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Mergers & Acquisitions, Value Acceleration & Exit Planning

Valuing Goodwill, Understanding Personal vs. Enterprise Goodwill

At a Glance

Main Takeaway

Most people think of the value of a business based on its tangible assets, such as cash flow, equipment, or land. But intangible assets, often called goodwill, are equally as important as tangible assets. Intangible assets may include brand recognition, reputation, supplier relationships, copyrights, and trademarks. Valuing goodwill can be vital in growing your business or preparing for a transition.

Next Step

Depending on the valuation’s purpose, business analysts often separate goodwill into personal (such as the divorce of two people invested in the company) and enterprise (selling your business). As a business owner, understanding the difference between personal and enterprise goodwill and how they each affect the value of your business can help you prepare for future growth.

Personal Goodwill

Personal goodwill is the intangible value of a company owner’s reputation, skills, and industry knowledge and experience. The value solely depends on the characteristics of the individual rather than the business as a whole.

These characteristics may include the personality, skills, technical expertise, business experience, or relationships of the owner or other individuals in the company, such as an executive or spokesperson.

Businesses with higher personal goodwill may find it harder to sell their business because many of the assets of personal goodwill are not transferable, and the company may see a drop in revenue after the sale.

However, some personal goodwill may be transferable through employment contracts or non-compete agreements. Transferable goodwill typically occurs over a transition period as the owner or other professionals in the business assist with the business operations, allowing the company to keep customers or suppliers that have a relationship with these individuals, even though their role has changed.

Enterprise Goodwill

Enterprise goodwill exists for a business regardless of who owns or operates it. It is the result of the business’s characteristics and intangible assets, such as the company name, location, phone numbers or website, trademarks, patents, workforce, suppliers, customer base, and anticipated future growth.

Companies with higher enterprise goodwill are viewed as more valuable to a potential buyer because the company will transfer intangible assets, such as location, phone number, and suppliers when transferring ownership. The earning potential will remain the same regardless of who owns the company.

Seven Elements of Personal and Enterprise Goodwill with Examples

To determine a company’s goodwill, a valuation expert will collect evidence on both personal and enterprise goodwill through interviews and research. The evidence collected will determine what, if any, personal or enterprise goodwill exists in a company.

Depending on the valuation’s purpose, the valuation will not separate enterprise and personal goodwill; instead, it will include an overall value of the company’s goodwill. The expert will examine the following areas:

1.    Income Generation

Income generation refers to where the business income originates. Examples include:

  • Personal Goodwill – The business is mostly or entirely reliant on a single individual for income generation. Income for the company will quickly disappear or significantly shrink if the individual leaves.
  • Enterprise Goodwill – The business creates income from multiple people or departments within the company. If an owner or other person in the company were to leave, there would be little impact on the income.

2.    Supplier and Customer Relationships

The valuation of supplier and customer relationships involves where relationships began and how they are maintained. Examples include:

  • Personal Goodwill – The relationship between suppliers or customers is with an individual inside the company, such as an owner, executive, or employee.
  • Enterprise Goodwill – Customer or supplier relationships are contractual with the business itself. The suppliers or customers would not end their business deals based on whether an owner, executive, or employee exited the company.

3.    Referrals and New Customers

This element assesses how the business typically acquires new customers or obtains referrals. Examples include:

  • Personal Goodwill – Customers, clients, or suppliers are referred to the business personally or come to the company because of an individual’s reputation or expertise. These relationships typically seek a particular person to work with and would most likely follow the individual if they were to leave the company.
  • Enterprise Goodwill – Client referrals are based on the company’s reputation and proximity. Relationships are contracted and transferable and have no intentional relationship to an individual in the company.

4.    Profit and Loss Allocation

Valuing profit and loss allocation examines how the company handles profits and losses. Examples include:

  • Personal Goodwill – Profit and Loss allocation is based on the income production of an individual within the company.
  • Enterprise Goodwill – Profits or losses are distributed equally among owners or executives, regardless of income.

5.    Marketing

Marketing valuation looks at the elements on which a company’s marketing strategy is focused. Examples include:

  • Personal Goodwill – Marketing focuses on the owner’s skills, experience, and reputation. The company name is the owner’s name, and marketing materials use personal photos.
  • Enterprise Goodwill – Marketing focuses solely on the company’s reputation without mentioning ownership or management. The business name is separate from the owner’s name. Key photos and marketing material use a logo or product images. There is no use of an owner’s image or images of key employees.

6.    Employment and Non-Compete Agreements

Goodwill valuation examines the type of non-compete and employment agreements the company uses. Examples include:

  • Personal Goodwill – No non-compete or employment agreements exist between employees, owners, or the business.
  • Enterprise Goodwill – Non-compete or employment contracts exist between the owners or employees and the business.

7.    Repeat Customers

As part of the goodwill valuation, the expert will analyze factors that keep customers or clients returning to a business. Examples include:

  • Personal Goodwill – Customers typically return because of a personal relationship with key employees or the owner despite other more convenient options widely available for a similar service or product.
  • Enterprise Goodwill – Customers return based on the price, convenience, location, or quality of the goods and services without a personal connection to the company.

When Should You Valuate Personal Goodwill

There are two instances when separating enterprise and personal goodwill is beneficial for understanding a business’s goodwill value:

  • Selling Your Business – Enterprise and personal goodwill distinctions matter when selling a business. A buyer will want to know the amount of personal goodwill in the company because buyers will typically only want to pay for the tangible assets that can be transferred, such as the enterprise assets of trademarks, store location, or website URL.

However, employment or non-compete agreements may transfer personal goodwill during the sale. One of the benefits of including personal goodwill in the transaction for the buyer and seller is to avoid specific corporate taxes. If goodwill is defined as personal, it is taxed on a single level, while enterprise goodwill is typically subject to double taxation.

When selling a company, make sure to follow three steps when it comes to personal goodwill:

  1. Have the goodwill valued by an independent valuation analyst.
  2. Make sure the buyer agrees on the goodwill valuation.
  3. Identify the goodwill clearly in the purchase agreement.
  • In a Divorce – In California, personal goodwill is almost always included in the marital assets of a divorce between two people who own a company. The nature of the business, the economic outlook, and earning capacity are also taken into account when separating assets or considering the sale of the company to an outside buyer or one of the parties involved in the divorce.

Considerations for Valuing Personal Goodwill

Valuing goodwill on the personal side can help determine a company’s exact value, especially during a sale or transition. Once an expert has identified the personal goodwill, they must calculate the value. There are two standard methods for determining the value: the multi-attribute utility model or the “with and without method.”

Multi-Attribute Utility Model – The Multi-Attribute Utility Model (MUM) is a technique used to help in decision-making and alternative assessment. A valuation expert will identify the types of personal goodwill in the company, such as referrals, marketing, or income generation. They then offer a valuation of these assets relative to the other goodwill based on importance

Based on these findings, the expert can determine the potential change a company may see in sales or profit when the individual is no longer attached to the company. The buyer may also weigh the pros and cons of personal goodwill to determine the risks of purchasing the business.

With and Without Method – The with and without method helps the expert examine the company’s value with or without the owner’s personal goodwill. The valuation expert will determine the company’s value with the individual still working at the business, then project a valuation after the owner leaves.

When determining the value in each situation, the analyst will calculate the discounted cash flow to make a projection of net income, revenue, and expenses for the business over a set time frame. For the scenario including the owner, the projections reflect the cash flows and assumptions of the company as it currently is.

In the without scenario, the analyst assumes the business will earn less in revenue due to the loss of the individual in question. This scenario may also assume it could take the company many years to reach the same earnings level and make up for the lost revenue due to the person’s departure. This method will almost always show a lower value for the business if the person were to leave the company.

Benefit From Value Acceleration Services From Windes

Value acceleration services can help you identify personal and enterprise goodwill for your company. If you plan to sell your business, separating enterprise and personal goodwill can determine its value and help you negotiate the right price. If you are buying a business, value acceleration can help you accurately assess your target company’s worth.

Windes can help determine the value of your business and help you calculate the value of a target company as part of a purchasing strategy.

Contact us today to learn how we can help you.

 

Rob Henderson
Robert B. Henderson, CPA, MST, CEPA, CM&AA

Practice Leader, Value Acceleration and Exit Planning

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