November 30 , -0001
Valuing goodwill is one of the potential pitfalls related to your business during divorce negotiations. There are really 2 types of goodwill, enterprise and personal. Both are business assets which can be quantified. These assets are classified as intangible as compared to tangible assets such as cash and equipment.
In my practice, I often classify personal goodwill as a cost against the unadjusted value of an enterprise in the form of a percentage reduction in value (i.e. a Key Man Discount). It may apply to some extent in any enterprise. It is not unique to the classic professional trades and could apply to your business during the divorce process. It’s important to note that businesses have many types of intangible assets other than goodwill. Goodwill is not simply the difference between enterprise value and tangible assets.
On the other hand, enterprise goodwill is an intangible asset attributed to the business without regard to who owns or operates it. If customers are more loyal to a technology or product as opposed to its owner, then enterprise goodwill exists. Enterprise goodwill can be transferred to another owner during a sale. Personal goodwill cannot. If it is determined that the value of the company would decrease significantly if the owner left, that is a strong indicator that a portion of the value of the company is attributable to the personal goodwill of the owner. If you are going through divorce and own a business, you’ll want to consider this.
Most states, including Georgia, include enterprise goodwill in the marital estate. As such it is subject to equitable distribution. Georgia excludes personal goodwill from the marital estate. In reality, after factoring in an owner’s market salary, a business can have no value and simply provide a job. Equitable distribution in Georgia does not include either spouse’s future earnings potential. Including personal goodwill can be a pitfall in divorce negotiations.
Double dipping is another pitfall. This occurs when a spouse’s income from the business is counted twice. Salary must be adjusted to market rates for the profession with the value of the business determined based on cash flow that remains. In the valuation process, salary adjustments are usually made that can result in higher value. This happens when an owner pays him/herself an above market salary. Making the adjustment and basing spousal support on the higher, unadjusted salary results in double dipping or double counting income. Diligence must be undertaken by the business-owning spouse, his/her attorney, and the valuation expert to understand what was included in arriving at the value for the business and subject to equitable distribution to avoid having the same funds used again in an alimony or child support award.
In a divorce situation, the first question that must be answered is whether it makes sense to incur the costs associated with hiring a business valuation expert. In many cases it makes sense to pay for an expert’s time if not just to understand if the business is a minor asset with little value beyond providing a spouse with a job. The savings from knowing this and justifying the conclusion can far outweigh the cost of an expert through legal fees and negotiating a bad settlement based on inaccurate conclusion of value.