How Personal Goodwill Affects Business Valuation in a Divorce

I have been asked to value professional services businesses (law firms, accounting firms, medical practices, engineering firms, consulting firms, etc.) in a number of instances for marital dissolutions in Bucks, Chester, Delaware, Montgomery and Philadelphia counties. When performing such valuations, it is important to consider the personal goodwill associated with the professional or business owner.

The Internal Revenue Service defines goodwill as “the value of a trade or business based on expected continued customer patronage due to its name, reputation, or any other factor.”  Recent court decisions have recognized a distinction between the goodwill of a business itself and the goodwill attributable to the owners/professionals of that business.  This second type is typically referred to as personal goodwill.

Personal goodwill differs from overall business goodwill in that personal goodwill represents the value stemming from an individual’s personal service to that business, and is an asset owned by the individual, not the business itself.  This value would encompass an individual’s professional reputation, personal relationships with customers or suppliers, technical expertise, or other distinctly personal abilities which provide economic benefit to a business.  This economic benefit is in excess of any normal return earned by the company.

An example of this can be seen from one of my past Delaware county cases. It involved the divorce of a specialist physician who had a reputation as being one of the top doctors in his field on the East Coast. As a result, he was sought out by patients up and down the East Coast – a far greater geographic area than most of practice served. Because of the larger than normal number of patients that visited the practice to see him and because he performed more expensive and complex procedures than most of the other doctors in his practice, he generated considerably more income for the practice than any of the other doctors.

In order to calculate the personal goodwill of this physician, I obtained compensation and productivity data for the “typical” physician in his specialty with the same level of education and experience. I compared this to the husband’s actual earnings and productivity. I then capitalized the stream of income arising from differences in revenue generated minus the differences in compensation. This capitalized amount was the personal goodwill associated with the husband. I subtracted the personal goodwill from the value of the practice in order to determine the business value of the practice. It was this value that was used in the marital dissolution proceeding. In this case, the personal goodwill of the physician represented almost ½ of the value of the entire practice.

In another case, involving a Bucks county physician who did not possess such a significant reputation or expertise, the amount I calculated for personal goodwill was less than 5% of the value of the entire practice.

Other key factors that can help determine personal goodwill derive from a Philadelphia case regarding goodwill for an attorney. In this case, we not only examined productivity, but also reputational information such as whether or not he was one of the firm’s named attorneys; how prominently the attorney was featured on his firm’s website; what public recognition of his accomplishments existed (for example, articles about him and awards he had received); and how well published he was. Our analysis determined that he was not a named attorney; that he had no prominence on the firm’s website; that he was of six attorneys in his firm named as outstanding in his practice specialty (but only in one publication, which required paid sponsorship); and that he had no published books, articles or blogs. We therefore calculated a low level of personal goodwill for the attorney.

About David Anderson, CPA, CFE, CVA

David Anderson, CPA, CFE, CVA is a forensic accountant and collaborative business valuation expert serving divorce lawyers and their clients in Bucks County, Chester County, Delaware County, Montgomery County and Philadelphia County. He provides a full range of divorce-related business valuation and forensic accounting services including forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support services, economic damage analysis, business consulting and outsourced CFO services. Anderson has more than 30 years of experience in financial and operational leadership positions. He is a Certified Public Accountant, a Certified Fraud Examiner and a Certified Valuation Analyst. Anderson also has provided expert witness testimony in the Greater Philadelphia area, and served as a forensic consultant and business valuation expert on both civil and criminal cases.

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