Compared to other assets transferred in a business transaction, the sale of personal goodwill can be treated more advantageously from a tax perspective by the seller. Under certain transaction structures, the owner of a business may be able to reduce his or her tax liability by selling the personal goodwill associated with the business separately from the business’ assets.
The owner can justify the existence of personal goodwill during the sale process by obtaining a valuation of their personal goodwill.
This article discusses goodwill and some signs that personal goodwill may be present at an organization.
Goodwill is an intangible asset of a business and is generally defined as the propensity of customers to return to the business. Goodwill has value only to the extent that it can generate cash flow above a reasonable rate of return on the value of a company’s other assets, and assuming adequate compensation is paid to all individual employees for the services they perform.
Goodwill can generally be separated into two types: enterprise and personal. Enterprise goodwill results from the assemblage and collective operations of a business’s assets, location, reputation of the business, longevity and operating procedures, while personal goodwill arises from the reputation and skills of the individual.
According to acclaimed valuation expert Dr. Shannon Pratt , “… separation of personal versus enterprise goodwill depends on whether (or the extent to which) the customer returns because of the individual or elements that belong to the enterprise.”
Classification of goodwill is influenced by the types of products or services provided by the company, the individual’s participation in management and overall direction of the company, the individual’s relationships with and reputation among customers and suppliers, and company factors like size and complexity.
Some factors supporting enterprise and personal goodwill are:
| Factor | Supports Enterprise Goodwill | Supports Personal Goodwill |
|---|---|---|
| Organizational Structure | Entity has formalized operating policies, procedures and systems in place to help the business function. | Entity lacks formalized written policies and procedures; governance limited to one or a few select individuals. |
| Workforce | Roles and responsibilities are spread among owner- and non-owner managers with no reliance on key individuals. | Entity is reliant to one or a few select individuals to function. |
| Brand Recognition | Entity name and logo used on marketing materials without emphasis on individual employees. | Entity is reliant to one or a few select individuals to function. |
| Customer Relationships | Customers are served by teams of employees and relationships would largely stay intact if any individual employee left the business. | Customers have strong relationships with only one individual employee. If that employee were to leave, the customer would no longer do business with the entity. |
Personal goodwill is most common in professional service organizations (e.g., law firms, accounting firms, medical practices, etc.) where customers often base their purchasing decisions on the reputation, skill and knowledge of individual employees. In contrast, personal goodwill may not exist at a manufacturer of machinery where customers decide to purchase from the entity based on the quality of the product and reputation of the company/brand name.
About Schneider Downs Tax Services
Schneider Downs’ tax advisors have experience and expertise in a wide range of industries, including Automotive, Construction, Real Estate, Manufacturing, Energy & Resources, Higher Education, Not-for-profits, Transportation and others. Our industry knowledge and focus ensure the delivery of technical tax strategies that can be implemented as practical business initiatives. Schneider Downs has significant experience in preparing personal goodwill valuations and business valuations for gift and estate tax, financial reporting, buying/selling and a range of other purposes. Please contact Steve Thimons (412-697-5281; [email protected]) or Thomas D. Pratt (412-697-5615; [email protected]) for more information about our business valuation services.
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