The handling of goodwill in divorce cases varies depending on the jurisdiction and case facts. And a court may sometimes consider cases in other states when there’s limited legal precedent in its jurisdiction.
In many states, the amount of “enterprise goodwill” in a spouse’s business can significantly boost the size of the marital estate subject to division. A recent Tennessee Court of Appeals decision provides an overview of the factors used to differentiate between personal and enterprise goodwill.
Spotlight on Goodwill
Most states include all or some goodwill when dividing a couple’s marital assets. In Tennessee and Texas, a spouse’s personal goodwill in a business isn’t divisible, but enterprise goodwill can be included in the business’s value — and is subject to equity distribution between the spouses.
Tennessee courts there have found a “disturbing inequity” in forcing a professional practitioner to pay an ex-spouse a share of intangible assets at a judicially determined value that the practitioner couldn’t realize through liquidating the asset. It also may be considered inequitable “double dipping” if a spouse receives the benefit of both personal goodwill and maintenance payments based on the same income stream.
Vastly Different Valuations
In Cela v. Cela, the wife opened a speech therapy practice in November 2012. The practice receives referrals from local school systems and physicians. The wife was responsible for 14.3% of the practice’s income during the relevant period.
At trial, the wife’s valuation expert said that she was considered a sole proprietor for tax purposes because the practice is a single-member limited liability company and all services provided by staff are billed to insurance companies through her Social Security number. The expert rejected the income approach because it considers “overall enterprise value,” including personal goodwill. He described personal goodwill as the patients’ propensity to return to a practice due to an individual, rather than due to elements that belong to the business as an enterprise.
Using the asset (or cost) approach, the wife’s expert valued the practice at $82,000. He didn’t consider the wife’s income, despite her draws as a sole proprietor of more than $600,000 between January 2018 and March 2019.
The husband’s expert concluded that the income approach was appropriate because the practice is a “true business,” not a “classic sole proprietorship.” This conclusion was based, in part, on the fact that the practice is marketed under the business name (not the practitioner’s name) and services are provided by a team. This expert valued the practice at $790,000.
The trial court found that the practice has a value beyond the net asset value. It, therefore, accepted the value based on the income approach. But the court reduced it by 14.3% to account for the wife’s personal goodwill, for a final value of $677,030. The wife appealed.
The Tennessee Court of Appeals declined to “second guess” the lower court because its valuation was within the range presented by the two experts. It found that the lower court’s decision to rely on the value derived using the income approach was supported by the expert’s testimony and evidence indicating the practice operated as a “true business with enterprise goodwill.”
Specifically, the appellate court pointed out that:
- The wife handed off her patients to other employees at the practice when she took a leave of absence in 2016,
- The practice carried on successfully during this absence,
- Business continued uninterrupted during a subsequent eight-week leave of absence by the wife in 2018,
- The wife works from only one of the practice’s two locations,
- The wife’s therapy services account for only 14.3% of production, and
- The wife repeatedly testified that “people are making money for her.”
These findings, the appellate court said, supported the trial court’s conclusion that the practice is a successful enterprise, not reliant on any single therapist. The wife has established a business model that leverages others’ skills and services to generate revenue.
The More You Know
In Cela, numerous factors relating to how the wife conducted her business pointed to enterprise goodwill rather than personal goodwill — even her own expert conceded that the practice’s goodwill wasn’t “100% personal goodwill.” Understanding these factors can help attorneys assess business valuations for divorce and other purposes.
TheKFORDgroup litigation team holds extensive knowledge and experience in expert witness engagements, forensic accounting, and business valuations. Our experts are trained and experienced in the litigation process. We have the extensive experience in divorce and business valuations. We can assist you or your client in determining the difference between personal and enterprise goodwill in their divorce. For more information, please call us at 210-340-8351.
Additional information included in this report was provided by PDI Global / Thomson Reuters © 2022