In a recent post, we discussed taxation on sales of a business’ assets. This time, we’re addressing one of the intangible assets – goodwill.
The first thing you need to know is that there are two separate types of goodwill – business goodwill, which is a corporate asset, and personal goodwill, which belongs to the business owner(s) individually. When you engage a business valuation specialist, make sure s/he pays careful attention to goodwill, and can untangle and estimate the value of both business and personal goodwill, as appropriate.
Your specialist can also help you determine whether personal goodwill is a moot point, due to any non-compete contracts you may have in place with your business (in the case of an S Corporation owned by a single individual, this is often not an issue, but be certain). You should find out whether any such non-compete contracts can be voided prior to entering into sales negotiations.
The value of a business’ goodwill, simply put, is the difference between the amount which is allocated to the various IRS-designated classes of the business’ tangible assets and the purchase price.
However, the purchase price allocation can be a thorny road to travel with your buyer, who will want to allocate as much as possible to tangible assets which can be depreciated over 5 years on a stepped up basis, and as little as possible to goodwill, which is depreciated over 15 years, thereby generating a smaller annual tax deduction.
You, on the other hand, will want to allocate less of the purchase price to tangible assets, as any gains on tangible assets are likely to be taxed at ordinary income rates, and more to goodwill, the sale of which is taxed as long-term capital gains, assuming you’ve been running your business more than a year.
That’s one reason it’s important to understand goodwill, and its estimated value, before you enter into negotiations with any buyer. Estimates of the value of each applicable intangible asset which can translate into goodwill should be current and readily available to the buyer to support your position.
Some examples of intangible assets which factor into a business’ goodwill are:
The above is by no means an exhaustive list, but touches on some of the more likely and/or significant business goodwill components.
If your business depends heavily upon your specialized skills and knowledge and/or your established good relationships with customers, suppliers, and team members, it’s a fair bet you may have some personal goodwill to offer your buyer.
In addition, if your employment contracts are “at-will,” terminable for any reason at any time by either party, that’s a plus for personal goodwill.
Further, it’s extremely important that you void any existing non-compete clause in your own employment contract (if you have one). A non-compete contract may (and should, if you want to recognize a sale of your personal goodwill as an asset) be entered into with your buyer, but should not exist between you and the business you own, as this effectively transfers your personal goodwill to the goodwill of your business.
Finally, when you (and your valuation specialist) determine that you generated personal goodwill in association with running your business, take care to handle any sale of such personal goodwill as a separate transaction solely between the buyer and yourself.
The above by no means represents an exhaustive list of the factors which go into valuing business and/or personal goodwill for a sale. Valuing both business and personal goodwill is a matter for experts – if you are even considering a potential sale of your business, please reach out to our Transaction Advisors for guidance – we can help you through every stage of the process.
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Until next time –