Valuing Personal Goodwill vs Enterprise Goodwill
Goodwill represents the intangible value of your business above and beyond the value of the identified tangible assets. Tangible assets may include items such as land, equipment, and cash flows. The intangible value may include items such as copyrights, trademarks, brand recognition, reputation, customer/supplier relationships, and contracts, among others. Goodwill can be separated into personal and enterprise goodwill.
Depending on the purpose of the valuation, an analyst may or may not separate goodwill. In situations like divorce or selling your business, the separation of goodwill matters a great deal. However, for every business owner, understanding the difference between personal and enterprise goodwill can help add value to your business.
What is Personal Goodwill?
Personal goodwill is the intangible value generated by the reputation of a business owner or other individual. The value is dependent solely on the personal characteristics of the individual rather than the characteristics of the business itself. This may include relationships, technical expertise or skills, personality, and reputation of the individual shareholder. These personal characteristics and relationships establish a revenue stream and help develop a customer base.
Businesses with higher personal goodwill often find it more difficult to sell their business because of the potential decline in earnings. Some personal goodwill is nontransferable such as specific skills or experience. But some personal goodwill is transferable through shareholder or employment contracts and non-compete agreements. Transferable goodwill often occurs over time as the professional exiting the business assists through a transition period.
What is Enterprise Goodwill?
Enterprise goodwill is a result of the characteristics specific to a business, independent of who owns or runs it. Contracts with suppliers, customers, or others and anticipated future customers add to the business’s enterprise goodwill. The company name, phone number, and location also add value. A great location with high traffic, visibility, and accessible parking all led to greater earning potential. Attributes such as trademarks, patents, and a highly skilled team also add to enterprise goodwill.
Enterprise goodwill is often easier to transfer to a potential buyer. As such, companies with higher enterprise goodwill are often more valuable to potential buyers. This is because the buyer will expect the earnings of the business to continue regardless of the owners or employees.
Examples of Personal and Enterprise Goodwill
Through research and interviews with management, a valuation expert will collect evidence of both personal and enterprise goodwill. The analyst then uses these facts and circumstances from the business to estimate the degree to which personal and enterprise goodwill exists. Here are a few examples of each.
|Examples of Personal Goodwill||Examples of Enterprise Goodwill|
|Customer/Supplier Relationships||Relationship between customers or suppliers is with a specific individual||Relationships are contractual with the business|
|Referrals and New Customers||Individuals come by referral or because of an individual’s personal reputation or expertise. They often seek a particular service provider||Referrals are based on business reputation and proximity. Referral relationships are contracted and transferrable. They seek a general service from the business|
|Income Generation||The business either is completely or mostly reliant on one individual for income generation. Income associated with the ownership interest being valued would disappear if that individual left||The business generates income from multiple individuals, the income associated with ownership interest being valued would not disappear if that individual left|
|Employment and Non-compete agreements||No employment or non-compete agreements exist between owners/ employees and the business||Employment or non-compete agreements exist for owners/ employees within the business|
|Marketing||Focuses on the reputation, experience, or skills of the owner, the business name is the name of the owner, use of personal photos||Focuses on the entity’s reputation without mentioning management or ownership, the business name is different than the owner’s name, use a logo rather than photos of key employees|
|Repeat Customers||Customers return due to personal relationships with the owner or key employee despite other options being widely available for a similar good or service||Customers return due to quality, location, convenience, price, or other company-specific factors. Goods or services may be unique to the specific area|
|Profit and Loss Allocation||Allocate profits and losses based on income production||Distribute profits and losses equally among owners|
Depending on the purpose of the valuation, many times goodwill is not separated into personal and enterprise goodwill. The overall value includes the total goodwill of the business.
When does personal vs enterprise goodwill matter?
Within valuation, there are some instances where differentiating between personal and enterprise goodwill matters. Two of these instances include: (1) When you are planning to sell your business. (2) When marital separation occurs between individuals who both have ownership in the business.
Personal Goodwill when Selling your Business
When you are looking to sell your business and structuring the business transaction both personal and enterprise goodwill matter a great deal. A potential buyer will want to know how much personal goodwill is in the business. Buyers prefer to pay only for the part of intangible assets that are transferrable in the transaction. As a result, often only enterprise goodwill continues with the acquirer. However, a transaction can be structured such that the personal goodwill is transferred to the acquirer most commonly through non-compete agreements and employment agreements.
One benefit to including personal goodwill for both the seller and buyer is to help avoid certain corporate taxes. For instance, if the goodwill is deemed personal it is taxed on a single level. Whereas if the goodwill is a corporate asset (or enterprise goodwill) it may be subject to double taxation.
When selling your company, it is vital to have three things regarding personal goodwill.
- Valued by an independent valuation analyst
- Clearly identified in the purchase agreement
- Agreed upon by the acquiring party
Personal Goodwill in Divorce
There is a great deal of debate within business valuation and legal professions about personal goodwill. Most particularly when it revolves around divorce. Each state varies in the way they handle divorce cases and whether personal goodwill can be included in the marital assets. Speak with your legal professional to learn how your state stands concerning personal goodwill in divorce situations.
Valuing Personal Goodwill
After identifying personal goodwill, the next step for a valuation expert is to calculate its value. Two methods are commonly used: the “with and without” method and the “multi-attribute utility model” method.
With and Without Method
- Value of the business with the individual continuing to work with the business,
- Value of the business without the individual’s continuing involvement
In both methods, the analyst calculates the discounted cash flows and makes projections for revenue, expenses, and net income the business expects over a specific time.
With the individuals continuing involvement, the projections reflect the assumptions and cash flows of the business as it is. This scenario includes the value attributed to the personal goodwill of the key individual.
The without scenario assumes the business will earn less revenue due to the loss of the key individual. It also assumes it will take the company several years to regenerate the same revenue and earnings lost due to the individual leaving. Thereby this scenario shows a lower value of the business because personal goodwill is excluded.
Multi-Attribute Utility Model
The multi-attribute utility model (MUM) is a mathematical technique to assess alternatives and assist in decision making. The valuation expert identifies various attributes of personal goodwill and then weights each attribute on its existence and relative importance. For more information, on the MUM model click here.
Valuing personal and enterprise goodwill is a complex process. Separating personal and enterprise goodwill in certain situations can have important outcomes. Especially if you are planning on selling your business, the separation is insightful. With any business transaction, intangible assets such as goodwill are often negotiated between the buyer and seller. Obtaining a professional business appraisal can help you allocate the appropriate amount of the purchase price to personal and enterprise goodwill.
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