Businesses with Goodwill

 Businesses with goodwill have repeat customers, clients, patients (CCPs)  or repeat referral sources, a large percentage of whom would continue to patronize the business after a change in ownership. The businesses have to have a transferable customer, client or patient(CCP) base. It is important to keep in mind that simply because a business has goodwill does not mean that the goodwill has any value. In other words, a business can have a base of repeat CCPs that will transfer that no rational buyer would be willing to pay for. Click here for a description of businesses that possess goodwill with little or no value.

On this page I am going to focus on the kinds of businesses that tend to have goodwill that is worth paying for. By the way, one test for the existence of goodwill is whether a buyer would pay more for an existing business than the sum of the businesses’ tangible assets (some even define goodwill as the excess value of a firms total assets over its tangible assets).

Small Service Firms

By any measure or criteria you care to use, businesses that possess goodwill worth paying for tend to be in sectors providing specialized services or products. Many of these firms are regularly bought and sold at prices well in excess of the value of their tangible assets. So let’s look carefully at the characteristics of these kinds of businesses:

  • Revenue is derived from services requiring more than a minimal level of skill.
  • Clients, patients, customers (CCPs) utilize the services repetitively on a fairly predictable basis.
  • Most CCPs tend to utilize only one firm exclusively in the provision of these services.
  • Many, if not most, firms in these service sectors operate at a small enough scale that active participation by ownership is required.
  •  If the firm were sold, a significant proportion of CCPs would continue patronizing the firm on the recommendation of the prior owner at least once.
  •  The cost of starting up the business in terms of equipment and leasehold improvements is not prohibitively high as long as the business owner has the requisite skill and experience to provide the service.
  • There are in each sector potential acquirers (PAs) with the requisite skill and motivation to acquire these firms and with access to the financing needed to successfully complete a transfer.

I emphasize that these firms are usually small because ordinarily they have fewer than fifty employees and gross revenue well below $10 million. Click here for a more operational definition of a small business.  The most common service sectors that exhibit these characteristics include:

  • Accounting and bookkeeping services
  • Dental practices
  • Chiropractors
  • Veterinarians
  • Optometrists
  • Barbers and Hair Stylists
  • House Cleaning Services
  •  Daycare Centers
  •  Plumbers
  •  Landscapers and Lawn Maintenance
  •  Pool Maintenance

The following table compiled from IBIS World research reports shows the most common service sectors that exhibit these characteristics along with an estimate of the total number of such businesses in the United States.

Other Types of Businesses with Goodwill

Personal service businesses are of course not the only kinds of businesses that can create goodwill with substantial value. If a business creates a product or service that distinguishes it from other competitors in their market those businesses can and will generate goodwill. However, the value of the goodwill will be a function of competitive advantage. If by virtue of a firm’s location, reputation of quality of product or service it would be difficult for a competitor to lure the firm’s customers away, then that business will possess goodwill with positive value.

Often businesses such as convenience stores, grocery stores and gas stations have what can be termed location based goodwill. The repeat business is a function not so much of the quality or uniqueness of the service or product but rather the fact that in their location there are no real competitors that can draw the customers away.

Absent locational advantages, most non-service businesses must offer products that have a competitive advantage over other firms in the same market. So a chocolatier, an ethnic restaurant, or a bike manufacturer must produce or provide offerings that some other firm does not offer at the same level of quality or price. We can actually generalize these ideas as it relates to the value of goodwill.

Quality, Price and Convenience

All CCPs choose a firm, product or service based upon weightings of price, quality and convenience. These weightings vary by the nature of the product or service. And of course there will be variation in how different consumers weight different products and services. Nonetheless there are important generalizations that can be made and these in turn lead to generalizations about which firms tend to create goodwill with significant value.

The critical generalization is that firms that offer products or services for which quality is weighted more heavily than price or convenience tend to generate goodwill and this goodwill tends to be more valuable than the goodwill that might be generated by firms that offer products or services for which convenience or price is weighted as heavily or more heavily than quality.

For example, a local accountant is likely to generate goodwill of greater value than a local gas station. Customers of the gas station will quickly patronize another gas station that offers even a slightly lower price holding convenience relatively equal. Clients of the accountant will be much less likely to switch to another accountant simply because another accountant offers a slightly lower price or might have a slightly more convenient office.

Quality, price, and convenience are what I term factors of attachment. When quality is more important than price and convenience customers and clients become more attached to those firms offering quality than firms offering products and services where quality is a lesser concern than convenience or price. The greater the CCP attachment the greater the goodwill value and vice versa.  

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Copyright 2018 Michael Sack Elmaleh