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The value of goodwill

October 2012

Imagine that you own a small supermarket.  You've been operating in the same location for just under a decade.

Since you opened, the business has established a regular customer base and business seems fairly consistent.  You might look to sell in a few years to capitalise on all the time and effort you put into building the business, and find something new. But this is something to think more seriously about in a few years time. 

Then, your landlord contacts you and says that the lease is due for renewal in a few weeks and gives you an ultimatum: pay double the current rent along with a hefty annual increase, or get out. 

You have a valuation of the current market rent completed and find that what you're paying now is about right.  Doubling the rent will put your rent well outside of market rates.

Goodwill value isn't the same as business value

If you sign the lease, the business will be difficult to sell as the rent will be an impediment for any purchaser.   If you leave, you walk away from the goodwill you have generated.  And, particularly for small retailers operating under franchise arrangements, the franchise arrangement often ends when the lease ends. 

If you leave, the landlord could set up a new business, identical to the one you created, and then run it under management until they can sell the business – effectively appropriating the goodwill you have worked hard to create.

While there is specific retail tenancy legislation in each State and territory to address bargaining imbalances the reality is that it is a common tactic to limit a tenant's bargaining power by seeking to negotiate at the very last minute. 

Relationships are important, but get agreements in writing

The number one rule is that you cannot rely on your relationships.  If the terms and conditions are not in writing, or if the process for managing lease agreements is not adhered to, disputes can quickly escalate. 

Generally, if you have already signed the contract, it's too late to do anything about the terms unless you have grounds to claim that the agreement was signed under duress.  Like with any legal agreement, you need be fully aware of what you are agreeing to.  And, if you have experience in the industry and access to advice, then the likelihood of redressing any issues is diminished.    

Your rights as a retailer

In most cases, retailers leasing a space of under 1,000 sqm are protected by specific legislation.  For example, in NSW the legislation sets out what is believed to be unconscionable conduct taking into account bargaining power, the use of undue influence or unfair tactics, and the amount for which an identical lease could have been obtained. 

In general however, the landlord has the right not to renew your lease.  As a result, you need to operate with the understanding that your current location just might not be available when your lease ends.  While you can't be forced to vacate immediately, the move (assuming you have the capacity to move), will still be disruptive.

The loss of goodwill is not uncommon in these sorts of scenarios – either directly by pushing the client out or surreptitiously by gouging the profit out of the business. 

Understand the value of goodwill

Goodwill is an important part of the value of your business and often a misunderstood one because most owners expect a payoff for all their hard work and effort.  It's important to understand what goodwill is and what you can do to ensure that the goodwill value rests with you, not someone else.  There are different types of goodwill, including corporate, personal and location goodwill.

Corporate goodwill is the value items such as brand, business presence, an excellent client database, and repeat customers add to the value of the business. When we talk about a brand, we are talking about something that is recognised, not just a logo.

When we ask business owners what differentiates their business from others, one of the commonest responses is "personal service". Your customers or clients come to you because they like dealing with you. That's personal goodwill. Your customers stay with you because of the strength of the relationship that you have developed with them. That's excellent if you are the owner but when it comes to selling your business, personal goodwill is generally worth less to the new owners.

Location goodwill is where the location of your business delivers a result for the business. For example, a service station on a major road that is convenient for motorists to enter and exit. If you have location goodwill, the value of the goodwill is determined by factors such as whether you own or lease the location, how long your lease is for and anticipated changes and development in the area. Security of tenure is critical to location goodwill.

Thinking of selling your business?

Bates Cosgrave has produced two fact sheets for business owners who are considering selling their business:

Selling Your Business

and

Capital Gains Tax - Thinking About Selling Your Business?

Both provide valuable information about what you need to do to get the best price for your business. You can also call us on 02 9957 4033 and speak to our team about your needs. 

 

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Disclaimer

This article is provided for information purposes only and correct at the time of publication. It should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.

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