We talked about the factors that create personal goodwill in small businesses and professional practices. The key takeaway is that personal goodwill is associated with the individual practitioner, not the business organization.
In contrast, institutional business goodwill arises from the business or practice itself. This is the type of goodwill that you can transfer easily when the business or a partner’s share sell.
Increase total business value by building the institutional business goodwill
One value-enhancing strategy you can follow is to make sure that the large part of goodwill is created by the business or practice itself. This is known as the institutional goodwill. So which factors indicate this important type of business goodwill? Here is the list:
Top 8 factors that create institutional business goodwill
Quality and skill of employees.
Business name recognition.
Competitive postion of the business or professional practice in its market place.
Location of the business premises.
Business referral base.
Stability of earnings.
How the 8 factors affect the value of business goodwill
It goes without saying that skilled, long-term staff is the major asset in any business or professional practice. If such employees remain with the practice after key partners depart, the new owners acquire the considerable benefit of trained and assembled workforce. The result? A higher value of business goodwill and the entire business enterprise.
Focusing on building the reputation and name recognition of the business tends to attract loyal customer following. The clients come to respect and prefer the company as the product and service provider. Needless to say, this translates into higher earning potential – and higher business goodwill.
If your business or professional practice has built up a set of sustained competitive advantages, it probably enjoys superior earnings – through lower costs and greater pricing flexibility. Above average earnings are a key element in creating business goodwill over the long term.
Excellent location makes the business more visible and accessible to its target market. The result is often strong repeat and referral business. Good location also tends to help reduce the marketing expenses.
You need to understand if new client referrals come because of the business reputation, rather than an individual practitioner. Should the expert depart, the clients will likely keep coming. Such client retention is the major contributor to the business goodwill.
Stable business earnings indicate the staying power of the business or professional practice. Business people pay attention to historic earnings stability to predict what is likely to happen in the future. Again, this future earnings outlook indicates how valuable the business is.
If you find a strong market for existing businesses in some industry, buyer competition tends to increase business selling prices. Remember that the value of business goodwill is the difference between the total business value and the appraised value of its assets. Hence, strong competition among the buyers – and higher business selling prices – point to higher value of business goodwill.
Business goodwill valuation comes up often in the context of valuing professional practices and consulting service businesses. The typical examples are medical, dental and other healthcare practices, CPA and law firms, engineering and architecture consulting businesses and other professional service companies.
A key question you may need to address is how much of the practice or business goodwill can be transferred to new ownership. In addition, legal dispute situations generally require that practice goodwill value be included in your business valuation.
Business goodwill sources: business or personal?
An important challenge you may face is how to distinguish between the business goodwill and professional goodwill. Business goodwill is created by the business or practice itself. On the other hand, professional goodwill is personal in nature – it is associated with the individual professional practitioners.
This distinction is significant because it is generally much easier to transfer goodwill that is associated with the business, rather than an individual professional practitioner.
Elements of professional goodwill
You may need to separate the professional from business goodwill in many practice valuation situations. Here are the key elements that help you identify the professional goodwill:
Practitioner skill and ability.
Practitioner age and health.
Professional’s reputation and name recognition.
Fee schedule commanded by the individual professional.
Personal referral base.
Level of client involvement.
High levels of specialized skill, demonstrated ability and excellent professional judgement are strong indicators of professional goodwill. Clients tend to trust professionals that are skilled and make correct decisions.
Professionals that are in good health and have a long career horizon have excellent earnings outlook – a major element of continued professional goodwill.
A professional who is respected by peers and clients tends to be successful and enjoys excellent earning potential.
In addition, the fee schedule indicates how well the professional can translate the skill and reputation advantages into superior earnings, and greater professional goodwill.
Clients are a lifeblood of any professional practice or service business. The practitioner who has a steady, high quality referral base creates a considerable level of professional goodwill. Answer this question: do the referrals occur because of the business or individual professional’s reputation? The greater the level of professional’s involvement with the clients, the greater professional goodwill.
While it is common knowledge that professionals work long hours, how well you allocate your time among the various tasks can make a big difference to your earnings.
Predictably, professional goodwill increases as the practitioner dedicates more time to the highest value-creating tasks.
Auto tire retail stores, classified under SIC code 5531 and NAICS 441320, represent around 19,000 establishments in the US alone. Over two thirds of these businesses are small, owner-run single store operations.
Check these interesting facts: while the industry as a whole generates over $77bn in revenues, the average store makes around $1,500,000 in annual gross sales, employing just 7 employees.
A well-run store offers around 6 – 12 brands of tires, with commercial dealers carrying as few as four or five. Big brand tire products are a major plus since they tend to attract repeat business from brand-loyal customers. As a result, a store which offers the right mix of top brand name products in its market tends to command valuation multiples that are 15 – 20% higher than its competitors.
Key factors that affect an auto tire store business valuation
When it comes to valuing a business or setting its selling price, not all auto tire stores are created equal. You need to consider the factors that drive business value in this industry. Here are the top ones:
Established, loyal customer base
Availability of trained employees and strong store management, beside the owners
Terms of lease
Condition and quality of store equipment
Percentage of sales derived from product sales and service.
For many stores, service offerings tend to be more profitable than tire sales. In times of rapidly increasing oil prices, tire product costs tend to crimp product profit margins. Service revenues on the order of 50% of the total typically indicate a store with excellent profit potential. The result is higher business valuation and, very likely, a higher business selling price.
Business valuation methods for auto tire stores
Auto tire stores sell often, so there is plenty of business sales to compare your selling price and terms against. Such business market value comparisons can give you very accurate and compelling results. Typical valuation multiples are based on the business discretionary cash flow plus inventory levels at replacement cost.
Valuing a Business using Market Comps
Another excellent way to value a business in this industry is to use the time-tested Multiple of Discretionary Earnings valuation method. In addition to the business earnings, this business valuation methods lets you account for all the key value factors above.
Using this business valuation technique, you can determine what the business is worth today, then see what can be done to increase business value – before making critical decisions such as offering the business for sale or bringing a partner on board.
Business Valuation based on Multiple of its Earnings
If you are looking to have a business appraised hiring an appraiser is one of the ways to do it. As with any professional engagement the question of costs comes up rather quickly.
Not surprisingly, professionally prepared appraisals don’t come cheap; the average hourly rates these days are around $300. A well-done business appraisal takes about 20 hours or more. Do the math, and the price tag runs to $6,000 and up.
That’s not including any extra consulting time to present the business appraisal to partners, other professionals, prospective buyers, sellers or investors.
Instant business appraisals – too good to be true
What about those “instant” business appraisals for a few hundred dollars? Let the buyer beware: professional appraisal takes time. And time costs money. With a “minimum wage” business appraisal you quite literally get what you pay for.
So, can you get an accurate, defensible business appraisal and save?
Yes indeed! Given the right tools, you can do your business appraisal yourself – and save quite a bundle.
Most of the business appraisal cost is in the time the appraiser takes to do the work. And most of the time is spent understanding the business being valued.
Obviously, you can use your own knowledge of the business to cut down on time and costs. But what about the business valuation tools and knowledge?
A complete business valuation system
That’s where ValuAdder comes in. To make sure you can do your business appraisal yourself, ValuAdder gives you both the knowledge and tools to do it:
There is a Business Valuation Guide to introduce you to the fundamentals of business appraisal. Detailed Tutorials on valuation methods and helpful How-To Sections with examples. Every term is defined and explained in the Glossary.
To save you both time and money, ValuAdder is designed to simplify and speed up your business appraisal:
One of the greatest strengths of ValuAdder business valuation software is that it evolves continuously to respond to our customer needs. Our latest product release, ValuAdder V4.0.5 is no exception – by popular demand we have added the following new features:
Business valuation Rules of Thumb Tab now provides the standard SIC and NAICS industry classification codes for all 402 industries.
As before, ValuAdder Rules of Thumb let you locate the industry of interest three ways:
By name: with all industries arranged in alphabetic order.
By industry group: so you can see all related business types for quick comparison.
By direct search: typing just part of the business description instantly produces all matches. You can quickly narrow down your choices by providing a more specific business description, e.g. specialty retail instead of retail.
Business market value comparison – quick and accurate
Once you have found the industry to do your market comparison, click on the Info button to see the actual SIC and NAICS industry classification codes. Make sure you are using the right industry for your market comparisons!
Business valuation as multiple of its earnings
Multiple of Discretionary Earnings business valuation automatically creates the earnings multiplier based on your assessment of the business across 14 key financial and operational performance factors.
With ValuAdder V4.0.5 your business valuation result now also displays the earnings multiplier value. This important result is also reported in the ValuAdder Earnings Multiple report. If you are creating a business valuation report, include this important value along with your valuation factors.
Assess company-specific risk for accurate business appraisal
If you are using the famous Discounted Cash Flow method for valuing a business, you will find that the accuracy of your business valuation results depends upon the discount rate you use. One of the most important and challenging parts is how to figure out the company-specific risk.
ValuAdder V4.0.5 worksheets introduce a build-up procedure to determine the company-specific risk.
Now you can estimate this important value easily – by ranking the business across 10 key risk factors:
Financial leverage risk
Operating risk factors
Quality of the management
Skill of employees
The result? Quite simply, the most systematic and accurate way to value your business based on the two essential parameters: