Hi all
Not looking for definitive advice on this but just wondering what the general feeling is.
Re. incorporating sole traders who have only been trading for a short while (in the post-April 2002 regime). Obviously there will be a small amount of goodwill has built up even if they have just traded for a few months (which we can claim tax relief on) – I am interested in the different valuation techniques people use
Eg- average of the last 2 years profits, 2 x profits in the most recent year etc. I know it will vary for each business but just wondering if there are any other techniques worth considering.
Also has anyone ever had HMRC disagree with a valuation?
Many thanks in advance! :)
Philip Hoyle
23rd July 2010, 09:36
As you will no doubt know, valuation of goodwill is a VERY inexact science - even in the real world, apparently similar businesses can buy/sell for unbelievably different amounts based on the buyers/sellers circumstances. Any valuation can be very subjective.
HMRC are very keen on evaluating exactly what kind of goodwill a business has. Some goodwill is "personal", i.e. a one-man consultancy, some will be part of the property, i.e. a pub, neither of which is readily transferrable on its own, and HMRC could argue that there is no transferrable goodwill.
Assuming that the goodwill in question is transferrable, the valuation is often arrived at by averaging the various different ways of valuation, i.e. 3 times net profit, or 1 times gross profit are two common ways, but watch out for the net profit one as it has to take account of the proprietors time if he's working in the basis, so a sole trader showing profit of £25k probably has no goodwill value as the £25k is little more than the guy's wage if he's working full time. If the net profit was £50k then you could deduct £25k prop's wage leaving £25k times 3 gives a £75k goodwill. If profits are growing, you can add a premium onto the 3 times historic profits, especially if you've got some forecasts showing that work done in the past continues to increase future turnover/profits, i.e. where there is organic growth from within the client base, i.e. customers wanting more, customers referring others, etc. If time/money is required to create future growth, then it won't command much of a premium as it's the buyer who has to do the work and he won't pay much of a premium for that.
Also, some trades, professions, industries have their own goodwill valuations. For example accountancy practices sell for around 1-1.5 times their gross recurring fees - i.e. not based on profits at all, just recurring turnover.
In my experience, HMRC will only challenge goodwill valuations on two grounds - firstly that there is no transferrable goodwill in the first place, so valuation arguments don't even come into it, secondly, when the valuation is ridiculously high or low. If, eg, you place a value of goodwill on a shop for £50,000, and the tax inspector has a quick look and thinks it more likely to be £60,000, he's very unlikely to spend time and effort arguing for such a small difference, but if you place a value of £250,000, or £nil, and he thinks it should be £60,000, then it's almost inevitable he's going to argue.
Don't forget that you can put off the issue of agreeing valuations by claiming hold-over relief and applying for deferment of valuations (I think it's the IR295 form), which neatly side-steps the potential problems of putting in a wrong value at transfer and delays the whole thing until the goodwill is subsequently sold by the transferee, which makes things more certain as once its sold to a third party, there's some evidence of a method of open market valuation that can be extrapolated backwards to prove your value was reasonable in the first place (as long as it was!).
Hope that helps.
Thanks Philip - some very good points there!
Strontium Dog
23rd July 2010, 14:49
Assuming that the goodwill in question is transferrable, the valuation is often arrived at by averaging the various different ways of valuation, i.e. 3 times net profit, or 1 times gross profit are two common ways, but watch out for the net profit one as it has to take account of the proprietors time if he's working in the basis, so a sole trader showing profit of £25k probably has no goodwill value as the £25k is little more than the guy's wage if he's working full time. If the net profit was £50k then you could deduct £25k prop's wage leaving £25k times 3 gives a £75k goodwill.
Philip: one thing I would add to your pretty comprehensive reply, as a qualified accountant who does get involved in business transfers and valuations from time to time. Often, especially in the case of a micro business you cannot use the rationale of adding in a market salary for the proprietor. For example, a small non VAT reg leasehold hair dressing salon may only make profits of under £20K. On the face of it a decent hairdresser could earn more than that. However the business may still sell to a third party for perhaps £20K. for that type of business it just makes sense to forget about the owners salary and just use a lower profit multiple when determining value.
Truemanbrown
23rd July 2010, 20:10
Adding to what has been said already there are two further points you should consider.
1. Do you have profits which will be one-off and will not carry on into the future.
For example, a couple of years ago Ken Livingstone brought in new legislation concerning the pollution levels of goods vehicles driving in London. As a result, most goods vehicles had to have new catalytic converters fitted.
Obviously, the mechanics fitting the converters would have seen a short-term growth in their profits.
Such one-off profits should be stripped out of any calculation when valuing goodwill.
2. Which year's profits due you use?
Obviously, at the moment we are in the recovery stages of a recession. The profits for the last two years will be expected to be low.
However, the business may have made much higher profits in 2006 and 2007. If the business is expected to recover to these heady heights there is nothing to stop you arguing with HMIT that the profits in 2006 and 2007 could be used as the basis to calculating goodwill.