Goodwill

How BC law treats it

In law, goodwill is the attractive force that brings in custom. It is the core interest protected by passing off, which requires goodwill, a misrepresentation that causes confusion, and resulting damage (Ciba-Geigy Canada Ltd v Apotex Inc, [1992] 3 SCR 120; Kirkbi AG v Ritvik Holdings Inc, 2005 SCC 65). Section 7(b) of the Trademarks Act, RSC 1985, c T-13 gives a similar statutory claim. Goodwill exists only in connection with a business; it cannot be sold separately from the business that generates it. In a sale of a business, a buyer pays for goodwill and protects it with non-competition and non-solicitation covenants from the seller. Courts apply a more lenient reasonableness test to covenants given on the sale of a business (Payette v Guay inc, 2013 SCC 45) than to covenants in employment contracts, which are presumptively unenforceable and will not be rewritten (Shafron v KRG Insurance Brokers (Western) Inc, 2009 SCC 6). The purchase agreement should assign goodwill expressly. For tax, since January 1, 2017 purchased goodwill is depreciable property in Class 14.1 under the Income Tax Act, RSC 1985, c 1 (5th Supp) and its regulations, replacing the old eligible capital property rules. How the purchase price is allocated between goodwill, equipment and inventory affects both the seller's tax and the buyer's deductions, so the allocation should be negotiated and recorded in the agreement. For accounting, under IFRS goodwill acquired in a business combination is not amortized; it is tested for impairment at least annually, and a write-down reduces reported earnings. Private enterprises using ASPE should confirm their treatment with their accountant. Valuators commonly measure goodwill as the excess of price over the fair value of identifiable net assets, or by capitalizing excess earnings.

What it means for your business

In many BC small business sales, especially service businesses, goodwill is most of the price. Buyers need it secured by enforceable covenants, assignment of the name and customer lists, and transition help from the seller. Sellers need to know that personal goodwill tied to the owner may leave with them, which lowers value or justifies an earn-out. The price allocation to goodwill drives tax outcomes for both sides, so it should be settled before signing rather than left to the accountants after closing. Example: A buyer pays $900,000 for a North Vancouver dental lab whose equipment is worth $150,000. The asset purchase agreement allocates most of the balance to goodwill, assigns the trade name and client list, and includes a three-year non-competition covenant from the seller within the Lower Mainland.

Risks and common mistakes

Buying a business without non-competition and non-solicitation covenants from the seller to protect the goodwill. Using an employment-style non-compete test when drafting a sale-of-business covenant, or the reverse. Leaving the purchase price allocation to goodwill unaddressed until tax filing season. Overvaluing goodwill that depends on the departing owner's personal relationships. Assuming an unregistered business name has no legal protection when its goodwill supports a passing off claim.