Business Funding Secrets
Business Funding Secrets

Financing Goodwill

 

When a large business is sold it is usually done by purchasing the “stock” of the company. When smaller businesses are sold it is usually an “asset” sale. Assets of a small business consist: 1. Real Estate, 2. Furniture, Fixtures, & Equipment, 3. Inventory, 4. Goodwill.


When purchasing or financing a business, each type of asset needs to be valued separately at its current value. This is typically done by a third party that does business valuations.

 

It is usually easier to value real estate and the tangible assets. Goodwill can be more difficult to value.

 

Goodwill is defined as an intangible saleable asset arising from the good reputation of a business, resulting in steady trade, and the expectation of continued patronage. However, it can also include patents, trademarks, customer lists, specialized software, etc. The goodwill of a company may also be divided into two types: 1. Goodwill derived from the location, advertising, market reputation, and business name. 2. Personal goodwill from the expertise and reputation of the business owner and employees.

 

When a business is sold the sale price will reflect the perceived value of the goodwill. Sellers are proud of what they have accomplished and will typically value the goodwill at a higher value. Buyers typically want to purchase the goodwill at a lower value for obvious reasons, but also because goodwill cannot be depreciated. Due to the buyer and seller valuing the goodwill differently the final purchase price will reflect the negotiated value - what the seller is willing to accept and the buyer willing to pay.

 

Goodwill can become a significant factor in the purchase price of a business. The elements of goodwill provide value over and above the value of the company’s other assets. When it comes to financing the purchase of a business, goodwill most certainly will be included as an asset of the existing business. 

                                                                                               

SBA 7(A) loan guarantee is often used for business acquisition financing in the U.S. and has a loan size from $250,000 to $2,000,000. It should be noted that with the current capital conditions there is a maximum limit of $250,000 allowed for goodwill when using SBA 7(A).  

                               

If the purchase price and financing of the business exceeds $2M or consists of more than $250,000 in goodwill, then alternative sources of funding (beyond SBA) will be required.

 

Tips:
1. Since goodwill involves intangibles, and is related to the cash flow of the business, only the portion that can be verified should be part of the transaction. If a seller states that large amounts of money have been withdrawn from the business (but these cash flows are not currently shown on the financial statements), and the seller wants to use this information for inflating the purchase price, then the money trail must be verified. Don’t purchase, or try and finance smoke and mirrors.
2. Accountants working for the seller may be reluctant to verify a money trail because they don’t want to admit to possibly doing something improper.
3. Understanding the industry, average ratios for that type of business, and what should typically be accepted will assist in determining and verifying goodwill.

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