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Last Update: Sunday March 29, 2020

Key Idea: Build Goodwill

Goodwill is what accountants call an "intangible asset". Goodwill is just as real an asset as cash or inventory, but you can't touch it. Another favorite definition of accountants for goodwill is "earnings capacity." 

Key Question:

A: 

Yes.  What the marketplace thinks of you and says about you is called goodwill.

Q: How do I know how much goodwill my company has?

A:
That's a tough one. It's obvious to us that the value of the business we own exceeds the value of our assets less our liabilities. In other words, the equity section of your balance sheet, which equals all your cash, receivables, inventory, equipment and other assets, less the amounts you owe your vendors, the bank, and any other liabilities, does not represent the value of your business.

Q:
Where is the goodwill in your business?

A: Goodwill is in lots of places, your customer relationships, your employees, the reputation of your business. All of these are sources of goodwill. These sources are what make your business more than a collection of assets.

Because of the goodwill elements, you are able to make money and because you make money, you are attractive to a buyer. The valuation of that goodwill is the toughest part of the determination of the fair price to be paid for your business.

Q:
If goodwill is an asset, why doesn't my CPA put it on my books?

A: Financial statements are prepared in accordance with "GAAP", Generally Accepted Accounting Principles. GAAP requires that all assets be recorded at cost, not to exceed net realizable value. That "not to exceed" caveat is why you record depreciation of long-term assets, to reflect the wear and tear of the assets. The buyer of your business will record goodwill, to the extent and in the amount that the purchase price exceeds the value of the assets acquired less the liabilities assumed.

Think about it

What do customers think of you right now? Can their good feelings toward you translate into goodwill for a business valuation? If customers don't think well of you, what should you do to get them to think well of you?

Clip from: Sell To A Public Company

La Jolla and Dallas: Every day the press reports, especially The Wall Street Journal and Forbes, about how big business acquires small businesses in order to grow.

If you are running a good business and have market share in your industry segment, you should consider preparing for that call or knock on the door, "Can I buy your business?"   In most every episode of this show we explore how and why the founder of a business gets started and how they get over the hurdles. This week we look at how they received a very large check for the fruits of their labor.

Today, we spend time with Tracy Myers and Gary Cantor, the founders of Advertising Arts College, and Bob Orenstein, founder of International Wine Accessories (IWA). Both have completed all eight steps within the business cycle, and they define what it means to "Exit At the Top." You met Bob a couple of years ago when we did his story about starting IWA from the extra bedroom of his townhouse.

Both stories are important.

Gary and Tracy's story is for all of us who are not even thinking about selling, then there comes a knock on the door.  Bob's story is for the rest of us who know that we have created a substantial asset. Bob, however, knew that his "time" was coming. Bob was strategic and spent several years getting ready for the day, and then it took over four years to consummate a deal.

To say the least, every one of us should have an exit strategy.

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International Wine Accessories, Inc. (IWA)

Robert Orenstein, founder

10246 Miller Road
Dallas, TX 75238
2143496097

Visit our web site: http://www.iwawine.com/

Office: 2143496097

Business Classification:
Home products

Year Founded: 1988

Build Goodwill

BOB: So they've allocated approximately half of the amount of the money to the mailing list, and the difference was called goodwill.

HATTIE: OK. Let's talk about that. Explain that to people.

BOB: Goodwill is effectively a number. Sometimes accountants call it the plug number. It's the difference that you can't explain. It's what a buyer will pay over anything they can put their finger on as a hot asset. Even though a mailing list may not be a hot asset, you can use different ways to value it. What you can't value, but what somebody's willing to pay for, is also called goodwill.

TRACY: During the due diligence process, the community is interviewed. What do you think of this school? What do you think of their graduates? Do you hire them? Are they trained? And what is the reputation of the school? What do you hear about it? And so that was important to us always, even before we even thought about selling.

You can't take back and undo a bad reputation. If you're going to start a business, you have to think right out of the block. Your reputation is so important. It's so valuable, especially if you go to sell your business down the road. Don't cut corners from the very beginning.
 
 

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