How does goodwill factor into the valuation of a business? How might business goodwill be treated when determining an equitable division of marital property in a divorce? Here’s an examination of the majority and minority definitions and the nuances of goodwill in each.
By Margaret Simpson, Family Lawyer
Divorce is seldom a pleasant or an uncomplicated matter. Inherent stresses are amplified when the division of marital property includes a business owned by one of the spouses. Further complicating matters are vagaries, from jurisdiction to jurisdiction, on goodwill’s definition, the types of goodwill, and approaches to goodwill in divorce matters – all of which can make goodwill valuation challenging for the family lawyer.
When the value of a marital business is in dispute, it is helpful to have an understanding of the courts’ definitions of goodwill, the types generally recognized by the courts, and the primary approaches to determining which types can be considered marital property and thus equitably divided.
Definition of Goodwill in Divorce Settlements
“It is uniformly recognized that goodwill is a species of property and constitutes a valuable asset of the business of which it is a part.” Edible IP, LLC v. Google, LLC, 2022 Ga. LEXIS 29, *9, 869 S.E.2d 481. Goodwill may be described generally as “the favor which the management of a business has won from the public, and probability that old customers will continue their patronage.” Gaydos v. Gaydos, 693 A.2d 1368, 1372 (Pa. Super. 1997). “[G]oodwill is defined as ‘that intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors not separately identified.’” 1 LexisNexis Practice Guide: Georgia Family Law § 1.41 (2021). See also Yoon v. Yoon, 711 N.E.2d 1265, 1268 (Ind. 1999) (defining goodwill “as the value of a business or practice that exceeds the combined value of the net assets used in the business”).
Types of Goodwill
There are essentially two types of goodwill recognized by courts in divorce litigation: enterprise goodwill (also called commercial or professional goodwill) and personal goodwill (also called professional goodwill). May v. May, 214 W. Va. 394, 589 S.E.2d 536, 541 (2003).
Enterprise or commercial goodwill is transferred whenever the enterprise to which it attaches is bought and sold as an ongoing concern. Individual or personal goodwill is not transferable when the enterprise is bought and sold, and instead resides primarily in the personal reputation of the owner. Miller v. Miller, 288 Ga. 274, 705 S.E.2d 839 (2010).
Approaches to Goodwill in Divorce
There is a split of authority on whether enterprise goodwill and/or personal goodwill in a professional practice may be characterized as marital property and thus equitably divided. Three different approaches have developed:
1. No Distinction.
Many courts make no distinction between personal and enterprise goodwill. These jurisdictions have taken the position that both personal and enterprise goodwill in a professional practice constitute marital property.[i]
The underlying rationale for this position is summarized by the court in Golden v. Golden, 270 Cal. App. 2d 401, 75 Cal.Rptr. 735 (1969) as follows:
In a divorce case, the goodwill of the husband’s professional practice as a sole practitioner should be taken into consideration in determining the award to the wife. . . . In a matrimonial matter, the practice of the sole practitioner husband will continue, with the same intangible value as it had during the marriage. Under the principles of community property law, the wife, by virtue of her position as wife, made to that value the same contribution as does a wife to any of the husband’s earnings and accumulations during marriage. She is as much entitled to be recompensed for that contribution as if it were represented by the increased value of stock in a family business.
2. Minority View.
A minority of jurisdictions have taken the stance that neither personal nor enterprise goodwill in a professional practice constitutes marital property and neither should be used in determining the fair market value of a business, subject to equitable division in divorce cases.[ii]
The justification for this view is summarized as follows:
It becomes increasingly difficult for experts to place a value on goodwill because it is such a nebulous term subject to change on a moment’s notice due to many various factors which may suddenly occur, i.e., a lawsuit filed against the individual or the death and/or serious illness of the individual concerned preventing that person from continuing to participate in the business. It is also difficult to attribute the goodwill of the individual personally to the business. The difficulty is resolved however when we recognize that goodwill is simply not property; thus it cannot be deemed a divisible marital asset in a divorce action.
Singley v. Singley, 846 So. 2d 1004 (Miss. 2003).[iii]
3. Majority View.
The majority of states differentiate between enterprise goodwill and personal goodwill. May v. May, supra at 545 citing Gilman v. Hohman, 725 N.E.2d 425, 429 (Ind. App. 2000). Courts in these states take the position that enterprise goodwill is marital property, but personal goodwill is not.[iv]
In Yoon v. Yoon, 711 N.E.2d 1265 (Ind. 1999) the court explains the view thusly:
Enterprise goodwill is an asset of the business and accordingly is property that is divisible in a dissolution to the extent that it inheres in the business, independent of any single individual’s personal efforts and will outlast any person’s involvement in the business. It is not necessarily marketable in the sense that there is a ready and easily priced market for it, but it is generally transferrable to others and has value to others…
In contrast, the goodwill that depends on the continued presence of a particular individual is a personal asset, and any value that attaches to a business as a result of this “personal goodwill” represents nothing more than the future earning capacity of the individual and is not divisible.[v]
In Miller v. Miller, the Georgia Supreme Court adopted the majority view that enterprise goodwill is marital property that should be included in the valuation of a professional practice. Supra at 844.
However, the Court’s narrow ruling, did not explicitly adopt the second component of the majority view: that individual goodwill does not constitute marital property. Id. Rather, the Court observed that the trial court, in accepting the testimony of the wife’s expert, had excluded individual goodwill from its valuation of the husband’s medical practice. Id. The Court upheld the trial court’s valuation of the husband’s business based on the assumption, made for purposes of the Miller case only, that individual goodwill does not constitute marital property in Georgia. Id.
This holding leaves open the possibility that, under other facts and circumstances, individual goodwill could be considered marital property in Georgia and included in the valuation of a business.
Valuation of Goodwill
The Miller Court recognized that there is no precise formula for determining the value of goodwill but held that “even though it is difficult, it must be undertaken in each divorce matter where applicable.” Id. “[G]oodwill may be measured by any legitimate method of evaluation that measures its present value by taking into account some past result, so long as the evidence legitimately establishes value.” Id.
Types of Valuation
“There are many accepted methods used by experts in valuing a business’s goodwill. Some of the acceptable methods include the excess earnings method, the straight capitalization of earning method, net asset value method, capitalized excess earnings method, market value method, and the buy/sell agreement method.” Papin v. Papin, 166 Idaho 9, 454 P.3d 1092 (2019).
Five common methods for valuing goodwill are discussed in In re Marriage of Hall, 103 Wn.2d 236, 692 P.2d 175, 178-80 (Wash. 1984) as follows:
- Under the straight capitalization accounting method the average net profits of the practitioner are determined and this figure is capitalized at a definite rate, as, for example, 20 percent. This result is considered to be the total value of the business including both tangible and intangible assets. To determine the value of goodwill, the book value of the business’ assets is subtracted from the total value figure.
- The second accounting formula is the capitalization of excess earnings method. The average net income is determined under the pure capitalization of excess earnings; the annual salary of the average employee practitioner with like experience is subtracted from this figure. The remaining amount is multiplied by a fixed capitalization rate to determine the goodwill.
- The IRS variation of capitalized excess earnings method takes the average net income of the business for the last 5 years and subtracts a reasonable rate of return based on the business’ average net tangible assets. From this amount, a comparable net salary is subtracted. Finally, this remaining amount is capitalized at a definite rate. The resulting amount is goodwill.
- The fourth method, the market value approach, sets a value on professional goodwill by establishing what fair price would be obtained in the current open market if the practice were to be sold. This method necessitates that a professional practice has been recently sold, is in the process of being sold, or is the subject of a recent offer to purchase. Otherwise, the value may be manipulated by the professional spouse.
- The fifth valuation method, the buy/sell agreement method, values goodwill by reliance on a recent actual sale or an unexercised existing option or contractual formula set forth in a partnership agreement or corporate agreement. Since the professional spouse may have been influenced by many factors other than fair market value in negotiating the terms of the agreement, courts relying on this method should inquire into the presence of such factors, as well as the arm’s length nature of the transaction.[vi]
“Among the factors which may affect the value of goodwill and which therefore are relevant in valuing it are the age, health, and professional reputation of the practitioner, the nature of the practice, the length of time the practice has been in existence, its past profits, its comparative professional success, and the value of its other assets.” Poore v. Poore, 75 N.C. App. 414, 331 S.E.2d 266 (N.C. App. 1985).
“Another factor at play is the clear intent not to include future earnings as part of an equitable division award and also order an award of alimony based on those same earnings – in essence, to prevent the inequity of a double recovery.” Moore v. Moore, 414 S.C. 490, 779 S.E.2d 533, (2015).
Miller holds that “a determination of goodwill is a question of fact and not of law” and “where it appears that the trial court reasonably approximated the net value of the practice and its goodwill, if any, based on competent evidence and on a sound valuation method or methods, the valuation will not be disturbed.” Supra at 845.[vii]
[i] May v. May, supra at 543 citing Wisner v. Wisner, 129 Ariz. 333, 631 P.2d 115 (Ariz. App. 1981) (medical practice); In re Foster, 42 Cal. App. 3d 577, 117 Cal.Rptr. 49 (1974) (medical practice); In re Marriage of Huff, 834 P.2d 244 (Colo. 1992) (law practice); Heller v. Heller, 672 S.W.2d 945 (Ky. App. 1984) (accounting practice); Kowalesky v. Kowalesky, 148 Mich. App. 151, 384 N.W.2d 112 (Mich. App. 1986) (dental practice); In re Marriage of Stufft, 286 Mont. 239, 950 P.2d 1373 (Mont. 1997) (law practice); Ford v. Ford, 105 Nev. 672, 782 P.2d 1304 (Nev. 1989) (medical practice); Dugan v. Dugan,92 N.J. 423, 457 A.2d 1 (N.J. 1983) (law practice); Moll v. Moll, 187 Misc. 2d 770, 722 N.Y.S.2d 732 (2001) (stockbroker); Poore v. Poore, 75 N.C. App. 414, 331 S.E.2d 266 (N.C. App. 1985) (dental practice); Mitchell v. Mitchell, 104 N.M. 205, 719 P.2d 432 (N.M. App. 1986) (accounting practice); Sommers v. Sommers, 2003 ND 77, 660 N.W.2d 586 (N.D. 2003) (medical practice); In re Marriage of Hall, 103 Wn.2d 236, 692 P.2d 175 (Wash. 1984) (medical practice).
[ii] May v. May, 214 W. Va. 394, 589 S.E.2d 536 (2003) citing Powell v. Powell, 231 Kan. 456, 648 P.2d 218 (Kan. 1982) (medical practice); Chance v. Chance, 694 So. 2d 613 (La. App. 1997) (medical practice); Singley v. Singley, 846 So. 2d 1004 (Miss. 2003) (dental practice); Donahue v. Donahue, 299 S.C. 353, 384 S.E.2d 741 (S.C. 1989) (dental practice); Smith v. Smith, 709 S.W.2d 588 (Tenn. Ct. App. 1985) (law firm).
[iii] Accord Rhodes v. Rhodes, 52 So. 3d 430, 2011 Miss. App. LEXIS 19 (holding “goodwill — whether personal or business enterprise — shall not be included in a business valuation in divorce proceedings.”)
[iv] May v. May, supra at 545-46 citing Richmond v. Richmond, 779 P.2d 1211 (Alaska 1989) (law practice); Tortorich v. Tortorich, 50 Ark. App. 114, 902 S.W.2d 247 (Ark. App. 1995) (dental practice); Eslami v. Eslami, 218 Conn. 801, 591 A.2d 411 (Conn. 1991) (medical practice); E.E.C. v. E.J.C., 457 A.2d 688 (Del. 1983) (law practice); McDiarmid v. McDiarmid, 649 A.2d 810 (D.C. App. 1994) (law practice); Thompson v. Thompson, 576 So. 2d 267 (Fla. 1991) (law practice); Antolik v. Harvey, 7 Haw. App. 313, 761 P.2d 305 (Haw. App. 1988) (chiropractic business); In re Marriage of Head, 273 Ill. App. 3d 404, 652 N.E.2d 1246, 210 Ill. Dec. 270 (Ill. App. 1995) (medical practice); Yoon v. Yoon, 711 N.E.2d 1265 (Ind. 1999) (medical practice); Prahinski v. Prahinski,75 Md. App. 113, 540 A.2d 833 (Md. App. 1988) (law practice); Goldman v. Goldman, 28 Mass. App. Ct. 603, 554 N.E.2d 860 (Mass. App. 1990) (medical practice); Roth v. Roth, 406 N.W.2d 77 (Minn. App. 1987) (chiropractic business); Hanson v. Hanson, 738 S.W.2d 429 (Mo.1987) (medical practice); Taylor v. Taylor, 222 Neb. 721, 386 N.W.2d 851 (Neb. 1986) (medical practice); In re Watterworth, 149 N.H. 442, 821 A.2d 1107 (N.H. 2003) (medical practice); Travis v. Travis, 1990 OK 57, 795 P.2d 96 (Okla. 1990) (law practice); Matter of Marriage of Maxwell, 128 Ore. App. 565, 876 P.2d 811 (Or. App. 1994) (self-employed advertising copywriter); Butler v. Butler, 541 Pa. 364, 663 A.2d 148 (Pa. 1995) (accounting firm); Moretti v. Moretti, 766 A.2d 925 (R.I. 2002) (professional landscaper); Guzman v. Guzman, 827 S.W.2d 445 (Tex. App. 1992) (accounting firm); Sorensen v. Sorensen, 839 P.2d 774 (Utah 1992) (law practice); Howell v. Howell, 31 Va. App. 332, 523 S.E.2d 514 (Va. App. 2000) (law practice); Peerenboom v. Peerenboom, 147 Wis. 2d 547, 433 N.W.2d 282 (Wis. App. 1988) (dental practice); Root v. Root, 2003 WY 36, 65 P.3d 41 (Wyo. 2003) (medical practice).
[v] Accord Soria v. Soria, 43 Fla. L. Weekly D 293 (2018) (holding enterprise goodwill is a marital asset subject to equitable distribution, and personal goodwill attributable to the skill, reputation, and continued participation of an individual is not a marital asset); Moore v. Moore, 414 S.C. 490, 779 S.E.2d 533 (2015) (holding any value that attaches to a business as a result of personal goodwill represents nothing more than the future earning capacity of the individual and is not divisible in a divorce proceeding.)
[vi] Accord Moffitt v. Moffitt, 749 P.2d 343, 348 (Alaska 1988) (referencing all five methods); Hanson v. Hanson, 738 S.W.2d 429, 435-36 (Mo. 1987) (discussing all five methods). See also McAffee v. McAffee, 132 Idaho 281, 971 P.2d 734, 740 (Idaho App. 1999) (discussing straight capitalization and capitalization of excess earnings); Skrabak v. Skrabak, 108 Md. App. 633, 673 A.2d 732, 736-38 (Md. App. 1996) (discussing capitalization of excess earnings).
[vii] See also In re Marriage of Kirkendoll, 2016 Wash. App. LEXIS 2357 (affirming trial court’s valuation of husband’s business, including goodwill, despite trial court’s failure to specify the factors considered or the method used to calculate the value where expert testimony supported the trial court’s findings).
Margaret Simpson is an Associate at Boyd Collar Nolan Toggle & Roddenberry. Her practice focuses on matters including divorce, alimony, asset division, child custody, and child support. She has handled numerous cases before the Georgia Court of Appeals and the Supreme Court of Georgia. www.bcntrlaw.com
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