Recently, I have dealt with a number of issues relating to the valuation of goodwill. One particular case involved a company that had been in business for a number of years and had created what would appear to be goodwill. Its name was well recognized and well regarded among its customer base that had consistently made purchases from the company. There was every reason to believe they would continue to do so based on their experience with the company's high level of customer service.
The problem was that while, in the mind of the owner and in common parlance, the Company had created goodwill, it had not been able to translate that goodwill and stream of business into profitability. It had bumped along, paying just about a living wage to its owner, but no more than the owner would have paid to a manager to run the business.
In the marketplace, the company may fetch a good price – the customer niche served by the subject company may provide some powerful synergies with a particular purchaser's existing business and that buyer may be willing to pay a premium for this market access. But this will not be the case under the fair market value standard of value, where no account can be taken of these potential synergies.
Without a history of a net cash flow and, even more importantly, in the absence of a prospect of future positive cash flows, the analysis of fair market value is often reduced to determining what it would cost a potential buyer to recreate the infrastructure of the business. How much would it cost to hire and train a suitably qualified workforce? What would the cost be of recreating the company's customer list or network of suppliers? Is there any inherent value in the operational systems the company employs? Even taking all these elements into account, the resulting value was far below the owner's expectations based on the effort and emotional capital invested. As ever in valuation, cash (flow) is King and without it, what an owner may think of as goodwill is worth very little.