Goodwill - "inseparable from the business" vs "personal"

Goodwill - "inseparable from the business" vs ...

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I am preparing a valuation report for the incorporation of a partnership and have read at length the multitude of answers on the site regarding goodwill, personal goodwill etc. However I'm still confused by HMRC's own guidance which, it appears to me, contradicts itself.

CG68010 says:

“Goodwill is inseparable from the business in which it is generated and has its existence, see CG68030. When a business is disposed of as a going concern any goodwill attributable to the business will be transferred to the new proprietor."

If goodwill is indeed inseparable from the business, then it seems to me that it cannot logically also be personal to the owner. This seems even clearer when the argument is turned round: if goodwill is indeed “personal”, then it cannot be owned by the business, in which case how can it be inseparable from the business?

In apparent direct contradiction with the first paragraph, HMRC’s guidance goes on to say, still in CG68010:

"Any goodwill attributable to the personal skills of the proprietor, for example the personal skills of a chef or a hairdresser, will not be transferred to the new proprietor. Advice should be obtained from the CG Technical Group if it is claimed that the goodwill attributable to the personal skills of the proprietor have been transferred with the business because his/her services have been retained for the foreseeable future by means of an employment contract. All of the relevant facts and circumstances should be established before referral to the CG Technical Group.”

Am I missing something obvious, and if not, what does this say about personal goodwill or the lack thereof? 

Meanwhile, I am preparing the valuation on the value of the business to an arms length, unconnected purchaser, from which the goodwill figure falls out without need to reference personal goodwill etc. But since many commentators still seem to recommend "a discount to take account of the personal element", I'm confused.

Any thoughts very welcome!

Replies (5)

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Teignmouth
By Paul Scholes
24th Mar 2013 23:18

There are two goodwills and you can only transfer one of them.

It's as simple as saying there is business goodwill, ie the bit that sticks with the business when it's sold, eg the name, organisation, location, reputation etc AND personal goodwill, ie the bit that sticks with the person and so is not transferable, eg personal skills and reputation.

Putting it another way, if a key person leaves an organisation, can the business still be sold?  If yes, then that is the business goodwill, if no, or unlikely, then the only goodwill is personal, making the business of little or no value.

There was a question on this some time back where a self employed surgeon had incorporated and transferred goodwill to the Ltd Company for £XXXK.  HMRC challenged it, asking for justification for £XXXK as business goodwill. Almost certainly they were right to challenge it, as the value of the business is with the person not the business, if he'd come to me and said, "want to buy my business, I've had enough of cutting people up" I wouldn't even give him £1 for it.

In many cases this is down to judgment based on how old the business is, is there a name/brand/trade mark, are there staff, is the client or customer base inextricably linked with the person(s)...... and so you end up using the standard techniques to come up with a value but then discount it for any personal element.

Hope that helps

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By Roxanne Wralls
25th Mar 2013 15:57

Perhaps an example might help

In order to value something for CGT purposes (and many other purposes that rely in the CGT assumptions), you have to value on the assumptions that there is an arm's length transaction, between a willing buyer and a willing seller, possessed of all the information they need to know the maximum price at which they're prepared to buy (in the case of the willing buyer) and the minimum price at which they're prepared to sell (in the case of the willing seller).

Now let's assume that I've got a French Polishing business in Eastbourne and Paul's got a French Polishing Business in Hastings. Now French Polishing is a real skill, and I'd hazard that in reality, I'm a better French Polisher than Paul.

To the uncouth antique weilding masses of this great nation though, French Polishing is a generic process that can be carried out by anyone with the requisite skill. Heathens!

Within my French Polishing business, I also do brass ball polishing, and it's known throughout the Queendom that nobody polishes brass balls quite the way I do. I've got prestigious awards for my brass ball polishing.  People come from far and wide to get their brass balls polished by me.

Now I'm selling my business to Paul (French Polishing and brass ball polishing). Now Paul and I know that Paul's not got a lot of experience at brass ball polishing and he'll never be as good as me. The far and wide coming folk, won't go to Paul to get their brass balls polished when I retire; they'll just go to their local brass ball polisher.

So when Paul (and I) value the business, we know we need to exclude the income/profits from the far and wide brass ball polishing that I do, because that's personal to me, Paul simply can't get his polishing hands on all my brass balls.

So if instead of selling to Paul, I was incorporating my business, I'd need to exclude the far and wide brass ball polishing income/profits from my calculations.

Is that any clearer?

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By Ding Dong
25th Mar 2013 11:30

@ Roxanne - Crystal Clear!

Perhaps the OP  can enlighten us as to what the trade is so we can give specific advice.

I'll throw in a brief example of an accountant - closer to home!

Mr X is a sole trading accountant, started on his own in 2007 and in 2013 decides to incorporate. For ease - and as is reasonable - he values his goodwill on a GRF of 1x annual fees for each client - Total of £50k. This basis is akin to what he might sell these fees for if he decided to sell off a block of clients.

However within Mr X's fees is one client whom he - as well as providing compliance and accounting services to - provides additional consultancy services to at £1k per month or £12k pa, this client is owned by a closde friend of Mr X who trusts Mr X and thus pays this fee. If the practice was sold, this client wouldn't engage anyone else for this service.

In this instance, on Incorporation Mr X would value the fees/goodwill at £38k by excluding the personal element of the consulting fee.

 

Not sure if that helps at all .....??

 

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By Connie1
25th Mar 2013 14:02

Thank you all

For the insights; they're most helpful. The business is a niche consultancy, so there is undoubtedly personal goodwill in the mix. However the trading name of the business is well known in the industry, they have lots of copyright knowledge and IP which could be transferred (training programmes etc), and the proprietors estimate that at least 50% of the business would be retained by Paul (using Roxanne's example!) if they both walked away. 

In addition a very large proportion of their business is retainer based and the retainer contracts are in the trading name of the business. So, legalities about contracts breaking on ownership changes not withstanding, would be likely to move over to any suitably qualified new owner.

I had worked thus far on  50% personal goodwill, 50% business goodwill, and your explanations have helped that thinking along.

Thanks again!

 

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Teignmouth
By Paul Scholes
26th Mar 2013 11:10

Hold on a minute Roxanne....

Just found a course on Brass Ball Polishing at my local college, will come back to you later in the year when I've got my certificate.

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