4/29/2015
WHEN GOODWILL GOES BAD
Understanding Personal & Enterprise Goodwill
April 29, 2015
Rand Gambrell, CPA, ABV, CFE, CFF, CVA
Director
[email protected]
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4/29/2015
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TO START THINGS OFF
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4/29/2015
WHAT IS “GOODWILL?”
• “the probability that the old
customers will resort to the
old place.” Cruttwell v Lye, 34 Eng.
Rep. 129, 134 (1810)
 Indications of presence of
“goodwill”
• Revenue growth
• Improved margins
• INCREASED PROFITABILITY
 For financial reporting,
“goodwill” is split into
identifiable intangible assets.
The residual is considered
“goodwill”
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DIFFERENT TYPES OF GOODWILL
• Business/enterprise
goodwill
 Goodwill associated primarily
with institution
• Personal goodwill
 Goodwill associated primarily
with an individual
• Non-transferrable goodwill
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4/29/2015
SO THERE’S A DIFFERENCE … WHO CARES?
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• Financial reporting –
characterization is generally
already addressed
• Tax implications – value of
personal goodwill may
receive capital gain
treatment
• Divorce – personal goodwill
may not be a marital asset
• Shareholder disputes – is
goodwill subject to division?
• Bankruptcy – is goodwill an
asset of the estate?
STANDARD OF VALUE CAN IMPACT “GOODWILL”
• Fair market value
 Revenue Ruling 59-60 (willing
buyer/willing seller)
• Fair value
 Statutorily defined
• Investment value
 Value to a particular investor
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4/29/2015
GOODWILL IN THE TAX COURTS
• Martin Ice Cream Company
v Commissioner, 110 TC 189,
1998
 Personal goodwill is asset of
individual (thus, business
cannot sell it), avoids double
taxation
• Adell v Commissioner, TC
Memo, 2014-155
 Sale of a for-profit satellite
company (father) to not-forprofit religious network (son)
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GOODWILL OWNERSHIP GUIDELINES
• Business goodwill factors
• Personal goodwill factors
 “Capital” dependent
 “Relationship” dependent
 Written employment/non-
 No written employment/non-
compete agreement
 No controlling owner
 Manufacturer
 Owner controls
compete agreement
 Personal Service Corporation
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4/29/2015
GOODWILL IN FAMILY LAW
• Personal goodwill is a
marital asset (no distinction)
 Colorado
• Personal goodwill is NOT a
marital asset
 Illinois
 Missouri
 Texas
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GOODWILL IN OTHER DISPUTES
• Partnership disputes
 Keane v Lowcountry
Pediatrics, 372 S.C. 136 (2007)
• Bankruptcy
 In re Edward R. Fitzsimmons,
725 F.2d 1208 (1984)
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4/29/2015
OKAY, WE HAVE IT, BUT HOW DO WE VALUE IT?
• With & without approach
 Value enterprise twice,
difference is personal
goodwill
• Bottom up approach
 Value all assets, what’s left is
personal goodwill
• Top down approach
 Value enterprise, separate
goodwill value
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WITH & WITHOUT APPROACH
• Benefits
 Incorporates reasonable
compensation analysis
 Concept “makes sense”
Year 1
Cash Flow With
Capitalization Rate
Year 2
Year 3
Terminal Value
Discount Periods
Discount Factor
Present Value
Terminal
$ 250,000 $ 300,000 $ 350,000 $ 400,000
12%
3,333,333
0.50
0.9325
1.50
0.8109
2.50
0.7051
2.50
0.7051
233,125
243,270
246,785
2,350,333
Sum of Present Values
$ 3,074,000
 Compensation data may be
Cash Flow Without
Capitalization Rate
$ 187,500 $ 225,000 $ 262,500 $ 300,000
12%
limited
 Must understand level of
cooperation
 Inputs can be subjective
Terminal Value
• Disadvantages
Discount Periods
Discount Factor
Present Value
2,500,000
0.50
0.9325
1.50
0.8109
2.50
0.7051
2.50
0.7051
174,844
182,453
185,089
1,762,750
Sum of Present Values
$ 2,310,000
Difference
$ 764,000 Value of Personal Goodwill
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4/29/2015
BOTTOM UP APPROACH
• Benefits
Enterprise Value
Less: Debt
Equity Value
$
Tangible Assets
Cash
Receivables
Other Assets
$
Liabilities
Payables
3,074,000
(500,000)
2,574,000
350,000
500,000
25,000
875,000
1,949,000
Identified Intangibles
Tradename
Non-Compete Agreement
Customer Relationships
Workforce
400,000
150,000
1,000,000
200,000
Residual (Personal) Goodwill
$
intangible assets, not just
goodwill
• Disadvantages
 Time consuming
 Difficult to explain
(250,000)
Intangible Asset Value
 Value is allocated to all
 Multiple assumptions must be
justified
199,000
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TOP DOWN APPROACH – STEP 1
Enterprise Value
Less: Debt
Equity Value
Tangible Assets
Cash
Receivables
Other Assets
Liabilities
Payables
Goodwill Value
$
$
350,000
500,000
25,000
875,000
3,074,000
(500,000)
2,574,000
• First, enterprise value of
business is determined
• Second, subtract any
tangible asset value, to
determine “goodwill” value
(250,000)
$ 1,949,000
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4/29/2015
TOP DOWN APPROACH – STEP 2
• Multiattribute Utility Model
(“MUM”)
 Define attributes of
personal/enterprise goodwill
 Assign a value to “importance
utility” for each attribute
 Assign a value to “existence
utility” for each attribute
 Do the math
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TOP DOWN APPROACH – STEP 2
Personal Goodwill Attributes
Specialized Knowledge
Personal Reputation
Direct Customer Contact
Marketing & Branding
Total Utilities
Enterprise Goodwill Attributes
Company Sales Staff
Business Reputation
Multiple Locations
Formalized Processes
Total Utilities
Importance
Utility (1-5)
Existence
Utility (0-4)
Multiplicative
Utility
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4
5
3
4
4
2
4
20
16
10
12
21.51%
17.20%
10.75%
12.90%
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14
58
62.37%
4
4
2
3
4
1
3
3
16
4
6
9
17.20%
4.30%
6.45%
9.68%
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11
35
37.63%
93
100.00%
Percent
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4/29/2015
TOP DOWN APPROACH – CONCLUSION
Total Goodwill Value
$ 1,949,000
Attributable to Personal Goodwill
62.37%
1,215,591
Attributable to Enterprise Goodwill
37.63%
733,409
Adjusted Equity Value
Cash
Receivables
Other Assets
Payables
Enterprise Goodwill
Total (Enterprise) Equity Value
$
350,000
500,000
25,000
(250,000)
733,409
$ 1,358,409
• Benefits
 Uses a systematic approach to
value personal goodwill
 Easier to explain than
valuation of individual
intangibles
 Has survived a Daubert
challenge
• Disadvantages
 Inputs can still be attacked as
subjective
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QUESTIONS?
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4/29/2015
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4/29/2015
THANK YOU!
FOR MORE INFORMATION
Rand Gambrell, CPA, ABV, CFE, CFF, CVA
1700 Lincoln Street, Suite 1400
Denver, CO 80203
303.837.3594
[email protected]
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