In many situations, most notably valuation for marital dissolution and allocation of purchase price for tax or financial reporting purposes, distinguishing personal goodwill from enterprise goodwill and other enterprise-level intangible assets is a critical undertaking.
In the marital arena, personal goodwill is not a divisible asset in some jurisdictions – and the status is uncertain in many – and therefore cannot be awarded by the Court. It is curious that many valuation analysts fail to provide evidence as to the separate values of personal and enterprise goodwill.
In tax planning, particularly for C Corporation asset sales or conversions to S Status, allocating the proceeds of a sale of a business to personal goodwill and/or a noncompete agreement, consistent with the Tax Court decisions in Norwalk, Martin Ice Cream and the important 2008 Derby case, can reduce the amount recognized as corporate gain and the related corporate level tax. In fact, Derby arguably makes consideration of the value of personal goodwill and a noncompete de rigeur in the valuation of a physician practice being acquired by a hospital. In valuation for purposes of a sale of a business, properly attributing value to different intangible assets is critical to both buyer and seller obtaining the proper measure of the bargain.
There are two fundamental issues in differentiating personal from enterprise goodwill: identifying which portions of cashflow are attributable directly to the individual’s characteristics and identifying which cashflows attributable to otherwise enterprise-level tangibles and intangibles would be lost if the individual competed.This makes the determination of reasonable compensation for the owner-employees of the business the single most critical aspect of valuation of goodwill. Mark contributed the most comprehensive work (27,000 words) on this topic to the new BVR/AHLA Guide to Healthcare Industry Compensation and Valuation, published in November 2012.
We have a comprehensive approach to these issues that was the subject of a paper written by Mark O. Dietrich, CPA/ABV in the AICPA’s Spring 2005 CPA Expert and was presented at a number of seminars and Conferences during 2005, including the joint AICPA/ASA National Business Valuation Conference in November and the Virginia Society of CPAs Business Valuation Conference in September. Mark also developed a one-day continuing education course on how to distinguish personal and enterprise goodwill. The 3rd Edition (2012) of the Guide to Healthcare Valuation (see our Publications page) contains several chapters devoted to the valuation of personal and enterprise goodwill.
For those of you who have followed my writings and lectures, you are aware that valuation of noncompetes is one of my areas of interest and expertise. I continue to be confounded by some of my colleagues who confuse the issue of whether Fair Market Value contemplates a willing seller who will sign a noncompete, as opposed to whether or not the noncompete has any value. They are two distinct but interrelated questions.
IF the hypothetical buyer expects the seller to sign a noncompete, then that noncompete must have value – otherwise, why would the buyer ask for it. If it has value, we should be able to value it. The value of that noncompete is part of the enterprise-level cashflows of the entity being sold.
In marital dissolution valuation, identifying the value of the assumed noncompete is important in many jurisdictions since that noncompete may not be a divisible asset. Similarly, personal goodwill may not be a divisible asset and I have identified a methodology for measuring that in conjunction with the noncompete. In states which have a "walk away" definition of fair market value – e.g., Florida after Held v Held – the value left to the buyer IF the seller was free to compete post-sale is what is divisible. Thus, a logical approach to determining that divisible value is to determine enterprise value THEN subtract the value of the noncompete/personal goodwill to arrive at a divisible value.
Fair market value may well contemplate a willing seller signing a noncompete, but that noncompete has value and it may be a substantial part of the value derived from enterprise-level cashflows.