When I write posts, I try to answer questions that are asked of me about valuation. Sometimes the questions are direct and sometimes I answer the questions that should have been asked. This is one of the questions that should have been asked.
What is Personal Goodwill? It is the intangible value associated with the reputation of a person, rather than of the business (usually referred to as Enterprise Goodwill). Personal Goodwill is most often an issue in divorce cases, but it can be an issue in all valuations, taking the form of a Key Person Discount. Personal Goodwill can be attributed to a shareholder or an employee.
Personal Goodwill is easily observed in professional practices. This reputation may result from the person’s manner, his or her technical skills or some other personal attribute. The personal reputation of a doctor or lawyer is often obvious.
It may be harder to see in other businesses. For example, in a manufacturing company, the key sales person is able to sell twice as much as any other sales person because she has developed a reputation in the industry for knowing what her customers need and making sure that they order based on those needs. While the brand reputation of the product she sells, the timely delivery of the product, and the service department reliability are part of Enterprise Goodwill, her personal reputation and resulting profit generated from the additional sales she is able to make above and beyond other sales people in the organization may be attributable to Personal Goodwill. This is the case if the value she brings to the business resulting from the additional sales is greater than the additional commissions she receives.
So how do you distinguish between Personal Goodwill and Enterprise Goodwill? The easy answer is to project what would happen to the business if the key person left? Would the company be able to continue generating the same level of revenue and profits? Could a replacement be hired?
So why does this matter? In valuing a business, the value is just that: the value of the business. If the business has not entered into contracts to retain personal goodwill , it does not belong to it and is usually not included in value. (Divorce law varies by state and is beyond the scope of this post.)
However, in valuations that are not for divorce, Personal Goodwill takes the form of a Key Person Discount, which reduces the value of the company for the economic impact of a key person leaving. As a business owner, there are ways to minimize the impact of Personal Goodwill on the value of a business through various types of contracts with key employees.
Employment contracts can tie an employee to a company for a period of time, maximizing the company’s ability to profit from the relationship. An employment agreement can also limit an employee’s ability to compete with the company once he or she leaves. An employment law attorney can assist you in drafting an agreement to safeguard your company to the fullest extent allowable by the law, minimizing the impact of a key employee on the value of the company.
As a business owner, the objective is to increase the value of a company. Understanding how the reputation of a company and its employees impacts value is a step to safeguarding the value created by Goodwill.
If you have questions about this or other valuation matters, please contact me.
©2011 Florida Business Valuation Group
