GOODWILL

When assessing the amount of compensation payable for damage to a viable business following a compulsory taking, goodwill can be a major part of the compensation payable. However, there are differences of opinion in the definition of goodwill:
It is a thing very easy to describe very difficult to define. It is the benefit and advantage of the good name, reputation and connection of a business. It is the attractive force which brings in custom. It is the one thing which distinguishes an old established business at its first start" - IRC v Muller, [1901] AC217.

In Fed Comm v Williamson (1943) The Valuer, October 1943, p306 Rich J made the following observations: Goodwill has been said to be "the attractive force which brings in custom" (Inland Revenue Commissioner v. Muller & Cos Margarine Ltd. # an English case). Hence to determine the nature of the goodwill in any one given case, it is necessary to consider the type of business and the type of customer which such a business is inherently likely to attract as well as all the surrounding circumstances. New customers vary.

In Whiteman Smith Motor Company v. Chaplin, the types were zoologically classified into cats, dogs, rats and rabbits. The cat prefers the old home to the person who keeps it and stays in the old home although the person who has kept the home leaves and so it represents the customer who goes to the old shop, whoever keeps it, and provides the local goodwill. The faithful dog is attached to the person, rather than to the place, he will follow the outgoing owner if he does not go too far. The cat has no attachments and is purely casual. The rabbit is attracted by mere propinquity. He comes because he happens to live close by and it would be more trouble to go elsewhere. These categories serve as a reminder that the goodwill, of a business is a composite thing, referable in part to its locality, in part to the way in which it is conducted and the personality of those who conduct it and in part to the likelihood of competition, many customers being no doubt actuated by mixed motives in conjerring their custom." (p307)
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As mentioned above, in Whiteman Smith Motor Co v Chaplain [1934] 2KB35 at 42,49,50 animals were used to describe the different types of goodwill as follows:


CAT CUSTOMER


The cat prefers the old home to the person who keeps it. Therefore, cat goodwill is "site goodwill".


DOG CUSTOMER

The faithful dog is more attached to the person than the place. Therefore, dog goodwill is "personal goodwill" and is transportable.


RAT CUSTOMER


The rat has no attachments and is purely casual. Therefore, the rat customer does not add to the business goodwill rather, his/her's input is part of the land value.
RABBIT CUSTOMER The rabbit shops by mere propinquity that is, convenience. This factor will almost certainly be part of the commercial land value and does not add to the value of goodwill. GOODWILL PARADIGMS There are two different paradigms of goodwill: THE EXTRA VALUE OF AN ESTABLISHED BUSINESS

It is common for business brokers and accountants to value goodwill as the payment made by the purchaser of a business on a "walk in walk out" basis. Typically, when a business is sold the purchaser will pay a purchase price for the business based on the rent paid (if there is a "profit rental"), residue length of the lease, the fact that the business is established (for example, clients on the books, regular customers), and any superprofits arising from the personality of the proprietor and site advantage.

The price paid for stock is "stock at value" (SAV) that is, after the sale the two parties stocktake and agree on it's value. If the value of stock cannot be agreed upon under the standard form business contract, an arbitrator will decide its value. This provides the total value of goodwill and includes personal and site goodwill (if any).


TOTAL DESTRUCTION OF THE BUSINESS


If the business is totally destroyed by the compulsory taking and the proprietor cannot reestablish nearby, then Consequential Losses must include the total value the goodwill as this is a marketable component of the business system which has been lost. The loss has been directly caused by the compulsory taking.
It was using these assets for the purpose of carrying on a business and if the value of the business based on its earning capacity exceeded the value of the tangible assets and that business was destroyed by the acquisition of the land, the compensation to which the plaintiff company is entitled should, having regard to the way the case was fought, be taken to include an amount equal to the value of the whole undertaking regarded as a going concern; for it was deprived of that sum by the loss of the land and that was the value of the land to it" - Eastaway v C of A (1951) 84 CLR 328, 12 The Valuer 42.

In Bennett v Comm for Railways, (1952) 12 The Valuer 169, Sugerman J considered that the plaintiff had proved that he had made reasonable efforts to find alternative suitable land to site elsewhere but could not find such land. In that case the land had to be physically similar but the available land was either too large to be economically used or situated in areas where the particular manufacturing business would not be allowed or lacking the necessary access at two levels.


Eastaway's case
(an engineering business) also held that although a business can be conducted elsewhere its continuance may be impossible because suitable alternate premises are not available to buy or rent within the area to which the goodwill extends.
In Hayes: Where the business is retail, of a local nature, depending on neighbours and customers and so on, then if no suitable premises can be found in the locality, obviously some compensation must be paid" - Hayes v Min of Works [1913] 15 WAR 106. McMillan CJ then went on to state that compensation for loss of personal goodwill could not be awarded but that compensation for the loss of site (local) goodwill if found, either in the case of freehold or leasehold interests could be awarded.

PARTIAL DESTRUCTION OF THE BUSINESS

If the dispossessed proprietor can relocate nearby (for example, in the same shopping strip) then the personal part of goodwill is taken with him to the new site and therefore, is not lost. He/she does not lose the advantages of an established business as described in Muller's case. The only part of the goodwill payable for the compulsory taking is "site goodwill", that part which attaches to the subject site and therefore, is lost on the compulsory taking of the real estate.


Most businesses are only partially damaged by a compulsory. This is because the proprietor can either continue trading on the residue land when only part of the site is affected (for example, following a highways department road widening) or relocate nearby (for example, in the same shopping centre). Therefore, the valuer is more concerned with "site" or "local goodwill" than "personal and established" goodwill. To determine whether or not there is site goodwill the business must enjoy some "superprofit".
Although the affected proprietor may be able to relocate, the new location after reestablishment may reduce the profitability of the business. In this case the difference must be site goodwill and therefore, is payable as compensation. The dispossessed owner cannot claim losses brought about by his own neglect or loss of health caused by the taking of his land. This is too remote to be a compensation head - Bailey v Derby Corp [1965], 1 WLR 213, 1 AllER 443.

The dispossessed proprietor can claim for "disturbance" that is, compensation for the loss of income and profits for the period until the new business becomes established.
Even if a business is being carried on at a loss, compensation for loss of goodwill should still be paid. This is on the basis that the proprietor is worst off because of the compulsory taking. That is, if the land had not been taken he/she would not have suffered as great a loss. Further, the business may have recovered in the long run.

See superprofit
See site goodwill
See disturbance


VALUING GOODWILL


The valuer should investigate the following factors of the business:


1. THE EARNING CAPACITY OF THE BUSINESS


Will the present profits be maintained in the future and if so, for how long? If a lease period has only 1 or 2 weeks to run there cannot be any goodwill.


2. CAN THE GOODWILL BE TRANSFERRED?


Personal knowledge and skill for example, that of a barrister cannot be sold as a separate identity and therefore, such goodwill has no value. The business may be so unusual it does not have a ready market. This would mean that the business does not have goodwill.


3. TAX ADVANTAGES


Many cash businesses have a high goodwill component for example, hotels. This is because the cash nature of the business allows the owner to under declare income earned and therefore, pay less income tax. The higher the tax avoidance in the industry, higher the goodwill.


METHODS OF VALUATION


ARBITRARY ASSESSMENT


The value of goodwill is determined by the market place usually through a business broker or agent. If sales are available they can be analyzed on a similar basis as for real estate transactions and the subject business can then be valued by "direct comparison" with the sale business. This method of assessment is used for unusual businesses were trade formulae have not yet been established and for some hotels and bottle shops.


CAPITALIZATION OF NET PROFITS


Average net profits are found from previous years trading. They are then capitalized at an appropriate capitalization rate commensurate with the risk of the business. The value of the net tangible assets (NTA) are then deducted the capitalized amount.


EXAMPLE OF THE CAPITALIZATION METHOD


Expected net profits: 100 000

Capitalize at 10% per annum:
100 000 * 100/10 = 1 000 000
Less Net Tangible Assets: (300 000)
GOODWILL: 700 000


PURCHASE OF PAST PROFITS


Under this method the average of a certain number of previous years net profits are taken and multiplied by an appropriate years purchase (YP):


EXAMPLE


Average 5 years net profits: 100 000

YP for the subject industry: 7

GOODWILL: 7 * 100 000 = 700 000


The profit figure used may be "gross" or "net" depending on what is typical for the subject industry. The years purchase depends on convention and varies with the type of business for example, a chemist shops typically uses 10x average weekly earnings as the method for the calculation of goodwill.


BASED ON TURNOVER


This method is suitable for businesses with a large turnover and a small profit per item for example, supermarkets. A conventional formula known to the trade is used:


EXAMPLE


Bakers: $10 000 per short tonne of flour used per week

Newsagents: $x per number of dailies and magazines and Sunday papers sold per week.


SUPER PROFITS

Is calculated as the annual amount remaining from the profits after deducting a reasonable amount for the proprietor and return on the value of the net tangible assets. The super profit is then multiplied by an appropriate years purchase:

EXAMPLE


Average net profits: 100 000

Net tangible assets (NTA): 600 000

Annual return: 600 000 @ 12% pa = (72 000)


Therefore, annual super profit = 28 000

Multiply by YP 2.5

GOODWILL: 70 000


APPORTIONMENT BETWEEN SITE AND PERSONAL GOODWILL


Once the total value of the goodwill is found, the following steps are taken:
  1. Determine whether or not the site has some special attribute which could add to the business's profit. However, this attribute must not be an inherent and normal feature of a commercial site (for example, a corner influence) as this is already included in the market value of the land.
  2. Determine whether or not the management is above average. If the management is normal then any goodwill must be site goodwill.
  3. Is there a famous name attached to the business? If so, then this is personal goodwill. The delay in profit caused by the reestablishment of a business after destruction through the construction of the public works and relocation should be treated as loss of profits under the head; "disturbance".
See right to occupy after a compulsory taking

THE BUSINESS MUST BE PROFITABLE


If the business is running at a loss then it has no value - Hobart Bridge v Tasmania, (1945) 9 The Valuer 62. However, since the compensation payable is "special value to the owner", the dispossessed owner should be compensated for any goodwill under a different head than "value of the business". Otherwise, the affected proprietor is worse off afterwards then before the compulsory taking. Further, the business should be assessed to determine whether or not the proprietor may trade out of the loss in the long run.

If the value of the business as a "going concern" is worth less than the value of it's assets then the value of the assets is the compensation payable and the business is ignored. For a claim for disturbance to a business to succeed the property must be used at it's highest and best use - Lodge v WCIC, 1967, 20 The Valuer 9, 14 LGRA 88.


See lessee's compensation

VALUATION OF SEPARATE INTERESTS ARE REQUIRED


Each person with an interest in land compulsorily taken can claim compensation for that interest. Therefore, the lessee and the lessor can each claim compensation so that neither claim is dependent on the other. It is immaterial when determining the land value component of each claim that the sum of the 2 parties interests exceeds the unencumbered market value of the property. Therefore, the lessor's interest should not be found by subtracting the lessee's interest from the unencumbered market value - Rosenbaum v Min (1965) 114 CLR 424, 19 The Valuer 456.
Not only are special factors applicable to each claim but probably because of "synergy", the sum of the 2 interests exceed the unencumbered market value.



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