What is “personal” or “professional” goodwill, and how is it distinguished from the asset known as “corporate” or “enterprise” goodwill? And why should you care?
In the context of a transaction, business enterprise goodwill refers to the price paid for a business above tangible assets and what the buyer can identify as intangible assets. Buyers perceive value in and quantify the value of recurring customers, technology, trade names, rights, contracts, and other agreements. Enterprise goodwill is what remains of the price paid after all these assets are identified and quantified. It comprises the idea that these items will substantially evolve in the future and encompass business relationships that haven’t been formed and technologies yet to be developed. It can also comprise the more discrete components of a business, such as its history in the marketplace, the assembled and trained workforce, and overall reputation.
In certain businesses, goodwill can also be composed of the unique attributes and skills brought to the company by individuals. These special attributes are known as personal goodwill. They are attached to the professional due to confidence in their skill and ability to generate revenue or profits for their business. These attributes would be extinguished in the event of the professional’s death, retirement, or disability. Personal goodwill differs from corporate goodwill in that personal goodwill represents the value owned by the person while the business owns enterprise goodwill.
Personal Goodwill: Where It Can Arise
The notion of personal goodwill often arises in the context of professional practices. Take the case of a sole shareholder of an accounting firm that has been in operation for decades. The shareholder’s relationships with clients and reputation in the community are representative to him or her personally. Clients return because of the shareholder or because of his or her standing as a business person in the community. This person’s continued involvement is critical to the continued success of the business. If the company were sold, there would be very little, if any, enterprise goodwill available for purchase.
By contrast, large public companies institutionalize relationships, protect intellectual properties, and primarily rely on the totality of their infrastructure for continued success.
For tax purposes, this distinction can have significant savings to the taxpayer involved in the sale of a C-corporation. When assets in a C-corporation are sold, shareholders will realize a taxable gain at the C-corporation level and again at the individual level. When any proceeds are distributed to shareholders, and a portion of the asset can be deemed a sale of personal goodwill, double taxation can be avoided. However, the idea must be well documented and supported, and a professional appraisal must be obtained to distinguish between enterprise and personal goodwill.
If you or your clients are considering a path to exit in the near term, Acuity Advisors can help you understand your options, anticipate the obstacles, and achieve the right result.
References: Norwalk v. Commissioner, T.C. Memo 1998-279.