When a business sells for more than the value of its physical assets and cash on hand, the difference is goodwill. For most service businesses, professional practices, and established SMEs, goodwill is the single largest component of the sale price.
Yet goodwill is also the most misunderstood element of a business valuation. Sellers tend to overvalue it. Buyers tend to scrutinise it. And the distinction between personal goodwill and commercial goodwill can determine whether your business is worth a premium — or barely saleable at all.
What Goodwill Actually Is
Goodwill is the premium a buyer pays above the net tangible assets of a business. Net tangible assets include things like equipment, stock, cash, and property minus any liabilities. Everything above that number is goodwill.
In accounting terms:
Goodwill = Purchase Price - Net Tangible Assets
Goodwill represents the intangible value that allows a business to generate profits above what its physical assets alone could produce. This includes things like:
- Established customer relationships
- Brand recognition and reputation
- Trained and experienced staff
- Proprietary systems and processes
- Market position and competitive advantages
- Favourable contracts and supplier terms
Goodwill is not something you can point to or hold in your hand. It’s the reason a dental practice with $200,000 in equipment sells for $800,000 — the extra $600,000 is goodwill.
Personal Goodwill vs Commercial Goodwill
This is the most important distinction in goodwill valuation, and it’s the one that catches many business owners off guard.
Personal Goodwill
Personal goodwill is value tied to the owner. It exists because of your reputation, your relationships, your skills, or your presence. If customers follow you rather than the business, that’s personal goodwill.
Examples:
- A physiotherapist whose patients book with them specifically
- A financial planner whose clients have a personal relationship with them
- A consultant whose expertise is the product
- A restaurant where the chef-owner is the drawcard
Personal goodwill has a fundamental problem: it walks out the door when you do. Buyers know this, and they will discount or refuse to pay for it.
Commercial Goodwill
Commercial goodwill is value tied to the business itself. It exists independently of any individual and will transfer to a new owner. This is what buyers actually want to pay for.
Examples:
- A brand that customers recognise and trust
- A location with high foot traffic and a long-term lease
- A customer base with recurring revenue under contract
- Documented systems and processes that any competent operator can follow
- A management team that runs the business without the owner
The more of your goodwill that is commercial rather than personal, the more a buyer will pay.
Why It Matters
Imagine two accounting practices, each generating $300,000 in normalised EBITDA:
- Practice A: The owner personally manages 80% of the client base. No other senior accountant. Clients know the owner by name and chose the firm because of them.
- Practice B: Three senior accountants each manage their own client portfolios. The owner handles strategy and business development but doesn’t manage day-to-day client work. The brand has strong recognition in the local market.
Practice B will sell for significantly more than Practice A — potentially 50-100% more — because the goodwill is commercial, not personal. Practice A has a key-person risk that buyers will either avoid entirely or price in heavily.
How to Calculate Goodwill
There are several methods used to value goodwill. The right approach depends on the size and nature of the business.
Method 1: Excess Earnings Method
This method calculates goodwill as the present value of earnings above a “normal” return on the business’s tangible assets.
- Determine the net tangible assets of the business
- Apply a “fair” rate of return on those assets (say 10-15%)
- The difference between actual earnings and the fair return on tangible assets is “excess earnings” — the earnings attributable to goodwill
- Capitalise the excess earnings using an appropriate rate to arrive at a goodwill value
Example:
- Net tangible assets: $400,000
- Fair return on tangible assets (12%): $48,000
- Normalised EBITDA: $250,000
- Excess earnings: $250,000 - $48,000 = $202,000
- Capitalisation rate for goodwill (25%): $202,000 / 0.25 = $808,000
Goodwill value: $808,000
Method 2: Capitalisation of Future Maintainable Earnings
This is the most common method for small and mid-market businesses in Australia. It values the entire business based on a multiple of sustainable earnings, then subtracts tangible assets to isolate goodwill.
- Calculate normalised EBITDA (future maintainable earnings)
- Apply an appropriate earnings multiple
- Subtract net tangible assets
Example:
- Normalised EBITDA: $250,000
- Earnings multiple: 4x
- Enterprise value: $1,000,000
- Net tangible assets: $400,000
- Goodwill: $600,000
Method 3: Market Comparison
Look at comparable business sales in your industry and geography. If similar businesses are selling at a consistent ratio of goodwill to revenue or earnings, that provides a benchmark.
This method works best in industries with frequent transactions and available data — such as medical practices, pharmacies, accounting firms, and childcare centres.
Factors That Create Goodwill
Understanding what drives goodwill value helps you build it before you sell:
- Recurring revenue. Subscription models, retainer agreements, and long-term contracts create predictable cash flows that buyers pay a premium for.
- Brand strength. A recognisable, trusted brand reduces the buyer’s customer acquisition costs.
- Customer diversification. A broad customer base with no single client dominating revenue reduces risk.
- Systems and processes. Documented SOPs, technology platforms, and operational frameworks make the business transferable.
- Experienced team. Skilled staff who will stay through the transition give buyers confidence.
- Market position. Being the leading provider in a niche or geography creates a moat that competitors can’t easily replicate.
Factors That Destroy Goodwill
- Owner dependency. The most common goodwill killer. If the business can’t function without you, the goodwill evaporates when you leave.
- Customer concentration. If one customer represents 30%+ of revenue, buyers see a single point of failure.
- Declining revenue. A business losing customers or market share has a shrinking goodwill value.
- Reputational damage. Negative reviews, compliance issues, or public disputes erode trust and brand value.
- Lease risk. A short-term or unfavourable lease undermines the business’s future in its current location.
- Key staff leaving. If critical team members depart before or during the sale, goodwill drops immediately.
When Goodwill Is Zero or Negative
Some businesses have no goodwill — or even negative goodwill. This happens when:
- The business earns less than a fair return on its tangible assets (the owner would be better off selling the assets and investing the cash elsewhere)
- The business is entirely dependent on the owner with no transferable value
- The business is in decline with no clear path to recovery
- The brand has been damaged or the market has shifted away
Negative goodwill means a buyer is essentially buying the assets at a discount because the business as a going concern is worth less than its parts. This is more common than many sellers realise, particularly in small, owner-operated businesses.
Building Goodwill Before You Sell
If your goodwill is largely personal, you have work to do — but it’s fixable. The key is to shift value from you to the business over 12-24 months:
- Hire a capable second-in-command who can manage client relationships
- Transfer key client relationships to other team members gradually
- Invest in brand and marketing that builds the business’s reputation independently of yours
- Document everything so the business operates through systems, not through you
- Build recurring revenue through contracts, subscriptions, or retainer arrangements
These steps don’t just increase goodwill — they make your business more attractive to a wider pool of buyers, which drives competitive tension and a better price.
Wondering what your business goodwill might be worth? Try our free valuation calculator to get an indicative range based on your financials, or contact us for a detailed assessment.
Related reading:
- How Much Is My Business Worth? — understand the full picture of business value
- What Buyers Look for When Buying a Business — see the sale from the buyer’s perspective