Aug 22, 2014
Divorce and Business Valuations
A Goodwill Issue by Joe Gibbons
Business valuators must always consider the existence of intangible value when performing their valuations. This intangible value or goodwill becomes particularly significant when the valuation is undertaken with respect to a marital dissolution action.
Case law in many states have recognized two types of goodwill, “enterprise or business goodwill” and “personal or professional goodwill”. The distinction and resulting allocation between enterprise and personal goodwill can directly impact value, subject to equitable distribution. Many states deem personal or professional goodwill “not a marital asset” and, therefore, not subject to equitable distribution. Conversely, in almost all these states, enterprise or business goodwill is “a marital asset” and it’s value transferable under matrimonial law.
Goodwill can generally be defined as the value of a business over and above the value of it’s tangible and identifiable intangible assets, this value having been created by earnings exceeding the normal rate of return on those assets. The valuation analyst in a divorce action, having identified this “excess value” must now confront the question of, what kind of goodwill? This question is answered by analyzing the factors and attributes comprising such goodwill and identification of their source, i.e. the reason they exist and whom do they belong.
Enterprise or Business Goodwill
Enterprise or business goodwill is typically created by the following factors:
- Recognizable trade name (not related to and individual)
- Recognizable brand name(s)
- Desirable or unique location
- Trained and experienced employees
- Superior products and/or competitive pricing
- Customer loyalty (not related to the presence of an individual)
- Earnings not materially impacted by the absence or leaving of an individual
Professional or Personal Goodwill
Professional or personal goodwill would be indicated by the following:
- The individual’s name or reputation is the attraction
- The individual has a professional degree or license
- The individual has advanced training or specific knowledge or skill
- The business cannot be operated without a specific license, i.e. medicine, law, CPA
- Earnings severely impacted by the absence or leaving of an individual
- Customers or clients principally interact with an individual
- Enhanced earning capacity related to an individual
In reviewing the above factors, one might automatically assume that where goodwill is identified, it’s character in a professional practice such as law or medicine is “personal goodwill” and other enterprises characteristically enjoy “business goodwill”. Although generally true, there are many examples where both types of goodwill coexist, regardless of the business nature.
Goodwill that is so personal in nature, as to be inalienable from an individual is “personal or professional” goodwill and cannot be transferred, and therefore, is not value subject to equitable distribution in many states. Business or enterprise goodwill inures to the entity itself, can be transferred with the business, absent any individual, and is marital property in the majority of states.
The coexistence of both types of goodwill, presents a unique challenge to the professional analyst. Here, the valuator must apportion value between the two types of goodwill; this allocation must include sound methodology that the courts will find reasonable.
Although the discussion and application of methodology is beyond the scope of this article, the valuation practitioner should be reminded to always consult applicable state case law, research relevant and recent court decisions, and stay abreast of current developments within the valuation community, as this goodwill issue continues to be debated.