Personal Goodwill - Who Owns It?

Personal Goodwill has always been a fascinating subject, impacting the sale of many small to medium-sized businesses – and even some larger companies. In order to hold personal goodwill, a business owner builds one or more of the following:

  • A positive personal reputation
  • A personal relationship with many of the largest customers and/or suppliers
  • Company products, publications, etc., as the sole author, designer, or inventor.

The creation of personal goodwill can go far beyond just customers and suppliers, and include employees, professional advisors, industry relationships, and personal technical knowledge. While these relationships are wonderful benefits, they are, unfortunately, non-transferable. There is an old saying: In a business built around personal goodwill, the goodwill goes home at night.

It can be difficult to sell any business where personal goodwill plays an integral role in the business’ success. In the sale of a small to medium-sized businesses, personal goodwill can be a prohibitive factor. This factor tends to decrease in importance as the size of a business increases, because the larger the business is, the less likely one person holds all of the keys to its success.

Businesses centered around the goodwill of the owner can certainly be sold, but usually the buyer will want some protection in case business is lost with the departure of the seller. One simple method requires the seller to stay for a sufficient period after the sale to allow him or her to work with the new owner and slowly transfer the goodwill. No doubt, some goodwill will be lost, but that expectation can be built into the purchase price. Another approach uses some form of “earnout.” When this approach is used,  the buyer is compensated over time for any lost business with an adjustment of the purchase price. The adjustment can be made to funds that are still owed to the seller, or to an escrow account that was set aside for that purpose.

In some cases, such as the sale of a C Corporation, the sale of goodwill may offer some favorable tax benefits for the seller. Since the tax courts have ruled that the business owner personally, rather than the business, owns the personal goodwill, the sale of the business can be two taxable events. The seller can sell the business and his or her personal goodwill in two separate transactions, which may result in tax savings. The seller’s tax professional will be able to give further advice on this matter.

In conclusion, personal goodwill is a strong asset to the current owner, but owners who want transferable value must assure the goodwill can be transferred. Owners who are preparing to build transferable value will work to transfer personal goodwill from themselves to their business, which increases business value.