In the sale of a business, the difference between personal goodwill and enterprise goodwill can significantly impact the final proceeds realized by the owners. In many cases, business operations are driven by the owners’ reputation and personal relationships.
Owners may know their customers personally, or have key relationships with suppliers that give them a competitive advantage. More than just good business practice, these things can also be an intangible asset called personal goodwill, which for accounting purposes is the personal property of the owners and not of the business.
Personal Goodwill vs. Enterprise Goodwill
Personal goodwill can take many forms, but is typically present in businesses with the following features:
| Attribute | Personal Goodwill | Enterprise Goodwill |
| Reputation | Customers know the owners personally and repeat customers return because of them. | Customers know the business because of its reputation, not the owners personally. |
| Sales | Sales are based on the efforts of the owners themselves, their reputation and their personal relationships. | Sales are based on advantages offered by the business, not the owners: price, location, national affiliation, etc. |
| New Customers | New customers are drawn because of the owners’ reputation or individual referrals. | New customers are drawn because of the company’s reputation or the services it provides. |
| Management | The owners would be difficult to replace because business operations are dependent on them. | The owners would not be difficult to replace because the business is not dependent on any individual managers. |
| Profit | The business would be less profitable without its existing owners. | The business would be just as profitable if the owners were replaced. |
| Employment Agreements / Non-Compete Agreements | There are no employment agreements and/or non-compete agreements in place. | There are employment agreements and/or non-compete agreements in place. |
When these features exist in a business, it may be useful to distinguish between the value of personal goodwill and enterprise goodwill, which are treated differently for tax purposes. The difference in tax treatment may result in meaningful savings to the owners of a business when it is sold.
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Why Do You Need to Distinguish Between the Value of Personal Goodwill and Enterprise Goodwill?
To understand why, consider the taxes paid in the sale of a hypothetical company, ABC Corp. Say that ABC Corp. is acquired in an asset sale for $1 million. The company itself, ABC Corp., pays taxes on the sale of the assets, and then the shareholders of ABC Corp. pay taxes on the liquidating dividends from the company. In other words, the proceeds from the sale of the business are taxed twice. (For reasons discussed further below, the benefits of personal goodwill are generally only applicable in asset sales involving C corporations.)
However, if the owners of ABC Corp. had personal goodwill in the business, the value of the personal goodwill would only be taxed once. To understand the possible savings due to personal goodwill, consider the same example again, but a little different. Say that the purchase price of ABC Corp. was the same, $1 million. Except this time, the value of the owners’ personal goodwill was determined to be $250,000, with the value of the company’s assets (including enterprise goodwill) being the other $750,000. Now, taxes would be paid twice on the $750,000 just like in our previous example, while the other $250,000 would only be taxed once, when it is purchased directly from the shareholders themselves. In other words, the owners would avoid paying double taxes on 25% of the transaction price by identifying the value of personal goodwill before the transaction occurs.
The example above is for illustrative purposes only, and should not be used as a reference for any specific business. Nevertheless, it shows that under certain circumstances, sellers may benefit from the valuation of personal goodwill associated with a business before a transaction occurs.
Benefits of Personal Goodwill in Selling a Business
As mentioned previously, the benefits of personal goodwill are generally only available in asset sales involving C corporations. This is because stock sales are treated differently than asset sales for tax purposes, and S corporations (as well as other pass-through entities) are not taxed at the entity level as C corporations are. A deep discussion of taxes in M&A is outside the scope of this article, but it is enough to understand that for selling shareholders of C corporations, there may be significant benefits to structuring the deal as an asset sale and separately identifying the value of personal goodwill beforehand.
Every business is unique, and should be evaluated individually by an appraiser to determine the presence of personal goodwill. Bennett Thrasher is committed to protecting our clients’ investments in their businesses and in themselves. For more information, contact us to see if a personal goodwill valuation is right for your business.
