What You Need to Know About the Valuation of Goodwill in Your Business

For some construction companies, a portion of their value may consist of goodwill, both business and personal. The distinction between business and personal goodwill is important because the type of goodwill present in your business can have a big impact on the value derived from a sale of the business.

The International Glossary of Business Valuation Terms defines goodwill as an “intangible asset arising as a result of name, reputation, customer loyalty, location, products and similar factors not separately identified.”

Often, goodwill value is expressed as the excess of a business’s total fair market value over the fair market value of its net tangible assets and specifically identifiable intangible assets, such as patents or trademarks.

Goodwill can be broken down into two components: personal and business. Personal goodwill is associated with an individual owner’s education, experience, skills, reputation and relationships. Business goodwill, on the other hand, is attributable to the company’s ability to attract business apart from any specific owner. It’s derived from characteristics such as a construction business’s name, reputation, location, workforce, technology and work quality.

The distinction between personal and business goodwill can be critical in the context of a business sale. C corporations that sell their assets are subject to double taxation on the proceeds (once at the corporate level and again when the proceeds are distributed to shareholders). S corporations that began as C corporations are also subject to double taxation on built-in gains — unrealized appreciation on assets owned at the time of the conversion — if those assets, sold in 2017, are sold within the recognition period of five years after electing S status. Under the PATH Act passed by Congress on December 18, 2015, the five-year recognition period was made permanent.

Whether your construction business is a C corporation or an S corporation with built-in gains tax exposure, the impact of double taxation is reduced to the extent the company’s value is attributable to personal goodwill. Why? Because personal goodwill is considered the property of the individual owners, not the company, so it escapes taxation at the corporate level.

The value attributable to personal goodwill varies from company to company. Generally, the more a business relies on its owners’ talents, knowledge, reputation and relationships, the greater the value of personal goodwill. Keep in mind that, if owners sign employment or non-compete agreements, they may be deemed to have transferred their personal goodwill to the company, exposing it to corporate tax.

If you’re thinking about selling your construction business, ask your advisors to estimate the value of personal goodwill. Knowing the amount allocable to personal goodwill will give you a better idea of the tax cost of a sale, making it easier to set a fair price.

This post was originally published on October 17, 2014. It was updated on May 2, 2017 to provide you the most current information.