What is Personal Goodwill and Why Should I Care?

When determining the value of a privately-held business, one key consideration is personal goodwill.  Personal goodwill is that portion of the value of a business that attaches to a particular person due to his or her name, reputation, expertise, relationships, or other factors.  Personal goodwill can have a substantial impact when valuing a business for divorce or sale.

In order to determine the personal goodwill, you must first calculate the total amount of goodwill and then determine the amount of goodwill that is personal in nature.  Simply put, goodwill is the difference between the total value of the business and the value of its tangible assets (ex. Cash, A/R, inventory, fixed assets, etc).  For example, let’s say the total value of the business based on cash flows is determined to be $1M.  The value of the tangible assets is $400K.  Subtracting the value of the tangible assets from the total business value, the value of total goodwill is $600K.  Now comes the hard part; how much of that goodwill is personal to the business owner?  One simple way to think of it is: if the owner of the business left and opened a competing business, how much of the original business would remain intact?  If the original business would be unaffected, then there is probably little, if any, personal goodwill.  On the other hand, if the original business would be drastically impacted by the leaving of the owner, then there is probably a lot of personal goodwill.  A good example is a solo dental practice.  A business like this has a lot of personal goodwill.  The dentist who owns it is responsible for acquiring and keeping patient relationships.  Patients come to that business primarily because of him or her.  If he or she left, the business would essentially cease to exist.  A business like this has almost 100% personal goodwill.

So why should you care about personal goodwill?  Here are just two examples:

  • In the case of valuing a business in a divorce in Texas, personal goodwill is NOT DIVISIBLE. That means that the value of the personal goodwill is not included in the marital estate, whether it was acquired before or after marriage.  This can have a dramatic impact in the case of a professional practice like the dentist example above.    The practice may be worth $1M, but the out-spouse is only entitled to 50% of the value of the tangible assets, maybe $200K.  That’s $800K of value that the owner spouse gets to keep to himself or herself.
  • In the case of a business sale, the amount of personal goodwill is an indication of business risk and it should inform the structure of the sale transaction. For example, if you are buying a business with lots of personal goodwill, you may want to include provisions in the sale agreement to keep the existing owner around for a year or two so the new owner can acquire the skills and relationships of the original owner.  You may also want to require the seller to sign a non-compete for some period of time to protect you from him or her opening a competing business that would negatively impact the business you purchased.

These are just a couple of examples of why personal goodwill matters.  Valuing a business and calculating personal goodwill can be very complicated and it can have a huge financial impact.  Get help from an experienced professional like Scott Abels.  Call him at 512-673-3530 or visit him on the web at www.Precisionvalsvcs.com

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