One of the topics that interests all professionals in business is succession planning. Whether you are a management consultant, engineer, architect or surveyor, succession planning is an issue which you will need to revisit throughout the lifecycle of your business.
In the first of three articles, Alex Shall, Partner at Haines Watts London, explores the important issue of goodwill.
What is Goodwill?
Goodwill is a tricky thing to get to grips with. From an accounting perspective it is defined as the difference between the value of a business and the sum of the values of its identifiable assets and liabilities. I may have lost you there…
Put plainly, a business has assets and liabilities: IT equipment, licences, amounts owed by customers, a leasehold office, some cash and perhaps some money owed to suppliers and so forth. The net asset value of the business is the value of all the assets, less the liabilities.
But you may well think that someone would be willing to pay more for your business than the sum of its parts, or net asset value? That ‘extra’ amount is called goodwill, and represents the value of your recurring work with customers, your reputation in the marketplace and your team’s capabilities.
Surely goodwill is something you want to maximise, so you can sell it and cash out? Well maybe, maybe not.
Goodwill vs. tenancy
First, there is your industry to consider. Goodwill can typically only be separated from the professional, and thus sold, in certain industries. For example, accountants and surveyors often have long standing client relationships which can, with care, be passed on to younger partners and retiring partners paid out.
By contrast, architects, particularly those in a very design-led practice, find that each generation must create their own language and ideas in order to attract clients; this can only partly be taught, and certainly can’t be bought and sold.
Secondly there is your business model. The two opposing concepts are known as full goodwill and tenancy. In a full goodwill model the owners of the business expect to sell the goodwill to the next generation for its market value, and so they must invest money to drive up the value of this goodwill.
Done well, this pervades everything the business does, from marketing to staff development, trying to ensure that there is an infrastructure and team which is independent of the owners, and which can ultimately be sold on.
In contrast, the tenancy model ignores the goodwill, and owners pay a fixed amount to buy in and cash out, usually enough to cover just the value of the net assets.
The advantage of this model to the younger generation is not having to buy out the current owners. The advantage to the owners is that they can focus on client care and maximising current earnings, and perhaps it is easier to recruit and retain future leaders.
The best of both worlds
In reality, many professionals would probably find most comfort in a model that mixes some investment in building goodwill with some ‘tenancy’ aspects, to help nurture younger talent.
What is worrying to me is the number of professionals I meet who have not given much consideration at all to goodwill and have not considered succession in setting their strategy.
Deciding whether goodwill exists within your business and whether it should be recognised is an important first step in planning your succession approach.
In the next article I will consider different mechanisms for succession, which in a way is the last step.
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