Professional v. Enterprise Goodwill - A Deeper Dive
1. A Global Reach with a Local Perspective
www.decosimo.com
Professional v. Enterprise Goodwill
A Deeper Dive
Shannon Farr, CPA¡ABV¡CFF
Decosimo Advisory Services | 423.756.7100 | ShannonFarr@Decosimo.com
October 24, 2012
2. Shannon Farr, CPA, ABV, CFF
Business Valuation Manager
(800) 782-8382 | shannonfarr@decosimo.com
Shannon Farr is a valuation manager in Decosimoâs
Chattanooga office with more than 15 years of accounting
experience. Her practice has focused on business valuation
and litigation since 2004. She is accredited in business
valuation (ABV) and also certified in financial forensics (CFF).
Shannon provides valuation services to clients in a wide
variety of industries, with a focus on healthcare entities. Her
specialized expertise in this area assists hospital and health
system clients in ensuring their acquisitions meet industry
regulations surrounding the concepts of fair market value and
commercial reasonableness. Her litigation support experience
has been used in numerous marital dissolution cases as well
as contract and shareholder disputes involving physicians.
Shannon provides expert witness testimony, as well as serving
the court as Special Master.
3. What are we going to do today?
Discuss concepts of goodwill, professional/personal goodwill and
practice/enterprise goodwill
Discuss related concepts of standard of value, purpose of value
Discuss precedent-setting cases in Tennessee
Identify practical solutions to apply in professional practice valuations
Debates, questions, comments, etc. at the end of the presentation as time allows
4. Goodwill, defined
ď§ Goodwillâthat intangible asset arising as a result of
name, reputation, customer loyalty, location,
products, and similar factors not separately
identified. (SSVS #1 Glossary of Terms)
ď§ As defined by the Indiana Supreme Court (Yoon v.
Yoon):
âŚthe expectation of continued public patronage.
Jay Myoung Yoon v. Sunsook Yoon. Indiana Supreme Court, Cause
No. 49S02-9906-CV-353. Decided June 21, 1999.
711 N.E. 2d 1265; 1999 Ind. LEXIS 402
6. Other horizons
ď§ Tax implications - potential 20% rate differential may
apply in certain purchase price allocations
ď§ Debate over goodwill within âhealthcare fair market
valueâ transactions
ď§ Valuation for financial reporting â isolating the value
of identifiable intangible assets, including workforce-
in-place (although workforce-in-place is recorded as
part of goodwill)
7. I Scream for Ice CreamâŚ
âThis Court has long recognized that
personal relationships of a shareholder-
employee are not corporate assets when
the employee has no employment
contract with the corporation. Those
personal assets are entirely distinct from
the intangible corporate asset of
corporate goodwill.â
Martin Ice Cream Company v.
Commissioner, United States Tax
Court (Docket No. 1477-93., 110 TC --,
No. 18, 110 TC 189, Filed March 17,
1998.
See also Norwalk v. Commissioner, decided July 30, 1998 by the
United States Tax Court
8. Who Authorized This?
⢠State statutes ⢠Payment for ⢠Intangibles
Marital Dissolution
Financial Reporting
Healthcare Fair Market Value
⢠Case law goodwill may such as
be deemed customer
payment for relationships
referrals may be
⢠Evidence of separately
intangible identified
value must be ⢠Workforce-in-
documented place is part
of goodwill
From the FASB Codification Master Glossary â Goodwill: an asset representing the future economic
benefits arising from other assets acquired in a business combinationâŚthat are not individually
identified and separately recognized.
9. Concepts Spanning the Purposes
Who or what ⢠Owner-professionals
⢠Employed professionals
is generating ⢠Specialized equipment or
earnings? processes
Importance ⢠New customers
⢠Returning customers
of the ⢠Referrals
customer
11. Goodwill as a spectrum?
Pure Transferable Pure
Personal Personal Enterprise
Goodwill Goodwill Goodwill
12. Consider Size and Complexity
ď§ As a business increases in size and complexity, its
goodwill transitions from primarily personal to
enterprise
Personal Enterprise
goodwill goodwill
13. Dr. Shannon Pratt
ď§ Understanding the Difference Between Personal and
Enterprise Goodwill is Vital to the Identification of
Marital Assets
âŚthe separation of personal versus enterprise
goodwill depends on whether (or the extent to
which) the customer returns because of the
individual, or because of an element or elements
that belong to the enterprise.
Pratt, Shannon P. Business Valuation Resources, LLC. BVRâs
Guide to Personal v. Enterprise Goodwill, 2008 ed.; Ch.1.
14. Personal Goodwill, defined
ď§ âPersonal goodwill is a personal asset that depends
on the continued presence of a particular individual
and may be attributed to the individual ownerâs
personal skill, training or reputation.â (Supreme
Court of Appeals of West Virginia, May v. May, (No.
31123))
15. Elements of Personal Goodwill
knowledge relationships
specialized
reputation
skills
The
professionalâs personality
expertise
(charisma)
goodwill
16. Pure Personal Goodwill = Nontransferable
Attorney /
Legal Advisor
Personal Personal Personal
Physician Relationships
Goodwill
Expert
Witness
17. The Concept of Transferability
ď§ The concept of transferability is closely linked to
distinguishing between professional and enterprise
goodwill
18. Transferable Personal Goodwill
ď§ Can relationships be transferred?
ď§ A process that may occur over time
Oversee
transferred
Demonstrate relationship
trust
Client /
patient files
Introduce to aid the
patients / transfer of
Ensure clients / etc. knowledge
adequate
skills
19. Enterprise Goodwill, defined
ď§ âEnterprise goodwill is an asset of the business and
may be attributed to a business by virtue of its
existing arrangements with suppliers, customers or
others, and its anticipated future customer base due
to factors attributable to the business.â (Supreme
Court of Appeals of West Virginia, May v. May, (No.
31123))
20. Elements of Enterprise Goodwill
Operating
procedures/protocols
Staff/employees Reputation
The
Branding: name, logo,
Location, location,
location!
Business website, phone
number
Goodwill
21. Is Branding More Important than Ever?
Logos Quiz: free ap available from iTunes
22. Majority Rules
ď§ The majority of states, but not all, have precedent-
setting cases establishing enterprise goodwill
attributable to the business itself as a marital asset,
and personal goodwill intrinsically tied to the
attributes and skills of an individual, as not marital.
download
For a state-by- a free
âGoodwill
state download
Hunting in
summary, from BVR
Divorceâ-
23. Goodwill as a Marital Asset
ď§ In the event of a marital dissolution it may be
necessary for the court to:
ď§ First distinguish between personal and enterprise
goodwill and, then,
ď§ Decide which type of goodwill is a marital or
distributable asset.
A number of courts, but not a majority, make no distinction between personal and enterprise
goodwill. These jurisdictions have taken the position that both personal and enterprise goodwill in
a professional practice constitute marital property. A minority of courts have taken the position that
neither personal nor enterprise goodwill in a professional practice constitutes marital property. The
majority of states differentiate between enterprise goodwill and personal goodwill. Courts in these
states take the position that personal goodwill is not marital property, but that enterprise goodwill is
marital property.
Gordon, Noah J. Business Valuation Resources, LLC. BVRâs
Guide to Personal v. Enterprise Goodwill: Goodwill Valuation
in the Courts, 2008 ed.; Ch.2.
24. Standards of Value
Fair Value
(for
Fair Market shareholder
Value dissent and
oppression
cases)
Fair Value for
Investment
Financial
Value
Reporting
25. Fair Market Value
ď§ The fair market value standard contemplates a
hypothetical exchange.
ď§ Therefore, applying this standard theoretically limits
the value of goodwill to transferable personal goodwill
and enterprise goodwill
26. Fair Value
ď§ For state legal matters only, some states have laws
that use the term fair value in shareholder and
partner matters. For state legal matters only,
therefore, the term may be defined by statute or case
law in the particular jurisdiction.
ď§ In this context, fair value typically excludes
consideration of minority interest discounts
ď§ For financial reporting: the price that would be
received to sell an asset or paid to transfer a liability
in an orderly transaction between market
participants at the measurement date.
27. Investment Value
ď§ Investment value - the value to a particular investor
based on individual investment requirements and
expectations. (SSVS #1, Glossary of International
Business Terms)
ď§ Often referred to as âthe value to the holder,â
goodwill may not need to pass the transferability test
to carry value under this standard
28. âFor Purposes of Marital Dissolutionâ
ď§ Although the valuation analyst may or may not be
asked to assist in the determination of child support
or alimony, the basis of these determinations is the
partiesâ (presumably ongoing) current income.
ď§ If the income used in the support determinations is
generated by a spouseâs professional practice, it is
conceptually unreasonable to assume that the
professional is âwillingâ to sell his/her practice.
30. Tennessee Goodwill Decisions Continuum
Neither Personal nor Enterprise Goodwill is a
Enterprise Goodwill is Marital Asset, Personal
Considered a Marital Asset Goodwill is Not
Smith v. Smith, Witt v. Witt,
709 S.W.2d 588 No. 01-A-019110CH00360, 1992 WL 52746
(Tennessee Court of Appeals, 1985) (Tennessee Court of Appeals, 1992)
York v. York,
Hazard v. Hazard, No. 01-A-01-9104-CV-00131, 1992 WL 181710
833 S.W.2d 911 (Tennessee Court of Appeals, 1992)
Tennessee Court of Appeals, 1991
McKee v. McKee,
No. M2009-01502-COA-R3-CV
(Tennessee Court of Appeals, 2010)
31. Smith v. Smith (TN Court of Appeals 1985)
ď§ The wife appealed the Trial Judgeâs treatment of the
husbandâs law practice as a nonmarital asset.
ď§ The Tennessee Court of Appeals stated as follows:
âWe are not persuaded, however, that this state should adopt the
rule that professional goodwill is a part of the marital estate. We find
the position taken by the Wisconsin Court of Appeals in Holbrook v.
Holbrook, 103 Wis. 2d 327, 309 N.W.2d 343 (1981) to be persuasive.â
The valuation should include only physical assets and
accounts receivable
Smith v. Smith, 709 S.W.2d 588
Tennessee Court of Appeals, 1985.
32. Eberting v Eberting (TN Court of App. 2011)
ď§ The Tennessee Court of Appeals upheld the trial
courtâs value of $500,000 and held to Smith, stating
as follows:
âWe agree that âprofessional goodwill is not a marital asset which
would be accounted for in making an equity distribution of the marital
estate.ââ (quoting Smith).
ď§ The Court emphasized that other evidence of value (in addition to the
two expert opinions, which were $224,000 (H) and $700,000 (W)) was
presented at trial: the price that Husband paid to purchase the
practice, Husbandâs testimony that he would be upset to sell the
practice for $224,000, and values presented on recent financial
statements (among other factors).
Specific facts and circumstances should always be
Eberting v. Eberting, No. E2010- considered
02471-COA-R3-CV, Tenn. Court of
App. 2011.
33. McKee v. McKee (TN Court of Appeals)
ď§ The wife (a pediatric dentist) owned a one-third interest in
the dental practice of which she was a partner.
ď§ The two experts testifying at trial agreed that it was
inappropriate to consider personal goodwill in valuing a
business for divorce purposes, but they differed in their
categorization of patient files. The wifeâs expert testified
that no value should be attributed to the patient records
in the context of the divorce proceeding because it
equates to personal goodwill.
ď§ Key points of his testimony included:
ď§ Patient records are not capable of earning money âwithout
a professional providing the service,â and
ď§ The presence of the restrictive covenant in the wifeâs
partnership agreement was âproofâ of the existence of
personal goodwill
McKee v. McKee, No. M2009-01502-COA-R3-CV
(Tennessee Court of Appeals, 2010)
34. Witt v. Witt (TN Court of Appeals)
ď§ The Husband was the chief of radiological services
at a hospital and also operated a diagnostic clinic
with eight technicians that provided services to
referring physicians.
ď§ The Court approved the trial courtâs finding that the
value of the husbandâs medical practice
substantially exceeded the net asset value even if
the husbandâs professional goodwill were excluded.
Witt v. Witt, No. 01-A-019110CH00360, 1992 WL 52746
Tennessee Court of Appeals, 1992.
35. York v. York (TN 1992)
ď§ Although husband originally had a solo surgical practice,
at the time of divorce he owned 85% of an incorporated
multi-specialty medical group employing 11 physicians,
10 nurses, a psychologist and an optometrist. The
company also owned an office building housing
physician offices, an ambulatory clinic, an optical store,
and space for an endoscopy clinic.
ď§ Husband âinsistedâ that any valuation of the company
should, as a matter of law, not include business goodwill
(citing Smith).
ď§ However, the appeals court ruled that Smithâs ânet asset
value principlesâ did not apply to incorporated
professional practices that do not depend solely on the
professional reputation of the practitioner (citing Witt).
37. Harmon v Harmon (TN Court of Appeals)
One issue on appeal was
whether the value
established by the buy-sell
governed the value
The Court found that factors
specifically excluded from the
buy-sell (like A/R) were
pertinent to the value and
should be considered
The trial court may also
consider whether the
limitations created by the
buy-sell affect the value
See also Bertuca v Bertuca, No. M2006-00852-COA-R3-CV,
Tenn. Court App., May 10, 2007
38. Personal Goodwill Is Not Just for
ProfessionalsâŚ
Contacts and
Relationships
Specialized
Reputation
Skills
Owner â or
employee
â of any
business
39. Alsup v Alsup (TN Court of Appeals)
The Court found that the
goodwill of Ms. Judyâs
Daycare would be
âvaluelessâ without Judy
Alsup
Also found that the fact
Extended concepts of Cites Koch v. Koch: ââŚa
Ms. Judyâs was
professional sole proprietorship is
organized as a
practitioner's goodwill analogous toâŚa
corporation had no
from Smith and Hazard professional practiceâ
effect
40.
41. Company/Practice Analysis
ď§ How is revenue generated? From the owner-
professionalâs efforts only? Or from employee-
professionals efforts as well?
ď§ How many employees does the practice have? What
are their functions? Do they have credentials/
certifications? Are they âhighly trainedâ?
ď§ How are the facilities contributing to patronage? Is
location a factor?
ď§ What equipment is in place? Is equipment integral to
the services provided?
ď§ How does the entity compare to other entities within
the same professional (smaller, larger, etc.)?
42. The Asset Approach
ď§ Asset approach â typically excludes all intangible
assets, including goodwill (whether personal or
enterprise)
ď§ Likely the best approach for valuing professional practices
similar to that in Smith
ď§ Can be used in conjunction with determinations of the value
of enterprise goodwill components such as a trained and
assembled workforce
43. The Income Approach
ď§ Often an option to value a professional practice
with enterprise characteristics
ď§ The discount rate/capitalization rate can be adjusted to
consider key man factors
ď§ The excess earnings method could be used to determine the
value apart from personal goodwill
ď§ If cash flows from ancillary services (services provided
without the direct effort of the professional) can be isolated,
these income streams can be capitalized
45. The Concept of âDouble-dippingâ
ď§ In Holbrook v. Holbrook, the (Wisconsin) Court said:
The concept of professional goodwill evanesces when one
attempts to distinguish it from future earnings
capacity. Although a professional businessâs reputation,
which is essentially what its goodwill consists of, is
certainly a thing of value, we do not believe that it bestows
on those who have an ownership interest in the business,
an actual, separate property interest. The reputation of a
law firm or some other professional business is valuable to
its individual owners to the extent that it assures
continued substantial earnings in the future. It cannot
be separately sold or pledged by the individual owners.
The goodwill or reputation of such a business accrues to
the benefit of the owners only through increased salary.
46. The Market Approach: An âUnwillingâ
Seller?
ď§ Many courts have considered the âunwillingâ seller
issue. This concept is sometimes referred to as
âvalue to the holder.â Quite simply, these courts
have considered the fact that the owner-professional
spouse is not a âwilling sellerâ as contemplated by
the definition of fair market value.
ď§ A covenant not-to-compete is an essential element in
this consideration
ď§ In these jurisdictions, the M&A method results likely
will not apply/be considered
47. Another thoughtâŚ
ď§ Do judges follow King Solomon's âsplit the babyâ
advice?
âIf the evidence of value is conflicting, the trial judge
may assign a value that is within the range of values
supported by the evidence. See Ray v Ray, 916 S. W.
2d 469, 470 (Tenn. Ct. App. 1995)â
From Cunningham v Cunningham, No. W1999-
02054-COA-R3-CV (Tenn. Ct. App. 2000)
48. David Woodâs MUM
ď§ The Multi-attribute Utility Model (MUM) was
developed by David N. Wood, CPA/ABV, CVA âto
allocate enterprise and personal goodwill by
assessing the utility of each attribute identified.â
ď§ MUM was first described in 2004 in the American
Journal of Family Law.
ď§ A methodology that âbring[s] more objectivity and
consistency to these [subjective] judgments and
decisions, and provide[s] results that are better
understood and more meaningful to those who
depend on the valuations.â
Source: âGoodwill Attributes: Assessing Utilityâ by David N. Wood,
CPA/ABV, CVA, The Value Examiner, January/February 2007.
49. MUMâs Seven-step Guide
Define an objective
Establish the alternatives
Define the attributes
Determine each attributeâs importance and existence utilities
Aggregate the results
Fit the results to the alternative and analyze the outcomes
Express an opinion
Source: âGoodwill Attributes: Assessing Utilityâ by David N. Wood,
CPA/ABV, CVA, The Value Examiner, January/February 2007.
50.
51. Step 1: Define the objective
âStep Zeroâ: Determine the value of the business (or
practice) including all tangible and intangible assets.
⢠For purposes of this example:
⢠Value of equity = $1 million
⢠Net tangible assets value = $200,000
⢠Goodwill/intangible value indicated = $800,000
Step 1: Our objective is to âdetermine the value of the two
elements of goodwill, personal and enterprise, from the
total goodwill, such that a reasonable, well founded basis
can be communicated as the support for the opinion of
value.â
Source: âGoodwill Attributes: Assessing Utilityâ by David N. Wood,
CPA/ABV, CVA, The Value Examiner, January/February 2007.
52. Step 2: Establish the Alternatives
FIVE ALTERNATIVE RANGES
ALTERNATIVE FROM (1) TO (1) OUTCOME (2)
1 0% 20% 10%
2 20% 40% 30%
3 40% 60% 50%
4 60% 80% 70%
5 80% 100% 90%
(1) A range of percentages of personal goodwill assigned to each alternative.
(2) A specific personal goodwill percentage within the range. Enterprise goodwill
is the reciprocal percentage.
Source: âGoodwill Attributes: Assessing Utilityâ by David N. Wood,
CPA/ABV, CVA, The Value Examiner, January/February 2007.
53. Step 3: Define the Attributes
Personal Enterprise
Attributes Attributes
Skills and Business name
knowledge and reputation
Age and health Branding
Personal Staff/workforce-
relationships in-place
These attributes are specific to the engagement
54. Step 4a: Determine the Attributesâ
Importance Utility Weight
1 3 5
Least Moderately Most
Important Important Important
How important is each selected attribute to
making an allocation between enterprise and
personal goodwill?
55. Step 4b: Determine the Attributesâ Existence
Utility Weights
0 1 2 3 4
Weak Below Moderate Above Strong
Presence Average Presence Average Presence
How present is each selected attribute?
Source: âGoodwill Attributes: Assessing Utilityâ by David N. Wood,
CPA/ABV, CVA, The Value Examiner, January/February 2007.
56. Step 5: Aggregate the Results
Importance Existence Multiplicative Percent
Utility Utility Utility
Personal Attributes
Skills and knowledge 5 4 20 35%
Age and health 3 1 3 5%
Personal relationships 3 3 9 16%
Total Personal Utility 11 8 32 56%
Enterprise Attributes
Business name/reputation 3 2 6 11%
Branding 3 1 3 5%
Workforce-in-place 4 4 16 28%
Total Enterprise Utility 10 7 25 44%
Total Multiplicative Utility 57 100%
This analysis is specific to the engagement
57. Step 6: Fit the Results to the Alternative and
Analyze the Outcome
FIVE ALTERNATIVE RANGES
ALTERNATIVE FROM TO OUTCOME
1 0% 20% 10%
2 20% 40% 30%
3 40% 60% 50%
4 60% 80% 70%
5 80% 100% 90%
The outcome is expressed as the percentage of personal goodwill; the reciprocal
is the percentage of enterprise goodwill.
âReview and analyze the outcome using sensitivity analysis to challenge and
confirm the assessments.â
Source: âGoodwill Attributes: Assessing Utilityâ by David N. Wood,
CPA/ABV, CVA, The Value Examiner, January/February 2007.
58. Step 7: Express an Opinion
Based on this analysis, we estimate that the value
of equity includes $400,000 of personal goodwill
value and $400,000 of enterprise goodwill value.
⢠Remember, for purposes of this example:
⢠Value of equity = $1 million
⢠Net tangible assets value = $200,000
⢠Goodwill/intangible value indicated = $800,000
âThis opinion may be expressed as an opinion of
value or as an estimate of value.â
Source: âGoodwill Attributes: Assessing Utilityâ by David N. Wood,
CPA/ABV, CVA, The Value Examiner, January/February 2007.
59. Other Valuation Techniques and Methods
With-and-without Multi-period
Cost to replicate
discounted cash excess earnings
(workforce-in-
flow (non-compete method (customer-
place)
agreements) related intangibles)
Relief-from-royalty
Relief-from-royalty
(proprietary
(branding-related
process
intangibles)
intangibles)
60. Resources
ď§ âGoodwill Hunting in Divorceâ free download available at
www.bvresources.com
ď§ Valuing Small Businesses and Professional Practices, Pratt, Reilly and
Schweihs
ď§ BVRâs Guide to Personal and Professional Goodwill
ď§ Wood, David N., CPA/ABV, CVA, âGoodwill Attributes: Assessing Utility,â
The Value Examiner, January/February 2007
ď§ Smith v Smith, 709 S.W.2d 558 (Tenn. App. 1985)
ď§ McKee v McKee, No. M2009-01502-COA-R3-CV (Tenn. Ct. App., Aug. 17,
2010)
ď§ Witt v. Witt, No. 01-A-019110CH00360, 1992 WL 52746 (Tenn. Ct. App., Mar.
20, 1992)
ď§ York v York, No. 01-A-01-9104-CV-00131, 1992 WL 181710 (Tenn. Ct. App.,
Jul. 31, 1992)
ď§ Harmon v Harmon, 2000 Tenn. App. LEXIS 137 (Tenn. Ct. App., March 2,
2000
ď§ Alsup v Alsup, 1996 Tenn. App. LEXIS 425 (Tenn. Ct. App., July 24, 1996)
ď§ Eberting v Eberting, No. E2010-02471-COA-R3-CV (Tenn. Ct. App., Nov. 8,
2011)
61. CONTACT SHANNON FARR
Shannon Farr
ShannonFarr@decosimo.com
423-756-7100
DISCLAIMER: The contents and opinions contained in this presentation are for informational purposes
only. The information is not intended to be a substitute for professional accounting counsel. Always seek
the advice of your accountant or other financial planner with any questions you may have regarding your
financial goals.