This article deals with people who own a service business and are the focal point in their business. In most states the assets owned by an individual going through a divorce must be valued. This includes a business that one spouse may own. The value of the business may include both tangible assets and intangible assets. The majority of the value of the intangible assets may be related to “goodwill”. Goodwill is defined as the characteristics of a business or individual that cause customers to return to that business or person.
In many cases, the value of the business or practice is determined based on the earning stream of the business. The concern to the spouse who owns the business, and who also has a spousal support obligation, is that the earning stream used to value the business is also used to pay the spousal support obligation. This is what is called the “Double Dip Theory”.
In many states, this situation is avoided when the portion of the business that is related to “Personal Goodwill” is excluded from the value of the business, or “Enterprise Goodwill”. Thus, it is very important to identify and differentiate Personal Goodwill from Enterprise Goodwill.
These two types of goodwill can be defined as follows:
- Enterprise Goodwill is associated with the entity itself. It takes into consideration issues such as location, qualified workforce, required licenses, name, etc. The key is that the value of the business is separate from the individual owner.
- Personal Goodwill is associated with the individual. It takes into consideration the individual’s age, health, personal reputation, training and effort. Customers return to the business because of the individual. The value of the business does not exist absent the individual.
The key is whether the Goodwill can be sold or transferred independent of the individual. Generally, Enterprise Goodwill is considered to be “saleable”, but Personal Goodwill is not. Here is a simple check list to determine Personal Goodwill or Enterprise Goodwill:
- Is the value of the business or professional practice inseparable from the actions, skill, the expertise and reputation of the individual owner?
- Is the value of the company, other than the hard assets, such that it cannot be Transferred without the individual?
- Can the economic benefits of the company to be transferred be realized only through the performance of post-divorce services of the individual?
- Is the revenue or the ability to acquire future income tied directly to the efforts of the individual?
- Is the ability of the entity to attract referrals separate and apart from the persona of the individual?
- In summary, make sure that your divorce attorney is aware of the key aspects of your business and the importance of you, individually, to the success of the business in an effort to avoid the perils of the Double Dip.
Bruce Richman (CPA/ABV, CVA, CDFA™), is the author of the book Guide to Tax and Financial Issues in Divorce. Since 1980, he has been actively involved in valuations, mergers and acquisitions and other financial and tax consulting matters. In his current position, Mr. Richman is responsible for various valuation projects and consulting services in the United States and, for U.S. clients, internationally.