Many business owners may consider themselves integral and inseparable from their business. From a valuation perspective, it may be important to consider this when valuing a business. The value of a business that exceeds its net asset value may include a component of goodwill value, which may include both Personal Goodwill and Enterprise Goodwill. The breakdown of the business goodwill is important during specific events, like the sale of the business or the divorce of an owner. For the purposes of this discussion, we will only be considering an owner divorce event.
Personal Goodwill vs. Enterprise Goodwill
Personal goodwill is the intangible value that arises from the attributes and characteristics of the business owner and not the business. This would be based on the owner’s skill, reputation, knowledge and various other factors. It is simplistically the characteristics of the business that would be lost if the owner was no longer a part of the business.
Enterprise goodwill is the intangible value arising from the attributes of the entity as opposed to the individual. These are the characteristics of the business regardless of who owns the business. These are the characteristics directly identifiable to business, such as its location, facilities, website, and reputation.
Separating Personal and Enterprise Goodwill
In separating the personal and enterprise goodwill, a valuator will examine the characteristics of both forms of goodwill and consider to which characteristic it belongs and to what degree. Items to be considered are:
- Customer relationships – individual relationship with the owner versus a contractual relationship with the business entity
- Supplier relationships – individual relationship with the owner versus a contractual relationship with the business entity
- Referrals and new customers – referral based on owner’s reputation versus the business reputation
- Income generation – new customers from the owner’s efforts versus from multiple individuals employed by the business
- Employment and Non-compete agreements – do agreements exist that prevent employees and/or the owner from taking customers with them if they are no longer with the business
- Marketing – do the marketing efforts of the business focus on the owner’s skills and experience or the business entity as a whole and/or the business characteristics
- Repeat customers – are customers returning for an individual experience or relationship as opposed to a location, convivence, or pricing
- Profit and loss allocation – are profits allocated based on income generation or are they distributed equally among all the owners
- Business name – is the business name the owner’s name or a name separate from the owner that is not as identifiable with the individual
- Business locations – the business location may indicate an enterprise value based on the operations and surrounding location demographics. A multiple location entity may indicate a greater enterprise value as opposed to a personal goodwill attributed to one person in one location.
Why It Matters
In a divorce proceeding in an equitable distribution state, the amount of goodwill related to the Personal Goodwill of the owner could be excluded from the marital estate. Depending on the type of business and the characteristics of the business and the owner, the amount of Personal Goodwill could be a significant amount and important to consider.
In a community property state, there is a presumption that marital property earned, purchased, or acquired during the marriage should be divided equally. It does not consider which spouse created the asset during the marriage, nor does it consider any additional issues in the marriage. However, consideration can be given to whether an asset is separate property and not subject to community property rules.
Conversely, an equitable distribution state holds that the marital estate must be divided in a manner that is reasonable and fair. The court will consider a variety of factors to determine how property should be divided. Consequently, an equitable distribution state can allow a business owner to separate the value of the goodwill value in their business into Personal Goodwill and Enterprise Goodwill, allowing the Personal Goodwill to be excluded from the marital estate.
The court will require a Goodwill Opinion report from a business valuation professional in order to consider the allocation between Personal Goodwill and Enterprise Goodwill.
Should you have questions about this topic, or any other topics related to your personal or business situation, please contact us at any time.
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