According to the International Glossary of Business Valuation Terms, goodwill is: “That intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors not separately identified.” It is really all the aggregate value of a business that exceeds the value of identifiable tangible and intangible assets. So when a business is valued under either the market approach or the income approach, it is only necessary to compare the overall business value to the value of the identifiable assets and liabilities in order to find the value of the goodwill.
IRS, FASB and Courts Focus on Goodwill
As the business valuation discipline has evolved over the years, more attention has been focused on identifying and valuing goodwill. For example, the following regulatory changes have cast the spotlight on goodwill in valuation:
- Internal Revenue Code Section 197, Amortization of Goodwill and Certain Other Intangibles. Starting in 1993, this tax law requires identification of the values of specific intangible assets for amortization purposes.
- Accounting Standards Codification (ASC) Topic 805 — Business Combinations. In the fall of 2001, the Financial Accounting Standards Board (FASB) changed its rules on acquisition accounting. Now acquirers must allocate the purchase price to assets and liabilities based on their “fair values” for book purposes. Purchase price allocations require both the identification of “identifiable” intangible assets and the determination of those values. Goodwill then becomes the value remaining after all identifiable intangible assets are valued.
Goodwill also takes center stage in divorce cases in some states. Some states include all business value (including goodwill) in the marital estate, while others specifically exclude all goodwill from the marital estate. About half of the states expect business owners to not only identify and value goodwill, but they also specifically exclude personal goodwill from the marital estate under certain circumstances. Sometimes, personal goodwill is further broken down into pure and transferable goodwill.
Because laws vary depending on legal precedent and case specifics, it’s important for attorneys and valuators to discuss the issue of goodwill before appraising the business for divorce purposes.
Leave Goodwill to the Experts
Goodwill has grown into a major player in the valuation paradigm, especially when appraising professional practices. It’s evolved from a nebulous clump of residual value into a concept that must be considered more closely in valuation and its components identified as appropriate for the purpose of the valuation.
Always hire a credentialed valuator who is aware of the nuances and emerging best practices regarding this valuable asset — and its underlying components.
Goodwill Isn’t a Catchall
Technically, not all intangible value is goodwill. So, you can’t necessarily compare the fair market value of a business to the net book value of its equity to arrive at the value of goodwill. That residual value may also include other intangible assets that can be valued separately from goodwill.
ASC 805 provides the following list of specific intangible assets that might be included in the aggregate intangible value:
Marketing Related Intangible Assets
- Trademarks, trade names
- Service marks, collective marks, certification marks
- Trade dress (unique color, shape, or package design)
- Newspaper mastheads
- Internet domain names
- Non-competition agreements
Customer Related Intangible Assets
- Customer lists
- Order of production backlogs
- Customer contracts and related customer relationships
- Non-contractual customer relationships
Artistic Related Intangible Assets (Copyrights)
Contract Based Intangible Assets
- Licensing, royalty, standstill agreements
- Advertising, construction, management, service or supply contracts
- Lease agreements
- Construction permits
- Franchise agreements
- Operating and broadcasting rights
- Use rights such as drilling, water, air, mineral, timber cutting, and route authorities
- Servicing contracts such as mortgage servicing contracts
- Employment contracts
Technology Based Intangible Assets
- Patented technology
- Computer software and mask works
- Unpatented technology
- Databases, including title plants
- Trade secrets, such as secret formulas, processes, recipes