What Does Goodwill Mean?
Goodwill represents the value of the intangible assets acquired in a business acquisition. The amount of goodwill is calculated by first determining the enterprise value of the business, and then deducting the tangible net assets.
Goodwill that is tied to the owner and not the business is called personal goodwill, which is not transferable and has little or no commercial value. Goodwill that can be transferred to a buyer has commercial value and, therefore, is usually paid up for by buyers.
Divestopedia Explains Goodwill
The amount of goodwill implied in the value of a business could impact the purchase price that a buyer may be willing to pay. Say, for example, that two companies generate free cash flow of $5 million each. Company A has $15 million in net tangible assets, compared to only $5 million for Company B. Company A, therefore, has less implied goodwill than Company B. Prospective buyers may be willing to pay more for Company A for two reasons:
Company A has more available security to finance the acquisition; and
The risk of the investment in Company A is perceived to be lower because under a worst-case scenario of insolvency, there are more assets that can be liquidated.
Companies that do not have significant net tangible assets should justify the value of goodwill implied in the business. This is done by finding ways to put a value on customer/supplier relationships, brand name, patents and trademarks.