Goodwill – what is it, who “owns” it and how is it valued?

The questions seem straightforward, but when the rubber hits the road the answers are quite complex and potentially contentious.

Let’s leave the question of how goodwill is valued for deliberation in future publications. In this article we will briefly explore who ‘owns’ the goodwill, the manufacturer or the Dealer (or even potentially the property owner).
But first, in order to consider who owns the goodwill we must define what goodwill is.

What Is Goodwill

Putting aside some definitions of goodwill which refer to an act or attitude of kindness or friendliness, we can either refer to accounting jargon or layman’s terminology to define goodwill in the context of business value.

Accounting jargon defines goodwill as an intangible asset that arises when a buyer acquires a business and pays an amount greater than the fair market value of the tangible assets. While goodwill is quantified and recorded in the accounting records, when a transaction takes place most business owners expect that there is an inherent value of goodwill which attaches to the business, regardless of whether it is recorded in the accounting records or not. What’s more, where the amount is recorded in the accounting records, it is recorded at historic cost and accordingly may not reflect the present fair market value of the goodwill.

A layman may use terminology to define the goodwill of a business, which might sound something like, the value of the positive reputation of a dealership business which supports the continued patronage by customers.
Regardless of the terminology used, we essentially arrive at the same meaning.

Who ‘Owns’ The Goodwill

Now we are getting into a potentially contentious area. The contention is generally borne out of the franchise model under which the manufacturers and Dealers operate. The article written by Vinesh George which is also published in this edition of Automotive Dealer addresses this topic. Vinesh makes valid observations with respect to whether the manufacturer or the Dealer should rightfully own the goodwill and concludes by noting that ‘Dealers ought to adopt a somewhat confident attitude in relation to their rights’.

BDO agree entirely with this view that the goodwill is ‘owned’ by the Dealer for reasons which are underpinned by a commercial application of the franchise relationship, rather than the potentially legal interpretation of the franchise agreement itself.

Together with the points raised by Vinesh, BDO’s reasoning follows:

a)  Despite the fixed term of franchise agreements, Dealers as a matter of necessity, conduct their businesses as if there is no end date. A Dealer’s anticipation of business longevity is obvious if you reflect on the considerable investment and effort dedicated to customer satisfaction and retention. It is particularly evident when you observe the significant investments that occur in respect to facilities, which for most are fit for few other purposes than operating a motor dealership.
b)  Dealership buy/sell transactions are negotiated between parties similarly to businesses outside of the franchise model. The exception is that the manufacturer must approve the purchaser (although they cannot reasonably withhold approval) and additionally some manufacturers have requirements regarding equity participation of the Dealer Principal. These manufacturer requirements simply reduce the ‘liquidity’ of a dealership business which will likely reflect in the capitalisation rate (multiple), which then reflects in the value. Let’s save the value debate for another time, my point is that market values of goodwill are negotiated and paid without the need for the manufacturer consent to the goodwill value.
c)  Dealership businesses are invested in, operated, traded and financed on the assumption that there is a value attached to goodwill, regardless of whether that value is notional or reflects an actual transaction. To express that another way, consider how the dealership model might look if shareholders/potential purchasers had no prospect of a capital return. And what might that mean to financiers with respect to their appetite to loan funds for dealership businesses and facility investment?

Recently, we have observed manufacturers terminate franchise agreements, as is their right under many franchise agreements, when a dealership business is subject to external appointment such as a receivership. In these circumstances any notional or actual value which might have attached to goodwill is immediately diminished to nil, obviously to the detriment of financiers, shareholders, employees and other creditors.

Imagine then the behaviour of these stakeholders if we extended the notion that dealership businesses could not be attributed a goodwill value – even under normal trading circumstances. Reflecting on item c) above, if the prospect of capital growth was taken away, it would undoubtedly change the inclination of stakeholders to invest in, operate or finance a dealership business.

In the next edition of AADA’s Automotive Dealer we will consider how a dealership is valued.

For more information, or if you’ve any questions about this article, you can contact Mark Ward, Partner, BDO Automotive by emailing mark.ward@bdo.com.au

 

Mark Ward
Partner,
Automotive – BDO

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