Goodwill is typically reflected in the excess of the fair market value of a company over the fair market value of its underlying identifiable assets. In other words, goodwill is the amount a potential investor would pay above the fair market value of its identifiable assets. In many instances, appraisers identify that goodwill exists and value the business assuming goodwill is transferable. However, in addition to merely determining whether goodwill exists, it is necessary to determine the nature of the goodwill, and what value to place on each type of goodwill. This is especially critical if the appraisal is for divorce or business dissolution purposes.
Types of Goodwill
There are two types of goodwill, which are as follows:
1. Institutional (or practice) goodwill; and
2. Professional (or personal) goodwill.
Institutional or practice goodwill may be described as the intangible value that would continue to inure to the business without the presence of specific owner. Professional or personal goodwill may be described as the intangible value attributable solely to the efforts of or reputation of an owner of the business. The key difference between the two types of goodwill is whether the goodwill is transferable upon a sale to a third party without a non-competition agreement.
Cases Affirming Non-Transferability of Personal Goodwill
The Utah Court of Appeals recently examined the nature of goodwill in the Marroquin v. Marroquin case which expanded on the state’s jurisprudence. This case involved the valuation of a network of vending machines which were maintained by the owner of the company. Sage Forensic Accounting performed a valuation of the business and determined that all goodwill was personal in nature and dependent on the expertise and relationships of the business owner and therefore, non-transferable without a non-competition agreement. The opposing appraiser did not perform an analysis of goodwill to determine if it was transferable.
At trial, the court rejected the opposing appraiser’s valuation and found Sage Forensic Accounting’s valuation to be more credible and adopted Sage’s value for the company.
The appeals court upheld the trial court’s findings that there was no institutional (enterprise)goodwill in a business that is entirely dependent on the owner-spouse’s efforts and reputation for competency.
Although the Marroquin case was specific to determining goodwill in the context of divorce, Sage Forensic Accounting has included an analysis of goodwill for other business dissolution cases. For example, in the corporate dissolution of Sheet Metal Works, Inc, Sage determined that all goodwill was personal in nature and non-transferable without a non-competition agreement. At trial, the court rejected the opposing appraiser’s valuation and found the analysis prepared by Sage Forensic Accounting to be more credible and reliable. In its ruling, the Court stated:
With regards to goodwill, the court concludes although it is undisputed that SMW has dedicated and skilled workers, it has very little, if any, enterprise goodwill. Instead, the Court finds that the goodwill associated with SMW is actually personal goodwill belonging to RC.
Because RC had not signed a non-compete agreement with SMW, his personal goodwill cannot be transferred to the SMW for purposes of valuation. See Peterson v. Jackson, 253 P.3d 1096 ¶¶ 39-40 (Utah App. 2011) (“[A]covenant not to compete is necessary for the protection of the goodwill of [a]business where a departing employee might draw away customers … if he were permitted to compete nearby …. ‘[P]ersonal goodwill [can] be transferred to a business via a non-competition agreement.” (quotations & citations omitted).)
Whether the appraisal assignment is for divorce or dissolution of a business, an analysis of goodwill should be performed. Personal goodwill is non-transferable without a non-competition agreement that is tied to a specific person’s abilities, reputation, efforts, and would disappear if the individual were to leave the company. Additionally, it cannot be assumed that a non-competition agreement would be executed to determine the value of the business in these cases.
Determining the Value of Professional(Personal) Goodwill
Valuation theory indicates that the best measure of the amount of personal goodwill is to take the difference between two valuations. Specifically, the amount of personal goodwill is determined as the difference between the value of a company assuming the person at interest remains active in the company and the value of the company assuming the person at interest is no longer involved in the company.
For example, the measure of the company’s value including the personal goodwill attributable to the person at interest is indicated maybe indicated by the income approach. The value of the company excluding personal goodwill attributable to the person at interest may be indicated by the Asset Approach. The difference between these two valuation approaches is the approximate value of personal goodwill attributable to the person at interest.
Determining the value of personal versus enterprise goodwill in a business can be difficult and often requires an expert, such as Sage Forensic Accounting, that is familiar the intricacies of goodwill.
Print the court's opinion of Marroquin v Marroquin, 2019 UT App 38 (March 14, 2019).