Preserving the Laboratory Ownership Status
What constitutes personal goodwill?
By Bruce Bryen, CPA
Litigation has become part of the laboratory owner’s life as it has in most other segments of our society. Because the laboratory owner has worked so hard to build a successful business, its value during the litigation process becomes the focal point. This is typically the asset with the highest value on the personal financial statement of the laboratory owner compared to the value of a house, savings accounts, and items such as those types of assets. When the allocation of that value is put on paper, after subtracting the depreciated equipment, supplies, and other tangible assets, the largest amount left is normally attributed to goodwill.
During a potential sale process of the laboratory, the allocation to goodwill is paramount to the owner due to the huge tax advantages attributed to that designation as a capital gain. This type of tax treatment creates an enormous savings to the laboratory owner caused by the favorable capital gains tax rates. The question then becomes, “Is the goodwill part of the laboratory’s allocation of enterprise value or is the goodwill assigned to the owner of the laboratory, as his or her own personal asset without regard for the existence of a material amount of goodwill assigned to the laboratory itself?”
The final court decision of the definition of goodwill during litigation and its designation as either a “personal” asset of the laboratory owner or its allocation to the laboratory or the enterprise will determine how much the laboratory owner keeps or pays at the conclusion of the litigation.
What is Goodwill?
A summary definition of personal goodwill can be the cash flow or earnings allocated to the individual. Are the earnings generated from repeat customers who seek the laboratory owner, or are they generated from that customer seeking any employee of the enterprise to perform the necessary service to complete a project? Are new customers and referrals obtained because of the laboratory owner or are they from the new customers that are coming to the laboratory regardless of who is preparing the product because of the attributes of the laboratory? The referrals may be from the laboratory owner’s skills, reputation, and community standing. The understanding is that if the laboratory owner was not there, the customers would go to a competing laboratory.
The laboratory goodwill can be summarized as the cash flow allocated to it and not to the owner. The earnings from the customers on a continuous basis that come to the laboratory and do not have a preference for whomever performs the duties associated with the completion of their projects causes the goodwill to be attributed to the enterprise and not to its owner. It is the cash flow generated by the business at the laboratory. The reasons can be the location of the laboratory, its staff, administrative responsibilities, or its reputation. The goodwill value of the enterprise depends on its ability to be transferred to a buyer.
How Does Goodwill Assist in the Decision Process?
All of the factors in the allocation process are analyzed and dollar amounts are assigned to each based on their value to the overall scheme of the enterprise compared to the individual laboratory owner. Each expert will lend support based on their studies of the laboratory as a going concern and the importance of the owner compared to that of the enterprise without the owner. Data gathered that will lend credibility to be analyzed will be included for additional support of the final opinion presented to a court or to the opposing party in an attempt to settle the issues without the need for a trial.
The laboratory’s formal appraisal will normally reflect an allocation between the tangible (physical asset value) and its intangible (goodwill value) on a “going concern” basis. The opinions of the experts retained to further differentiate between the portion of the intangible value allocated to the laboratory owner as personal goodwill, and to the laboratory as enterprise goodwill, will provide a basis for determining how the laboratory owner’s financial future may be decided.
About the Author
Bruce Bryen, CPA, is a managing partner of Bryen & Bryen LLP, Certified Public Accountants, in Marlton, New Jersey. For more information, please contact Bruce at 800-988-5674 ext. 112.