Valuing Goodwill: Factors to Consider and Sources of Information

• Publication year: 1998
• Pages: 45
• Citation: Vol. 27 No. 12 Pg. 45

27 Colo.Law. 45 Colorado Lawyer 1998.

1998, December, Pg. 45. Valuing Goodwill: Factors to Consider and Sources of Information

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45

Vol. 27, No. 12, Pg. 45

The Colorado Lawyer
December 1998
Vol. 27, No. 12 [Page 45]

Specialty Law Columns
Family Law Newsletter
Valuing Goodwill: Factors to Consider and Sources of Information
by Shari Lutz

In April 1997, this column featured an article entitled "Valuing Business Goodwill in a Divorce."1 In it the author discussed valuation standards applicable to valuing goodwill in the context of marital dissolution, as well as some of the inherent difficulties in valuing goodwill

This article offers practical guidance on understanding what goodwill is, understanding the factors that contribute to its existence and value, how to properly use objective compilations of data on the value of goodwill, and how to evaluate the quality of valuation reports issued in connection with this asset. The focus of the article is on valuations of goodwill associated with medical practices in the context of marital dissolution. However, much of the information will be applicable to any professional practice valuation

Elements that Contribute To Goodwill

The first difficulty generally encountered when valuing goodwill is understanding what goodwill is and what elements show that it exists. The courts have variously defined goodwill as an expectation of continued and repeated public patronage,2 the value of an on-going business in excess of its fixtures and accounts receivable,3 and a supplement to earning capacity but not the earning capacity itself.4 A book entitled Valuing Small Businesses and Professional Practices defines goodwill "as the ability to earn a rate of return in excess of a normal rate of return on the net assets of the business."5 All of these definitions describe some aspect of goodwill, but it is essential that the practitioner recognize those elements of a business that contribute to the existence of goodwill and influence its value.

It is important to understand these contributing elements for two reasons. First, knowing the elements of a business that contribute to goodwill will assist the practitioner in evaluating the existence of goodwill. Not every business or professional practice has goodwill. Second, familiarity with factors contributing to goodwill gives the practitioner tools to evaluate the amount of goodwill in a specific business or professional practice relative to other businesses or professional practices.

Certain Colorado cases are well known for addressing certain aspects of goodwill. In re Marriage of Bookout6 discusses the nature of goodwill and how it should be measured. In re Marriage of Huff7 discusses which methodology is more appropriate in valuing a law practice, including its goodwill: a partnership agreement specifying how a law practice is to be valued or a specific valuation methodology.

The goodwill issue in In re Marriage of Graff8 is whether the husband's business, an insurance agency bearing his name, constitutes a valuable property right. Certain factors discussed in the case were used to show that the husband did have a valuable property right and that therefore goodwill existed. These included that:

the husband set his own hours;

the husband decided the location of his office;

the husband hired and fired his own employees and set their salary;

the husband selected and purchased his own supplies;

the husband was characterized in his contract as an independent contractor; and

the husband reported his income as that of a business on Schedule C of his income tax return.

In a more recent case, In re Marriage of Banning,9 three specific factors were discussed as contributing to the existence of goodwill, including:

reputation;

customer base; and

customer relations.

Lopez v. Lopez,10 a California appellate case, clearly sets out certain factors to consider in estimating the goodwill of a professional practice. The factors include:

the age and health of the professional;

the professional's demonstrated past earning power;

the professional's reputation in the community for judgment, skill, and knowledge;

the professional's comparative professional success; and

the nature and duration of the professional's practice...