Goodwill Matters When Valuing A Construction 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 total fair market value over the fair market value of its net tangible assets and specifically identifiable intangible assets, such as patents or trademarks.

PERSONAL VS. BUSINESS GOODWILL

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

WHY IT MATTERS

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 2013, are sold within the recognition period of five years after electing S status. However, this temporary reduction in the recognition period will revert to 10 years beginning in 2014 as the temporary provision expires.

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 value is attribuTableto 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

noncompete agreements, they may be deemed to have transferred their personal goodwill to the company, exposing it to corporate tax.

SETTING YOUR PRICE

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.