Business Valuation and Goodwill

One of the most valuable assets in a marriage may be a family business or professional practice, such as a medical practice or dental practice. Typically, a judge will try to determine the fair market value or fair value of the business. The judge will then allocate the business to the spouse who operates the business and award a compensating asset or value to the other spouse. One of the key aspects in the determination of the business value is the evaluation of the business goodwill.

The rule varies from state to state, but goodwill has long been recognized in Washington as property subject to division. Goodwill is a benefit the business or practice receives from regular customers on account of its local prominence in the community or reputation for skill. There are two forms of goodwill: enterprise/practice goodwill and personal goodwill. Enterprise/practice goodwill is based on the fact that customers return to an enterprise because of its location, staff, telephone number, facilities and reputation. Personal goodwill is goodwill that derives from an individual, based on the individual’s personal relationships, skill, personal reputation and various other factors. One of the arguments against valuing goodwill is that in many cases it cannot be sold.This is certainly true in many personal goodwill circumstances.

For example, a lawyer who sells his practice and moves to another state is not likely to leave clients behind who will continue to patronize his firm in his absence.So he is not likely to be able to sell his practice’s goodwill. Nonetheless, the Washington courts have held that although goodwill may not be readily sold, the important consideration is not whether the goodwill of the practice could be sold without the personal services of the professional, but whether it has value to the owner. Several factors are considered by the court in determining the value of goodwill, including the practitioner’s age, health, past demonstrated earning power, professional reputation in the community as to his judgments, skill, knowledge and his comparative professional success.

Once the existence of the goodwill has been determined, there are generally five major formulas which are used to value the business. These are the straight capitalization accounting method, the capitalization of excess earnings method, the IRS variation of capitalized excess earnings method, the market value approach, and the buy/sell agreement method. These are not the only formulas a judge may use in valuing a business or practice, and it is common to combine one or more methods to arrive at a fair value of any professional’s goodwill. That is why typically we will hire an experienced CPA to review all of the business records, meet with all parties who have significant knowledge of the operation of the business and then evaluate the business’ value using all appropriate methods. We have worked with several CPAs over the years, and can assist you in retaining one who will value your business accurately, reasonably, and fairly.

For more information about business valuation, please feel free to call the office and request a consultation.

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