?  Surely not, since the SBA is only willing to loan $20,000 plus one half of this so called blue sky, and not to exceed $250,000.  Maybe with this thinking a buyer should forget this machine as it is obviously risky with all that goodwill and purchase another machine that only has cash flow that will support a loan of $40,000.

 

 I think you can see by this silly scenario that there is goodwill. A business should be looked at the same as a money machine.  The appraiser needs to study the company to find its strengths and weaknesses and calculate risk. Based on its current operation what does the future hold for this business? Will future government regulation slow down or end the cash flow?  What about the company’s suppliers, is cost going to increase; is there other suppliers the company can buy from or are is the company at the mercy of a single supplier. As stated above, all machines need repair, so what kind of condition is the equipment in and how old is it.  Does the seller have a good reason for selling his or her business? How hard will it be for a new owner to fill his shoes?  It’s good to hear that the workforce has been with the company for years with hardly no turnover and that these excellent employees and managers made the company grow throughout the years, but what is the age of the employees and management?  Are they all going to retire soon? When was their last raise?

 

 

 

Just who are the company’s customers?  Is that one big account that represents over 50% of their business going to buy from the company through ownership change; and are they under contract to buy; or is the customer’s CEO a long time college buddy of our retiring seller?

 

 Another factor in calculating risk is the economy and the company’s trade area.  Based on the foreseeable future, is the company’s product or service going to be negatively affected? 

 

 Salaries and wages are usually the second largest expense after cost of goods. Considering the nature of the business and the degree of technical expertise needed to make the company’s products; is the new owner likely to find new people to replace retiring employees and management; and what will they have to pay them? A shortage of talent is like everything else, the more scarce, the more you have to pay.  Being the second largest expense, and not able to project future costs, means any projections are guesswork, and as we all know, anticipated future earnings is the foundation of all valuation models.

 

 Value has a lot to do with the size of the buyer pool. Is this company such that the technical expertise needed to manufacture, improve, market, and upgrade its product such that only a handful of buyers are qualified; or would it be a perfect fit for the thousands of unemployed managers from corporate downsizing.

 

 Ease of entry plays a big part in value. How hard is it to start up and compete with this company?  If you are successful, one certainty in business you can count on is your neighbor will be selling a close substitute product or worse; one of the huge companies with millions to spend on advertising and marketing will shut you out of the market completely.  If a buyer can open up across the street from the business and make as much money in six months to a year, why would the buyer pay 4 or 5 years of earnings. However, if the buyer was looking at a substantial upfront investment in assets and a 5 hard years to get where the owner is now; knowing he would be constantly shelling out his personal capital to keep his new start up business afloat and receiving no salary during those 5 years, would realize he would be way ahead by paying the 5, 6 or maybe 7 years of earnings because he would start making money the first month, receiving a salary and does not have to compete with the company.

 

 Every question in this article must be assigned a degree of risk.  The compilation of these risk factors determines the capitalization rate or multiple of earnings used to establish the value of the company and determine its goodwill.  

 

The Small Business Administration (SBA) defines goodwill as:

 

 “Goodwill” is created when an existing business is acquired and the acquiring entity pays more for the business than the book value of the business’s assets.  Simply put, “goodwill” is the premium the seller is requiring as part of the purchase price (and the buyer is willing to pay) for an established business in the marketplace as compared to that same buyer starting a new business.  By paying a premium for an established business, the buyer is relying on the existing business’s established market share to continue due to such reasons as an established customer base, a premium location, etc.  (Customer lists and non-compete agreements are documents that the seller may provide to support the goodwill the seller is requesting.) 

 

Therefore, simply stated, it is the difference between what a company will sell for and it’s hard assets.  To get to the price the company will sell for, the appraiser has researched, analyzed, compared prior sales and analyzed a myriad of factors that would contribute to or decrease value.  In the Excess Earnings method, each asset of the business is analyzed as to the return it should earn.  The amount of earnings after this is considered excess and is capitalized to calculate goodwill.

 

In summary, there is a huge difference between goodwill, blue sky, and pie in the sky, because goodwill is painstakingly analyzed, researched, compared to comparable sales and calculated.  Blue Sky and Pie in the Sky are values that are guessed at or just pulled out of thin air so the next time you hear someone using them interchangeably I hope you will correct them.

 

 

Image





Business valuation, an analysis of risk

3 08 2012

Analyzing risk is the predominate factor in valuing a business.  The appraiser must analyze every aspect of the business and quantify his or her analysis of the company’s risk into value.  A study of the significant risk factors in the business must be identified and then rated as to the degree of risk each carries.  The following are some of the factors to analyze in a business.

 Labor

There are many key factors to analyze as far as labor is concerned. Are employees hard to find? What educational skills or level is required and is the labor pool such that they could be replaced?  If the company is highly technical, there may not be many individuals in the area that have those skills and thus make it difficult for the company to grow. On the other hand, many of these companies can outsource or use virtual offices with employees in any part of the country.

Are key employees and management due a significant salary increase? Again, many employees are faithful to the owner and feel that once the company grows a little more, they will be rewarded both in salaries and advancement.

What are the ages of the employees and key management?  If many of the key managers are close to retirement age, they may just retire when ownership changes. After many years on the job and very close to retirement, many in management don’t want the changes they perceive with new ownership.

What is the liability risk with the employees? Are the jobs they are performing such that accidents are a normal occurrence in the industry?  If this is the case, have the employees been trained sufficiently in safety procedures?  Is safety an on-going program for the employees?  If the company has delivery vehicles, a check of the accident history is in order.

 Management

Will key employees’ stay once the company changes ownership? It is not uncommon for key employees to leave the company for a more lucrative position with a larger competitor.  Many times, the key employees stay with the company  as they are close to the owner and are in a position to contribute to the company’s growth and success and feel they will be rewarded heavily someday.

Has management been efficient?  Are they up to the challenges of the future?  Many companies have employees that grew up with the business but now the company has outgrown them.  They do not have the education or expertise to take the company to the next level. 

How many of the key managers are relatives?  If all or most of the key managers are relatives, and will be gone after the company sells, there is no management.

Who is responsible for the majority of sales? Does the company have a sales force or is the owner responsible for most of the sales and if so, how hard would it be to replace him. 

Financial Strength

Is the company solid or are they in a cash crunch?  Some ratio analysis can tell you what kind of financial position the company is in and how it compares to other companies in its industry.  An analysis of the company’s account receivables is necessary to see how they are getting paid.  An abundance of slow paying customers can drain the company’s working capital.  Insufficient working capital can prohibit the company from growing because it can’t buy enough raw materials or inventory to meet an increase in sales. 

Does the company have the ability to buy from several suppliers or are they enslaved by one that can raise prices whenever they want?  Another question that pops up is how stable is the supplier?  Cost of sales is usually the largest expense for a company.  If you have no idea what the future costs are going to be, you can’t make any kind of meaningful future projections or budgets.

 Facilities & Location

What is the length of the lease? Is it likely to increase? Are the facilities sufficient for the business and possible expansion? What about the company’s location? Are any major roadways or changes in the area likely to affect the company?

 Diversity of Accounts

If the company loses one or two accounts will they be out of business?  Many companies have one account that equals a large portion of their business.  Unless these large accounts are under contract for several years, a buyer may be hard to find.  Will the accounts stay with a new owner is the heart of the analysis for the appraiser.

 Competition

How strong is competition? What is the level of ease of entry into this industry? Are technological changes going to give a major competitor with more cash a significant advantage?

 Predictability

What has the historical financial picture shown? What would it tell a buyer as to what he or she can expect in the future?

 Marketability

How hard would it be to sell this company? How many buyers would be interested in this type of business?  Does the company have a really unique niche? What is the future of its customer base?  Do they manufacture sewing machines or medical equipment?

 Future Outlook

Always remember that a business is bought on the assumption of its economic benefit to its owner. The more stable the financial future, as well as other factors like technological changes, environmental regulations, and public attitude, can have an effect on a buyer’s emotion. This relates to how long the buyer is willing to risk his or her money and therefore how fast he or she would want it back and thus the multiple of earnings he or she is willing to pay.

In business appraisal, value has its basis in “anticipated future benefits” (earnings).  What the company will do in the future is what its value is based on.  The risk factors mentioned in this article are the key to the projections that have to be made in the appraisal process and are all critical points that the appraiser must consider. Image





Measuring Enterprise and Personal Goodwill

3 08 2012

By: George D. Abraham

CEO & Chief Appraiser

Business Evaluation Systems

 

 

In the state of Texas and several other states, appraisals for divorce, requires the appraiser to consider and analyze personal and enterprise goodwill in the dissolution of marital assets. Personal goodwill is not considered part of the marital assets to be divided.

The American Journal of Family Law states that Goodwill is “that intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors not separately identified.[1]  It can be separated into two parts, defined as follows:

  • Personal goodwill is the value of earnings or cash flow directly attributable to the individual’s characteristics or attributes.  Personal goodwill, sometimes referred to as professional goodwill, is a function of the earnings form repeat business (customers) that will patronize the individual practitioner as opposed to the business, new consumers who seek out the individual, and new referrals who will be made to the individual. 

 

  • Enterprise goodwill is the value of earnings or cash flow directly attributable to the enterprise’s characteristics or attributes.  Enterprise goodwill, sometimes referred to as practice goodwill is a function of earnings from repeat business (customers) that will seek out the business (as opposed to the individual), new consumers who will seek out the business, and new referrals who will be made to the business.

Most appraisers approach the allocation by simply dividing the attributes into personal and enterprise, but you can take it one step further which offers a reasonable position if challenged and provides a consistent method and a defensible bases for your opinion.  

Once the appraiser has a solid goodwill value, the analysis of personal and enterprise goodwill can begin by analyzing the attributes that make up goodwill. The appraiser must keep in mind that the process requires several key factors:

  • The attributes that impact personal goodwill are a percentage within a range.
  •  Enterprise goodwill is the reciprocal percentage.
  • Does the presence of this attribute add to the earnings of the business? The greater the impact on earnings, the greater is the presence of the attribute.
  • The difference between total goodwill and personal goodwill is the enterprise goodwill.

Goodwill Attributes

Personal Attributes

These are attributes that relate directly to the ‘goodwill subject”. This is the person for whom the goodwill allocation is being performed (physician, architect, accountant, etc). Personal attributes reflect the efforts by the goodwill subject and are inherent in the individual.  These personal attributes indicate personal goodwill, including:

 

 

  • Ability, Skills, and Judgment.  These attributes focuses on the “doing” by the goodwill subject;        e.g., the ability to perform at a level to generate sufficient earnings to establish goodwill.  The            goodwill subject’s education, training and demonstrated ability will almost always be important             personal attributes.

 

  • Age and health.  These are significant as they help determine the longevity of the subject’s   impact on earnings. Underlying all value is the time frame for cash flow or earnings.  Older and less healthy subjects could mean a shorter and more uncertain stream of future earnings, and      thus, a lesser personal goodwill allocation.

 

  • Personal Reputation. This is the customer’s perception about the person’s ability, skills and judgment.

 

Business Attributes

These are the result of decisions that affect the business organization, operations, finances, and image.  If the goodwill subject makes decisions that improve enterprise attributes, this increases enterprise and not personal goodwill. Examples of business attributes to the enterprise include:

  • Location, location, location.  There is a multiple location attribute and the business location attribute. Keep in mind that multiple locations do not mean a strong indication of enterprise goodwill. The appraiser must understand how the locations are being used.

 

  • Systems and organization.  This encompasses the management decisions that determine how the business performs. These are well defined and maintained systems that make the business strong are a good indication of enterprise goodwill, even if the goodwill subject created the systems.

 

  •  Business reputation. If the customer’s perception about the product or service, including price, customer support, quality and satisfaction are on the business, the characteristic is enterprise.  In some cases the customers commonly associate a business with an individual, but it is the business reputation they are counting on.  Keep in mind that some businesses have both personal and enterprise attributes that the appraiser must separate and analyze.

 

  • Staffing. Staffing encompasses all the employees of the business, other than the goodwill subject. Usually employees are associated with enterprise goodwill, but there are times when employees may seek a position because of the personal reputation of the goodwill subjects training that would add value to their own resume.

 

  • Personalized business name.  This is the most misunderstood attribute as it is automatically assumed that if the business carries the subject’s name, all is personal goodwill. However, many businesses are sold and carry on with the personalized name and others change the name sometime after the purchase. The question to address is:  “Would the customers abandon the business solely because it changed its name?”
  • Closeness of contact. Sometimes the goodwill subject’s work habit includes more contact with the customer, and the more direct contact, the more likely the subject will have personal goodwill. (Dentists have close contact, while radiologists do not.) However, it is not so much the closeness of the contact as it is the personal nature of the contact.

 

  •  Closeness of contact. Sometimes the goodwill subject’s work habit includes more contact with the customer, and the more direct contact, the more likely the subject will have personal goodwill. (Dentists have close contact, while radiologists do not.) However, it is not so much the closeness of the contact as it is the personal nature of the contact.

 

  • Referrals. Referrals to a goodwill subject often indicate a high level of respect for one’s abilities and are personal in nature and increase the individual’s personal goodwill. However, referrals can certainly be made to a business and those referrals would support a greater enterprise allocation.
  • Repeating revenue stream.  This attribute deals with the specific nature of the revenue stream and is the heart of goodwill. Repeating business can be due to either enterprise or personal goodwill.  However, some businesses are more likely to enjoy repeat business by the nature of their industry and are not concerned with the reason for the repeating business, such as a great location.

 In summary, the appraiser will analyze and separate each of the attributes into personal and enterprise goodwill by establishing a range with each attribute weighted according to its importance (impact on earnings).  Each attribute is then given a weighting as to its degree of existence.  The value of an attribute established by multiplying the degree of existence by the degree of importance represents a percentage of  100%.  As personal goodwill increases, enterprise goodwill decreases by the same amount. 

 


[1] Article: An Allocation Model for Distinguishing Enterprise Goodwill from Personal Goodwill,” American Journal of Family Law

 

 

Image