Measuring Enterprise and Personal Goodwill

3 08 2012

By: George D. Abraham

CEO & Chief Appraiser

Business Evaluation Systems

 

 

In the state of Texas and several other states, appraisals for divorce, requires the appraiser to consider and analyze personal and enterprise goodwill in the dissolution of marital assets. Personal goodwill is not considered part of the marital assets to be divided.

The American Journal of Family Law states that Goodwill is “that intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors not separately identified.[1]  It can be separated into two parts, defined as follows:

  • Personal goodwill is the value of earnings or cash flow directly attributable to the individual’s characteristics or attributes.  Personal goodwill, sometimes referred to as professional goodwill, is a function of the earnings form repeat business (customers) that will patronize the individual practitioner as opposed to the business, new consumers who seek out the individual, and new referrals who will be made to the individual. 

 

  • Enterprise goodwill is the value of earnings or cash flow directly attributable to the enterprise’s characteristics or attributes.  Enterprise goodwill, sometimes referred to as practice goodwill is a function of earnings from repeat business (customers) that will seek out the business (as opposed to the individual), new consumers who will seek out the business, and new referrals who will be made to the business.

Most appraisers approach the allocation by simply dividing the attributes into personal and enterprise, but you can take it one step further which offers a reasonable position if challenged and provides a consistent method and a defensible bases for your opinion.  

Once the appraiser has a solid goodwill value, the analysis of personal and enterprise goodwill can begin by analyzing the attributes that make up goodwill. The appraiser must keep in mind that the process requires several key factors:

  • The attributes that impact personal goodwill are a percentage within a range.
  •  Enterprise goodwill is the reciprocal percentage.
  • Does the presence of this attribute add to the earnings of the business? The greater the impact on earnings, the greater is the presence of the attribute.
  • The difference between total goodwill and personal goodwill is the enterprise goodwill.

Goodwill Attributes

Personal Attributes

These are attributes that relate directly to the ‘goodwill subject”. This is the person for whom the goodwill allocation is being performed (physician, architect, accountant, etc). Personal attributes reflect the efforts by the goodwill subject and are inherent in the individual.  These personal attributes indicate personal goodwill, including:

 

 

  • Ability, Skills, and Judgment.  These attributes focuses on the “doing” by the goodwill subject;        e.g., the ability to perform at a level to generate sufficient earnings to establish goodwill.  The            goodwill subject’s education, training and demonstrated ability will almost always be important             personal attributes.

 

  • Age and health.  These are significant as they help determine the longevity of the subject’s   impact on earnings. Underlying all value is the time frame for cash flow or earnings.  Older and less healthy subjects could mean a shorter and more uncertain stream of future earnings, and      thus, a lesser personal goodwill allocation.

 

  • Personal Reputation. This is the customer’s perception about the person’s ability, skills and judgment.

 

Business Attributes

These are the result of decisions that affect the business organization, operations, finances, and image.  If the goodwill subject makes decisions that improve enterprise attributes, this increases enterprise and not personal goodwill. Examples of business attributes to the enterprise include:

  • Location, location, location.  There is a multiple location attribute and the business location attribute. Keep in mind that multiple locations do not mean a strong indication of enterprise goodwill. The appraiser must understand how the locations are being used.

 

  • Systems and organization.  This encompasses the management decisions that determine how the business performs. These are well defined and maintained systems that make the business strong are a good indication of enterprise goodwill, even if the goodwill subject created the systems.

 

  •  Business reputation. If the customer’s perception about the product or service, including price, customer support, quality and satisfaction are on the business, the characteristic is enterprise.  In some cases the customers commonly associate a business with an individual, but it is the business reputation they are counting on.  Keep in mind that some businesses have both personal and enterprise attributes that the appraiser must separate and analyze.

 

  • Staffing. Staffing encompasses all the employees of the business, other than the goodwill subject. Usually employees are associated with enterprise goodwill, but there are times when employees may seek a position because of the personal reputation of the goodwill subjects training that would add value to their own resume.

 

  • Personalized business name.  This is the most misunderstood attribute as it is automatically assumed that if the business carries the subject’s name, all is personal goodwill. However, many businesses are sold and carry on with the personalized name and others change the name sometime after the purchase. The question to address is:  “Would the customers abandon the business solely because it changed its name?”
  • Closeness of contact. Sometimes the goodwill subject’s work habit includes more contact with the customer, and the more direct contact, the more likely the subject will have personal goodwill. (Dentists have close contact, while radiologists do not.) However, it is not so much the closeness of the contact as it is the personal nature of the contact.

 

  •  Closeness of contact. Sometimes the goodwill subject’s work habit includes more contact with the customer, and the more direct contact, the more likely the subject will have personal goodwill. (Dentists have close contact, while radiologists do not.) However, it is not so much the closeness of the contact as it is the personal nature of the contact.

 

  • Referrals. Referrals to a goodwill subject often indicate a high level of respect for one’s abilities and are personal in nature and increase the individual’s personal goodwill. However, referrals can certainly be made to a business and those referrals would support a greater enterprise allocation.
  • Repeating revenue stream.  This attribute deals with the specific nature of the revenue stream and is the heart of goodwill. Repeating business can be due to either enterprise or personal goodwill.  However, some businesses are more likely to enjoy repeat business by the nature of their industry and are not concerned with the reason for the repeating business, such as a great location.

 In summary, the appraiser will analyze and separate each of the attributes into personal and enterprise goodwill by establishing a range with each attribute weighted according to its importance (impact on earnings).  Each attribute is then given a weighting as to its degree of existence.  The value of an attribute established by multiplying the degree of existence by the degree of importance represents a percentage of  100%.  As personal goodwill increases, enterprise goodwill decreases by the same amount. 

 


[1] Article: An Allocation Model for Distinguishing Enterprise Goodwill from Personal Goodwill,” American Journal of Family Law

 

 

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