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Anatomy of Commercial Goodwill in a Large Professional Practice

The International Glossary of Business Valuation Terms defines goodwill as, “that intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors not separately identified.” A business interest may possess two different types of goodwill:

Business (or entity) goodwill. This belongs strictly to the entity itself. Business goodwill may arise from many sources, including the company’s name, phone number, location and special attributes, such as special menu items or recipes at a restaurant.

Personal (or professional) goodwill. This type of goodwill is directly attributable to an individual’s characteristics or attributes. It includes not only the owner’s skills, knowledge and reputation, but also his or her contacts and relationships.

About half of the states specifically exclude personal goodwill from the value of a professional practice (but still include business goodwill) if the business owner’s earnings are used to determine maintenance payments. Other types of businesses — such as retailers and manufacturers — may also possess elements of personal goodwill, depending on the facts and circumstances of the case.

Here are two court cases involving the valuation of minority interests in large professional practices that illustrate the dichotomy of opinions on how to handle business goodwill in a divorce context.

Bobrow v. Bobrow

Here, the husband (Richard) owned a 0.22 percent interest in Ernst and Young (EY), an international accounting firm. Richard testified that his business interest possessed no personal goodwill, but it might include some elements of business goodwill.

When valuing this business interest, the court adopted the value and methodology of the wife’s (Janet’s) expert, which valued his interest at nearly $9.75 million. Janet’s expert valued EY by adding the separate values of its tangible assets (essentially the value of the capital accounts) and then separately identified and valued intangible assets.

The court in Bobrow fell into a common valuation trap. Instead of valuing the interest at hand — Richard’s minority interest in EY — it valued the underlying assets held by the entire company on a controlling basis. The court also failed to take any lack of control or lack of marketability discounts, because neither expert quantified any valuation discounts.

The case was appealed but settled before any final decision was rendered. So, only the trial court decisions are available. It’s likely that major reductions in the value were made in the settlement. Nevertheless, the decision suggests that a large professional practice can be valued as though it was being sold in the open market and the pro rata value attributed to the individual partner.

(Bobrow v. Bobrow, State of Indiana, Hamilton Super Ct., 29D01-0003-DR-166)

Hill v. Hill

More recently, in Hill, the husband (Steven) was a principal at KPMG, another international accounting firm. The wife’s (Jessica’s) expert determined the value of his interest using the excess earnings method. (Note: The wife’s expert in Bobrow also used this methodology as a sanity check.) Steven’s expert opined, based on the partnership agreement, that the value of the interest was equal to the book value of his capital account less any debt ($14,000).

The trial court judge refused to accept the value set forth under the partnership agreement, but decided that the interest possessed only personal goodwill (although the court opinion suggests that there also may be some hard-to-value elements of business goodwill inherent in the interest). The judge also noted that, if the interest possessed business goodwill, the only way Steven could access it was to remain employed and hope that KPMG eventually goes out of business. So, in the absence of a rebuttal, the trial court sided with Steven’s expert that the value of his interest was $14,000. The appellate court affirmed.

(Hill v. Hill, 2014 Tex. App. LEXIS 292)

No Definitive Answers

In both cases, the experts failed to properly value the husband’s business interest or rebut the other expert’s conclusion. As a result, in Bobrow, the husband’s interest was valued at $9.75 million on compensation of $2.5 million. In Hill, the husband’s interest was valued at only $14,000 on compensation of $1.5 million.

In Hill, the judge also made two key points:

  • 1. Logically, a partnership interest in a large accounting practice possesses some elements of business goodwill.
  • 2. The value of business goodwill in a large professional practice is hard to quantify.

The wife’s expert in Bobrow attempted to quantify business goodwill. But, the methodology was similar to a purchase price allocation in which the company already knows the total purchase price. When valuing a business interest for divorce purposes, the end result is not to value individual assets to fit into a known total entity value. Instead, the purpose in divorce is to value the individual’s interest in the entity, with consideration of their ability to actually realize a concluded value for that particular interest.

Both Bobrow and Hill seem to miss the point. Clearly, there remains significant confusion in divorce matters related to personal versus business goodwill. Bifurcating personal and business goodwill is always going to be a matter of opinion, because these elements are never sold as separately identifiable assets. Therefore, it’s imperative to use a trained valuation professional to present a well-supported and logical analysis of the facts at hand.

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