Valuing Business Goodwill in a Divorce

• Jurisdiction: Colorado,United States
• Citation: Vol. 26 No. 4 Pg. 53
• Pages: 53
• Publication year: 1997

26 Colo.Law. 53 Colorado Lawyer 1997.

1997, April, Pg. 53. Valuing Business Goodwill in a Divorce

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53

Vol. 26, No. 4, Pg. 53

The Colorado Lawyer
April 1997
Vol. 26, No. 4 [Page 53]

Specialty Law Columns
Family Law Newsletter
Valuing Business Goodwill in a Divorce
by Richard E. Poley

Column Eds.: Bonnie M. Schriner, a sole practitioner in Denver - (303) 458-5100; Lesleigh Wiggs Monahan of Polidori Gerome, Franklin & Jacobson, LLC, Lakewood - (303) 936-3300

This newsletter is prepared by the CBA Family Law Section This month's article was written by Richard E. Poley Boulder, a sole practitioner and financial consultant in domestic relations law, (303) 545-6462.

Goodwill is the financial soul of a business and the most likely point of contention in a business valuation. The purpose of this article is to explain how Colorado courts have valued business goodwill in divorce cases and how they are likely to do so in the future.

Colorado law requires the court to "divide the marital property."1 The purpose of dividing marital property in a divorce proceeding is to allocate to each spouse that property which, as a result of the marriage, should properly belong to him or her.2

Is Goodwill Property?

The issue of whether goodwill is property to be divided in a divorce was first reviewed by the Colorado Court of Appeals in 1979 in In re Marriage of Nichols.3 The husband in Nichols owned a dental practice. The court was asked to decide whether that portion by which the total value of a dental practice exceeded the market value of the furniture, fixtures, and accounts receivable - that is, the goodwill - constituted marital property within the broad definition of property under CRS § 14-10-113(2). The appellate court ruled that the goodwill was marital property. "[I]n a division of marital property," the court said, "the value of goodwill incident to husband's practice which is an asset acquired during this marriage, must be considered as marital property."4

The husband argued that professional goodwill is an expectancy because it is similar to an advanced educational degree. The court rejected the dentist's argument and distinguished goodwill from an educational degree by observing that goodwill can be sold along with the business, but an educational degree cannot be transferred.

The court's reasoning implied another, perhaps more fundamental, difference between goodwill and an educational degree. The business community regularly places a dollar value on goodwill, and established procedures exist for valuing goodwill. However, the business community rarely places a dollar value on human capital or educational degrees, and no common valuation procedures exist for so doing. Therefore, the Colorado courts would have a more difficult job determining the value of an educational degree than the value of goodwill.5

Goodwill Defined

The Nichols court defined goodwill as that portion by which the total value of a business exceeds the market value of the furniture, fixtures, and accounts receivable. The Nichols court recognized that the probability of continued patronage has a present market value to the purchaser of a professional practice. A later case, In re Marriage of Bookout, made clear that the goodwill being valued must be in existence at the time of the dissolution, because marital property includes only property acquired during the marriage.6 The Bookout court said that "goodwill is a property or asset which supplements the earning capacity of another asset, a business or a profession, and therefore it is not the earning capacity itself."7

Despite the appellate court's best efforts, goodwill continues to be misunderstood by many attorneys. What financial analysts and accountants are really trying to calculate, according to one commentator, "is the capacity for repeat patronage and a certain immunity to competition to produce earnings"8 (that are greater than average for that kind of business).

Relative to a marital dissolution, goodwill represents the ability of a business to earn money after the divorce based on efforts made during the...