Goodwill when selling a small business
When you add up your equipment and stock, the total is often far below what you hope to sell for. The difference is goodwill: the value of a business that already has customers, a name and steady earnings. It is often the biggest part of a small business sale, and also the part buyers question most. Here is what it is, how it is valued, and how to make yours worth more.
The short answer
Goodwill is what a buyer pays above the value of the assets they can list and count. It comes from things like:
- a name people know and trust,
- repeat customers and steady sales,
- a good location and a fair lease,
- trained staff and simple systems,
- supplier terms, contracts and online reviews.
A buyer pays for goodwill because it saves them years of building those things themselves. They will only pay for it if they believe it will stay after you leave.
How buyers put a number on it
Few buyers value goodwill directly. They usually start with the whole business, most often from its earnings, using the methods in our guides on what your business is worth and earnings multiples. Then they subtract the agreed value of the things they can see:
- equipment, vehicles and furniture,
- inventory,
- any other assets included, such as a deposit or prepaid items.
What remains is goodwill. So the way to grow goodwill is mostly the way to grow the whole value: steadier, provable earnings that do not depend on you. Clear add-backs help buyers see your true earnings.
Personal goodwill and business goodwill
Not all goodwill is equal to a buyer.
- Business goodwill belongs to the business: the brand, the location, the phone number and website, contracts, systems and a team that serves customers well without you.
- Personal goodwill belongs to you: clients who come because of you, your personal skill or your reputation in town.
Buyers pay more readily for business goodwill, because it stays. Personal goodwill can leave when you do, so buyers often discount it or ask you to protect it with a longer handover, a non-compete, or part of the price paid later through an earn-out. Moving personal goodwill into the business before you sell is one of the best ways to raise your price.
How the price is split
In an asset sale, the purchase agreement usually lists how the price is divided between goodwill, equipment, inventory and any other assets. This split matters for tax on both sides:
- For the buyer, equipment can usually be written off faster than goodwill. Since January 1, 2017 the CRA puts goodwill in capital cost allowance class 14.1, which is written off slowly.
- For you, a gain on goodwill is generally a capital gain. Equipment sold for more than its depreciated tax value can bring back past write offs as regular income. Inventory is generally regular business income.
Because the interests pull in different directions, the split is a normal part of negotiation. It should be reasonable and based on fair values, and it should be agreed before closing, ideally first raised in the letter of intent. In a share sale, you sell shares rather than assets, so the split is usually less of an issue for you. See our guide to taxes when selling a business for the wider picture.
A simple worked example
These numbers are made up and rounded for illustration only. Your own deal will differ.
A buyer agrees to pay $300,000 for the assets of a neighbourhood bakery.
- Ovens, mixers, display cases and furniture are agreed at $60,000.
- Inventory on closing day is counted at $15,000.
- That leaves $225,000 for goodwill: the name, the regulars, the wholesale cafe accounts and the trained morning crew.
- The buyer first asks to put $120,000 on equipment, to write it off faster. The seller's accountant points out the equipment's fair value is closer to $60,000 and that a higher number would bring back past write offs as income for the seller.
- They settle on the fair values above and write the split into the purchase agreement.
The headline price stayed the same, but the split changed what each side kept after tax. Agreeing it early, with fair values, avoided a late surprise.
How to build goodwill a buyer will pay for
- Keep clean, steady books. Two or three years of clear earnings are the base buyers value goodwill from.
- Make the business run without you. Write down how things are done and train staff to serve key customers. Our guide on making your business run without you has a checklist.
- Put relationships in the business's name. Contracts, accounts, the phone number, website, social pages and reviews should belong to the business, not to you personally.
- Secure the location. A lease that can be assigned with time left on it protects goodwill tied to where you are.
- Spread out your customers. Goodwill that rests on one or two big customers is worth less than goodwill spread across many.
- Show the proof. Repeat customer counts, reviews, contracts and supplier terms help a buyer believe the goodwill will last.
Questions to take to your accountant and lawyer
- Is my sale better as an asset sale or a share sale, given my goodwill?
- What is a fair split of the price between goodwill, equipment and inventory?
- Would any past write offs on equipment come back as income?
- Could the lifetime capital gains exemption apply to my sale?
- How should the non-compete and handover protect the goodwill the buyer is paying for?
For more, read what your lawyer and accountant do. This guide is general information, not legal or tax advice for your situation.
Common questions
What is goodwill when you sell a business?
Goodwill is the part of the price that is paid for more than the business's physical and listed assets. It reflects things like your name, loyal customers, location, staff, systems and steady earnings. In simple terms, it is what the buyer pays for the business being up and running rather than starting from zero.
How is goodwill calculated?
Most buyers do not price goodwill on its own. They value the whole business, often from its earnings, then subtract the agreed value of equipment, inventory and other identifiable assets. What is left over is goodwill.
Can a business have no goodwill?
Yes. If a business earns little more than a fair wage for the owner, or depends almost entirely on the owner personally, a buyer may only pay for the equipment and inventory. Building steady earnings and making the business run without you is how goodwill grows.
What is personal goodwill?
Personal goodwill is value tied to you as a person, such as clients who come because of you, your skills or your reputation. It is hard to sell because it can leave with you. Business goodwill stays with the business, such as its brand, location, contracts, systems and trained staff.
How is goodwill taxed when I sell?
In an asset sale, goodwill is generally treated as capital property, so a gain on it is usually a capital gain. Since January 1, 2017 the CRA puts goodwill in capital cost allowance class 14.1. In a share sale you sell shares instead, and goodwill is part of their value. The details depend on your situation, so ask your accountant.
Why does the buyer care how the price is split?
The split between goodwill, equipment, inventory and other assets changes the tax for both sides. Buyers can usually write off equipment faster than goodwill, while sellers may pay less tax on goodwill than on equipment that has been depreciated. That is why the split is negotiated and written into the purchase agreement.
Sources
Ready when you are
Listing is free and takes about 10 minutes. Your details stay private until you choose to share them.
Want a hand getting ready?
Listing stays free. If you'd like help, our optional ReadyToSell Pack (C$99, one time) includes a written review of your listing and our Seller Edition handover binder.
About the ReadyToSell Pack