Business owners often ask how their intangibles (i.e. their employees, reputation, customer list) are being valued in a business sale. While there is no simple formula to use, there is a way to understand how these intangibles contribute to the overall enterprise value of a business.
Similar to the tangible assets in your business (inventory, machinery, equipment, etc.), you invest in intangible assets in an effort to make a return or a profit. Collectively, all the assets in your business (both tangible and intangible) are used to generate revenues and, hopefully, profits. Companies that have subpar management or a poor reputation in the marketplace are likely not as successful and less profitable as their counterparts with professional management and an excellent reputation.
Understandably, many business owners believe that too much emphasis is placed on the cash flow of their business when it comes to determining the value of their company; however, the ability to generate cash flow is the result of ALL your assets put to use/work. From a transaction perspective, Goodwill is one of several types of intangible assets. For example, if a business is sold for $10MM, and it allocates the purchase price as follows: $5M to tangible assets and receivables, the remaining “intangible assets” could include $500k to non-compete, $500k to customer list, and the remaining $4MM allocated to Goodwill.
The next time you review your P&L statement, take a minute to consider what went into generating that profit (or loss). You’ll quickly realize it was your sales team out making calls or your factory floor workers executing on the game plan. These are your intangibles working on your behalf to help generate a profit for the company which ultimately play into valuing your business at the time of a sale.