How To Calculate Goodwill
As one popular finance website puts it,
The value of a company’s brand name, solid customer base, good customer relations, good employee relations and any patents or proprietary technology represent goodwill.
To further clarify, I’d add to this definition:
The value of your website, phone number, and any other intellectual property such as parked web domains your practice owns. It also includes your business’s history, online reputation, and even its location.
Think about the goodwill of Nike. It’s been around for decades, has a reputation for its technology and functionality where athletic clothing is concerned, a huge number of trained employees around the world, and a logo that most people recognize without needing to even see the word “Nike.” This is all goodwill.
Now imagine that someone wants to create a new brand of athletic clothing to compete with Nike. They won’t just be competing on the quality of their clothing; the hardest part may be going up against the goodwill of Nike. And if they wanted to buy Nike, the whole company, the value of Nike’s goodwill would represent much more than their tangible assets—it would have to include the company’s goodwill.
Just as a lot of goodwill is a barrier to entry for competition, and an asset for a buyer to inherit, it can also be an impediment to a sale if valued too highly.
When Facebook first started getting popular, Yahoo, Viacom and others offered well over $1 billion for it long before it started to be a profitable company.
As we now know, those offers were turned down. At the time of this writing, Facebook is said to be worth half a trillion dollars. Too high a valuation for anyone to afford!
So while you may not be selling a practice that equates with the goodwill of a Nike or Facebook, you will need to be careful that you don’t price your goodwill (and practice) higher than the market could possibly bear.
Understanding Goodwill Is Tough
Goodwill is a poorly understood concept among most physicians and lawyers, and even among some CPAs and MBAs. But one way to look at it is to say it is the value of the practice over and above its tangible assets (including cash, cash equivalents, and A/R). This, of course, is a bit vague, so let’s be more specific about what gives this extra value to the practice, beyond the value of its tangible assets. A September 15, 2008, article in the AMA’s American Medical News lists the following elements of goodwill: (i) location; (ii) payor mix, A/R, and collection rate, not as a pot of cash in hand, but as a predictor for the practice’s financial future; (iii) competitors in the market; (iv) the practice’s reputation; and (v) the effect of the anti-kickback and anti-trust laws. Looking specifically at item (iv), we should add that part of the practice’s reputation is personal to the physician-owner, and while that value is real, it cannot be transferred to anyone else, so it is not going to be part of the goodwill value within the sale price unless the seller is going to work for the buyer.
Given that goodwill is intangible (not a real thing you can objectively see or touch), it is often the part of the valuation equation that is most difficult to calculate. That said, with the sale of a medical practice, in the final analysis, it often accounts for the largest amount of the value of the business.
Goodwill only exists and is determined when a business and/or its stock is being considered for sale. Otherwise, it doesn’t really exist.
These days, our experience is that buyers are paying less for goodwill and basing most of the value of the practice on past numbers and the perception of being able to continue or increase profit.
We have also found that, the way to give a buyer the greatest confidence that they will be able to replicate the seller’s success (and retain its goodwill) is to put incentives in place to minimize attrition, as well as show that the practice can make even more through a few simple tweaks.
The “how to” of reducing attrition and maximizing and increasing potential future earnings for the buyer are subjects we love talking about, and we’d be happy to share some of our ideas with you.
Other Useful Resources
Valuing Small Businesses and Professional Practices, by Shannon P. Pratt, Robert F. Reilly, and Robert P. Schweihs is quite a huge resource.
What Every Business Owner Should Know About Valuing Their Business, by Stanley J. Feldman, Timothy G. Sullivan, and Roger M. Winsby
Resources On This Site
For a more complete post on valuing your medical practice, check out our be-all, end-all article on it here.
If you’ve got a good sense of the value of your practice and are ready to look for a buyer, click here to learn how to do it.
If you have a potential buyer who would like to speak to you, be sure to read about the five important steps before talking to a potential buyer.
And if you need any help with any of this, please drop us a line below. We're always happy to help!
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