Running your own business can be complicated. Just as complicated if not more complicated is figuring out how to address the business during a divorce. When dividing the business, or figuring out what its “value” is, you not only have to take into consideration the actual worth of the assets of the business but also the goodwill of the business. It is possible that in some instances, the goodwill of the business is worth more than the assets.
So what is “goodwill”? Goodwill is the expectation of continued customers. It’s the reputation of the company. It’s the customer knowing exactly what to expect. It’s the brand of the business.
For instance, McDonald’s is worth far more than a couple deep fryers, freezers, and paper happy meal boxes. McDonald’s is worth the continued patronage of its loyal customers. The customers that purchase an egg McMuffin every morning, or the customers that have the numbers of the value meal memorized. The McDonald’s reputation is worth far more than its assets. That is goodwill.
The legal definition of goodwill is described as “the advantage or benefit which is acquired by an establishment beyond the mere value of the capital stock, funds or property employed therein, in consequence of the general public patronage and encouragement which it receives from constant or habitual customers, on account of its local position, or common celebrity, or reputation for skill or affluence, or punctuality, or from other accidental circumstances, or necessities, or even from ancient partialities or prejudices…it is the probability that the old customers will resort to the old place. It is the probability that the business will continue in the future as in the past, adding to the profits of the concern and contributing to the means of meeting its engagements as they come in.” In re Marriage of Foster (1974) 42 Cal.App.3d 577, 581-582.
So then the next question becomes, how do I value the goodwill? Unfortunately, there is no easy answer or standard formula to determine the goodwill of a business. The value of goodwill in a business is a question of fact and needs to be decided on a case by case basis evaluated on its own set of facts and circumstances.
There are however factors that the court uses to determine business goodwill. The court may take into consideration; the situation of the business premises, the amount of patronage, the personality of the parties doing business, the length of time the business has been active, and the market value which the business goodwill could be sold.
In the case of Marriage of Foster, an expert used a business’ most recent three months of gross receipts on accounts receivable (a total of $27,000) and determined that was the goodwill of the business. The expert in Marriage of Foster stated that there are a number of ways to value a business’ goodwill. “One way is to take the net income for the year and subtract from that what a comparable employer [sic] would have as a salary in a comparable situation, and take that difference, and multiply that by a factor anywhere from, one year factor of anywhere from two to ten…you can take the net earnings of the business, one year’s net earnings of the business. You can take two years net earnings of the business. You can take three years net earnings of the business. You can take three months charges to accounts receivable. You can take three months receipts on accounts receivable.” In re Marriage of Foster (1974) 42 Cal.App.3d 577, 579.
The business owner in Marriage of Foster appealed, contending the method of calculation was incorrect. The court of appeal affirmed the judgment.