(Personal) Goodwill Hunting
What exactly is “personal goodwill,” how do you measure it, and is it transferrable to another party in the event of a sale? Valuation professionals are oftentimes engaged to determine exactly that. This analysis is integral in regards to tax implications and equitable distributions within a divorce, among many other purposes.
There are numerous tangible and intangible aspects directly tied to the success of a business as well as its competitive position within the market. By definition, goodwill is best stated as the portion of a business’ value above and beyond the market rate of its net tangible assets such as furniture, fixtures, and equipment. Personal goodwill, then, is the portion of goodwill that is attached directly to a person in the business (for our purposes most often a shareholder).
We often run into instances such as the following scenario:
Jane Smith is the owner of Ms. Smith’s Hair Boutique; a high end beauty salon. On paper, the Company has a steady and predictable inflow of revenue attributed to an extensive client base, recurring revenue streams, and low overhead. A significant portion of this revenue (namely the current clientele) is directly tied to relationships cultivated with the owner. Ultimately, upon a sale of the salon, it is more than likely that majority of the current client base would not continue frequenting Ms. Smith’s Hair Boutique if Ms. Smith herself were no longer the stylist.
While the financials alone may dictate a high company multiple, beyond the fair market value of the Company assets, the business value is significantly tied to Ms. Smith’s goodwill. Other factors may come into play that would aid in the transition and salability of the business such as the boutique’s location or any transition efforts put in place from the Shareholder to a new owner.
In the end, however, certain relationships are ultimately nontransferable and decline the overall value of a business. The value attached to these non-transferable relationships is personal goodwill.
So how much does goodwill actually impact the value of a company? Oftentimes it is a significant portion. Depending on your state’s laws, the treatment of personal vs. organizational goodwill can have a material impact on a divorce settlement.