Goodwill: what it is and how it is valued

When a business sells for more than the value of its fixtures, stock and other tangible assets, the difference is usually goodwill. Goodwill is what the buyer pays for the fact that the business already works: customers come back, the name is known, processes run and staff know what to do. For most small businesses — webshops, service firms, agencies and SaaS in particular — goodwill is by far the largest part of the price.

This guide explains what goodwill consists of, how it relates to the valuation of the business, how it is calculated in practice, and how it is treated for tax in Denmark for both seller and buyer.

What goodwill is made of

Goodwill is not one thing but the sum of what makes the business earn more than its physical assets alone could. Typically that means:

• Customer relationships: regular customers, subscribers, framework agreements and a customer base that brings recurring revenue.
• Name and reputation: brand, reviews, search visibility and a location customers know.
• Organisation and know-how: staff, processes, systems and supplier agreements that keep things running.
• Market position: location, niche expertise and a head start over competitors.

Some of these values can be separated out as distinct intangible assets — a domain, a trademark, software or a licence. Danish tax law distinguishes between goodwill and other intangible rights, which can affect depreciation. The purchase agreement should therefore spell out what is goodwill and what are separate rights.

How goodwill fits into the valuation

Goodwill is rarely valued on its own. Usually the price is set for the whole business — often as a multiple of normalised earnings — and goodwill is what is left once the value of the tangible assets and liabilities has been deducted:

Goodwill = price for the business − market value of the tangible assets (fixtures, stock, receivables etc.) + the liabilities the buyer takes over

So anything that lifts the price — stable earnings, low owner dependency, growth, recurring revenue — also lifts goodwill. Conversely, a business with low earnings relative to its assets can have zero goodwill and effectively sells at asset value. The seller guide chapter on valuation covers multiples, EBITDA and DCF, and Sitavo’s valuation gives you a first price range.

The excess earnings method

A classic way to calculate goodwill directly is to look at excess earnings: the part of profit above a normal return on the assets employed and a market salary for the owner. The excess earnings are capitalised — converted to a present value — over the number of years they are expected to last. The more robust and durable the excess earnings, the longer the lifetime and the higher the goodwill.

The same logic is used in the Danish schematic valuation for family successions, where excess earnings are capitalised at the capital return rate plus 8 percentage points over a lifetime of no more than 15 years, based on the last five years of accounts. That method applies only to gift and estate duty within the family — see business succession.

Example: from price to goodwill

The figures are illustrative. In a real deal each item must be justifiable, because the Danish tax authorities can adjust an allocation that does not reflect market value.

What drives goodwill up — and down

If you want to raise goodwill before a sale, the most effective levers are reducing dependence on you, spreading the customer base and documenting operations. See the seller guide chapter on preparing the business.

Goodwill in online and physical businesses

In a webshop, SaaS business or content site there are few physical assets, so nearly the whole price is goodwill and other intangibles — domain, code, traffic, newsletter list and customer data. Goodwill here depends mainly on how stable traffic and revenue are, and on how dependent the business is on a single ad channel or platform. A buyer will usually ask for access to analytics and payment data to check that the figures hold up.

In a restaurant, shop or trade business, fixtures, machinery and stock make up a larger part of the price, and goodwill often depends on location, the lease, regular customers and staff. A short or uncertain lease can in practice wipe out much of the goodwill, because customers are tied to the address. See the chapter on physical businesses.

Goodwill and tax

For the seller

In an asset deal the seller is taxed on the gain on goodwill: the part of the price allocated to goodwill minus the seller’s tax base. Self-generated goodwill usually has a tax base of zero, so the whole amount is gain. A selling company pays 22% corporate tax; an individual owner is taxed on the gain as personal income. Details are in tax on selling a business.

In a share deal there is no separate goodwill taxation. Goodwill is part of the share price, and the seller is taxed on the gain on the shares.

For the buyer: 1/7 a year

If you buy goodwill in an asset deal, you can write off the cost at up to 1/7 a year for Danish tax (section 40 of the Depreciation Act). The write-off is optional, so you can take less in a given year, and it can start in the income year in which the final agreement is made. It is calculated on the cash-equivalent price paid for the goodwill.

In the example above the buyer can write off up to DKK 2,400,000 / 7 ≈ DKK 342,857 a year for seven years. For a corporate buyer at 22% that is a tax saving of about DKK 75,400 a year. This is why buyers often prefer an asset deal with a high goodwill share, while sellers with a holding company prefer to sell shares — see asset sale or share sale.

• No write-off on a share purchase: If you buy the shares, you cannot depreciate the price. The company keeps its own tax values.
• Self-generated goodwill cannot be written off. The write-off requires goodwill to have been bought.
• Buying from a company you control (typically more than 50%) can mean a lower depreciation base.
• An earn-out or contingent price affects the total goodwill — see earn-outs.

Goodwill in the purchase agreement

In an asset deal the price must be allocated to the individual assets in the purchase agreement. The allocation determines the seller’s tax and the buyer’s depreciation, so the parties’ interests pull in opposite directions: the buyer may prefer more on equipment (faster write-off), the seller possibly the reverse. Either way the allocation must reflect market value and be the same in both parties’ tax returns.

• The price is allocated to goodwill, equipment, stock and any separate rights.
• The allocation is supported — for example by a valuation of fixtures and a stock count.
• Domains, trademarks, software and licences are listed separately if they are transferred.
• The non-compete clause matches the goodwill: the buyer pays for the customers, so the seller must not take them along.
• Both parties have had a tax calculation from their accountant.

Sitavo’s asset purchase agreement has an asset list and a section for allocating the price. If the seller chooses Sitavo’s agreements for the deal, the purchase agreement, asset list and transfer declaration are filled in free of charge from the deal — but you still need to agree the split between goodwill and other assets with your accountants. As a buyer you can use the due diligence checklist to test whether the goodwill holds up — for example whether customers are tied to the business or to the owner. Browse businesses with documented earnings among the listings.