This post discusses important concepts of personal goodwill in divorce litigation engagements. The discussion relates directly to several divorce litigation cases involving owners of automobile dealerships. These real-life examples display the depth of analysis that is critical to identifying the presence of personal goodwill and then estimating or allocating the associated value with the personal goodwill. The issues discussed here pertain specifically to considerations utilized in auto dealer valuations, but the overall concepts can be applied to most service-based industries.

It is important that the appraiser understands the industry and performs a thorough analysis of all relevant industry factors. It is also essential to determine how each state treats personal goodwill. Some states consider personal goodwill a separate asset, and some do not make a specific distinction for it and include it in the marital assets.

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Personal goodwill was an issue in several of our recently litigated divorce engagements. It is more prevalent in certain industries than others and varies from matter to matter. Although there are several accepted methodologies to determine personal goodwill, no textbook discusses where it exists and where it doesn’t. Before any attempts to measure and quantify it, an important question to ask is, “Does it exist?” Often, with ambiguous concepts like personal goodwill, the adage “you know it when you see it” is most appropriate.

In this post, we examine personal and enterprise goodwill using a specific fact pattern unique to the auto dealership industry. Beyond this illustrative example, the analyses can be applied in other industries but must be considered carefully for the unique facts and circumstances of each matter.

What Is Personal Goodwill?

Personal goodwill is value stemming from an individual’s personal service to a business

Personal goodwill is value stemming from an individual’s personal service to a business and is an asset that tends to be owned by the individual rather than the business itself. Personal goodwill is part of the larger bucket of an intangible asset known as goodwill. The other portion of goodwill, referred to as enterprise or business goodwill, relates to the intangible asset involved and owned by the business itself.¹

Commercial and family law litigation cases aren’t typically governed by case law resulting from Tax Court matters and can differ by jurisdiction, but Tax Court decisions offer more insight into defining the conditions and questions that should be asked in an evaluation of personal goodwill. One seminal Tax Court case on personal goodwill is Martin Ice Cream vs. Commissioner.² Among the Court’s discussions and questions to review were the following:

• Do personal relationships exist between customers/suppliers and the business owner?
• Do these relationships persist in the absence of formal contractual relationships?
• Does an owner’s personal reputation and/or perception in the industry provide intangible benefit to the business?
• Are practices of the owner innovative or distinguishable in their industry, such as the owner adding value to the particular industry?

Another angle with which to evaluate the presence of personal goodwill, specifically to professional practices, is provided in Lopez v. Lopez.³ Lopez suggests several factors that should be considered in the valuation of professional (personal) goodwill as:

• The age and health of the individual;
• The individual’s demonstrated earning power;
• The individual’s reputation in the community for judgment, skill, and knowledge;
• The individual’s comparative professional success; and,
• The nature and duration of the professional’s practice as a sole proprietor or contributing member of a partnership or professional corporation.

Why Is Personal Goodwill Important?

Many states identify and distinguish between personal goodwill and enterprise goodwill. Further, numerous states do NOT consider the personal goodwill of a business to be a marital asset for family law cases. For example, a business could have a value of $1 million, but a certain portion is attributable and allocated to personal goodwill. In this example, the value of the business would be reduced for personal goodwill for family law cases, and the marital value of the business would be considered at something less than the $1 million value.

How Applicable/Prevalent Is Personal Goodwill in the Auto Dealer Industry?

In litigation matters, we try to avoid the absolutes: always and never. Keeping that in mind, the concept of personal goodwill is more easily identified and prevalent in service industries such as law practices, accounting firms, and smaller physician practices. Does that mean it doesn’t apply to more traditional retail and manufacturing industries? Not necessarily. In each case, the fundamental question that should first be answered is, “Is this an industry or company where personal goodwill could be present?”

For the auto dealer industry, the principal product, outside of the service department, is a tangible product — new and used vehicles. For personal goodwill to be present in this industry, the owner/dealer principal would have to exhibit a unique set of skills that specifically translates to the heightened performance of their business.

Just having a name on the business doesn’t guarantee the presence of personal goodwill

We are all familiar with regional dealerships possessing the name of the owner/dealer principal in the name of the business. However, just having a name on the business doesn’t guarantee the presence of personal goodwill. However, a valuation professional is more likely to ascribe personal goodwill to “Harkins Ford” than “Nashville Ford,” all else equal.

An examination of the customer base would be needed to justify personal goodwill. It would be more difficult to argue that customers purchase vehicles from a particular dealership only for the name on the door rather than the more obvious factors of brands offered, inventory availability, convenience, etc. An extreme example might be having a recognized celebrity as the name/face of the dealership, but even then, it would be debated how that materially affects sales and success. While the John Elway dealership group benefits from the branding association, most customers likely know they won’t get to throw a football with John Elway just for buying a car at one of his dealerships. Still, Broncos superfans might be more likely to show their support at one of these dealerships, which can extend to more casual supporters of the team, even if in a subconscious, civic pride way.

Beyond just the name, presence in marketing/advertising can be a distinguishing factor. Dealers who regularly appear on local TV ad spots are likelier to see an allocation to personal goodwill, all else equal.

Something else to think about when considering whether the dealer’s name impacts the success/value of the business is determining how active the owner/dealer principal is in the business and if he/she personally impacts the selling process with customers. Simply put, there should be higher bars to clear than just having a name in the dealership for personal goodwill to be present. In more obvious examples of personal goodwill in professional practices, the customer usually interacts directly with the owner/professional such as with the attorney or doctor in our previous examples. How often does the customer of an auto dealership come into contact or deal directly with the owner/dealer principal, or do they generally engage with the salespeople, service manager, or general manager?

Another factor that often helps identify the existence of personal goodwill is the presence of an employment agreement and/or non-compete agreement

Another factor that often helps identify the existence of personal goodwill is the presence of an employment agreement and/or non-compete agreement. The prevailing thought is that an owner of a business without these items would theoretically be able to exit the business and open a similar business and compete directly with the prior business. Neither of these items typically exist with an owner of an auto dealership. However, owners of auto dealerships must be approved as dealer principals by the manufacturer.

The transferability of a dealer-principal relationship is not guaranteed, and certainly, an existing dealer principal would not be able to obtain an additional franchise to directly compete with an existing franchise location of the same manufacturer for obvious area of responsibility (AOR) constraints. So, does the fact that most dealer principals don’t have an employment or non-compete agreement signify that personal goodwill must be present? Not necessarily. Again, it relates back to the central questions of whether an owner/dealer principal is directly involved in the business, has a unique set of skills that contributed to a heightened success of the business, and whether that owner/dealer principal attracts customers to their particular dealership that could not be replicated by another individual.

Conclusion

Personal goodwill in an auto dealership and any industry can become a contested item in a litigation case because it can reduce the enterprise value consideration by the amount allocated to personal goodwill. As much as the allocation, quantification, and methodology used to determine the amount of personal goodwill will come into question, several central questions should be examined and answered before simply jumping to the conclusion that personal goodwill exists.

Instead of arguing whether the value of an auto dealership should be reduced by some percentage, the real debate should begin around the examination of whether personal goodwill exists in the first place. The difference in reports from valuation for experts in litigation matters generally falls within the examination and support of the assumptions (that lead to differences in conclusions). If present, personal goodwill for an auto dealership, or any company in any industry for that matter, must exist beyond just having the owner’s name in the title of the business.

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¹ In the auto dealer industry, goodwill and other intangible assets are referred to as Blue Sky value.
² Martin Ice Cream Co. v. Commissioner, 110 T.C. 189 (1998).
³ In re Marriage of Lopez, 113 Cal. Rptr. 58 (38 Cal. App. 3d 1044 (1974).