Protecting goodwill. Ways to retain value in your business
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27th July, 2018
This article is the second in a series on intangible assets where lawyer, Jack Ding from Salvos Legal, looks at two scenarios in which goodwill can be very important and how everyday businesses can take some simple steps to protect themselves.
What is goodwill?
In business, goodwill is an expression used to describe the premium value of a business when it is sold. When a business is sold, the value of goodwill is usually the difference between the purchase price and the value of the tangible assets. The difference is designated as the ‘goodwill’ in the sale transaction and can capture the value from your client relationships, your market position, your brand name, your proprietary technologies or company know how.
Goodwill can therefore be a very valuable part of your business.
How might goodwill be vulnerable?
These are some common scenarios your business could encounter:
1. Stealing of client contacts
Scenario: Your competitor has poached your highest performing staff and secretly incentivised them to bring over clients with them by offering payments. They are able to covertly transfer client contacts to a USB drive before they notify you of their resignation. The best you are able to do is terminate their access to client records after the loss event or put them on garden leave.
Intangible assets such as your client relationships are the kind of assets that are best protected when preventative steps are taken. Because they are not physical, intangible assets are very difficult to completely restore after a loss or breach event. How do you restore a client’s business once your former employee has already offered them better terms and locked them into a new arrangement? Short of commencing court proceedings to seek an injunction, assuming this option is even available, you have limited options.
For this reason, one important action businesses must consider is having a ‘restraint of trade’ clause in employment contracts as standard for staff particularly those who handle your client relationships. These clauses can prevent your former employees from:
a. contacting your clients for a certain period (known as a ‘non-solicitation clause’);
b. competing in the exact business field (known as a ‘non-compete clause’); or
c. working for a competitor within a certain geographic distance for a certain period of time.
The restriction must be capable of being considered reasonable in the circumstances and only used to protect a business’ legitimate commercial interests. For example, if the effect of the restraint is that you are virtually preventing that employee from working in their chosen field in their city, it will be deemed too oppressive. If drafted appropriately, a restraint of trade clause can be a strong deterrent for those employees who might think about taking your business along with them. If they are not deterred and persist, it gives your business grounds to approach the Court for relief. If their new employer is aware of the restraint and still encourages your ex-employee to bring over clients, your business may also have relief under the tort of interference directly against that new employer.
2. Not keeping track of your intellectual property
Scenario: Your business is looking to acquire a start-up which has had a rapid ascension to success. In that process, they have come up with many new products that are now being distributed to many different countries. Your lawyers are conducting due diligence before the acquisition and discover many of the inventions, designs and brand names have not been properly registered or are not adequately protected by the relevant intellectual property laws.
Businesses must ensure there is consistent and timely registration of their intellectual property such as trademarks, patents or designs so the value of their creations can be captured and the value of those creations can be formally recognised when prospective buyers are conducting due diligence. Proper steps also need to be taken to protect intellectual property that cannot be protected by registration process (such as copyright).
The more intellectual property that is captured, the more value it adds to your business.
Where intellectual property has not been registered or protected, it could significantly compromise the value of your business’s goodwill, especially if you have direct competitors who deliver similar products and you are relying on formal recognition to claim your market monopoly. It is also difficult for your prospective buyers to know what your business has created if there is no formal paperwork or endorsement to address it.
A paper trail of creation and registration for intellectual property gives your potential buyers an assurance that your business has its competitive advantage enshrined in the local country’s laws and cannot be disturbed by other claims.
It is important that your employees or contractors recognise when they are creating original works for your business. Once that is identified, your business must have a clear process for those staff to follow so that they capture that creation into an intellectual property registration. There is a significant difference in ownership between intellectual property created by employees and that which is created by an independent contractor.
Protecting goodwill can mean tremendous value for your business when it is being sold or valued. By taking steps to protect these features of your business now, it will mean potential buyers pay a greater price for your business later on.