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Selling goodwill

When you sell a business, you are not just selling tangible assets. If that were the case, the value of your service business would be almost non-existent. You are selling goodwill, which represents what you have achieved with your assets and liabilities. This goodwill is intangible. You can sell shares in a business, or assets like provider agencies or data, but you still haven’t transferred goodwill. That’s because it is largely bound up in relationships, especially in a financial planning business.

The vast majority of small business sales are structured with an initial payment and a number of annual payments, spread over a few years following the sale. These deferred payments will typically have an element of contingency, the most common of which is the maintenance of annual recurring income. This is known as an earn-out. In this way, the buyer’s position is protected while they transfer the goodwill.

Where a firm has already transitioned goodwill between the current owner and one or more advisers inside the business, the owner’s negotiating position strengthens. They could ask a third party buyer for a larger initial payment and/or a shorter deferred payment timeline, with less or no contingency. So, why doesn’t this actually happen more often? Why aren’t more founders becoming non-advisers and striking deals with no earn-out?

The answer is risk. Firstly, developing adviser talent inside small firms is expensive and there are no guarantees of success. A business needs to be a certain size and the owner needs to have a long enough timeline to exit, to justify the investment. Secondly, the adviser you’ve been developing in-house, could leave. If you pass your clients over to them, they might leave and take clients with them. Of course, most firms have restrictive covenants but they are often limited in nature and expensive to defend.

This comes back to the alignment of interests. If you make your adviser(s) shareholder(s), they are far less likely to leave. If you plan to sell externally, the thought of selling equity to the team will probably not be high up on your list. You’re unlikely to get a fair market price from them and if you did, you’ve just increased the complexity of the sale process. The alternative is to accept the earn-out and try to limit the potential downside in negotiations.

If, however you plan to sell to the team, then selling some equity to them early on in the process, will allow you to transfer goodwill internally. You can then focus on growing the business and maximising your exit value, with the interests of your team aligned and the downside risk reduced. You should be able to avoid an earn-out structure too. Especially if you include the terms of the final sale of equity, in with the negotiation of the first sale.

You can find out more about selling to your team, including our two-step MBO strategy, by downloading our MBO Guide. We hope it helps.