Resources

Request a Quote

Join Our Newsletter

Form Heading

Allocation of Goodwill Towards Business and Personal
March 28, 2017

© 2017, by Daniel T. Jordan, ASA, CBA, CPA, MBA

Goodwill is an intangible asset of an enterprise.  It is the essence of a business that makes it more than just a collection of other assets, like real estate, equipment, inventory, receivables, and cash. Goodwill is a concept based in old English law dating from the early 1800’s.  Goodwill “is the probability that customers will return to the old stand.”[1]

In the early 1900’s in the United States, Justice  Cardozo captured the essence that goodwill was the tendency  for customers to return to the same location or company because of its name or other reasons, regardless of its location.[2]

Goodwill is defined  as  the  total  value  of  an  enterprise  less  those  other  assets,  such  as  current assets, investments,  and  fixed  assets,  whose  value  can  be  determined  through  other  means.  Goodwill can be separated into two parts:  personal goodwill and enterprise goodwill.  They are defined as follows:

Personal goodwill is the value of earnings or cash flow directly attributable to the individual’s characteristics or attributes. Personal goodwill, sometimes referred to as professional goodwill, is a function of the earnings from repeat business that will  patronize  the  individual  as  opposed  to  the  business,  new consumers  who  will  seek  out  the  individual,  and  new  referrals that will made to the individual.

Enterprise  goodwill  is  the  value  of  earnings  or  cash  flow directly  attributable  to  the  enterprise’s  characteristics  or attributes.  Enterprise  goodwill,  sometimes  referred  to  as practice  goodwill,  is  a  function  of  the  earnings  from  repeat business  that  will  patronize  the  business  as  opposed  to  the individual, new consumers who will seek out the business, and new referrals that will be made to the business.[3]

In two instances, we are asked to separate professional goodwill from enterprise goodwill:

  1. For divorce purpose, there are many states that do not consider professional goodwill as marital property.  This reduces the value of the Company.
  2. When selling a business, the capital gains tax is lower for personal goodwill (20%) than for business goodwill (35%).  This saves our clients substantial amounts of money.

How do we separate professional goodwill from enterprise goodwill?

Multiattribute Utility Model (“MUM”)

We use the multi-attribute utility model (MUM), which is a court-accepted method of measuring goodwill attributes for importance and presence in the business, developed by David Wood, CPA, ABV, CVA.

The  Multiattribute  Utility  Model  is  an  allocation  model  for  distinguishing  enterprise goodwill  from  personal  goodwill.[4]

MUM  is  a  well-defined  method  used  in  many disciplines  —  economic,  political,  and  scientific  —  to  establish  decision  support  for subjective  problems.  MUM  lends  itself  to  consistency,  introduces  objectivity  into  an otherwise subjective assignment, and provides for sensitivity analysis of the outcome.

MUM’s objective is to determine the value of the two elements of goodwill, personal and enterprise,  from  the  total  goodwill,  such  that  a  reasonable,  well-founded  basis  for  the allocation can be formed and communicated.

MUM divides attributes into those that tend to indicate either enterprise or professional goodwill, and then uses the relative weights to determine the attribute’s importance and presence in the business.

Personal Goodwill Attributes (“PGA”)

A  personal  goodwill  attribute  is  one  that  is  indicative of  goodwill  directly associated with an individual. Assessment of these attributes are a direct reflection of  the  consumers  that  seek  out  the  individual,  are  referred  to  the  individual,  or repeat  patronage  due  to  the  attributes  of  the  individual  as opposed  to  other attributes that are reflective of the business.

Enterprise Goodwill Attributes (“EGA”)

An  enterprise  goodwill  attribute  is  one  that  is  indicative  of  goodwill  directly associated  with  the  business.  Assessment  of  these  attributes  is  a  direct  reflection of consumers that seek out the enterprise, are referred to the enterprise, or repeat patronage due to the attributes of the enterprise as opposed to other attributes that are reflective of the individual.

Measure the “Utility” of Each Attribute

“Utility”  as  used  in  MUM  is  an  assessment  of  each  attribute.  There  are  two  utilities assessed  in  this  step  –  the  “importance  utility”  and  the “existence  utility.”  The importance  utility  is  a  relative  measurement  of  each  attribute’s  importance  to  the valuator. Each attribute has some measure of importance, since it has been selected as an attribute, therefore, the attribute must have a weight greater than zero.

a. Importance Utility

Each  attribute’s  relative  importance  is  determined  by  the  valuator  and  weighted according to a scale. The  scale  is a  weighted scale with each attribute  in relative importance   from   a   “least   important”  to   a   “most   important”   attribute.   The assessment and weighting of the importance of each attribute results in the Utility of Importance.

b. Existence Utility

The  valuator  examines  the  business  to  determine  the  existence  of  each  attribute.  The scale  is  a  weighted  scale,  similar  to  the  weighted scale  for  the  importance utility. The existence utility weights are continuous with unit weights beginning at zero. This scale allows the valuator to score an attribute with a zero if its presence is weak or absent. The assessment and weighting of the existence of the attributes result in the Utility of Existence.

Aggregate the Results

Aggregating the results is essentially performing MUM’s math. The math underlying the  use  of  MUM  in  the  allocation  of  goodwill  is  multiplicative.  The  attributes  are divided  into  the  two  groups  –  personal  and  enterprise.  The  importance  utility  is multiplied  by  the  existence  utility  for  each  attribute  to determine  the  multiplicative utility  of  each  attribute.

We then establish the respective percentages of each attribute for professional and enterprise goodwill.  We can now calculate the dollar amount of professional and enterprise goodwill based on these percentages.  We typically also include a sensitivity analysis for different outcomes of personal goodwill.

Endnotes

[1] Cruttwell V. Lye, 34 Eng. Rep 129, 134 (1810).

[2] In re Brown, 242 N.Y. 1, 6, 150 N.E. 581, 582 (1926).

[3] “Goodwill Attributes: Assessing Utility,” The Value Examiner, David Wood, January/February, 2007, Edition.

[4] “An Allocation Model for Distinguishing Enterprise Goodwill from Personal Goodwill.” American Journal of Family Law, Volume 18, Number 3, David Wood, Fall 2004.