What is goodwill in business?

For days, you have been anxiously checking your inbox for the message: Investors want to buy your restaurant, and the offer is coming—so they say. When you finally see the message, your heart skips a beat. When you open it, your heart sinks.

The offer is half of what you want. You grab a takeout menu and start adding up your inventory, revenue, the dishes, and the kitchenware. You know your restaurant is worth more than this but, looking around the quiet kitchen, you cannot find anything else to tally up.

Valuing your business

Correctly valuing a business is difficult. Assessing the business value, in tangible terms, is relatively straightforward. What is the total value of all the assets the business owns? These assets have a market value.

The trick to valuing a business is the intangible part of the business. A complete business appraisal for the valuation of a business needs to include both the tangible and intangible.

Some of that intangible value is in your intellectual property. Every patent, copyright, and trademark adds to your intangible value. Intellectual property that you can formally register is easier to value. Patents, trademarks, and copyrights all have established markets, with comparable parcels of intellectual property. Valuing other forms of intellectual property gets more complicated.

Customer lists, proprietary know-how, and other things that a business does to turn inventory into profit are the remaining intellectual property. Finding all of your business's intellectual property is difficult enough, let alone providing value for it.

Defining the goodwill of a business

A suitable business goodwill definition would be all the intangible value left over outside of your intellectual property. These include your relationships with customers, your brand's value (apart from the trademark itself), and the relationship between your business and the community.

You puzzle over the menu and realize the additional value is staring you in the face: Your ginger moo goo gai pan, your almond kung pao chicken, and your garlic potstickers with the hoisin dipping sauce—where is that in your business valuation? Where is your special supply chain to get the best baby bok choy or your secret six-spice Chinese five-spice?

Then you look at your restaurant's online profile. Your customers have an intense love for your specialty dishes that they can get nowhere else. Confident, you get to work on your counteroffer.

What is goodwill accounting?

To capture the intangible value, you need to protect it. Patent, copyright, and trademark law allow you to file applications to formally protect your intellectual property and make that intangible value more tangible.

The valuable content on the webpage or code on the back end should be prominently marked Copyright (or a circle C mark) with the business's name. Businesses need to mark and register the logos and names they are using as trademarks.

To protect the rest of the goodwill business value requires creativity and diligence: The consulting practice with the proprietary database needs to document the security used when accessing it.

The Web 3.0 marketing firm needs to keep its sales representatives under strict confidentiality and non-compete agreements to protect its customer list.

Goodwill in business is even harder to protect. If a business can protect its goodwill, it first has to recognize it. It is all the value outside of your tangible assets and intellectual property.

Now that customers build relationships with businesses through the internet it is easier than ever to demonstrate goodwill. How many likes do you have on Facebook? How often do you get re-tweeted?

Goodwill cannot be protected like intellectual property. Instead, you have to manage, cultivate and document it. Like social media, it does have value, but, like social media, it is tough to own and measure.

But getting back to your restaurant: Six weeks later, you get the final contract in the mail. When you submitted your counteroffer, you also sent along a comprehensive listing of all your trademarks, recipes, and the words of your loyal customers.

You didn't quite get your counter, but the investors were happy to pay more. There is value in the goodwill business assets that you identified and protected. You added value to the business the investors wanted to buy, which put everyone more at ease to close the deal.