A business can be marital property without every component of the business’s value being a marital asset. When a closely held business is closely identified with one spouse, this distinction is particularly important.
For example, Spouse A founded the company, established its reputation, and generated most of its revenue. Spouse A may credibly argue that without Spouse A, there is no business.
However, Spouse B argues that the company has a recognizable name, employees, systems, equipment, customer records, contracts, and relationships that will stay after Spouse A leaves.
Both spouses may be correct.
A business can contain value attributable personally to the owner and also separate value that has become embedded in the actual enterprise. In Illinois, the law distinguishes between these two forms of value as personal goodwill and enterprise goodwill.
Personal goodwill is mainly associated with the individual, whereas enterprise goodwill is mainly associated with the business or institution. Jay Fishman, Personal Goodwill Versus Enterprise Goodwill, in BVR’s Guide to Personal v. Enterprise Goodwill 24 (5th ed. 2012).
This difference may materially affect the amount included in the marital estate. Enterprise goodwill may be included in the value of a marital business, but personal goodwill may not.
The Illinois Supreme Court explained the distinction between personal and enterprise goodwill in In re Marriage of Talty, 166 Ill. 2d 232, 239-40 (1995). The case involved the valuation of an automobile dealership. Id. at 235. The court held that the concerns previously identified in the professional-practice context applied to the dealership’s goodwill, as well. Id. at 238-39. The dealership may contain a combination of personal goodwill and enterprise goodwill. Id. at 239.
The court explained that “[t]o the extent that goodwill inheres in the business, existing independently of William’s personal efforts, and will outlast his involvement with the enterprise,” it should be treated as “an asset of the business, and hence of the marriage.” Id. at 240. However, goodwill that is “personal to William, depends on his efforts, and will cease when his involvement with the dealership ends” should not be considered property. Id. The court remanded the case for the trial court to decide whether the dealership’s goodwill consisted of personal goodwill, enterprise goodwill, or a mix of both. Id. at 239-40.
David Wood observes in BVR’s Guide to Personal v. Enterprise Goodwill that Talty “opened up the argument in all types of businesses.” David Wood, Goodwill: Where Are We? How Did We Get Here? What Do We Do About It?, in BVR’s Guide to Personal v. Enterprise Goodwill 8 (5th ed. 2012).
A commercial business is not automatically enterprise based. A medical practice is not automatically personal. A company with facilities, employees, and substantial revenue can depend greatly on an owner’s skills and relationships. By contrast, a professional practice may have institutionalized its reputation and workforce so thoroughly that substantial value would survive the professional’s departure.
Many successful owners are important to their companies. Yet, the fact that an owner is important does not answer the goodwill question. The more helpful question is: If the owner left tomorrow, what would be left?
Determining the answer is hard, as goodwill has been called “the most intangible of intangible assets.” Jay Fishman, Personal Goodwill Versus Enterprise Goodwill at 23.
Still, the distinction must still be made.
What Is Goodwill In An Illinois Divorce?
Goodwill refers to an intangible asset that helps explain why a business may be worth more than the physical property it owns.
The following “workable definition” of goodwill is that it “is the value of a business or practice that exceeds the combined value of the physical assets.” In re Marriage of Talty, 166 Ill. 2d 232, 238 (1995) (quoting In re Marriage of White, 151 Ill. App. 3d 778, 780 (1986)).
Think about two businesses. Both own comparable equipment and inventory, but one may still be worth substantially more because it has: a longstanding reputation, recognizable branding, recurring customers, valuable contracts, trained employees, established operating procedures, and other advantages allowing it to earn more than a less-established competitor.
Although these advantages may not appear as individual physical assets on a balance sheet, they can still produce real economic value.
Goodwill Is The Expectation Of Continued Patronage
Goodwill has historically been defined as the expectation that customers will keep returning to the same source. In other words, the classic formulation of goodwill is “the probability that the old customers will resort to the old place.” Jay Fishman, Personal Goodwill Versus Enterprise Goodwill at 23.
Dr. Shannon Pratt explains “the classic definition of goodwill is the propensity of the customer to return to the business.” Shannon P. Pratt, Overview of Enterprise and Personal Goodwill in Valuing Goodwill in Divorce: A BVR Special Report 4 (2011). Put simply, whether goodwill is personal or enterprise goodwill depends on whether the customer comes back because of the individual or because of aspects belonging to the actual business. See id.
For example, a customer may follow the same dentist from office to office because the customer trusts that dentist personally. That repeat patronage points toward personal goodwill.
However, a customer may instead patronize an office because of its location, products, reputation, or convenience. The dentist is unimportant. That repeat patronage points toward enterprise goodwill.
Fishman explains this distinction similarly. Personal goodwill exists when people come to the individual because of “the individual’s skill, knowledge, reputation, personality or other factors.” Jay Fishman, Personal Goodwill Versus Enterprise Goodwill at 24. Enterprise goodwill exists when people come to the business because of its “location, staff, telephone number, facilities, reputation of the entity, or other factors.” Id.
Not Every Profitable Business Has Goodwill
Goodwill does not exist just because a business earns money. A business owner may earn substantial income because the owner works extremely long hours, has exceptional professional skill, personally obtains almost all of the customers, manages the employees, or handles sales and marketing. Those profits may reflect compensation for the owner’s labor instead of an asset belonging to the business.
Goodwill has economic value only to the extent that the business produces earnings exceeding both a reasonable return on the assets employed and adequate compensation for the work performed.
This is a critical distinction because otherwise, a valuation expert could turn the owner’s future labor into a present marital asset.
Goodwill Must Be Valued Under Illinois’s Fair-Market-Value Standard
Section 503(k) of the Illinois Marriage and Dissolution of Marriage Act provides that “[i]n determining the value of assets or property under this Section, the court shall employ a fair market value standard.” 750 ILCS 5/503(k).
Fair market value usually asks what property would exchange for between a willing and informed buyer and seller, with neither acting under compulsion.
That is not automatically the same as the business’s value to its present owner. A company may produce substantial income for an owner who has special skills and irreplaceable personal relationships. Yet, a hypothetical buyer may not pay for income that cannot be transferred to the buyer.
Wood describes this problem through the example of a small-business owner who effectively “owns a job.” The enterprise generates income due to that individual’s continuing labor, but a little amount of value exists beyond those personal efforts. David Wood, Goodwill: Where Are We? How Did We Get Here? What Do We Do About It? at 4.
This does not mean the business has no value. It may own equipment, inventory, contracts, receivables, or other transferable assets. It may further possess enterprise goodwill. Still, the owner’s ability to continue earning income through future personal effort is not automatically an asset that can be sold to someone else.
The Two Goodwill Questions
So, a proper goodwill analysis should ask two questions:
- Does economically valuable goodwill exist?
After paying reasonable compensation for the labor performed and allowing a reasonable return on the company’s other assets, does the company continue to produce excess earnings or other transferable value? - If goodwill exists, to whom or what does it belong?Is the value dependent on the owner, or would it stay with the company after that individual left?
The first question decides whether there is goodwill to allocate. The second decides whether the goodwill is personal or enterprise goodwill.
Dr. Pratt describes the owner’s hypothetical absence as a helpful “litmus test,” meaning that goodwill is enterprise goodwill only to the extent that excess earnings would remain without that individual. Shannon P. Pratt, Overview of Enterprise and Personal Goodwill at 6.
This hypothetical departure asks whether the owner converted personal effort into something that can function independently. Did the owner train employees to serve the customers? Would customers call the company or the individual? Could management continue operations? Would a buyer receive repeat business after the sale?
This determines whether the intangible value follows the individual or stays with the enterprise.
What Is Personal Goodwill In An Illinois Divorce?
According to the Illinois Appellate Court, personal goodwill is defined as “that which is attributed to one’s personal efforts and will cease when that person is no longer involved in the business.” In re Marriage of Alexander, 368 Ill. App. 3d 192, 195 (2006) (citing In re Marriage of Talty, 166 Ill. 2d 232, 240 (1995)). Personal goodwill “is not considered a marital asset for the purposes of the just division of marital property.” Id.
What Makes Goodwill Personal?
Some sources of “personal goodwill include skill, knowledge, reputation, personality, and business relationships.” Jay Fishman, Personal Goodwill Versus Enterprise Goodwill at 30.
These characteristics alone do not automatically make all of a business’s goodwill personal. The issue is whether those characteristics stay attached to the owner or become institutionalized within the business.
Consider a physician whose reputation initially caused patients to seek treatment from that particular physician. However, over time, the physician hired other doctors, trained employees, and developed a recognizable name associated with the practice rather than with the physician alone. In that case, the physician’s reputation created the business, but some of that value eventually became embedded in the enterprise.
The expert’s task is to determine “the degree to which the enterprise relies on the attributes, reputation, or relationships of an individual,” as compared with the institutionalized value and other intangible assets that would survive the individual’s departure. Id.
So, the question is not just whether the owner contributed to the company’s success. The question is also whether the resulting value is still dependent on that individual.
Personal Goodwill Follows The Individual
A good indication of personal goodwill is that customers would follow the owner to another business.
For example, a chiropractor has patients who call the office specifically to see that chiropractor. The chiropractor then leaves the practice and opens another office. If the patients follow the chiropractor, the relationship belonged primarily to the individual instead of the former practice.
Wood’s definition focuses on the earnings produced by these relationships: “Personal goodwill is the value of earnings or cash flow attributable to attributes of the individual resulting in earnings from consumers that return because of the individual, in earnings from new consumers who seek out the individual, and in earnings from referrals made to the individual.” David Wood, Personal Goodwill in Search of a Functional Definition at 40.
This definition points the analysis toward the source of the company’s cash flow. If customers return because of the owner, referrals are made to the owner, and new customers seek the owner, the resulting earnings suggest personal goodwill.
A Business Can Have More Than One Source Of Goodwill
To be clear, personal and enterprise goodwill are not mutually exclusive.
A customer may initially contact a company because of the owner’s reputation but remain because of the company’s employees, service, location, or systems. Similarly, a referral source may trust the owner personally while still referring customers to other professionals employed by the business.
The allocation is “fact-sensitive.” Jay Fishman, Personal Goodwill Versus Enterprise Goodwill at 30. The business’s success or failure may depend partly on the owner’s services and partly on assets and relationships that have been institutionalized within the company.
Accordingly, the owner’s departure does not necessarily create an all-or-nothing result. The business may lose some customers and revenue, but it may retain the rest.
The relevant question is how much of the company’s value would disappear with the owner.
Personal Goodwill Is Future Earning Capacity, Not Marital Property
Illinois excludes personal goodwill from the marital estate, as it reflects future income-generating capacity that is already accounted for through other statutory considerations.
In In re Marriage of Zells, the Illinois Supreme Court considered whether the professional goodwill associated with a lawyer’s practice could be valued, divided, and distributed as marital property. 143 Ill. 2d 251, 252 (1991). The court stated that “[g]oodwill represents merely the ability to acquire future income” and that treating professional goodwill as a divisible marital asset would cause “gross inequity.” Id. at 254.
Section 503(d) provides that, when dividing marital property, a divorce court is required to consider the spouses’ relevant economic circumstances; their occupations, income, vocational skills, and employability; and their opportunities to acquire capital assets and income in the future. 750 ILCS 5/503(d)(5), (8), (11).
Thus, the Zells court concluded: “Adequate attention to the relevant factors in the Dissolution Act results in an appropriate consideration of professional goodwill as an aspect of income potential. The goodwill value is then reflected in the maintenance and support awards. Any additional consideration of goodwill value is duplicative and improper.” 143 Ill. 2d at 256.
So, the owner’s future income-generating capacity cannot be capitalized and divided as a present business asset, then considered again through the statutory factors that govern property division, maintenance, and support.
Personal Goodwill Remains Excluded Even Without Maintenance
Importantly, personal goodwill does not turn into marital property just because the nonowner spouse does not receive maintenance.
In In re Marriage of Schneider, the appellate court found that personal goodwill should have been included in the value of a dentist’s practice since the other spouse had waived maintenance. 214 Ill. 2d 152, 164-65 (2005). The appellate court reasoned that “if goodwill is not considered as part of a spouse’s income-generating ability relative to a maintenance award,” it may be included in the valuation of a professional practice as a divisible marital asset. Id.
However, the Illinois Supreme Court rejected that interpretation. Id. It clarified that the rule from Zells was “not simply” based on the fact that support and maintenance were awarded. Id. at 166. Rather, personal goodwill is already reflected in the circumstances the court needs to consider under section 503(d) when equitably dividing marital property. Id. at 166-67.
In Schneider, the circuit court considered the dentist’s personal goodwill when applying the statutory factors and deciding to award the other spouse a disproportionate share of the marital estate. Id. at 167. When valuing the dental practice, considering the goodwill again would therefore amount to “impermissible double counting.” Id.
Thus, the exclusion of personal goodwill does not depend only on whether support or maintenance is actually awarded. Personal goodwill stays excluded when its underlying elements have already been considered through the statutory factors governing the division of marital property, such as through a disproportionate property award. Id. at 166-67.
Personal Goodwill Is Not Limited To Professional Practices
Personal goodwill is usually easiest to recognize in legal, medical, dental, or other service practices. This is because customers often choose a specific professional. However, personal goodwill can also exist in an ordinary commercial business.
As seen in Talty, an automobile dealership may contain personal goodwill to the extent that the goodwill is “personal to” the owner, “depends on his efforts,” and “will cease when his involvement with the dealership ends.” 166 Ill. 2d at 240. The same principle may apply to other owner-dependent commercial businesses, such as insurance agencies, manufacturers, construction companies, and retail businesses.
The classification does not turn on the type of business. It turns on the facts.
What Is Enterprise Goodwill In An Illinois Divorce?
Enterprise goodwill is the part of a business’s goodwill that belongs to the business, not to a particular owner.
According to the Illinois Appellate Court, enterprise goodwill is defined as goodwill that “exists independently of one’s personal efforts and will outlast one’s involvement with the business.” In re Marriage of Alexander, 368 Ill. App. 3d at 195 (citing In re Marriage of Talty, 166 Ill. 2d at 240). Unlike personal goodwill, “[e]nterprise goodwill is considered a marital asset for the purposes of the just division of marital property.” Id. at 195.
The issue is whether an owner’s efforts produced value that now exists independently within the enterprise. Put simply, did the owner simply create a job that depends on the owner, or did the owner create a functioning business that can continue without the owner?
What Makes Goodwill Enterprise Goodwill?
Enterprise goodwill may arise from the business’s name, location, institutional reputation, customer base, contracts, workforce, systems, or intellectual property.
As Fishman explains, enterprise goodwill exists when customers use the business because of its “location, staff, telephone number, facilities, reputation of the entity, or other factors.” Jay Fishman, Personal Goodwill Versus Enterprise Goodwill at 24.
Further, Alexis A. Dawicki and Richa Prakash explain that business goodwill “relates to the ability of a business enterprise to generate earnings without the presence of any particular employee/owner or professional.” Alexis A. Dawicki & Richa Prakash, Personal Goodwill and Business Goodwill—Are They Marital Assets?, in Valuing Goodwill in Divorce: A BVR Special Report 15 (2011). Common indicators include “[l]ocation, computer software and automated databases, an assembled workforce, operating procedures, patents, copyrights, and a recurring client/customer base.” Id.
Enterprise Goodwill Produces Earnings For The Business
Wood provides a functional definition focused on the source of the business’s cash flow:
“Enterprise goodwill is the value of earnings or cash flow directly attributable to attributes of the enterprise that result in earnings from consumers that return because of the enterprise, in earnings from new consumers who seek out the enterprise, and in earnings from referrals made to the enterprise.”
David Wood, Personal Goodwill in Search of a Functional Definition at 41.
This definition asks whether customers and revenue belong economically to the company. Consider customers who hire a construction company because of its established name, trained crews, and reputation for completing projects efficiently. The founder is involved; however, if the employees keep providing the same services and customers keep patronizing the company, the resulting value points toward enterprise goodwill.
This is also true when customers buy a product due to its branding, quality, or location without knowing who actually owns the company.
Enterprise Goodwill Remains After The Owner’s Departure
The main characteristic of enterprise goodwill is its ability to survive a change in ownership or management.
In Talty, the Illinois Supreme Court stated that goodwill should be seen as “an asset of the business, and hence of the marriage” to the extent it “inheres in the business,” exists outside of the owner’s personal efforts, and “will outlast his involvement with the enterprise.” 166 Ill. 2d at 240.
Relevant questions may include:
- Would customers continue calling the company if the owner retired?
- Would customer, supplier, and referral contracts stay with the company?
- Could employees continue providing the products or services?
- Could replacement management keep operations running?
The owner’s departure can cause a disruption without completely eliminating enterprise goodwill. The question is not whether the business would remain completely unchanged. Rather, it is whether meaningful intangible value would stay with the enterprise.
Enterprise Goodwill Must Have Transferable Value
When valuing marital property, Illinois courts must use a fair-market-value standard. 750 ILCS 5/503(k). So, enterprise goodwill should reflect value a hypothetical buyer could acquire through the business instead of income the owner must personally generate through future labor.
A buyer may pay for a recognizable brand, customer contracts, recurring revenue, a favorable location, or a trained workforce. A buyer usually will not pay the seller for income the seller can earn only by continuing to work personally after the sale.
Transferability does not mean every customer has to be contractually obligated to remain. Name recognition, customer loyalty, workforce continuity, and established systems can create value. Still, the more heavily the company depends on the owner’s continued presence, the less enterprise goodwill is likely to exist.
Can A Professional Practice Have Enterprise Goodwill?
Enterprise goodwill can exist in a legal, medical, dental, accounting, or other professional practice.
Dr. Pratt describes a neuropsychiatric practice with more than 60 employees. Although the founder possessed personal goodwill, a lot of the practice’s value had become institutionalized through company-owned hospital contracts, noncompetition agreements, other professionals’ patient relationships, and independent management. Shannon P. Pratt, Overview of Enterprise and Personal Goodwill at 7-9.
The professional label does not decide the issue. The question is whether the practice holds value that will remain without the particular professional.
How Do Experts Separate Personal Goodwill From Enterprise Goodwill?
Separating personal goodwill from enterprise goodwill is more complicated than determining whether the owner is important to the company. The valuation expert must determine whether economically valuable goodwill exists. Then, the expert must decide how much belongs to the owner and how much belongs to the enterprise.
The Expert Must First Determine The Total Goodwill
Using an allocation method does not figure out how much goodwill exists in the first place. The expert needs to value the business under Illinois’s fair-market-value standard and determine the amount of goodwill available to allocate. Illinois courts are required to “employ a fair market value standard” when valuing marital property. 750 ILCS 5/503(k).
Dr. Pratt cautions that goodwill has economic value only when the business produces earnings that exceed a reasonable return on its assets and adequate compensation for the labor performed. Shannon P. Pratt, Overview of Enterprise and Personal Goodwill at 4-5.
Reasonable compensation is quite important in an owner-operated business. Reported profits can appear unusually high because the owner may work substantially more than 40 hours per week, possess exceptional skill, or perform several jobs. Adequate compensation must account for both the time spent and the quality of the owner’s services. Otherwise, the valuation might incorrectly treat the owner’s labor as goodwill. Id. at 5.
For instance, imagine that a business reports $500,000 in annual earnings. The owner serves as its chief executive, operations manager, and lead salesperson. Replacing those services would cost $400,000 annually. Importantly, the full $500,000 cannot be treated as excess earnings supporting goodwill. The expert must account for the cost of replacing the owner’s labor.
The Expert Must Determine What Would Remain Without The Owner
Once total goodwill is determined, the expert considers whether the company’s excess earnings would continue absent the owner. Pratt calls the owner’s hypothetical absence a helpful “litmus test,” asking whether the excess earnings would continue “in the absence of the key individual.” Id. at 6.
This analysis may consider whether customers ask for the owner or the company, whether referrals are made to the owner, whether other employees are able to provide the services, whether management can maintain operations, and whether contracts and customer relationships stay with the company.
An interview with the owner can be quite helpful. In fact, “the best way to get at the personal component of goodwill” is often to interview the person whose goodwill is being appraised. Alina V. Niculita, Angelina McKedy & Kimberly Linebarger, How to Distinguish Personal Goodwill From Enterprise Goodwill, the Key Person Discount, and Noncompete Agreements at 102.
The interview should not just ask whether the owner thinks the business depends on that owner. Instead, it should identify the owner’s specialized knowledge, reputation, actual duties, customer relationships, hours, management responsibilities, and contribution to revenue.
The Multiattribute Utility Model
The valuation expert in In re Marriage of Alexander used the Multiattribute Utility Model to allocate the medical practice’s goodwill between personal and enterprise goodwill. 368 Ill. App. 3d at 198-200.
The expert found attributes associated with each category. Personal attributes were specialized knowledge, a personalized business name, personal reputation, inbound referrals, and a lack of transferability. Enterprise attributes were business location, multiple locations, multiple service providers, years in operation, business systems, enterprise staff, outbound referrals, and marketing. Id. at 199.
Then, the expert assigned each attribute separate scores that reflected its importance and the extent to which it existed in the business. Those scores were combined to estimate the respective percentages of personal and enterprise goodwill. Id. at 199-200.
Wood explains that the model divides attributes into those that tend to indicate personal or enterprise goodwill then uses relative weights to “challenge, confirm, and communicate the valuator’s opinion.” David Wood, Goodwill Attributes: Assessing Utility at 87.
Yet, the model does not get rid of professional judgment. The expert selects the attributes, classifies them, evaluates their importance, and determines how much each is present. Wood cautions that “[t]here are no hard and fast rules in attribute determination.” Id. at 96. The expert makes a reasoned judgment about whether each attribute is more personal or enterprise-based and explains how that judgment impacts the allocation.
The Alexander court held the model did not constitute scientific evidence subject to a Frye hearing. 368 Ill. App. 3d at 201-03. Instead, the method incorporated “basic math with the observations and experience of the valuator,” while leaving the selection and weighting of the attributes mostly to the expert’s subjective judgment. Id. at 201-02.
Noncompetition Agreements And Transferability
The expert may also evaluate whether the business or owner is subject to a noncompetition agreement.
A common issue in a business transaction is whether the buyer can retain the goodwill the company previously enjoyed. One means of helping the company “retain some of that personal goodwill” is a noncompetition agreement that prevents the seller from immediately taking customers to a competing business. Niculita, McKedy & Linebarger, How to Distinguish Personal Goodwill From Enterprise Goodwill, the Key Person Discount, and Noncompete Agreements at 107.
In Alexander, the expert’s valuation assumed that the seller would enter into a covenant not to compete with the buyer because similar transactions “almost always” included that kind of agreement. 368 Ill. App. 3d at 203. The expert testified that the values assigned to personal and enterprise goodwill would be “greatly diminished” absent the covenant. Id.
Although a noncompetition agreement is relevant, it does not automatically transform personal goodwill into enterprise goodwill. The analysis still must determine what value already belonged to the company and what value could be preserved only through the owner’s future cooperation.
The Allocation Must Be Tested Against Fair Market Value
The Multiattribute Utility Model allocates total goodwill between personal and enterprise goodwill. It does not independently determine the business’s overall fair market value.
In In re Marriage of Johnson, the appellate court explained the model determines what portion of the business’s total goodwill or fair-market value consists of enterprise goodwill and personal goodwill, but “does not address the overall fair market value of the business before the discount for personal goodwill.” 2016 IL App (5th) 140479, ¶ 80.
The trial court accepted an enterprise-goodwill value of $196,250 for a financial-advisory business. Id. ¶¶ 65, 67, 79. However, one year before trial, the owner paid an adjusted purchase price of $366,255 for a smaller group of customer accounts that he acknowledged was less valuable than the company’s existing accounts. Id. ¶¶ 26, 81-82.
Even assuming that a $115,000 consulting fee represented personal goodwill, the comparable transaction reflected $251,255 in enterprise goodwill for the less valuable customer accounts alone. Id. ¶ 83. So, the appellate court held that valuing the enterprise goodwill of the whole business at $196,250 was against the manifest weight of the evidence. Id. ¶¶ 82-84.
Johnson shows that a goodwill-allocation model cannot substitute for an overall fair-market-value analysis. If reliable evidence of an actual comparable transaction exists, the expert’s valuation and goodwill allocation should be tested against that market evidence.
What Evidence Proves Personal Or Enterprise Goodwill?
A goodwill classification is fact intensive. The strongest evidence typically shows how the business produces revenue, obtains customers, and operates when the owner is unavailable.
The Owner And Other Witnesses
The owner’s interview should identify:
- specialized knowledge or skills;
- personal relationships with customers, clients, and suppliers;
- the owner’s duties and working hours;
- responsibility for hiring and training employees;
- involvement in marketing and obtaining referrals;
- the percentage of revenue generated by the owner alone;
- whether others can perform the owner’s duties; and
- what would occur if the owner joined a competitor or retired.
Additionally, Niculita, McKedy, and Linebarger’s proposed questionnaire asks about the owner’s industry reputation, customer loyalty, customer contracts, professional referrals, health, and whether profits would decline if the owner departed. Niculita, McKedy & Linebarger, How to Distinguish Personal Goodwill From Enterprise Goodwill, the Key Person Discount, and Noncompete Agreements at 103-104.
An owner might exaggerate or underestimate the owner’s significance. Other witnesses may give more objective information about how the company functions. The expert should therefore interview managers, employees, referral sources, suppliers, and customers when appropriate.
Customer And Referral Evidence
Customer and referral records may demonstrate whether business comes to the enterprise or to the owner. Potentially relevant evidence includes customer communications, intake forms, appointment records, referral logs, sales reports, and revenue by employee.
Historical evidence may be especially persuasive. Did customers stay when the owner became ill, reduced working hours, took an extended vacation, or transferred accounts to another employee? Actual customer behavior can be more reliable than an expert’s prediction about how customers might behave.
Operational And Contractual Evidence
Business records can demonstrate whether the enterprise can function by itself. Relevant documents may include:
- customer, supplier, and referral contracts;
- employment and noncompetition agreements;
- organizational charts and job descriptions;
- training manuals and operating procedures;
- customer databases and company-controlled records; and
- financial reports.
When Wood discusses goodwill attributes, he identifies reputation, location, workforce, systems and organization, recurring revenue, marketing, referrals, intellectual property, and transferability as considerations that can point toward personal or enterprise goodwill. David Wood, Goodwill Attributes: Assessing Utility at 89-100.
Dr. Pratt similarly identifies company-owned contracts, multiple service providers, formal organizational structures, institutionalized systems, and sales generated through the company’s name or sales force as common indicators of enterprise goodwill. Personal goodwill is more likely when know-how, sales, and customer or supplier relationships rest mainly with the owner. Shannon P. Pratt, Overview of Enterprise and Personal Goodwill at 6-7.
Transaction And Market Evidence
Industry transaction data, offers to purchase, buy-sell agreements, prior sales, and actual acquisitions can give concrete evidence of transferability and fair market value.
Johnson showed that closely held-business valuation turns less subjective when a similar transaction exists, especially when the comparison involves the same property. 2016 IL App (5th) 140479, ¶¶ 76-77. The owner’s recent purchase of the Indiana customer accounts contradicted the expert valuation accepted by the trial court, requiring a new valuation of the business’s enterprise goodwill. Id. ¶¶ 81-84.
Ultimately, the evidence must answer what earnings and relationships would go away with the owner, and what valuable business structure would stay in place?
The Bottom Line About Personal Goodwill vs. Enterprise Goodwill In An Illinois Divorce
Personal goodwill and enterprise goodwill may materially affect the value of a closely held business in an Illinois divorce. Illinois law provides a framework for distinguishing between the two. Personal goodwill is not marital property, but enterprise goodwill may be included in the value of a marital business.
However, a business can contain both forms of goodwill. Determining whether goodwill exists, how much goodwill exists, and how it should be allocated requires evaluation of the owner’s responsibilities, compensation, referral sources, customer relationships, business systems, contractual restrictions, and available market evidence.
Overall, goodwill valuations turn on its own facts. The central question is: If the owner left, what valuable business structure, customer relationships, and earning capacity would stay in place?
Russell D. Knight is a Chicago divorce and family law attorney with more than 19 years of experience representing clients in complex Illinois divorce matters, including cases involving high-net-worth marital estates, closely held businesses, business valuations, and difficult-to-value financial assets. His practice focuses exclusively on divorce and family law in Illinois.
CASES, STATUTES, AND OTHER SOURCES REFERENCED IN THE PERSONAL GOODWILL VS. ENTERPRISE GOODWILL IN AN ILLINOIS DIVORCE ARTICLE
750 ILCS 5/503(d)(5), (8), and (11) — Factors Governing The Division Of Marital Property
750 ILCS 5/503(k) — Fair-Market-Value Standard
In re Marriage of Talty, 166 Ill. 2d 232 (1995)
In re Marriage of White, 151 Ill. App. 3d 778 (5th Dist. 1986)
In re Marriage of Alexander, 368 Ill. App. 3d 192 (5th Dist. 2006)
In re Marriage of Zells, 143 Ill. 2d 251 (1991)
In re Marriage of Schneider, 214 Ill. 2d 152 (2005)
In re Marriage of Johnson, 2016 IL App (5th) 140479
Jay Fishman, Personal Goodwill Versus Enterprise Goodwill, in BVR’s Guide to Personal v. Enterprise Goodwill 23-33 (5th ed. 2012)
David Wood, Goodwill: Where Are We? How Did We Get Here? What Do We Do About It?, in BVR’s Guide to Personal v. Enterprise Goodwill 1-8 (5th ed. 2012)
Shannon P. Pratt, Overview of Enterprise and Personal Goodwill, in Valuing Goodwill in Divorce: A BVR Special Report 4-9 (2011)
David Wood, Personal Goodwill in Search of a Functional Definition, in BVR’s Guide to Personal v. Enterprise Goodwill 34-42 (5th ed. 2012)
Alexis A. Dawicki & Richa Prakash, Personal Goodwill and Business Goodwill—Are They Marital Assets?, in Valuing Goodwill in Divorce: A BVR Special Report 15 (2011)
David Wood, Goodwill Attributes: Assessing Utility, in BVR’s Guide to Personal v. Enterprise Goodwill 87-100 (5th ed. 2012)
Alina V. Niculita, Angelina McKedy & Kimberly Linebarger, How to Distinguish Personal Goodwill From Enterprise Goodwill, the Key Person Discount, and Noncompete Agreements, in BVR’s Guide to Personal v. Enterprise Goodwill 101-110 (5th ed. 2012)
Frequently Asked Questions About Personal And Enterprise Goodwill In An Illinois Divorce
Is Personal Goodwill Marital Property In Illinois? No, personal goodwill depends on the owner’s own efforts and future earning capacity, so it is not included as a divisible marital asset.
Is Enterprise Goodwill Marital Property In Illinois? Yes, enterprise goodwill may be included in the value of a marital business, as it exists independently of the owner and stays with the enterprise.
Can A Business Have Both Personal And Enterprise Goodwill? Yes, some value may depend on the owner’s reputation and relationships, while other value remains in the company’s employees, systems, contracts, brand, and customer base.
How Do Experts Separate Personal And Enterprise Goodwill? First, an expert determines whether economically valuable goodwill exists. Then, the expert evaluates the personal and enterprise attributes of the business to allocate the overall goodwill between the two categories.
Does A Noncompetition Agreement Make Goodwill Enterprise Goodwill? A noncompetition agreement does not automatically do that. It may help preserve goodwill for a buyer, but the expert still is required to determine whether the underlying value belonged to the business or depended on the owner.
