• PROFILE
• VALUATIONS
• FORENSIC
• CONSULTING
• ARTICLES
• ENGAGEMENTS
• CHECKLIST
• CONTACT US

Increasing the Price Paid for Goodwill

Foreword

Greg A. Raffaele CPA CVA FCPA

You've worked hard your whole life building your business. Now it's time to cash out. You have a big number in mind only to find out from a valuation analyst that most of your company's value is trapped in your head and in your business relations.

In a different scenario, your spouse is sitting at your desk. That 'bus' we all talk about just hit you. The news of your condition is not good. Your business survives while you're away, but it's in chaos. Once you recover, your business has lost market share and the competition is rapidly gaining more ground.

These scenarios point to the fact that you, as the owner, drive the value of your business. Without you, the business is not as valuable because a significant part of its goodwill is personal - you. So what must you do to increase the value paid for your company's goodwill?

First, you must determine the value of your company and your personal goodwill. Afterwards you must invest in a mechanism that systematically transfers your goodwill to the business (not its people) to increase its value. You may think that your business is your people. Though this may be true to some degree, your business is really your processes because your people too can get hit by that bus. So don't wait until you're at the end-stage of selling your business or unable to perform your function as its owner to transfer your value because it may be too late by then.

Douglas Grindstaff, in his 23 years of authoring and developing process guides, operations manuals and training courses, has just written an article about the precarious position business owners place themselves when they don't transfer their knowledge.

Increasing the Price Paid for Goodwill

In the business world, possessing superior know-how can often be the difference between great success or failing miserably. When an organization has the intangible asset of exceptional know-how, it must do everything in its power to utilize, duplicate, and safeguard all of the competitive advantages it brings.

Unfortunately, all too often this knowledge resides only in the heads of the business owner and key personnel. At the end of the day, this knowledge walks out the door. Without the know-how of the owner and key personnel, there is a great potential for lost future earnings. Clearly documenting the knowledge bearer's know-how and detailing all repeatable processes and procedures can solve this problem.

The true value of documentation is avoiding lost future earnings and replacement costs. During the process of valuing an organization, the total value is based on the sum of identifiable net assets and unidentifiable net assets. The unidentifiable assets are often the goodwill possessed by the entity and its personnel. An entity's goodwill can be assets such as patents, trademarks, software and so on. Personal goodwill is most often undocumented proprietary processes, profits attributed to individual employees, and special know-how possessed by members of the organization.

Documenting know-how has several tangible advantages to an organization's overall success and net value:

• All assets that can be classified as personal goodwill are identified. Forgetting anything that qualifies as goodwill will reduce the value of the organization.
• Competitive advantages are clearly recognized.
• Processes are quantified allowing consistent replication and possible duplication.
• Know-how can be evaluated for improvements. This ensures that industry trends and competitive
pressures do not make the know-how obsolete.
• Documenting know-how can convert personal goodwill to entity goodwill. This ensures that the future value of the know-how remains with the organization.

One of the fundamental principles behind successful documentation to increase an organization's value is the methodical capture, understanding, and utilization of know-how and knowledge. In some organizations, knowledge is captured strictly for archival purposes; others use it to teach new employees a process. Mastering know-how requires understanding its dynamics, using it everyday, and always searching for improvements.

Doing the Right Things Correctly

If know-how is viewed as the practical application of knowledge, then the goal of documentation is to capture and make the most of all available knowledge. The value of know-how is the ability to interpret and apply the culmination of work experience, practical information, education, personal wisdom, collaboration, and failure recovery. An organization's knowledge does not lie on servers or in file cabinets, but in the minds of your employees and senior management. The process of capturing this knowledge needs to involve analysis and must remain ongoing.

When a problem occurs in an organization, why can some workers solve it quickly and others struggle? Is it magic or is it a process? Thriving and dynamic organizations understand that success does not happen by chance. It is a combination of detailed strategies, processes, and the ability to capture and effectively utilize knowledge. Again the concept of capturing know-how leads to increasing the value of an organization.

One of the originator's of management science, Peter Drucker, describes the paradox of "Doing the right thing" vs. "Doing things right." The idea of "Doing the right thing" refers to effective decision making on the part of management, whereas "Doing things right" emphasizes increasing the efficiency of a process. A hybrid philosophy of "Doing the right things correctly" enables knowledge to act as the catalyst for a more efficient organization. When an organization possesses the documented know-how to do the right things correctly they have a competitive advantage and the value of future earnings can increase.

Documentation Makes Things Better

Many organizations eke by with a minimal amount of documentation. It is important to bridge the gap between what is known and what is communicated. Once the documentation process begins, organizations often find themselves asking, "Is this really how we do it." It is very common that creating documentation leads to business process re-engineering. Better, stronger, faster is quite often the unintentional effect of documenting know-how.

The Failure of Oral History

As time goes by, procedures that have been ignored become out of sync with technology and efficient business practices. Time and time again, organizations have doomed themselves by relying on oral history to keep track of information. Take for example the story of Bob who works for Widgets 'R' Us. One day Jennifer asked Bob, "Hey Bob, how do we ship widgets?" "Well Jennifer, we do this, that, and the other thing and boom they are gone." A bus hit Bob two days later (the police said it was better left unsolved). Jennifer tries to remember what Bob told her. Was it 'that, the other thing, and this' or was it 'the other thing, this, and that.' Because of the failure of oral history, Widgets 'R' Us is now Widgets 'Were' Us.

When information is documented, the originator of the knowledge has an opportunity to read and review the text to verify its accuracy and clarity. Oral history also creates the dilemma of multiple reiterations. Every time a task is described verbally, the process will have a varying degree of depth and accuracy. Business know-how that is accurately repeated with successful results can help ensure future earnings. Documentation is the cornerstone of developing these processes.

Summary

Though the cost of personal know-how is often measured based on the criteria below, but the true cost of not transferring it is lost future earnings.

• How many hours did it take to develop the know-how?
• What technical education or specific experience is needed to perform the tasks using the know-how?
• What is the pay scale of the person with the know-how?
• What would it cost to develop or reconstruct the know-how from scratch?

By documenting the existing know-how in a format that can be easily communicated to a person with similar education or experience, personal goodwill can be valued by the organization as entity goodwill. The knowledge can be passed along to new management or owners thereby increasing the future earnings of the organization.

We proudly serve Orange County and Greater Los Angeles. We are dedicated to serving the business valuation and forensic accounting needs of business owners, especially small business owners. We are also dedicated to serving the business valuation and forensic accounting needs of attorneys, CPAs and their clients. We are a solid alternative to high-priced business valuation and forensic accounting firms. We are a solid value. Contact us for a free consultation.