Winter 2017: Recognizing Personal Goodwill - And is any of it transferable?

By Stephen J. Bravo*

*The author wishes to thank Michael Mattson for his assistance and insights with this article

In recent years there has been quite a bit written about whether the value of a profitable business is due to the personal efforts of an individual or if it is because of the cohesive efforts of an enterprise. When a business has value more than the values of its individual tangible parts (e.g., its furniture and equipment, trade receivables, cash, etc.) it likely has some sort of “goodwill.”

Goodwill is an intangible asset.1  Conceptually, goodwill is based in old English law dating from the early 1800s. It “is the probability that customers will return to the old stand.”2  In the early 1900s in the United States, Justice Cardozo captured the essence that goodwill was the tendency for customers to return to the same location or business because of its name or other reasons, regardless of its location.3  It usually does not appear on a company’s balance sheet, but it is an important asset in determining the enterprise’s profitability.

In a valuation context, not only is it important to acknowledge that a company has goodwill, it is important to know “whose goodwill is it?” The answer will help determine what the business is worth, or not worth for that matter. It also helps answer another important question: Is the business transferable to an unrelated third party who would expect to continue to receive the same economic benefits as the seller?

When valuing a business, goodwill is generally computed as the total value of an enterprise less the market values of other assets, such as current assets, investments, fixed assets, and other identifiable intangible assets whose value can be determined through other means. In other words, goodwill is the residual asset; it is the value, if any that remains, after all other tangible and intangible assets have been assigned values.4

If goodwill does exist, the next step is to separate it into two parts: personal goodwill and enterprise goodwill. A generally accepted definition for each 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 from repeat business that will patronize the individual as opposed to the business, new clients who will seek out the individual, and new referrals that 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 the earnings from repeat business that will patronize the business as opposed to the individual, new clients who will seek out the business, and new referrals that will be made to the business.5

Making the distinction between the two sounds easy enough; however, why is it, in practice, so difficult to allocated between these two types of goodwill? Business appraisers often have differing views concerning personal goodwill and enterprise goodwill when valuing smaller companies, particularly service firms. Although the underpinnings of valuation theory are the same regardless of business size, valuation is a question of fact, and it is the relevance of those facts that can help identify characteristics specific to the business being valued. Gaining an understanding of these characteristics can bring clarity and can aid the business appraiser in determining the appropriate valuation procedures to use.

In smaller businesses, there is often little depth at the management level, with perhaps only a few or maybe even only one owner/key employee (“specialist” or “key person”). This places more importance on the key person’s role regarding the future viability of the business. It is in these types of businesses where the issue of personal goodwill becomes most relevant.

An important indicator about whether there might be personal goodwill is if there is a key person in the organization. For personal goodwill to exist, this person should be client-facing (rather than a back-office person) and be responsible for generating and performing new and existing business. In a service business, is this key person explicitly cited in contracts with clients as performing a significant portion of the services? Would the client have engaged the business without having this key person involved? As with any key person, if this person were to leave the business there would be a substantial loss of revenues and/or profitability.

Here are two initial questions to ask:

  • What services generate income for the business?
  • Are the services from the sole efforts of the specialist or by others?

Consider the following factors6  when attempting to answer these questions:

  • Is there a difference between a business having a specialty and the business having a specialist in the area?
  • Is it difficult to make a clear distinction between the business specialist and the business specialty value?
  • Business value is created when attributes are transferable to new owners, with or without the specialist.
  • Business value is created when the specialist makes the effort to transfer knowledge, contracts and referral sources to the business.
  • Is the business name and reputation recognized and highly regarded in the marketplace?
  • Is the business brand name considered top-of-mind when clients are making their purchasing decisions?
  • Is the business building brand awareness through various media channels or is the focus on the specialist?
  • Does the business have a critical mass and diversified client base?
  • Are operating procedures in place and consistently used to support the businesses services?
  • Are these operating procedures repeatable?
  • Would the loss of the specialist have a material impact on the business?
  • Is the specialist replaceable?
  • Are covenants not to compete and other employment agreements in force?

These factors are mostly economic or operational in nature. The last factor, however is a legal consideration. What asset(s) does the business own to protect its right to generate future income? Agreements, such as non-competes, employment and non-solicitation are examples of property that can be owned by a business.7   However, if the business does not have these types of contractual rights in-force, how can it sell the economic benefits to an unrelated party? Who would pay for economic benefits without ensuring that the seller could not immediately compete and solicit the businesses customers? The Tax Court, in answering these questions, has indicated that personal goodwill only exists when an individual has the right to sell the goodwill.8    On the other hand personal goodwill is transferred to a business and, therefore, no longer exists when agreements, like those mentioned above, are in-force. These agreements are property of the business, providing exclusive rights to ensure that the individual can no longer benefit from the goodwill without working for the business.

Below are excerpts from and some commentary by others regarding several matrimonial and tax cases where Courts have decided if goodwill was owned by the individual or by the business.

Matrimonial Cases

GOLDMAN – Massachusetts – 28 Mass. App. Ct. 603 – 10/12/89, 1/19/90-5/24/90

“We reject the wife’s most significant claim of error in valuation, the failure of the judge to allocate any amount to the goodwill of the husband’s professional corporation. The judge was warranted in accepting the husband’s accountant’s opinion that there was no goodwill in this one-man professional corporation.”

Under Massachusetts law, covenant not to compete agreements are enforceable except for specific professions, such as doctors (FALMOUTH OB-GYN VS. ABISIA, 629 N.E. 2d 491, 417 Mass 176).

CHAMPION – Massachusetts, 54 Mass. Appendix. Ct. 215 (2002)

Husband operated a telecommunications business. Husband’s expert made distinction between personal goodwill and enterprise goodwill. Court agreed that any goodwill generated by the business was personal goodwill and would not be transferable to any potential successors in ownership.

AHERN – Maine - January 3, 2008 Superior Judicial Court 2008 ME Han 06-738

The case involved the valuation of a dental practice. “We now adopt the enterprise/personal framework for evaluating the goodwill of a professional practice in the context of an equitable distribution of property.” Both parties’ appraisal experts “unequivocally” testified that the goodwill value of the dental practice resulted from the husband’s skill and reputation. “Although we do not presume to address all possible permutations of the enterprise/goodwill distinction-and we caution that these categories could prove overly simplistic when applied to the circumstances of other cases.” The Court had “no difficulty” concluding that the personal goodwill value of the dental practice was “not a species of property subject to equitable division.”

MORETTI – Rhode Island 766 A.2d 925 RI 2001

Neither appraiser attempted to evaluate enterprise goodwill, as opposed to personal goodwill. Court remanded the case back to the family court so that enterprise goodwill may be evaluated.

LOPEZ – California - In the Marriage of Lopez, 113 Cal Rptr. 58 (38 Cal. Appendix. 3d 1044 (1974)

With respect to professional practices this case suggests several factors should be considered:
  • Age and health of the individual
  • Individual’s demonstrated earning power
  • Individual’s reputation in the community for judgment, skill and knowledge
  • Individual’s comparative professional success
  • The nature and duration of the professional’s practice as a sole proprietor as a contributing member of a corporation

Tax Cases

MARTIN ICE CREAM 110 TC 189, 1998

The corporation was in the business of distributing ice cream to supermarkets, grocery stores, and food-service accounts. Arnold, who owned 51% of the corporation, had an oral agreement with an ice cream company that the corporation would act as a distributor of its ice cream. Arnold also had longstanding relationships with the owners and managers of supermarket chains. Arnold did not have an employment contract with the corporation nor did he sign a covenant not to compete. The Tax Court held that the valuable intangible assets embodied in Arnold’s oral distribution agreement with the ice cream company and his relationships with the supermarket chains were not owned by the corporation. Rather, Arnold was the sole owner of these intangibles and made them available to the corporation by working for it. Thus, the value of the corporation’s goodwill was zero.

The corporation’s client list was held to have no value in the hands of the liquidating corporation because no covenant not to compete agreement with the corporation was effective against the shareholders.

The Tax Court’s considered the following issues:
  • Do personal relationships exist between customers or suppliers and the owner/manager of the business?
  • Do these relationships (customer or supplier) persist in the absence of formal contractual obligations?
  • Does the owner/manager’s personal reputation and/or perception in the industry provide an intangible benefit to his business?
  • Are the practices of the owner/manager innovative or distinguishable in his or her industry, such that the owner/manager is regarded as having added value to that particular industry?
  • With respect to the above factors, is the owner/manager currently under any employment agreement or covenant not to compete with the business?

NORWALK: William Norwalk, TC Memo 1998-279

The IRS argued that a professional accountancy corporation owned approximately $580,000 of intangibles when it liquidated. However, the Tax Court concluded that the goodwill associated with the practice was not a component of the corporation’s value but rather was a personal asset of the shareholders. Further, the corporation’s client list was held to have no value in the hands of the liquidating corporation, because no noncompete agreement with the corporation was effective against the shareholders. Without such a noncompete agreement, the shareholders were free to take the corporation’s clients and serve them individually, rendering the client list valueless to the liquidating corporation.

The court noted the importance of the lack of a noncompetition agreement between the shareholder-employees and the corporation by stating “there is no salable goodwill where, as here, the business of a corporation is dependent upon its key employees, unless they enter into a covenant not to compete with the corporation or other agreement whereby their personal relationships with clients become property of the corporation.”

Citing MACDONALD (below) the Tax Court in Norwalk stated: “We find no authority which holds that an individual’s personal ability is part of the assets of a corporation by which he is employed where, as in the instant case, the corporation does not have a right by contract or otherwise to the future services of the individual.”

MACDONALD - 3 TC 720 (1944)

The Tax Court acknowledged that any value the business had, in addition to the tangible assets, was due to the personal ability, business acquaintanceship and other individualistic qualities of D.K. MacDonald and then concluded that a person’s personal ability is not part of the assets of a corporation by which he is employed where the corporation does not have a right by contract or otherwise to the future services of that individual. “The insurance business was personal in its nature and depended very largely upon the personal relation between Mac Donald and the customers.” The Tax Court held that no goodwill was transferred.

HOWARD Larry E. Howard v. U. S. (U.S. District Court, E. Dist. Wash., 07/30/10),

The sale of personal goodwill by the sole shareholder dentist was re-characterized as a sale of a corporate asset by his professional corporation because Howard had previously entered a covenant not to compete with his wholly owned corporation.

ADELL TC MEMO 2014-155

The IRS expert greatly undervalued the pivotal role the son (a non-shareholder employee) played in the operating both companies and his personal relationship with customer. Also, if the son quit he could complete directly with the company.


IRS contended the Company distributed appreciated intangible assets (including goodwill) to its sole shareholder. The Court found the Company had no corporate goodwill at the time of the transaction. The Court relied heavily on the precedent in MARTIN ICE CREAM.

Bross never entered an employment contract or a non-compete agreement. He was free to leave the company and take his relationships with him if he chose to compete against the business. The court stated that “an employer has not received personal goodwill from an employee where an employer does not have the right, by contract or otherwise, to the future services of the employee.”

Ultimately facts and circumstances carry the day in distinguishing personal goodwill from enterprise goodwill. Gaining insights into the factors mentioned above, although not all-inclusive, should act as a framework to analyze, discuss and hopefully develop conclusions about whose goodwill it is.

Mr. Bravo is an Accredited Senior Appraiser (ASA), Certified Business Appraiser (CBA), Certified Public Accountant/Accredited in Business Valuation (ABV), Certified Public Accountant (CPA), Certified Financial Planner (CFP), and a Personal Financial Specialist (PFS). Mr. Bravo earned a Master of Taxation from Bentley College and a Bachelor of Science in Business Administration from Suffolk University.

Mr. Bravo is a technical editor of the following books written entirely, or in part, by Dr. Shannon Pratt: Valuing A Business, Cost of Capital, Business Valuation Body of Knowledge, Market Approach to Valuing Businesses, Business Valuation Discounts and Premiums, and Standards of Value. He is on the Editorial Boards of the Business Valuation Review (BVR), published by the ASA and the Business Appraisal Practice, published by the IBA. He is on the "Panel of Experts" for Financial Valuation and Legal Expert publications. He has instructed for the AICPA, AAML, BBA, MCLE, MAPA and several colleges & universities. He was on the AICPA Task Force for the AICPA ABV Examination Review Course, and taught the review program for several years.

1  The International Glossary of Business Valuation Terms defines intangible assets asnon-physical assets (such as franchises, trademarks, copyrights, goodwill, equities, mineral rights, securities, and contracts, as distinguished  from physical assets) that grant rights, privileges, and have economic benefits to the owner.”
2  Cruttwell V. Lye, 34 Eng. Rep 129, 134 (1810).
3  In re Marriage of Brown, 242 N.Y. 1, 6, 150 N.E. 581, 582 (1926).  
4  If the value of a business is derived from either the income or market approaches, goodwill can be computed. 
5  “Goodwill Attributes: Assessing Utility,” The Value Examiner, David Wood, January/February, 2007 Edition.
6  We would like to thank the late James S. Rigby, a mentor, for some of these factors. A variety of opinions and thoughts were also collected from conversations with other valuation professionals. 
7  See Black’s Law Dictionary, definition of Property for a legal definition.
8  One way to do this is if for the individual to take a position with another company where he/she can continue to work his/her specialty and compete with the former employer.