Valuing personal goodwill in a business
Valuing personal goodwill in a business requires specialist expertise to avoid leaving significant value on the table.
Owner operator businesses and partnerships are unique to other enterprises in that the business’ performance (and hence value) are highly reliant on the owner/individual driving the business. Business valuations assess the importance of the owner’s involvement by evaluating the nature of the goodwill contained in the business’ value as either personal goodwill or enterprise goodwill.
Personal goodwill (generally non-transferable) attaches to the individual and enterprise goodwill (generally transferable) is derived from characteristics specific to a business, regardless of the owner/operator.
It is important to distinguish between the two categorisations for tax purposes (ATO Tax Ruling 1999/16), for consideration in matters subject to Court proceedings, and/or for disposal or acquisition of businesses. It is especially important to isolate personal goodwill within a Family Law matter, as seen in Wall & Wall, for the purposes of asset division, as it may be considered a financial resource being of a future financial benefit as opposed to owned property for distribution.
Intangible Assets, such as goodwill, are those assets that make up the remaining value of a business after deducting the value of its tangible assets. For example, a hairdressing salon may be valued at $100K with $50K of plant & equipment and $25K in other intangible assets (trademarks, patents, or contracts), and would therefore hold $25K in goodwill.
Classifying goodwill between enterprise goodwill and personal goodwill is an inherently difficult task, and often even more difficult when dealing with a service business. The hairdresser goodwill ($25K) could be attributed to personal goodwill or enterprise goodwill depending on the nature of the business and circumstances of revenue earned as:
- Enterprise goodwill would be categorised if the hair dresser receives earnings tied directly to the enterprise such as location, business model, and mechanism for distributing profit. For example, the goodwill calculated would likely have a large enterprise component if the salon was located in a high traffic area, had consistent profit margins over a long period of time, low stylist turnover and a well-understood commission structure; or
- Personal goodwill would be categorised if the hairdresser receives earnings tied directly to their personal skills, relationships, reputation, and repeat clientele. A large personal goodwill component would be assigned if the owner was the central stylist and they were strongly familiar with most of the customers.
In determining the value of goodwill, it is important to carefully evaluated the business’ attributes. We often consider:
- the business’s customer base and sources of revenue;
- the source of the business’s customer base i.e casual walk-in walk-out customers or relationships that are developed between key personnel and those customers;
- the existence of non-compete agreements (as these can indicate the existence of personal goodwill);
- the business structure;
- information sourced from interviews with directors, company management, and/or key personnel;
- historical and projected financial data; and
- market information.
We are often able to add significant value in a situation where you need valuation services for either:
- sale of business;
- merging with another business;
- family law matters – the business forms part of your asset pool;
- for litigation purposes; and/or
- to obtain finance.
Contact Hollie Ponton, Head of Forensic Accounting, to discuss further on +61 8 6145 0700 or via email on firstname.lastname@example.org