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The term “goodwill value” is a term of art that is applied to the incremental increase in value of an enterprise over and above the simple replacement value of the fixed assets. Unless it is added to a balance sheet reflecting an actual purchase of goodwill in an acquisition, it almost never is seen on a balance sheet based upon Book Value. It is the primary reason for business appraisals, and a necessary element to determine the actual Fair Market Value of a business enterprise.
Two Basic Potential Components of Goodwill
Similar to Personal Goodwill, Professional Goodwill is often characterized as "conceptually distinct from that associated with a trade or business," and attached to the individual. It is usually associated with reputation and experience. In most professional practices, Professional Goodwill is largely dependent upon the skills and attributes of the individual practitioners.
There are two basic reasons for valuing Personal/Professional Goodwill, Marital Dissolutions and Sales of Businesses.
The most common reason for an actual appraisal of Personal/Professional Goodwill value is marital dissolutions. This is because it varies widely from state to state, as determined by case law. The two issues are whether Enterprise Goodwill and/or Personal/Professional Goodwill are included in the marital estate. Our research shows the following:
Typically, a business appraisal obtained by a seller will not consider Personal Goodwill as separate from Enterprise Goodwill unless the entity is a C-Corporation. This is because normally, any Personal Goodwill is mitigated in the purchase and sale agreement to provide a means whereby the buyer will inherit the Personal Goodwill of the seller. This can be achieved with such tools as:
The objective of all the above tools is to create time and exposure to the buyer by the client or customer base to allow them to become inured to the purchaser.
The principal reason a seller will want to know what percentage of the total Goodwill Value is Personal/Professional is that these can often be mitigated prior to the sale by effectively transferring the Personal/Professional goodwill to key employees. This typically results in the buyer's willingness to pay a higher price for the business.
If Personal/Professional Goodwill is mitigated, it also opens the field to investor-buyers as opposed to operator-buyers. For more valuable businesses, the investor-buyer is likely the most efficacious way to sell.
The biggest problem for owners of C-corporations is the double taxation of capital gains upon a sale. First, it is taxable to the corporation, then when distributed to the shareholders, it is taxed again at the personal tax level. This is not the case with proprietorships, partnerships, LLCs or S-Corps.
However, when Personal Goodwill is part of the sale, it can be structured as two separate transactions. One is a sale of the C-corporation’s interest (either stock sale or asset sale) and the other is a personal sale of Personal/Professional Goodwill, which will then be taxed only at the personal rate.
*Disclaimer*: Harvard Business Services, Inc. is neither a law firm nor an accounting firm and, even in cases where the author is an attorney, or a tax professional, nothing in this article constitutes legal or tax advice. This article provides general commentary on, and analysis of, the subject addressed. We strongly advise that you consult an attorney or tax professional to receive legal or tax guidance tailored to your specific circumstances. Any action taken or not taken based on this article is at your own risk. If an article cites or provides a link to third-party sources or websites, Harvard Business Services, Inc. is not responsible for and makes no representations regarding such source’s content or accuracy. Opinions expressed in this article do not necessarily reflect those of Harvard Business Services, Inc.