Professional v. Practice Goodwill - Professional Practice Valuations for Marital Dissolutions
A Global Reach with a Local Perspective www.decosimo.comProfessional v. Practice GoodwillProfessional Practice Valuations for Marital DissolutionsShannon Farr, CPA·ABV·CFFDecosimo Advisory Services | 423.756.7100 | ShannonFarr@Decosimo.comOctober 19, 2011
Today’s Objectives Define goodwill, professional/personal goodwill and practice/enterprise goodwill Identify the variety of treatments by state courts Discuss precedent-setting cases in Tennessee Identify practical solutions to apply in professional practice valuations
Goodwill, defined Goodwill—that intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors not separately identified. (SSVS #1 Glossary of Terms) As defined by the Indiana Supreme Court (Yoon v. Yoon): …the expectation of continued public patronage.Jay Myoung Yoon v. Sunsook Yoon. Indiana Supreme Court, CauseNo. 49S02-9906-CV-353. Decided June 21, 1999.711 N.E. 2d 1265; 1999 Ind. LEXIS 402
Personal Goodwill, defined Business Valuation Resources (BVR): Personal Goodwill is the goodwill associated with an individual. Fishman, Jay. Business Valuation Resources, LLC. BVR’s Guide to Personal v. Enterprise Goodwill, 2008 ed.; Ch.1.
Personal Goodwill, defined ―Personal goodwill is a personal asset that depends on the continued presence of a particular individual and may be attributed to the individual owner’s personal skill, training or reputation.‖ (Supreme Court of Appeals of West Virginia, May v. May, (No. 31123))
Elements of Personal Goodwill The professional’s expertise and/or specialized skills The professional’s knowledge The professional’s relationships The professional’s reputation The professional’s personality (charisma)Fishman, Jay. Business Valuation Resources, LLC. BVR’sGuide to Personal v. Enterprise Goodwill, 2008 ed.; Ch.1.
Enterprise Goodwill Business Valuation Resources (BVR): Enterprise Goodwill is the goodwill associated with the enterprise or institution.
Enterprise Goodwill, defined ―Enterprise goodwill is an asset of the business and may be attributed to a business by virtue of its existing arrangements with suppliers, customers or others, and its anticipated future customer base due to factors attributable to the business.‖ (Supreme Court of Appeals of West Virginia, May v. May, (No. 31123))
Elements of Enterprise Goodwill The business’s location(s) The business’s staff/employees The business’s operating procedures/protocol The business’s reputation The business’s name, logo, website, phone number (branding)Fishman, Jay. Business Valuation Resources, LLC. BVR’sGuide to Personal v. Enterprise Goodwill, 2008 ed.; Ch.1.
Dr. Shannon Pratt Understanding the Difference Between Personal and Enterprise Goodwill is Vital to the Identification of Marital Assets …the separation of personal versus enterprise goodwill depends on whether (or the extent to which) the customer returns because of the individual, or because of an element or elements that belong to the enterprise.Pratt, Shannon P. Business Valuation Resources, LLC. BVR’sGuide to Personal v. Enterprise Goodwill, 2008 ed.; Ch.1.
Characteristics of a Professional Practice Primarily a service business with fewer tangible assets than most small businesses. A relationship of trust and respect exists between the client and the professionals or employees of the practice. This is because the client must rely on professional expertise that the client is not fully capable of understanding or evaluating. The practice or the practitioner often relies on referrals. A specific college or graduate degree is usually required by regulatory bodies for the professional to practice in the chosen field. The practitioner is licensed by a governmental or regulatory agency and/or certified by a recognized professional organization.Source: Valuing Small Businesses and Professional Practices, Pratt, Reilly and Schweihs, pp. 560 - 561
Standards of Value Fair Market Value Fair Value (for shareholder dissent and oppression cases) Fair Value for Financial Reporting Investment Value
Fair Market Value Fair Market Value—the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.(SSVS #1 Glossary of International Business Terms)
Fair Value For state legal matters only, some states have laws that use the term fair value in shareholder and partner matters. For state legal matters only, therefore, the term may be defined by statute or case law in the particular jurisdiction. In this context, fair value typically excludes consideration of minority interest discounts For financial reporting: the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Investment Value Investment value - the value to a particular investor based on individual investment requirements and expectations. (SSVS #1, Glossary of International Business Terms)
Goodwill as a Marital Asset In the event of a marital dissolution it may be necessary for the court to: First distinguish between personal and enterprise goodwill and, then, Decide which type of goodwill is a marital or distributable asset. A number of courts, but not a majority, 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. A minority of courts have taken the position that neither personal nor enterprise goodwill in a professional practice constitutes marital property. The majority of states differentiate between enterprise goodwill and personal goodwill. Courts in these states take the position that personal goodwill is not marital property, but that enterprise goodwill is marital property. Gordon, Noah J. Business Valuation Resources, LLC. BVR’s Guide to Personal v. Enterprise Goodwill: Goodwill Valuation in the Courts, 2008 ed.; Ch.2.
Majority Rules The majority of states, but not all, have precedent- setting cases establishing enterprise goodwill attributable to the business itself as a marital asset, and personal goodwill intrinsically tied to the attributes and skills of an individual, as not marital.
The Concept of Transferability The concept of transferability is closely linked to distinguishing between professional and enterprise goodwill
Does Size Matter? As a business increases in size and complexity, its goodwill transitions from primarily personal to enterprise
Tennessee Court Decision Continuum Neither Personal nor Enterprise Goodwill is a Enterprise Goodwill is Marital Asset, Personal Considered a Marital Asset Goodwill is Not Smith v. Smith, Witt v. Witt, 709 S.W.2d 588 No. 01-A-019110CH00360, 1992 WL 52746(Tennessee Court of Appeals, 1985) (Tennessee Court of Appeals, 1992) York v. York, Hazard v. Hazard, No. 01-A-01-9104-CV-00131, 1992 WL 181710 833 S.W.2d 911 (Tennessee Court of Appeals, 1992)Tennessee Court of Appeals, 1991 McKee v. McKee, No. M2009-01502-COA-R3-CV (Tennessee Court of Appeals, 2010)
Smith v. Smith (TN Court of Appeals) The wife appealed the Trial Judge’s treatment of the husband’s law practice as a nonmarital asset. The Tennessee Court of Appeals stated as follows: ―We are not persuaded, however, that this state should adopt the rule that professional goodwill is a part of the marital estate. We find the position taken by the Wisconsin Court of Appeals in Holbrook v. Holbrook, 103 Wis. 2d 327, 309 N.W.2d 343 (1981) to be persuasive.‖ Smith v. Smith, 709 S.W.2d 588 Tennessee Court of Appeals, 1985.
The Concept of ―Double-dipping‖ In Holbrook v. Holbrook, the (Wisconsin) Court said: The concept of professional goodwill evanesces when one attempts to distinguish it from future earnings capacity. Although a professional business’s reputation, which is essentially what its goodwill consists of, is certainly a thing of value, we do not believe that it bestows on those who have an ownership interest in the business, an actual, separate property interest. The reputation of a law firm or some other professional business is valuable to its individual owners to the extent that it assures continued substantial earnings in the future. It cannot be separately sold or pledged by the individual owners. The goodwill or reputation of such a business accrues to the benefit of the owners only through increased salary.
McKee v. McKee (TN Court of Appeals) The wife (a pediatric dentist) owned a one-third interest in the dental practice of which she was a partner. The two experts testifying at trial agreed that it was inappropriate to consider personal goodwill in valuing a business for divorce purposes, but they differed in their categorization of patient files. The wife’s expert testified that no value should be attributed to the patient records in the context of the divorce proceeding because it equates to personal goodwill. Key points of his testimony included: Patient records are not capable of earning money “without a professional providing the service,” and The presence of the restrictive covenant in the wife’s partnership agreement was “proof” of the existence of personal goodwill McKee v. McKee, No. M2009-01502-COA-R3-CV (Tennessee Court of Appeals, 2010)
Witt v. Witt (TN Court of Appeals) The Husband was the chief of radiological services at a hospital and also operated a diagnostic clinic with eight technicians that provided services to referring physicians. The Court approved the trial court’s finding that the value of the husband’s medical practice substantially exceeded the net asset value even if the husband’s professional goodwill were excluded.Witt v. Witt, No. 01-A-019110CH00360, 1992 WL 52746Tennessee Court of Appeals, 1992.
York v. York (TN 1992) Although husband originally had a solo surgical practice, at the time of divorce he owned 85% of an incorporated multi-specialty medical group employing 11 physicians, 10 nurses, a psychologist and an optometrist. The company also owned an office building housing physician offices, an ambulatory clinic, an optical store, and space for an endoscopy clinic. Husband ―insisted‖ that any valuation of the company should, as a matter of law, not include business goodwill (citing Smith). However, the appeals court ruled that Smith’s ―net asset value principles‖ did not apply to incorporated professional practices that do not depend solely on the professional reputation of the practitioner (citing Witt).
Company/Practice Analysis How is revenue generated? From the owner- professional’s efforts only? Or from employee- professionals efforts as well? How many employees does the practice have? What are their functions? Do they have credentials/ certifications? Are they ―highly trained‖? How are the facilities contributing to patronage? Is location a factor? What equipment is in place? Is equipment integral to the services provided? How does the entity compare to other entities within the same professional (smaller, larger, etc.)?
The Asset Approach Asset approach – typically excludes all intangible assets, including goodwill (whether personal or enterprise) Likely the best approach for valuing professional practices similar to that in Smith Can be used in conjunction with determinations of the value of enterprise goodwill components such as a trained and assembled workforce
The Market Approach: An ―Unwilling‖Seller? Many courts have considered the ―unwilling‖ seller issue. This concept is sometimes referred to as ―value to the holder.‖ Quite simply, these courts have considered the fact that the owner-professional spouse is not a ―willing seller‖ as contemplated by the definition of fair market value. A covenant not-to-compete is an essential element in this consideration In these jurisdictions, the M&A method results likely will not apply/be considered
―For Purposes of Marital Dissolution‖ Although the valuation analyst may or may not be asked to assist in the determination of child support or alimony, the basis of these determinations is the parties’ (presumably ongoing) current income. If the income used in the support determinations is generated by a spouse’s professional practice, it is conceptually unreasonable to assume that the professional is ―willing‖ to sell his/her practice.
The Income Approach Often an option to value a professional practice with enterprise characteristics The discount rate/capitalization rate can be adjusted to consider key man factors The excess earnings method could be used to determine the value apart from personal goodwill If cash flows from ancillary services (services provided without the direct effort of the professional) can be isolated, these income streams can be capitalized
Resources ―Goodwill Hunting in Divorce‖ free download available at www.bvresources.com Valuing Small Businesses and Professional Practices, Pratt, Reilly and Schweihs BVR’s Guide to Personal and Professional Goodwill Smith v Smith, 709 S.W.2d 558 (Tenn. App. 1985) McKee v McKee, No. M2009-01502-COA-R3-CV (Tenn. Ct. App., Aug. 17, 2010) Witt v. Witt, No. 01-A-019110CH00360, 1992 WL 52746 (Tenn. Ct. App., Mar. 20, 1992) York v York, No. 01-A-01-9104-CV-00131, 1992 WL 181710 (Tenn. Ct. App., Jul. 31, 1992)
CONTACT SHANNON FARR Shannon Farr ShannonFarr@decosimo.com 423-756-7100 DISCLAIMER: The contents and opinions contained in this presentation are for informational purposes only. The information is not intended to be a substitute for professional accounting counsel. Always seek the advice of your accountant or other financial planner with any questions you may have regarding your financial goals.