Personal vs. Enterprise Goodwill: Where Are We and How Do I Deal With It? By: Gary R. Trugman CPA/ABV, MCBA, ASA, MVS

Personal vs. Enterprise Goodwill: Where Are We and How Do I Deal With It? By: Gary R. Trugman CPA/ABV, MCBA, ASA, MVS

Speaker Biography Gary R. Trugman is the President of Trugman Valuation Associates, Inc., a business valuation and economic damages firm with offices in Plantation, FL and Parsippany, NJ. He is a Certified Public Accountant licensed in the states of Florida, New Jersey, and New York (inactive). He is Accredited in Business Valuation by the AICPA, is a Master Certified Business Appraiser as designated by The Institute of Business Appraisers Inc., and an Accredited Senior Appraiser (ASA) in Business Valuation by the American Society of Appraisers. Gary is regularly court appointed and has served as an expert witness in Federal court and state courts in several jurisdictions, testifying on business valuation, matrimonial matters, business and economic damages and other types of litigation matters. Gary is Past Chairman of BV Education and the current Ethics Committee Chair for The American Society of Appraisers. Gary has been on numerous AICPA committees and has also received an AICPA Hall of Fame Award for his service to the accounting profession in assisting in the accreditation in business valuation process. Gary lectures nationally on business valuation topics. He is the author of a textbook entitled Understanding Business Valuation: A Practical Guide to Valuing Small to Medium Sized Businesses and an e book entitled Essentials of Valuing a Closely Held Business, both published by the AICPA.

WHAT ARE WE GOING TO DISCUSS? Where is the case law today and what are the trends? The impact on business valuation assignments In divorce In tax Quantifying the unquantifiable

PERSONAL GOODWILL DIVORCE Majority of states provide that personal goodwill is not subject to division in marital disputes Trend is growing Case law appears to be redefining our standard of value TAX Allocation of purchase price has more emphasis to personal goodwill of shareholders

DIVORCE STANDARDS OF VALUE Fair Market Value Fair Value Investment Value Intrinsic Value a/k/a Investment Value a/k/a Value to the Owner Recognizes no sale to take place Recognizes no change in ownership Recognizes that the existing owner will continue to receive the benefits of ownership (good or bad!)

WHAT DO THE DEFINITIONS MEAN? Fair Market Value Hypothetical Buyer and Seller Arm s Length Transaction Minority and Marketability Discounts Applicable Intrinsic Value Attributes of the Owner Considered

Personal vs. Practice Goodwill John Smith CPA or KPMG? Transferability of the goodwill Referral sources Market realities Sale of a law firm

Covenant Not To Compete Does Fair Market Value include a covenant? Would you buy if the seller could open up next door? Appraisers differ in opinion as to whether a covenant is included in fair market value Some courts take the position that without a CNC, all goodwill is personal

Covenant Not To Compete From an economic perspective, value is dependent on: the ability of the seller to compete the derivation of the non compete agreement the losses the company would suffer if the seller competed In the instance where the seller has the ability to compete, the relevant question becomes: What impact would competition from the seller have on the business? Answer depends on a myriad of factors, but chief among them are: the seller being in possession of relationships that could redirect business from the company to a new company established or invested into by the seller the seller having either sufficient knowledge or technology to allow him or her to bring competitive services to market

In Williams v. Williams,(No. 95 00577, 1996 WL 47675 (Fla.App.2 Dist. Feb. 7, 1996) The appellate court stated:... the goodwill of [a] professional practice can be a marital asset subject to division in a dissolution proceeding, if it exists and if it was developed during the marriage... However,... for goodwill to be a marital asset, it must exist separate and apart from the reputation or continued presence of the marital litigant... When attempting to determine whether goodwill exists in a practice such as this, the evidence should show recent actual sales of a similarly situated practice, or expert testimony as to the existence of goodwill in a similar practice in the relevant market... Moreover, the husband's expert, who testified the practice had no goodwill, stated that no one would buy the practice without a noncompete clause. This is telling evidence of a lack of goodwill.

Personal Goodwill What s An Appraiser To Do? No Generally Accepted Appraisal Techniques Goodwill Considerations Can a professional have goodwill but no goodwill value? In a sole proprietorship, what about other intangibles? How can we quantify goodwill? Excess earnings method Residual allocation of value

Personal Goodwill What s An Appraiser To Do? Personal Goodwill Monitor Intake Adjust Reasonable Compensation Covenant Not To Compete Analysis Transaction Databases

Divorce Case Study Valuation of A Dental Practice

Valuation of Entire Practice Net Tangible Value $208,000 Intangible Value 618,450 Total Value $826,450 The normalized balance sheet was used to derive the value of the net tangible assets By subtraction, any remaining value would be attributable to intangible assets This would be the maximum amount that a willing buyer would be looking to protect in an acquisition of ABC Dental Care.

Market Evidence Transaction With Dr. Mayer

Contract For Sale Between Dr. Brown and Dr. Mayer Asset purchase agreement included a restrictive covenant Allocation on page 3 of this agreement, the $366,000 purchase price was allocated between tangible and intangible assets as follows: Tangible Assets $153,720 Intangible Assets 212,280 Total $366,000

Contract For Sale Between Dr. Brown and Dr. Mayer The intangible assets were broken down between patient records and restrictive covenant as follows: Patient Records $131,760 Restrictive Covenant 80,520 Total $212,280

Accounts Receivable Was not part of deal and had to be estimated This was calculated as follows: 3/23/2000 A/R $ 478,352 1999 Revenues 1,911,743 % of Receiv. to Fees 25.02%

Accounts Receivable Second Office 1989 Revenues $616,191 % of Receiv. to Fees 25.02% Estimated Receivables $154,182 2nd Office Purchase Price $366,000 Total Value $520,182 Non Compete Covenant $80,520 % of Covenant to Value 15.48%

More Market Evidence Use of Transaction Database

Conclusion From Pratt s Stats Database Average non-compete agreement value to net selling price = 14.29% Removed all specialty practices New average = 14.74% Market evidence = 14% to 15% is indicative of the non-compete values

Reaching The Final Conclusion Best indication non compete would be using market data involving Dr. Brown Although the transaction was older, it is within the range of reasonableness (15.48 percent versus 14.74 percent) based on the other market evidence We have used 15.48% as portion to be excluded Value of ABC Dental Care subject to equitable distribution would be $730,714, or $731,000 rounded

Value Calculation Net Tangible Value $208,000 Intangible Value 618,450 Excluded Portion ($618,450 x 15.48%) 95,736 Intangible Included 522,714 Total Value 730,714 Rounded 731,000

Allocation of Purchase Price ASC 805 The purchase price is allocated in the following order: Net Working Capital Assets Fixed and Tangible Assets Other Tangible Assets Identifiable Intangible Assets Goodwill Assets that are of an intangible nature must meet the separability criterion.

Tax Case Study Allocation of Purchase Price

FACTS OF THE CASE XYZ was purchased by a larger company The total purchase price was $7 million We were asked to determine what could be allocated to the shareholder that was running the business

STEPS TAKEN Value XYZ as a stand alone company Determine the value of those assets that were transferred as part of the Asset Purchase Agreement

NORMALIZED EARNINGS December LTM 31, June 30, 2009 2010 Historic Net Income $(10,872) $(14,989) Adjustments Officers' Compensation Addback 494,046 492,242 Officers' Compensation Replacement (341,800) (350,345) Historic Income Taxes 530 (7,536) ADJUSTED PRETAX NET INCOME $141,904 $119,372 Income Taxes 43,353 33,810 ADJUSTED HISTORIC NET INCOME $98,551 $85,562

CAPITALIZATION OF LTM DEBT FREE NET INCOME Debt Free Net Income $106,448 One Plus the Long Term Rate of Growth x 1.025 Debt Free Net Income for Capitalization 109,109 Capitalization Rate 15.40% Market Value of Invested Capital $708,500 Less Interest Bearing Debt (651,302) Fair Market Value of XYZ $57,198 Rounded $57,000

VALUE OF TRANSFERRED ENTITY Fair Market Value XYZ $ 57,000 Plus Retained Liabilities Accounts Payable 1,029,197 Notes Payable 651,302 Accrued Expenses 136,415 Income Taxes Payable 129,573 Less Retained Assets Cash (121,619) Accounts Receivable (1,387,626) 401K Escrow Account (2,668) Value of Transferred Assets $491,574 Rounded $490,000

FMV OF ASSETS TRANSFERRED Fixed Assets Minor so we redepreciated over useful lives. Est. $40,000 Contracts DCF based on expected cash flows. Est. $350,000 Proprietary Rights DCF based on expected cash flows. Est. $30,000

ALLOCATION OF FMV OF TRANSFERRED ASSETS Fair Market Value of Transferred Assets $490,000 Fair Market Value of Fixed Assets (40,000) Value of Software Contracts (350,000) Value of Software 2 Module (30,000) Goodwill $70,000

PURCHASE PRICE ALLOCATION OF $7M Purchase Price $7,000,000 Fixed Assets (40,000) Value of Software Contracts (350,000) Value of Software 2 Module (30,000) Remaining Unallocated Amount of Purchase Price $6,580,000

COVENANT NOT TO COMPETE ANALYSIS Performed various scenario testing Considered lost revenues and saved expenses Resulted in CNC value of $1.2 million

FINAL ALLOCATION Fixed Assets $40,000 Software Contracts 350,000 Software 2 Module 30,000 Non Compete Value 1,200,000 Personal Goodwill 5,380,000 Subject to capital gains tax for the individual Price Paid by BPC $7,000,000

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