Goodwill and How to Value a Company

Goodwill appears as an item on our Balance Sheet usually as a Non Current Asset and is essentially the value a company attaches to intangibles that it purchases. Having Goodwill on your Balance Sheet may be an indication that you have overpaid when acquiring another company or it's assets.
Under current accounting rules companies are not expected to amortize the Goodwill, but are expected to provide fair market value based on future profits generated by the acquired company. If for example the Goodwill was valued at 300k based on Net Profits of 60k per year over 5 years and the net profit drops, the value of the Goodwill needs to be reduced accordingly. If the Net Profit increases, it needs to be adjusted upwards.

For example:

Let's say a company decides to purchase another. Usually the purchaser will require that it be permitted to perform "due diligence" and inspect the sellers financial statements, and more importantly it's tax returns. (Companies sometimes lie to themselves, but lying to the Government is fraud) In return the seller will likely ask for a non disclosure/confidentiality agreement. If satisfied that the company's financials are in order and verified, the purchaser will usually obtain an equipment and asset list in order to fix a value on those items.
So imagine that the selling company has net assets of $200,000 and is asking $500,000 from the purchaser for it's business. Everything over the $200k is considered Goodwill, which in this case equals $300k. There are many ways of determining whether the amount of Goodwill is appropriate for the purchaser to spend but it is normally a calculation based on Net Profit multiplied by a number of years, usually 4-5. In this case, as the purchaser we would expect that Net Profit is somewhere around $60-75k per year in order to value the company's Goodwill at $300k.

Existing coffee companies purchase others for many reasons and we don't have to look to long to see some recent examples. Intelligentsia's purchase of Ecco Caffe is a private business matter where only the principals and their lawyers really know the details, but certainly a great deal of the purchase price would have been valued as Goodwill due to the excellent distribution, customer list, reputation and name brand associated with Ecco Caffe. In this case acquiring the facilities and hard assets of the Ecco Caffe may have been less enticing than the Goodwill itself, but for individuals starting out in the coffee business, beware.

If you are looking at purchasing an existing coffee company, remember that everything above the value of the Net Assets is Goodwill and that you should be very very careful purchasing anything you can't see.