It is common to value Personal Goodwill separately in divorce cases when State statute treats personal goodwill as a non-marital asset. Occasionally, but not often enough, personal goodwill is separately valued for tax purposes when the assets of a C Corporation are sold and the personal goodwill can be separately identified to avoid double taxation and obtain capital gains tax. The valuation of personal goodwill is a two-step process. Step one is the identification of the attributes associated with the existence of personal goodwill. Step two is to value the attributes held by the key person.
The existence of goodwill should be questioned in every asset transaction. In most privately held businesses, personal goodwill exists and is seldom contractually held by the business. Generally, the value of the personal goodwill is attempted to be captured in the non-compete agreement. However, the non-compete may not adequately address the total value of the personal goodwill, if at all.
The value of personal goodwill has been argued in numerous tax cases, most notably, Providence Mill Supply Co., O’Rear, Wyler, Watson, LaRue, Rudd, Martin Ice Cream Co., and Norwalk. In these cases the court consider key factors to identify the existence of personal goodwill and established the value of the personal goodwill based on the weight of each factor.
KEY FACTORS TO IDENTIFY THE EXISTENCE OF PERSONAL GOODWILL
- Does a non-compete agreement between the corporation and the key employee exist?
- Does the corporation have a contractual right to the future services of the key individual’s personal abilities, specialties, skills and expertise?
- Does the key employee have the experience, ability and capability to establish and operate a separate company?
- Is the location of the Company important to the value of the business?
- Is the name of the Company important to the value of the business?
- Has the Company contractually protected and secured its ownership and documented the Company processes, trade secrets, customer lists, and systems? Many of the processes, trade secrets, systems and customer relationships resonate in the personal ability, skill, experience and other personal characteristics or qualification of the key person and would remain with the key person if he or she left the Company.
- Does the corporation have an agreement with the key person assigning his or her future income to the corporation?
- What are the intentions of the key person and the buyer and seller?
- What contracts exists between the key personal and the Company, if any?
- Is general public patronage and encouragement received from constant and/or habitual customers on account of the Company’s local position, common celebrity, reputation for skill or affluence, punctuality, other accidental circumstances or necessities or even from ancient partialities or prejudices?
In many closely-held businesses, these key factors are seldom contractually transferred from key individuals to the business entity. When the existence of personal goodwill can be proven with an analysis of the key factors above, there is an opportunity to separately value the personal goodwill from the enterprise goodwill.
Check out Determining the Existence of Personal Goodwill – Part II for the next part of this discussion.