Why Most Businesses Lack Goodwill

Most businesses lack goodwill. These businesses have no value in excess of their net tangible assets. There are several reasons for this. First, a large percentage of closely held businesses are very small businesses that operate with very little profit or provide their owners with hardly any significant compensation. Second, many businesses do not have repeat customers. These businesses must continually recreate their customer base. Common examples of these types of business include most attorneys, architects and construction contractors who must gain business through competitive bidding. Finally, many profitable service businesses may have repeat customers but most of these customers will be unlikely to continue patronizing the firm after the key owner employee has left.

Transferability is the Key

Sometimes the owner of a business does not have sufficient influence over their customers, clients or patients (CCPs) to convince them to keep patronizing the firm in the owner’s absence. For example, a psychotherapist’s patients may not be very willing to simply continue seeing another therapist just based on their former therapist’s recommendation.

Some service firms rely heavily on referral sources and it often can be difficult to convince referral sources to keep referring to a successor than convincing CCPs. In any event it is not enough for a business to have a CCP base. For the CCP base to have value, and thus possess goodwill, that base must be transferable.

Scale and Profitability: Too Small

Many businesses have a transferable CCP base but still lack goodwill with any value. This is usually due to the fact that the business either operates at a sufficiently small scale or generates too little profit to motivate a buyer to acquire the equity. Most businesses in the U.S. are very small and do not generate sufficient profit for their owners or any prospective buyers.

One reason for the lack of profitability is that these firms are selling goods or services to a market segment that is not willing or capable of paying prices that would generate enough profit for larger scale operations. So, while a larger scale operation might in theory be interested in acquiring a smaller firms CCP base they would have to raise prices in order to make the proposition profitable. Therein lies the rub. If they try to raise prices on the acquired CCP base those CCPs will refuse to continue to do business with the new ownership.

Another related problem can occur when the profitability of the firm relies heavily on the labor of the owner manager and it would be difficult to find a non-owner replacement with sufficient skill and energy to successfully manage and service the CCP base. In these circumstances a larger or similar sized firm would be willing to merge with such a business but only on the premise that the current owner would be willing to continue in the business.

Click here for a good summary of why most small businesses are unprofitable.

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