Goodwill in Partnerships and LLPs
The subject of goodwill has been cropping up again in these difficult times with partners wondering what might happen to any goodwill they have in their partnerships or LLPs.
To start on the subject of goodwill, I’ll go back to a learned judge who in 1901 concluded that goodwill is very easy to describe but very difficult to define. It is made up of all those intangible assets that help a business run effectively.
These include its brand, and brand is another difficult thing to define. My favourite definition of brand is from de Chernatony and McDonald and is, “A successful brand is an identifiable product, person or place, augmented in such a way that the buyer or user perceives relevant unique added values which match their needs most closely. Furthermore its success results from being able to sustain these added values in the face of competition.” This definition is also not a bad definition of goodwill.
The accountants state fairly simply that goodwill is the difference between the net value of the tangible assets of the business and what anyone is willing to pay for the business. It’s what the business is worth over and above the value of what it owns.
Goodwill includes a firm’s brand name, reputation, contacts, people and location. Positive marketing activities, including client care, serve to strengthen goodwill. Essentially, as the learned judge phrased it; ‘it is the one thing which distinguishes an old-established business from a new business at its first start’.
Goodwill, although not a separate entity, can attract significant value. When a partner leaves a partnership (or a member leaves an LLP), he or she may be entitled to a share of this value. Many partnership and LLP agreements specifically exclude this. The difficulty resides in realising the true value of goodwill. It is not easy to estimate what a list of client contacts could be worth, or how valuable your image is in generating new business. Goodwill could be calculated as a percentage of the annual turnover, or be devised according to profit, assets, or the cost of replacing key individuals. Whatever calculation is used, it eventually boils down to how much a buyer is prepared to pay for it.
There are specialists in valuing every type of business. Trading businesses will have their specialist valuers and professional partnerships – solicitors, accountants, doctors, dentists, surveyors, architects etc. – also have specialist valuers. There are specialists in valuing GP surgery premises and accountants who specialise in medical practices, although GPs cannot currently sell the goodwill in their lists.
Quite often in professional practices the mantra is that partners come in naked and go out naked. That means they do not pay for goodwill on being admitted as a partner and do not sell their goodwill on retirement. They pay in capital, draw out a healthy profit share and then retire with their capital. In this model, what they don’t get is any benefit for the increase in the value of the firm that their work has generated.
In a goodwill model, a partner’s share on his or her retirement may be greater than what they paid for it going in, if the firm has increased in value. Conversely it could of course be worth less, and in the current climate that is a serious risk.
Goodwill makes sense for a small partnership or LLP where the aim is to grow the business and sell to a third-party. It is more difficult to justify for a long established partnership where the partners see themselves as custodians of the firm (or brand).
Please contact Mark Briegal on firstname.lastname@example.org to discuss Partnership Agreements, LLP Agreements, partner entries or exits, or goodwill in general.