April 5, 2011

How Goodwill Is Separated- The Mechanics

Recall from the last post that I discussed the significance of understanding the different types of goodwill. It is very important to be able to quantify, given a value of total goodwill that is part of the value of a company, how much of that goodwill is personal, and how much is professional. At the […]

Recall from the last post that I discussed the significance of understanding the different types of goodwill. It is very important to be able to quantify, given a value of total goodwill that is part of the value of a company, how much of that goodwill is personal, and how much is professional.

At the risk of losing several people forever, I am going to describe at a 10,000 ft level the mechanics of calculating the proportions of personal and professional goodwill.

For a given value of goodwill, the simple formula is:

• Personal GW + Professional GW = Total GW.

Expressed in a different fashion:

• % of Personal GW + % of Professional GW = 100% GW.

How do you determine what constitutes an appropriate percentage in each category?

Answer: the Multi-Attribute Utility Model.

I’ll spare you the gory details of the mechanics of the model; for purposes of understanding in layman’s terms how the model is applied, you need only understand that there are several questions that are posed for a given company whose goodwill is being analyzed. Some of those questions might be:

• What is the personal reputation of the owner?
• What does the location of the business have to do with why people give it their patronage?
• What is the age and health of the owner?
• To what extent is there physical closeness of the owner to providing the service (as would be the case for a surgeon or a massage therapist)?
• Is the owner’s name included in the business name ( eg. Wal-Mart, Randall’s Grocery, Brian Walters and Associates )?
• Are there multiple locations of the business?
• Are there systems in place that allow the business to function independently of the owner’s presence?

After these questions are posed (typically about 20 or so), there is an assessment made by the valuation specialist as to:

• The importance of the answer that is sought by each question (referred to as “attributes”)
• The extent to which each attribute applies to the business being assessed.

Having gone through this process (and again, this is a 10,000 ft view of the process), the valuation specialist now has the mechanism to be able to mathematically calculate the appropriate percentages of personal and professional goodwill. A typical calculation might be:

• % of Personal GW: 65%
• % of Professional GW: 35%

For a given total goodwill (for example, $10 million), the specialist then applies each percentage to the total to obtain the numeric value of each category of goodwill:

• Personal GW = .65 x $10 million, or $6,500,000
• Professional GW = .35 x $10 million, or $3,500,000

So that’s the process- or at least a very high-level view of it. If you would like to discuss the specifics of how this process might apply to a particular situation of which you are aware, feel free to contact me.

A few thoughts: