What exactly is Goodwill?
Goodwill is an intangible asset of a business. Although there are many varieties of goodwill, some of the more common examples include a high traffic or exclusive location, a strong reputation, brand name recognition, and great customer relationships.
And what’s the difference between personal goodwill and commercial goodwill?
Personal goodwill is attributed to an individual in the company – most often the owner or a key employee, while commercial goodwill (which is sometimes referred to as business goodwill or enterprise goodwill) arises out of the features of the business itself, irrespective of who the owners, management or employees are.
To elaborate, personal goodwill is what the owner or a key employee personally brings to the company. For example, if the company is named after the owner; if the owner or a key employee is integral to the management of the company; if customer retention and supplier relationships are largely owing to experiences and interactions that people have had with the owner or key employee; if referrals are made exclusively to the owner, rather than to the company as a whole; or if the expertise in connection with the company’s products or services rest primarily with the owner or key employee, then there are elevated amounts of personal goodwill affiliated with that particular business. In short, if an owner or key employee is absolutely indispensable to an organization, then the business will likely possess a great deal of personal goodwill.
Contrastingly, commercial goodwill is built into the organization itself—it is distinct and independent from the individuals who manage the company. For instance, if clients and sales are generated through strong brand name or company logo recognition; if knowledge of the products and services, and policies and procedures are documented through a centralized database system within the company; if the convenience or exclusivity of the business’ location is a significant reason that customers choose to deal with the business; or if the organization has a more diverse management team, then there is a good chance that commercial goodwill forms a strong part of that particular corporation.
As a practical illustration, let’s say there’s an accomplished and renowned chef in town. This celebrity chef would likely fill whichever restaurant she works at, simply because of her personal reputation and goodwill. The chef will bring her expertise, flair, and create her own recipes and menus for the restaurant, and if she leaves or is replaced by another chef, that same restaurant may not do so well. This example is representative of the personal goodwill of the famous and talented chef.
On the other hand, a well-known chain restaurant will consistently draw in customers due to the strength and recognizability of its brand, regardless of who cooks there. The recipes, menu items, logo, convenient location and ambiance of this chain restaurant are expectedly standardized, predictable, and consistent across all locations of that restaurant brand, which represents commercial goodwill.
Often, and not surprisingly, small to medium sized companies will carry more personal goodwill and larger corporations will possess a greater amount of commercial goodwill.
Why does this distinction matter?
The significant difference between personal goodwill and commercial goodwill is that one set may be worth a lot more than the other. Naturally, personal goodwill is not a negative feature, especially from the perspective of a company owner. It’s more likely than not that the skills, know-how and personal relationships of the owner play an immense factor in the organization’s success. However, it is important to be aware that personal goodwill may present itself in an undesirable manner when it comes to succession planning and selling the business. In short, personal goodwill can bring down the value of a company if the business is unable to function effectively without the owner or a key employee after the sale has taken place, which makes it a substantially riskier investment for a potential buyer.
Conversely, commercial goodwill will raise the value of a business since the merit of those goodwill characteristics is not dependent on any single individual and can easily be transferred to the new owner. Intrinsically, one of the soundest methods of increasing the value of a business is by establishing an abundant amount of commercial goodwill. Simply put, a purchaser of a business would expect to pay for commercial goodwill only, since it is transferrable and would offer direct benefits to the new owner.
How do I turn personal goodwill into commercial goodwill?
It will require a combination of time, determination, effort and planning in order to effectively transform personal goodwill into commercial goodwill, so it is always beneficial to consider and act on this as far in advance of the sale of a business as reasonably possible. One method may involve training various employees to perform specific duties and responsibilities as proficiently as the owner or key management does; another approach may include introducing long-time clients and established suppliers to other employees within the organization, so that the relationships, confidence, and trust can continue to develop even after the owner and key management are no longer with the company.
If there isn’t enough time to effectually transform the personal goodwill into commercial goodwill prior the completion of the sale, there are other ways to add value to the business. Some business sales are structured so that the owner stays on as an employee or consultant, to both maintain a presence and to facilitate the smooth transfer of knowledge, expertise and relationships to the new owner.
In sum, a business without its principal asset is worth significantly less. However, if business owners do a good job at passing on their personal knowledge, expertise and skills, if they entrust others to continue and develop relationships that have been established, and if they plan ahead to transform the organization’s personal goodwill into commercial goodwill, the business will undoubtedly become more attractive to potential purchasers and its value will increase as well.