Practice Valuation - Distinguishing Personal Goodwill from Business Goodwill
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The Kentucky Supreme Court recently issued an important, perhaps landmark, decision regarding the valuation of closely-held businesses, specifically professional practices. The case, Gaskill v. Robbins (2007-SC-000190-DGE), grew out of a divorce proceeding, and it focused primarily on the issue of whether the goodwill of a closely-held business can be divided between personal goodwill and business goodwill.
Background: Julie Anne Gaskill, an oral and maxillofacial surgeon practicing in Bowling Green, filed for divorce in late 2003 from her husband, John Kevin Robbins. Gaskill was the sole owner of a very successful practice. The testimony in the case indicated that Gaskill was highly skilled and extremely hard working, and managed her practice with frugality. As the only surgeon, she alone was responsible for patient acquisition, and though Robbins assisted with some administrative tasks, Gaskill was also primarily responsible for management of the office and staff. The single largest marital asset to be valued and divided was the practice.
Valuation Methodology: The practice was valued by experts for each party. Gaskill's expert valued the practice at $221,610, using an asset-based approach. He assigned a value of zero to goodwill. In defending his position, he asked, "Why would a purchaser pay more than fair market value of the tangibles if Dr. Gaskill can take her patients, go down the hall, and set up a [new] practice?" Robbins' expert used four different methodologies (capitalized earnings, excess earnings, adjusted balance sheet, and the market approach), and averaged the four amounts to arrive at his conclusion of value of $669,075. Robbins' value included goodwill value and assumed a noncompete agreement was in place.
Rulings: The trial court accepted the value of Robbins' expert, but in doing so, it relied on the premise that there is no legal authority for a distinction between personal and business goodwill in Kentucky law. Gaskill appealed and the Court of Appeals reversed on the goodwill issue, believing that the trial court had incorrectly determined that goodwill must be assigned a value greater than zero. The Kentucky Supreme Court granted discretionary review to consider the proper valuation of goodwill. It ultimately concluded that personal goodwill can be distinguished from business goodwill and that personal goodwill is nonmarital property that cannot be transferred and should not be included in determining the fair market value of a closely-held business [at least in the context of divorce]. The case was remanded to the trial court to determine the value of the practice consistent with the decisions made by the Supreme Court.
Basis of Decision: In arriving at its decision regarding goodwill, the Supreme Court ("Court") acknowledged that under Kentucky law it is generally accepted that goodwill is a factor to be considered in valuing a business. However, the Court also acknowledged that whether goodwill can be divided between the business and the individual had never been established in Kentucky law. In tackling this issue, the Court stated that "there can be little argument that the skill, personality, work ethic, reputation, and relationships developed by Gaskill are hers alone and cannot be sold to a subsequent practitioner." The Court likened personal goodwill to an advanced professional degree which it had previously decided (in another case) should not be treated as marital property because it is personal to the holder and nontransferable. In rendering this decision, Kentucky now joins 25 other states that differentiate between personal and business goodwill.
Implications: It is not yet clear whether the Court's decision will have valuation implications beyond the context of divorce, but it is quite possible, considering the Court's rationale. In future valuations, appraisers will have to distinguish between personal goodwill and business goodwill; this will add a greater measure of complexity and subjectivity to the valuation process. On the other hand, the removal of personal goodwill from the value of a business should make it easier to avoid the "double-dipping" that sometimes occurs with the division of marital property and the award of maintenance. Retaining a qualified valuation analyst and competent professional advisors will be critical to arriving at appropriate results.
From a valuation perspective, there are other items to consider from the Court's decision, of which we comment on a couple. The Court ruled that using an average of four separately-determined values to value a business (like Robbins' expert did) when there is no basis for relying on the average "is tantamount to [using] no method at all". The Court also considered it improper for Robbins' expert to assume a noncompete agreement in performing his valuation when one did not exist and there would be no requirement that Gaskill enter into one unless it was negotiated as a term of an actual sale.
Note: A motion to clarify the ruling in this case has been made, and that ruling has not yet been released.
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