Business owners typically focus on creating sustainable value that would endure even in their absence. After all, a buyer will only pay for the value of an enterprise which can actually be transferred in an acquisition. “Goodwill” is a concept that is often raised when positioning a business for sale, but what does is mean and what are its implications for the sale of your business?
In this context, goodwill is an accounting concept that is generally defined as the value of an acquired business over and above its identifiable tangible and intangible assets. If a business is purchased for $10 million but has identifiable (net) assets of only $7 million, the difference of $3 million would be recorded by the acquirer as goodwill. In an economic sense, goodwill is the value created over and above the identifiable net assets residing in a business enterprise.
In a corporate acquisition, goodwill can be identified as either “personal” or “business” goodwill. The value of goodwill may be attributable to the owners personally, to the company, or to a combination of both. Whereas a cardiology practice is likely to have more personal goodwill, a branded consumer products company would be likely to have more goodwill attributable to the business.
So what’s the difference and why does it matter?
The Impact: Economics vs. Taxes
From an economic standpoint, a business owner planning for the sale of his business would be wise to focus on increasing business goodwill. Buyers will only pay for earnings that are “portable,” and thus an enterprise which has been successful primarily as result of its owners’ or executives’ personal goodwill may be less marketable and command a lower price.
However, from a tax standpoint, it is important for sellers of a business to appreciate the implications of assigning goodwill to the seller personally as opposed to the business or assets being sold. In a transaction structured as an asset sale (versus a stock sale), double-taxation on distribution of the sale proceeds can be avoided by identifying value attributable to personal goodwill rather than business goodwill associated with the acquired assets or trade name.
Assigning Personal vs. Business Goodwill
Whether the value of your business is related to personal or business goodwill, consider several factors that help to separate the types of goodwill. Ultimately, the determination of personal versus business goodwill in a given case will depend upon the facts and circumstances.
Age, reputation, and duration of professional practice are key factors in assessing personal versus business goodwill. A relatively young business owner may not have sufficient industry exposure to have developed personal goodwill, while an owner nearing retirement may have a limited window and ability to leverage relationships and generate a continuing earnings stream. Conversely, a highly-reputed, experienced individual in her prime would be more likely to have substantial personal goodwill. In such a situation, a seller in an asset transaction may find significant tax advantages of identifying personal rather than business goodwill.