The October 7, 2015 Supreme Court opinion in Moore v. Moore, 414 S.C. 490, 779 S.E.2d 533 (2015), is the first published South Carolina appellate opinion to distinguish personal goodwill from enterprise goodwill for equitable distribution purposes. As this is a frequently recurring issue, the Moore opinion is necessary reading for any family court attorney who handles equitable distributions cases involving business valuations. Further the Supreme Court’s opinion helpful provides substantial guidance in distinguishing these two forms of goodwill.
The primary issue on appeal was the valuation of Wife’s lighting business, Candelabra. At trial, Husband’s and Wife’s experts differed on the value of the business, on whether to apply a marketability discount to the business, and on how much of the goodwill value of the business was enterprise goodwill versus personal goodwill. It was undisputed that Candelabra had fixed assets of $353,687 when marital litigation was filed.
Wife’s expert valued the business at $1,200,000, of which approximately $846,000 represented goodwill. Her expert opined that 20–25% of this goodwill value was personal to Wife and that without Wife, Candelabra’s sales (and profits) would suffer. Wife’s expert also opined that the fair market value of Candelabra was not its full unadjusted value but that the value should be discounted by 20% to reflect the illiquidity or lack of marketability of shares of a closely held business. Accordingly, his ultimate opinion was that the adjusted fair market value of Candelabra was $960,000 as of June 30, 2011.
Husband’s expert valued Candelabra at $2,960,000 as of June 30, 2012—a date approximately one year after the marital litigation was commenced. He did not include a marketability discount and did not including any personal goodwill in his valuation. At trial he conceded that Wife’s personal goodwill was perhaps between 5–10%.
Relying exclusively on the testimony of Husband’s valuation expert, the family court utilized a valuation date approximately one year after the commencement of marital litigation and found the value of Candelabra was $2,960,000. The family court determined that, of the company’s overall goodwill, 10% represented Wife’s personal goodwill, and as a result that percentage was excluded from the marital estate. The family court granted Wife first option to purchase Husband’s interest in Candelabra, including a five-year period to pay Husband his share, together with interest. The family court further ordered Wife to pay Husband $122,557 in expert witness fees.
Both parties appealed. Wife argued the family court’s valuation of the business was wrong, that its erred in finding that any goodwill existed in the business, and that it erred in failing to use a marketability discount in valuing the business. She also appealed the award of Husband’s expert witness fees. Husband appealed the finding that there was any personal goodwill in the business and in allowing Wife five years to buy out his interest in the business.
As a threshold issue the Supreme Court analyzed whether and to what extent the enterprise goodwill of Candelabra is a marital asset. The opinion finds that both enterprise and personal goodwill can exist within a business. It further gave detailed definitions of both types of goodwill:
Enterprise goodwill is that which exists independently of one’s personal efforts and will outlast one’s involvement with the business. Enterprise goodwill is based on the intangible, but generally marketable, existence in a business of established relations with employees, customers and suppliers. Enterprise goodwill attaches to a business entity and is associated separately from the reputation of the owners. The asset has a determinable value because the enterprise goodwill of an ongoing business will transfer upon sale of the business to a willing buyer.
Personal goodwill is associated with individuals. It is that part of increased earning capacity that results from the reputation, knowledge and skills of individual people. The implied assumption is that if the individual were not there, the clients would go elsewhere. Accordingly, the goodwill of a service business, such as a professional practice, consists largely of personal goodwill. Any value that attaches to a business as a result of this personal goodwill represents nothing more than the future earning capacity of the individual and is not divisible in a divorce proceeding. In the family court setting, future earning capacity based on a spouse’s reputation, knowledge and skills—personal goodwill—is considered nonmarketable and thus not property subject to division.
Where goodwill is a marketable business asset distinct from the personal reputation of a particular individual, as is usually the case with many commercial enterprises, that goodwill has an immediately discernible value as an asset of the business and may be identified as an amount reflected in a sale or transfer of a business. However, if the goodwill depends on the continued presence of a particular individual, such goodwill, by definition, is not a marketable asset distinct from the individual.
Citations omitted.
The Supreme Court“recognize[d] enterprise goodwill as marital property subject to equitable
division. We continue to hold that personal goodwill, which follows the owner and is entirely dependent on the owner’s personal or professional services and skills, is not marital property subject to division. However, we are persuaded that enterprise goodwill, which inheres in the business itself and is transferrable in the market, should be distinguished from personal or professional goodwill.” It further determined that Candelabra had elements of both personal and enterprise goodwill.
The opinion then begins a lengthy analysis of how to differentiate personal from enterprise goodwill. “In separating personal and enterprise goodwill, the essential question is: can the business generate revenue from continued patronage without the current owner’s participation?” The vital portion of the explanation:
First, the type of the business being valued can often indicate the existence of personal or enterprise goodwill. For example, an important factor is whether the business involves the manufacture or sale of goods, which can indicate enterprise goodwill, or whether the business involves delivering highly skilled or personal services, which may indicate personal goodwill. Moreover, the nature or attributes of the particular industry may also impact the goodwill analysis; for example, dentists have close contact with their patients, but radiologists do not. It is also important to consider how customers are drawn to the business, including whether customers return/repeat their business or whether transactions are largely nonrecurrent and whether new business comes primarily from customer referrals or from advertising. As to the company itself, factors to consider include whether the company is a start-up or a well-established business; whether the business has its own name or is named after an owner; the number of owners; and whether the operating systems and procedures are in-place or still in the process of being established. In ascertaining whether any personal goodwill exists, it is also important to consider the personal characteristics of the owner, including the owner’s personal reputation, community visibility, age and health, work habits, as well as the owner’s education, experience in the industry, judgment, ability, and special skills or talents. We underscore that this list of factors is not exhaustive or exclusive, but rather is included merely as a starting point to guide the family courts’ inquiry.
Citations omitted.
The opinion also includes a table delineating distinguishing factors between personal and enterprise goodwill and provides an example of competing beauty salons, one highly reliant on personal goodwill and the other on enterprise goodwill.
Ultimately the Supreme Court determined that 20% of the goodwill value was personal to Wife. In reaching this conclusion it relied heavily on the opinion of Wife’s experts, noting that Husband’s expert had failed to give much consideration or analysis to the issue of Wife’s personal goodwill. Wife’s valuation expert opined that at least 20–25% of Candelabra’s goodwill is personal to Wife. In reaching this conclusion, her expert collected data from the business records, visited the storefront in Mt. Pleasant, interviewed Wife and other Candelabra employees, and prepared a detailed report of the history of Candelabra’s operations and pertinent financial information, along with discussions of various accounting and valuation methods and several issues surrounding the value of Candelabra’s goodwill. In his valuation report, he explained that the factors supporting the existence of Wife’s personal goodwill included: Wife’s total responsibility for day-to-day management of the business; total control and responsibility for ongoing product selection; Wife’s continuing website monitoring, revision, and presentation; Wife’s direct personal contact and dealings with manufacturers and vendors; and Wife’s formal, degreed college training in products marketing (with a minor in business administration), along with her extensive previous retail experience. Her expert testified that without Wife, Candelabra would not have the ongoing ability to offer a current mix of trendy products and that sales would decline. He further opined that no bona-fide third-party purchaser would pay full fair market value for Candelabra without requiring a covenant not to compete from Wife, which signaled the existence of personal goodwill attributable to Wife.
The Supreme Court noted that several circumstances surrounding Candelabra’s website indicate the presence of enterprise goodwill. First, the website’s domain name, www.shopcandelabra.com, is associated with the business itself and is not specific to or associated with Wife personally. Further, in connection with Candelabra’s shift in business strategy, the website that initially began as a minor feature of Candelabra’s overall marketing strategy was transformed into the central feature of all business operations, now serving as the online portal through which approximately 80% of all sales are placed. All three experts agreed that Candelabra’s internet presence, through the SEO campaign and website format and functionality, significantly drives Candelabra’s sales and overall value as a business.
In valuing the business, the Supreme Court rejected Husband’s expert’s valuation–in part because his valuation was from a date a year after the date of filing–and it rejected the expert’s contention that the increase in value during that year was not attributable to Wife’s efforts (Wife solely ran the business during the litigation period. However the Supreme Court declined to adopt a marketability discount:
We decline to impose a bright line rule regarding the appropriateness of such discounts in all family court business valuations, but we find no justification for discounting the value of Candelabra in this case due to lack of marketability. Because Wife will retain ownership of Candelabra, we see no legitimate reason to indulge in the fiction of a marketability discount.
The Supreme Court also rejected Wife’s request to grant her a majority of the marital estate:
[W]hile awarding a greater share of the marital estate to Wife could be justified, we see no reason to set aside the family court’s equal division of the marital estate. We, therefore, affirm the family court on the equal division and deny Wife’s request for a greater share of the marital estate.
It concluded:
As of the date marital litigation was filed, Candelabra had a value of $1,200,000. Subtracting from that figure the value of Candelabra’s hard assets, which was $353,687,15 [and which had already been equally divided during the appeal] we arrive at the value of Candelabra’s goodwill, which is $846,313. Only 80%, or $677,050, of the overall goodwill value is enterprise goodwill includable in the marital estate. Thus, only $677,050 is a divisible marital asset, and Husband’s 50% share of such enterprise goodwill is $338,525. Wife shall pay $338,525 to Husband together with interest at the rate directed by the family court. Interest shall be calculated from the date of the family court final decree.
The Supreme Court found the family court erred in giving Wife five years to buy out Husband’s interest and instead gave her 90 days. Based on Wife’s successful results on appeal, it reversed the award of Husband’s expert’s fees.
Finally Husband argued that because Wife desired to retain ownership of Candelabra, she forfeited her ability to challenge the family court’s value on appeal. Husband advanced the “acceptance of benefits” doctrine in support of his position. That doctrine provides that when a party voluntarily accepts benefits provided to him under a decree, such acceptance acts as a waiver of his right to challenge the benefit on appeal. The Supreme Court rejected this argument:
This Court and the court of appeals routinely address such valuation challenges. The suggestion that a spouse in family court litigation who is awarded an asset has somehow waived the ability to challenge the asset’s value on appeal borders on frivolity.
Moore is the most important business-valuation-within-equitable-distribution decisions in over a decade. The issues addressed in Moore recur frequently and there has been little previous guidance to family law attorneys or judges. The language in Moore opinion goes well beyond addressing the unique facts of that case and is explicitly intended to provide substantial guidance on these issues. Just last month I consulted with a woman seeking to appeal issues of personal versus enterprise goodwill and marketability discounts. Before Moore I could offer little guidance. Yesterday I was able to inform her an appeal would be worth pursuing. South Carolina family law attorneys addressing business valuation issues are advised to read the whole opinion.
Very instructive, and certainly consistent with AICPA and NACVA business valuation theory and principles.
When negotiating business valuations, is there an “industry standard” for deducting income taxes at 40% on accounts receivable or, as in the Arkansas case below, is the effective tax rate considered?
http://law.justia.com/cases/arkansas/court-of-appeals/2004/ca03-782.html