What does the concept of goodwill cover exactly?
This Anglo-Saxon term refers to the excess value between the assets found on the balance sheet and the real value of the company or business assets. This surplus value consists of various intangible elements, such as customer goodwill, trademarks, etc. These elements are obviously less identifiable and therefore more difficult to value, especially when interests diverge. Does goodwill appear on the balance sheet? As an intangible asset, goodwill should normally be found on every balance sheet because it is supposed to reliably reflect the reality of the company. Very often, however, a company's intangible assets are low or even nonexistent on the balance sheet. Precisely because these items are difficult to quantify, they have often never been capitalized. Thus, a company that has built up a large customer base and/or a strong brand over time may not have formally valued it. Goodwill may also have been amortized, under Belgian accounting standards, such that its residual value is low. If, on the other hand, intangible assets are still significant on the balance sheet—for example, when a business was purchased with an explicit surplus value or when a patent incurred research costs that are being amortized over time—one must also ask whether there is a surplus value relative to the book value.
The concept of adjusted net assets.
One of the main valuation methods consists of calculating adjusted net assets. This involves adding all latent capital gains to the company's equity (its net asset value). There may be a capital gain on real estate, as well as on other assets of the company. These net capital gains—after deducting tax—must be added to equity. This method therefore makes it possible to calculate the asset value of the business.
How to calculate goodwill?
To determine goodwill, the company's recurring profitability must be taken into account. This profitability allows for the calculation of the surplus value relative to the asset value or adjusted net assets. Numerous methods exist to factor in this profitability. The simplest methods consist of adding a multiple of net profit, net cash flow, or EBITDA to the adjusted net assets. Goodwill can also be calculated by subtracting the earning value obtained (ideally using several methods) from the adjusted net assets. Finally, goodwill can be calculated by discounting the expected returns of the company and comparing them to the risk-free rate.
Intuitively, it seems clear that a highly profitable company is worth more than its twin sister, which has the same assets but is less profitable. Goodwill precisely expresses this surplus value by discounting future revenue flows. By adding goodwill to the adjusted net assets, one obtains a coherent value for the company, which can be compared to other valuation methods. This quantitative approach should at the very least allow the parties to objectify their discussion—an essential prerequisite to potentially reaching an agreement.
Article initially published in La Libre Économique by Tanguy della Faille, partner at Fondaris, on 13/06/2015. Published/updated version on the Fondaris website with the author's permission.
