Valuing a business for a divorce proceeding is never an easy task, especially when there is a need to distinguish between enterprise and personal goodwill.
The International Glossary of Business Valuation Terms defines goodwill as “that intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors identified.” Other examples of business intangibles are copyrights, trademarks, brand recognition, and contracts. Under the goodwill umbrella sit enterprise goodwill and personal goodwill.
Enterprise goodwill is the set of characteristics associated with the business entity itself and which is transferable to a new owner upon a sale. Examples include location, brand, patents, customer base and workforce. Enterprise goodwill exists regardless of who owns or operates the business.
Personal goodwill is associated with the specific owner’s reputation, experience, industry knowledge, and skills. These personal characteristics and relationships drive the revenue stream and help create a customer base.
Why is this so important in valuing a business in a divorce?
It is important for the valuation analyst to be familiar with the laws in the state in which the business valuation is being performed. In many states, personal goodwill is not considered a marital asset. In Florida, for example, personal goodwill is treated as a non-marital asset and is not subject to equitable distribution. However, enterprise goodwill is treated as a marital asset and is subject to equitable distribution. It is the business valuator’s informed judgment that will determine how to distinguish between and quantify the two.
Thompson v. Thompson is a landmark Supreme Court case that held: “If a party can produce evidence demonstrating goodwill as an asset separate and distinct from the other party’s reputation, it should be considered in distributing marital property.”
But how are personal and enterprise goodwill quantified?
The business valuation analyst will first research the entity and perform interviews with management. The analyst will then use those findings to estimate the degree to which personal and enterprise goodwill exists. Questions the analyst might ask the business owner include:
- Are customer and supplier relationships linked with a specific individual, or are they contractual with the business?
- Are customers generated through the reputation or expertise of a specific individual, or are they based on business reputation?
- Is income generated mostly by one particular individual in the company or by multiple individuals?
- Are there any non-compete agreements with owners/employees in place?
Once the analyst is able to separate the personal goodwill from the enterprise goodwill, the next step is to calculate its value. The two most commonly used methods to value personal goodwill are the “with and without” method and the “multi-attribute utility model” (MUM) method. In the “with and without” method, the analyst determines the fair market value of the business under two scenarios. The first is where the business owner is assumed to remain in the business, and the second assumes the owner leaves and competes elsewhere. The difference between the two values is the estimated amount allocated to personal goodwill.
The MUM method is a court-accepted method of measuring goodwill. It is an allocation model that categorizes attributes according to indications of enterprise or professional goodwill and then uses the relative weight of each attribute to determine its importance and presence in the business being valued. This assists the analyst in determining the amount to carve out and distinguish as personal goodwill.
The treatment of enterprise and personal goodwill continues to be an evolving topic. Having a good understanding of the differences between personal and enterprise goodwill is quite important as it could have a significant impact on the marital estate to be distributed. Therefore, relying on a qualified valuation professional who can utilize their knowledge and expertise will help to ensure an equitable outcome in marital dissolution cases.
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