Goodwill is a familiar term that most of us have heard and read about, and believe that we have a basic understanding of. Despite its familiarity, few business owners have a clear sense of what the term means or understand its application and legal implications for their businesses. There is probably good reason for this as goodwill is not a tangible item, as is, say, a piece of equipment; nor is it easily identifiable, as is, say, a patent, trademark or copyright. The ephemeral, fleeting, nature of goodwill makes it hard to value and even subjective. Despite the inherent element of subjectivity, goodwill is often of more value to a business than tangible assets.
California law defines goodwill as “the benefit that a business gains as a result of its location, reputation for dependability, skill or quality, and any other circumstances…”. Code of Civil Procedure section 1263.510. Despite this expansive definition, California limits recovery of damages for loss of goodwill in litigation to businesses which operate from a physical location.
Goodwill is a category of business assets, which also include tangible assets, intellectual property assets, and other proprietary assets. Of these, tangible assets are the easiest to valuate. Determining the value of Intellectual Property is more complicated and subjective than that of tangibles. However, patents, trademarks and copyrights usually have established markets, with comparable assets for determining their value. Trade Secrets and other proprietary information such as customer lists, skill and talent, management systems and methods, technical processes, contacts, etc. are even more difficult to valuate. Goodwill is often referred to the difference between the market value of a business’s assets and its actual sales price.
Goodwill often becomes an issue in determining the value of a business, or in legal disputes involving infringement of an asset associated with Goodwill such as harm to reputation and trademark infringement.
The inherent uncertainty associated with defining Goodwill has also caused uncertainty about the methodology which should be applied to its determination. Courts have refused to identify a single acceptable method of valuing goodwill. Valuation methods will differ with the nature of the business or practice and with the purpose for which the evaluation is conducted.
Building goodwill, with its many aspects, is critical to increase a business’s customer base, attract investors and create opportunities for growth. As such, it must be a vital aspect of every business’s growth and success strategy.
© 2017 Dr. Dariush Adli