Valuation Methods and Goodwill
Investopedia.com says, "Goodwill is seen as an intangible asset on the balance sheet because it is not a physical asset such as buildings and equipment. Goodwill typically reflects the value of intangible assets such as a strong brand name, good customer relations, good employee relations and any patents or proprietary technology.".
Goodwill, being an intangible asset, is very difficult to value. Purchased goodwill is normally the balancing figure between the purchase price of an acquired entity and the total fair value of the acquired assets, both tangible and intangible, and liabilities (say, in the case of liquidation). Frequently, however, the goodwill represents over half of the total purchase price.
Since lab services are increasingly commoditised, the value of goodwill can sway considerably depending on the acquirer/ seller. There are various methods to compute a business valuation, most of them taking goodwill into account indirectly. Net asset value, discounted cash flow (of future earning estimate), price-earnings multiple, etc are popular options of business valuation.
A general rule of thumb in the service industry is EBITDA (Earnings Before Interest Tax Depreciation & Amortisation) multiplied by a commonly used factor (depending on the growth potential, country, etc.) For example, in US labs, the factor is 7 to 8. A lab with an EBITDA of $10 Million per year would sell for around $70 Million. Now if the resale value of all the tangible goods (building, equipment, fixtures, etc) was $45 Million, the difference ($25 Million) accounts for 'goodwill'.
Note: In India, since the market hasn't quite matured in terms of M&A (Mergers and Acquisition) activity, the price-earnings multiple is not standardised. The factor is usually based on historic transactions. Until sufficient data gets collected, the 'discounted cash flow' method is used. Though more complicated, it is a viable option.
