What are you buying when you pay for goodwill?

The coffee machine does not bring its own customers

Take two cafés with similar equipment and fit-outs. One opened yesterday. The other has been operating for years, has regular customers and employs staff who can survive the morning rush without needing a crisis meeting.

You might spend a similar amount replacing their physical assets. You would not necessarily pay the same amount to own each business.

The established café offers a reason to expect people will come through the door tomorrow. Its name, reputation and customer relationships can contribute to goodwill. Australian Government guidance recognises these as sources of value alongside the physical assets. Other assets, such as intellectual property, may need to be identified separately. Everything you cannot touch does not automatically become goodwill.

From a buyer’s perspective, the commercial attraction is straightforward. Someone else has already spent time persuading people to try the business and giving them reasons to return.

You are paying for that head start.

Whether it is worth the asking price depends on what those customers are likely to do next.

Are they customers of the business, or customers of Dave?

Let’s give our hypothetical café owner a name. Dave.

Dave knows everyone’s order. He remembers their children, asks about their holidays and somehow discusses the football while making six coffees. The catering customers call his personal mobile. Staff ask him how to handle anything unusual.

Dave would now like to sell the café and go fishing.

Understandable. But if you’re buying it, Dave’s retirement creates a problem. How much of the business works because of the café, and how much works because Dave is standing in it?

Think about your own habits. Would you follow your hairdresser to another salon? Would you keep using a tradesperson’s business if the person you trusted sold it? You might stay. You might not. The answer depends on what kept you coming back.

This does not mean an owner with strong relationships has built something worthless. Those relationships helped create the earnings in the first place. It means a buyer needs evidence that the business can retain them through a change of ownership.

Business Queensland’s valuation guidance specifically asks whether goodwill can transfer, whether operations depend on particular people and what effect the owners’ departure will have.

For Dave’s café, I would want to know what happens when he takes a week off. Do customers still come in? Can the staff make decisions? Does the catering work continue, or does everyone wait for Dave to get back?

And who is doing Dave’s job?

There is another reason to look closely at what the owner does. Their work can make the profit look more attractive than it will be for the buyer.

Suppose a business produces $180,000 a year before allowing anything for the owner’s labour. Now assume hiring someone to replace that work would cost $100,000 a year, including employment costs.

That leaves $80,000 before any other adjustments.

These are illustrative figures, not a valuation formula or a claim about what café managers earn. The point is that the original $180,000 includes the benefit of someone doing a job without a separate cost being allowed for it.

You could do that work yourself. Plenty of people buy businesses precisely because they want to work in them. But part of what you receive would then be payment for your time, rather than a return on the money you invested.

There is nothing wrong with buying yourself a job. Ideally, you find out before buying it.

This also changes how you assess goodwill. Loyal customers are useful if serving them produces enough profit to justify the purchase price. A full café is less impressive if keeping it full requires the owner to work extraordinary hours for very little reward.

I would rather understand what is left after properly paying for the work than be impressed by how busy the place looks.

What is actually staying behind?

Once you understand why customers return and who produces the earnings, the handover becomes much more concrete.

If customers depend on a particular employee, will that employee stay? If the location attracts the trade, can the buyer secure the premises on workable terms? If important orders come through the owner’s personal relationships, how will those customers be introduced to the buyer?

Staff, lease arrangements and commercial contracts all form part of the information Business Queensland says should be examined in a valuation.

In our café example, an introduction from Dave could give a catering customer confidence in the new owner. Written procedures could help the staff keep producing the same service. A sensible transition period could give the buyer time to learn what Dave has been carrying around in his head.

None of this guarantees the same results. It gives the buyer something more useful than “don’t worry, everyone loves this place”.

The buyer has responsibilities too. If they change the coffee, cut the staff and stop opening when the regulars arrive, losing customers would hardly prove the goodwill was imaginary. They may have removed the reasons people came.

Buying an established reputation gives you something to maintain. It does not excuse you from maintaining it.

Dave deserves a retirement. What should you pay for it?

For a seller, there is an awkward tension here. Being essential to every decision can feel like proof of how valuable you are. When you want to leave, it can become the buyer’s biggest concern.

The years of early starts and difficult customers deserve respect. But the buyer is trying to work out what those years have built that they can continue benefiting from.

My view is that paying for goodwill can be entirely sensible. An established business with returning customers and repeatable earnings offers something a room full of equipment does not. The price needs to reflect how likely those advantages are to survive the sale.

Dave can charge for the business he built. The buyer should remember that Dave is going fishing.