Personal Goodwill — Can The Contributions Of One Person Alter The Value Of A Business?
Two different types of goodwill contribute to the value of a company: enterprise and personal goodwill
. Most companies are aware of enterprise goodwill especially those involved in mergers and acquisitions. Enterprise goodwill results from a combination of factors, such as the number of years the company has been in business, the expertise and strength of the staff, the number of locations and its overall profitability. Read on to learn how personal goodwill can affect a business valuation.Personal goodwill applies to individuals rather than a company. Factors related to personal goodwill include the individual's years of experience; his or her licenses, unique skills or areas of expertise; peer and community reputation; and relationships with customers or clients.
Some forms of personal goodwill are transferrable for example, contact lists or brand names. However, not all things are transferrable; this type of goodwill is referred to as pure personal goodwill. An example of pure personal goodwill is skills such as those obtained by a neurosurgeon or dentist.
While personal goodwill is a concept that evolved in litigation matters, specifically in marriage dissolution cases, personal goodwill can play an important role in mergers and acquisitions. Prior to the commencement of a merger or acquisition, identifying and quantifying personal goodwill can have favorable tax implications for the seller.
While the term "personal goodwill" does not appear in the Internal Revenue Code, it is a creation of case law and was established by U.S. Tax Court case, Martin Ice Cream Co. v. Commissioner, 110 T.C. 189 (1998). In that decision, the tax court reaffirmed that when a corporation has no employment contract with an employee (in this case, the owner) the employee's personal relationships are not corporate assets. Martin Ice Cream recognized that personal goodwill may be unique and is present only if supported by particular facts.
Because of Martin Ice Cream, over the past 20 years, the courts tested various methods to determine pure personal goodwill. To quantify personal goodwill, experts use various methodologies:
- With vs. Without One approach determines the business enterprise value or business valuation of the company overall with and without the key individual anticipated to have personal goodwill. The question this methodology answers is how much income would be lost without the efforts of this key individual or if the key individual were to compete directly. For example, an individual starts a company selling widgets. Over the years, he developed a great personal relationship with each of his customers. If he were to compete against the original company he founded, many of his customers would probably stay with him even though he was with a different company.
- Bottom-Up Another business valuation approach to personal goodwill applies the same methodology used in a purchase price allocation. The appraiser allocates the value of the enterprise to the tangible and identified intangible assets. Any remaining value is attributable to personal goodwill.
- Top-Down This business valuation approach values the business enterprise, but then attempts to separate personal goodwill from enterprise goodwill. The Multi-attribute Utility Model (a point-scoring method) can help separate the two types of goodwill. For example, an individual starts a company featuring his name, selling replacement widgets. He thought of a new, never-before-developed concept, created the infrastructure necessary, has an in-depth knowledge of the industry he serves, has personally developed relationships with key suppliers, and has been a strong community philanthropist. Everyone knows who he is and what his business does. A good portion of the business enterprise value is attributable to his knowledge, relationships and name.
If structured properly, the seller of personal goodwill can receive significant benefits with no adverse tax impact to the buyer. However, allocations of personal goodwill must be reasonable and objective. So when determining whether a personal goodwill business valuation is appropriate, one must consider myriad factors. Any individual anticipating he or she may have personal goodwill in a company should consult a tax professional in addition to a qualified business enterprise appraiser.
Note: Pursuant to the rules of professional conduct set forth in Circular 230 as promulgated by the United States Department of the Treasury, nothing contained in this article was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.
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