Summary
This goodwill valuation guide discusses the difference between valuing personal goodwill and company or enterprise goodwill. Knowing the market value of goodwill is critical for tax purposes even if you own a C corporation.
Personal vs Business Goodwill: What You Need to Know When Selling a Business
A Personal Goodwill Valuation Guide when business owner selling a business
Valuing Business Goodwill versus Personal Goodwill
When business owners are selling a business, every aspect of the business must be considered. A business is much more than just numbers on paper, and the presence of goodwill exemplifies this. However, a business entity has two types of goodwill: personal and enterprise or business. Knowing the difference can keep you from the tax court or make a fair divorce settlement.
While dealing with goodwill, you will encounter personal goodwill and business goodwill. It is essential to understand the difference between the two. This article will explore how goodwill is defined, why it is essential, and the differences between personal goodwill and business goodwill.
The Value in Reputation: How is Goodwill Defined in Business?
In business, the goodwill asset is an intangible asset you calculate and include as part of a business’s value when you sell it. It increases a business’s purchase price and helps accurately reflect the true value. Any well-established company will have goodwill value. Even many bankrupt businesses with zero earning power have goodwill. The name Polaroid sold for a million dollars in the bankruptcy court, and you now see Polaroid-branded televisions.
The definition of goodwill is: “a friendly or helpful attitude towards other people, countries, or organizations,” as defined by Collins Dictionary. A business’s reputation and good name allow it to grow, and without maintaining positive relationships and fostering ‘goodwill,’ no successful business would be where it is today.
Learn about goodwill assets in business valuations with our article, and obtain a business valuation before you sell your business. The higher the cash flow, the higher the corporate goodwill valuation.
The Book Value versus Market Value of a Business
The book value and market value are fundamentally different calculations that tell a story about a company’s value, especially when selling a business. Here’s a brief overview of each:
- Book Value: This is the net value of a firm’s assets found on its balance sheet, and it is roughly equal to the total amount all shareholders would get if they liquidated the company. Mathematically, it is calculated as $ Book Value of a Company=Total Assets – Total Liabilities. For example, if a company has total assets of $100 million and total liabilities of $80 million, the book value of the company would be $20 million.
- Market Value: This is the company’s worth based on the total value of its outstanding shares in the market, which is its market capitalization. Market value tends to be greater than a company’s book value since it captures aspects like profitability, intangibles, intellectual property, and future growth prospects. When you calculate goodwill, this is part of the fair market value.
- The price-to-book ratio (P/B) is a popular metric for comparing book and market values. A company with a lower P/B can make for a great target company because of strong cash flows.
Understanding these values can help investors make informed decisions about buying or selling stocks. They provide different perspectives on a company’s financial health and potential for growth. Book value offers a more conservative measure, while market value can reflect the more speculative aspects of how the market views a company’s future.
Fair Value versus Fair Market Value
The terms fair value and fair market value are often used interchangeably, but they have distinct meanings in the context of business valuation:
• Fair Value: This accounting standard is used to measure assets and liabilities and is often used in financial reporting. It’s the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value takes into account the characteristics of the asset or liability, considering factors such as future cash flows, present value, and credit risk.
• Fair Market Value: This is the price at which an asset would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. It is the most widely accepted standard of value for tax and market transactions. Fair market value is determined by the market and is influenced by supply and demand. It does not consider strategic or investment value, which might be specific to a particular buyer.
In essence, fair value is more of an accounting concept, while fair market value is a legal concept used in the market and tax contexts. Fair value can include adjustments for various factors and may not always align with the price in the open market. In contrast, fair market value is what the asset would actually sell for in a competitive market environment.
Goodwill Valuation Guide
Items that impact the goodwill of business assets include (but are not limited to):
- Reputation
- Company branding recognition
- Employment agreements and employment contracts
- Employee operations knowledge
- Customer relationships
- Customer base and loyalty
- Email lists
- Proprietary software
- Digital assets
- Supplier relationships
- Trade secrets
- Licenses and permits
- Training systems
Know how to choose a business appraiser to evaluate your goodwill with our complete guide on how to choose the best business appraiser.
Why is Goodwill Important in Selling a Business?
Your business is not just worth its face value. When valuing your business, using goodwill can help to achieve the most accurate terms possible, proving that numbers on paper only mean so much. Goodwill is an intangible asset versus a tangible asset.
Please read the important role of a business valuation in exit planning.
When valuing your business, including every aspect will help you get the most effective asking price and save on taxes. The good news is, you don’t need to go at this alone: with a business valuation from the professional business appraisers at Business Appraisal FL|GA|HI, we can assess your goodwill and determine your business’s true value with the most accurate, objective, and fair assessment possible.
Determining the target company’s tangible and intangible assets is critical in mergers and acquisitions. The proper allocation of goodwill drives many business sales. You will hear the terms personal and enterprise goodwill.
Learn more about business valuations with our article what is a business valuation.
Business Goodwill: The Value of Brand, Customers, and Locations
Business goodwill, also known as corporate or enterprise goodwill, pertains to the business and transfers to the new owner upon the completion of a sale. It can encompass aspects such as location, employee expertise, and customer loyalty.
This type of goodwill exists no matter who owns the business, enabling its ability for consistent transferability. There are tax court decisions that separate personal goodwill from corporate goodwill. The Internal Revenue Service (IRS) can scrutinize your goodwill allocation, and you must substantiate it, or you could visit the tax court.
Is your business running its operations in Florida or Georgia? Read our article about why now is the time to get a business valuation in Florida or Georgia.
How to Prove Business Goodwill with Legal Documentation
Fostering trust, transparency, and confidence is key when working with prospective buyers. Therefore, proving business goodwill with financial documents, legal records, and contracts will assist you in showing solid evidence of its worth. Legitimizing your business goodwill with concrete evidence can help make your business more attractive to the buyer. Buyers and sellers have different views on a company’s goodwill.
Personal Goodwill: The Worth of Reputation, Relationships, and Knowledge
Professional goodwill or personal goodwill is goodwill that comes from the owner’s specific contributing characteristics. Personal goodwill includes the business owner’s reputation, contacts, vendor relationships, customer patronage, and industry knowledge. The employment agreement and covenant not to compete help convey personal goodwill to the new owners as enterprise goodwill. We are also trying to minimize blue sky value in the eyes of the buyer and create tax savings.
Also, understand the different business valuation methods.
Understanding Pure Personal Goodwill and Transferable Enterprise Goodwill
You may encounter a couple of different ways when defining personal goodwill. These two sub-versions of personal goodwill include pure personal goodwill and transferable goodwill.
Pure personal goodwill includes goodwill based on a purely personal relationship with the business owner. For example, this can include whether the owner has developed a personal relationship with certain customers or a key vendor. Because the owner’s personal ties heavily influence this type of goodwill, businesses often exclude it when selling. as part of the intangible assets.
How personal goodwill is treated regarding capital gain and capital gains tax rates is critical in a business sale or transfer. Always take the tax implications into consideration when making an ownership transfer. You care more about the net selling price of a business sale than the gross selling price.
Selling a Professional Practice
When selling a professional practice, much personal goodwill can be transferable enterprise goodwill. Consider a medical practice and minimize patient run-off. The allocation of goodwill is critical when determining your tax liability.
Also, learn the difference between SDE and EBITDA.
Personal goodwill can transfer to new owners during the business sale. It includes teaching special knowledge, providing contact lists, managing supplier relationships, and considering these factors in business valuation. Treating the different classes of goodwill correctly is critical for calculating your capital gain.
Personal versus Business Goodwill in a Divorce
In addition, 35 states are personal goodwill states where personal goodwill in a business is not part of the marital assets. Your divorce attorney should know your state law regarding personal versus business goodwill.
Many states through statute or case law, guide the proper business valuation methods in divorce cases.
You can also read our article about the rule of thumb in business valuation.
How can you make personal goodwill more transferable for the buyer?
To maximize the value of personal goodwill for your potential buyers, you can enhance transferability by documenting knowledge, training employees, and nurturing customer relationships. This will help show the prospective buyer that your business’s personal goodwill is worth it, bringing more value to your business.
Know what counts as an add-back with our article understanding add-backs when selling a business.
Why is the Difference Between Personal and Business Goodwill Relevant?
In selling a business, understanding personal vs business goodwill’s tax implications is crucial. The IRS taxes personal goodwill only once, whereas it often taxes business goodwill twice. Knowing your business’s goodwill type clarifies potential income taxes. Also, understand how a covenant is not to compete and how an employment contract can be structured for your tax benefit.
Help your business be prepared for anything with our article disaster planning made easy.
Why Work with Business Appraisal FL|GA|HI for Your Business Valuation, Including Goodwill?
Especially in today’s highly competitive market, you cannot underestimate the importance of accurately valuing your business when selling it. Evaluating goodwill is an essential aspect of the valuation process, and a business valuation company like Business Appraisal FL|GA|HI will represent your business’s true value with the utmost accuracy.
Read what should be included in a business valuation, whether for an asset sale or stock sale.
Simple Goodwill Calculations versus a Goodwill Allocation Study
Simple goodwill calculators you can find on the internet may seem helpful, but they will only get you so far. With a business valuation from Business Appraisal FL|GA|HI, we will examine your goodwill with the backing and guarantee of our decades of expertise and knowledge.
Our accredited valuation analysts (AVA) perform business valuations that meet the IRS, AICPA, and NACVA standards. Rest assured that we will keep you safe and correctly value your personal goodwill based on court cases, overall fair market value, and purchase price allocation.
Understand more about how a business valuation benefits you with our article about the top 7 benefits of getting a business valuation for business owners and their personal and enterprise goodwill allocation needs.
How goodwill is taxed when selling is critical, and BA FL|GA|HI can help with this once-in-a-lifetime event.
Ready to sell your business and evaluate your personal versus business enterprise goodwill? Contact BA FL|GA|HI about your business valuation today, and have a free, confidential consultation with our expert accredited analysts.