CPA.net

Enterprise and Personal Goodwill

In preparing for my recent course on the topic of this post, I came across a Technical Advice Memorandum from the IRS - 200244009 - dealing with a Physician Practice Management Company Transaction that cited Martin Ice Cream as the basis for part of the decision - which was highly favorable to the taxpayer. Well worth the read if you happen to be structuring such a transaction, or in any event if you have an interest in the area.

In connection with an upcoming piece (TBA)  I have also been giving some thought to the implications of the 8th Circuit's decision in Exacto Spring on reasonable compensation under an independent investor test. At least for medical practices, service businesses in general and many small businesses, reasonable compensation is the key factor in determining the value of the business. The difference between personal and enterprise goodwill should be a key factor in reasonable compensation; it is also a key factor (Martin Ice Cream and Norwalk) in allocating sale proceeds. An Exacto Spring reasonable comp analysis should also consider who owns the underlying goodwill - the corporation or the key employee.

Noncompetes

For those of you who have followed my writings and lectures, you are aware that valuation of noncompetes is one of my areas of interest and expertise. I continue to be confounded  by some of my colleagues who confuse the issue of whether Fair Market Value contemplates a willing seller who will sign a noncompete, as opposed to whether or not the noncompete has any value. They are two distinct but interrelated questions.

IF the hypothetical buyer expects the seller to sign a noncompete, then that noncompete must have value - otherwise, why would the buyer ask for it. If it has value, we should be able to value it. The value of that noncompete is part of the enterprise-level cashflows of the entity being sold.

In marital dissolution valuation, identifying the value of the assumed noncompete is important in many jurisdictions since that noncompete may not be a divisible asset. Similarly, personal goodwill may not be a divisible asset and I have identified a methodology for measuring that in conjunction with the noncompete. In states which have a "walk away" definition of fair market value - e.g., Florida after Held v Held - the value left to the buyer IF the seller was free to compete post-sale is what is divisible. Thus, a logical approach to determining that divisible value is to determine enterprise value THEN subtract the value of the noncompete/personal goodwill to arrive at a divisible value.

Fair market value may well contemplate a willing seller signing a noncompete, but that noncompete has value and it may be a substantial part of the value derived from enterprise-level cashflows.