Understanding Contract Terms (post 1): Goodwill
In a new series on the iVLG blog, we’ll take common terms you see in various contracts and break them down so you can understand what exactly the term means, and its role in your contract. In today’s post, we’ll look into the definition of goodwill.
Webster’s Dictionary defines goodwill (in terms of business) as:
(1) the favor or advantage that a business has acquired especially through its brands and its good reputation (2) : the value of projected earnings increases of a business especially as part of its purchase price (3) : the excess of the purchase price of a company over its book value which represents the value of goodwill as an intangible asset for accounting purposes
Successful businesses build a strong brand name, good customer relations, good employee relations, and may own patents or proprietary technology. These assets have value since they are the reason that customers continue to come back to the business over and over again (which translates to revenue). As the definition suggests, these intangibles give your business a competitive advantage over others in the industry.
When a business is being acquired the value of its goodwill is reflected through its projected earnings. For example, a company with a great reputation and large customer base (or unique patent or other proprietary technology) will receive a higher value for goodwill since it will have higher projected earnings than a young startup company with relatively little recognition or reputation. The amount of the purchase price for a company that exceeds its book value generally accounts for the intangible assets such as reputation, brand name, and other proprietary technology. As you’ve probably guessed, you’ll see the term’goodwill’ most often in transactions where one company or individual is acquiring an existing company.
Does goodwill affect the day-to-day value of your company? It depends. If you’re a private company, then goodwill has no predetermined value prior to the time when your company is acquired. Public companies, by contrast, are subject to constant market valuation, so goodwill will always be apparent and reflected in its day-to-day value. If you’re interested in learning about how goodwill is reflected on a your company’s books, here’s a brief explanation of impaired assets.
If you’d like to learn more about goodwill or other common terms in business acquisition, please don’t hesitate to comment below or contact us today.