Navigating Personal Goodwill in Divorce Cases

In marital dissolution, the division of marital assets can often be complex, especially when it involves the valuation of a business. One of the more complicated aspects of valuing a business is understanding and appropriately accounting for personal goodwill. For family law attorneys, a thorough understanding of the topic and the applicable case law in your state, is essential to guide you to a fair and equitable asset distribution.

What is Personal Goodwill?

Goodwill, by definition, represents the value of future economic benefits that arise out of the assemblage of a business’ assets that is not directly ascribed to any other asset.¹ Simply stated, goodwill represents the value of a business beyond its tangible, or real, assets and liabilities. This definition is consistent with that provided in Appendix B of the American Institute of Certified Public Accountants’ Statement on Standards for Valuation Services No. 1 (SSVS-1), which defines goodwill as “an intangible asset which represents any future economic benefit arising from a business, an interest in a business, or from the use of a group of assets which has not been separately recognized in another asset.”²

Goodwill reflects elements such as the company’s trade name, reputation, customer relationships, location and other intangible factors that contribute to its income-generating potential. Whereas, personal goodwill, specifically, is linked to the specific individual attributes of the business owner or key employees, which includes that individual’s personal reputation, skills, relationships, efforts, and expertise.

Distinguishing Personal Goodwill from Enterprise Goodwill³

Depending on the scope of your specific engagement, generally, in business valuation, it is critical to differentiate between personal goodwill and enterprise (or business) goodwill:

• Personal Goodwill: Tied to the individual’s personal attributes and is often not transferable if the individual leaves the company.⁴
• Enterprise Goodwill: Attributable to the business entity itself, including its brand, processes, systems, and workforce, and is typically transferable with the business.⁵

Importance in Family Law

The distinction between personal and enterprise goodwill is particularly significant in divorce cases where the valuation and division of business interests are in question. Here’s why:

• Equitable Distribution: Many jurisdictions treat personal goodwill as non-marital property, not subject to division, while enterprise goodwill is considered marital property. Therefore, accurate identification of each can substantially impact the division of assets.⁶
• Fair Valuation: Misattributing personal goodwill as enterprise goodwill can inflate the value of the business, leading to an unfair distribution of assets. Conversely, underestimating personal goodwill can lead to the business being undervalued, and potentially cause disputes and/or issues.
• Tax Implications: Correctly classifying goodwill has tax implications, particularly in the structuring of settlements and sales.

Factors Affecting Personal Goodwill

Several factors can influence the presence and extent of personal goodwill. These include, but are not limited to the following:

• Reputation and Relationships: The owner’s or key person’s personal reputation and their relationships with customers/clients, suppliers, and other stakeholders.
• Skills and Expertise: Unique skills, knowledge, or expertise of the individual that contribute to the business’s overall success.
• Personal Branding: Any branding associated specifically with the individual, rather than the business entity.
• Independence and Control: The degree to which the business’s success is dependent on the individual’s personal efforts and decisions.

Valuation Methods

Valuing personal goodwill can be challenging, and various methodologies are utilized. The analysis necessarily includes both a qualitative and quantitative analysis. However, each methodology ultimately has the same goal, and that is to quantify the value of personal goodwill. The various methodologies utilized are:⁷

• Market Approach: The market approach is rarely applied to value personal goodwill as it requires reliable data from transactions involving sufficiently comparable assets that were recently acquired in an arm’s length transaction.⁸ However, if applicable data is available, the market approach is sometimes utilized to compare the subject business with similar entities that have been sold.
• Income Approach: Estimating the future income streams attributable to the individual’s efforts and discounting them to present value. This process can be done utilizing the “with and without” method, which determines and compares what the revenues and cash flows of the business would look like with and without the individual subject to personal goodwill.⁹
• Excess Earnings Method: Calculating the earnings attributable to personal efforts of the individual over and above a reasonable return on tangible assets and enterprise goodwill.¹⁰

Relevant Court Cases

This issue of personal goodwill in case law and valuation is not a new one.  The concept gained momentum with two seminal 1998 Tax Court (the “Court”) cases: Martin Ice Cream¹¹ and Norwalk.¹² In these cases, the shareholder’s reputation and skills contributed heavily to the business and, as also in Estate of Adell v. Commissioner¹³ and Bross Trucking, Inc. v. Commissioner,¹⁴ there were no employment contracts or non-compete agreements that would have transferred the personal goodwill to the corporation. The case law presented in these court cases supports the notion that an allocation of personal goodwill for owners who provide substantial services through their reputation, skills and knowledge would be reasonable and appropriate.

Implications for Family Law Practice

Family law attorneys should collaborate closely with valuation experts to accurately identify and quantify personal goodwill. Here are some practical steps:

• Retain Experts Early: Retain experienced business valuators who can differentiate between personal and enterprise goodwill so they can identify, review, and analyze any issues or concerns early in the process.
• Gather Information: Obtain detailed information about the business’ operations, including, but not limited to, financials and tax returns, as well as the individual’s role, expertise, experience and relationships within the business. Gather information from customers, employees and other industry peers who may know the individual personally.¹⁵
• Prepare for Mediation or Trial: Be ready to challenge opposing valuations and ensure the methodologies used are appropriate and well-supported. Have additional witnesses, including, but not limited to, long lasting employees, customers and competitors, that can corroborate the personal goodwill of the individual.

Conclusion

For family law attorneys, the nuances of personal goodwill in business valuation require careful attention and expertise. By understanding the distinctions, required analyses and methodologies involved, attorneys can better advocate for their clients, guiding them to fair and equitable outcomes in the division of marital assets. As the landscape of business and professional practices evolves, staying informed about valuation practices, case decisions and engaging with skilled experts will be key to successful case resolutions involving the identification of personal goodwill and the valuation of a business.

[1] Shannon P. Pratt and ASA Educational Foundation, Valuing a Business: The Analysis and Appraisal of Closely Held Companies, 6^th Ed., New York: McGraw-Hill Education (2022) (“VAB6”), Chapter 25, page 573 and 574.
[2] SSVS-1 Appendix B includes a verbatim reproduction of the International Glossary of Business Valuation Terms.
[3] VAB6, Chapter 44, page 1042-1043.
[4] VAB6, Chapter 25, page 575.
[5] VAB6, Chapter 44, page 1042-1043.
[6] VAB6, Chapter 43, pages 1016, 1017 and 1021 .
[7] VAB6, Chapter 43, page 1020 – 1023.
[8] VAB6, Chapter 25, page 585.
[9] VAB6, Chapter 25, page 583.
[10] VAB6, Chapter 43, page 1020 – 1023.
[11] Martin Ice Cream Co. v. Commissioner, 110 T.C. 189 (1998).
[13] Estate of Adell v. Commissioner, T.C. Memo. 2014-155. (2014).
[14] Bross Trucking, Inc. v. Commissioner, T.C., No 7710-11, T.C. Memo 2014-107, (2014).
[15] VAB6, Chapter 43, page 1021.