As a business owner, you undoubtedly have created some personal goodwill in the business – intangible assets that originated from your personal efforts. You may not realize that these same efforts that have helped build your business into what it is today can help you minimize taxes and increase your proceeds when selling a business, without much negative impact on your buyer. The M&A advisors at Doeren Mayhew explain.

What is Personal Goodwill?

The International Glossary of Business Valuation Terms defines goodwill as “that intangible asset arising as a result of name, reputation, customer loyalty, location, products and similar factors not separately identified.”

Sometimes goodwill is defined as the difference between a company’s fair market value and its net tangible (asset) value. This broad definition may lump identifiable intangible assets together with goodwill. In fact, Financial Accounting Standards Board (FASB) Statement No. 142, Goodwill and Other Intangible Assets, lists the identifiable intangible assets that appraisers can value separately from goodwill.

Goodwill can be further broken down into two types:

  1. Business (or entity) goodwill is intangible value attributable to the business itself, including its established processes and location(s). Businesses retain this portion of goodwill even if owners retire, sell or otherwise part ways.
  2. Personal (or professional) goodwill is tied to the efforts and reputation of owners. It generally cannot be transferred to a third party without significant time and effort.

Some distinguishing features considered when analyzing goodwill include:

  • Personal attributes of the owner(s). Companies that rely heavily on the reputation, skills and knowledge of owners possess personal goodwill. For example, state laws require partners in an accounting or law firm to possess the requisite education, training and professional designations.
  • Marketing techniques. When categorizing goodwill, appraisers consider how the business attracts and retains customers. Businesses that typically generate leads via walk-ins and Yellow Page ads more likely possess business goodwill. When customer (and employee) loyalty is based on the efforts, contacts and referrals of individual owners, it suggests personal goodwill.
  • Management structure. Business owners who are unwilling (or unable) to relinquish control may unwittingly create personal goodwill – especially if they also possess specialized knowledge, experience and training. Centralized management structures make it harder for businesses to transition to new ownership without sellers’ ongoing involvement.

Using Goodwill in Your Favor

When selling a business, tax implications are a major seller concern, but especially in the case of a C corporation, which is taxed at both the corporate and personal levels. For such business sales, a good deal of tradeoff exists when weighing the transaction type – what’s favorable for the buyer is often not as optimal for the seller, and vice versa.
Where personal goodwill comes into play is the asset sale. While this transaction type can position the buyer more favorably, it also allows the seller to allocate purchase price to personal goodwill to reduce tax rates and increase after-tax proceeds.

Consider this example:

Selling a Business: Using Personal Goodwill

* Assumes material participation; 3.8% Medicare tax added otherwise

In closing, when used effectively under an asset transactional structure, allocating purchase price to personal goodwill can help to mitigate tax exposure on the sale and increase after-tax proceeds. The buyer benefits from the step-up basis under an asset deal, while the seller increases his dollars – a win-win for all parties.

For assistance maximizing proceeds when selling a business, contact an M&A advisor at Doeren Mayhew, one of the nation’s top investment banks, with offices in Michigan, Houston and Ft. Lauderdale.