New companies and goodwill

One reason not to invest in start-ups

Yesterday I used the example of a Japanese restaurant to try and show how the goodwill value of a new business builds over time.

“Imagine that I open a restaurant. I start with zero goodwill. But over time people pass the restaurant and remember where it is - that is goodwill. It may get included in guidebooks - that is goodwill. It will build up a base of repeat diners - that is goodwill. And they may recommend it to friends - that is also goodwill.”

“It gets even more complicated. Say I have a Japanese restaurant in a town of 50,000 people. It can only support one Japanese restaurant. Therefore, just by opening the restaurant, I will discourage another entrepreneur from doing the same. I’ve acquired a local monopoly that will make my restaurant more profitable - in asset terms, that is goodwill.”

I think this is one reason why so many business plans are over-optimistic: they think in terms of an established operation that has built up goodwill. A new restaurant will take time - often a long time - to build up custom.

For me, this is a roundabout way of saying that I don’t like startups. On the other hand, I think there can be attractive buying opportunities when startup companies disappoint their investors, often just as they are getting properly established.

January 9, 2008 | Filed Under Companies

 

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