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The Changing View of Personal Goodwill in North Carolina Equitable Distribution

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Daniel R. Young

When an equitable distribution matter involves an ownership interest in a business, the business valuation becomes an integral part of the matter. As a result of the recent Supreme Court of North Carolina (“NCSC”) decision in Sneed v. Johnston (Sneed), 293 N.C. App. 650 (2024), in the event the individual is an owner of a professional practice (e.g., law firm, medical practice), one of the largest questions the valuation appraiser must address is how to handle goodwill. Goodwill is an intangible asset. Unlike a car, boat, machines, or real estate, goodwill reflects the value derived from components that are intangible (e.g., reputation, process, brand name, among others).

Prior to the NCSC discretionary review of Sneed, North Carolina appellate courts had not addressed the distinction between personal and enterprise goodwill. Under Poore v. Poore, 75 N.C. App. 414 (1985) and McLean v. McLean (1988), goodwill was valued as part of the practice, and all the value was treated as divisible.

In Sneed, one issue was the valuation of a law firm owned by the plaintiff, in which the expert determined that 90 percent of the total goodwill value of the law firm was attributed to the personal goodwill of the plaintiff, while 10 percent of the total goodwill was attributed to the enterprise. The trial court ruled that defendant was entitled to half of the value of the entire firm. The decision was affirmed by the Court of Appeals and recently reversed in part by the NCSC. In its opinion, the NCSC explained:

“In purporting to distribute a professional practice’s personal goodwill between the parties to an equitable distribution proceeding, a trial court is really granting one spouse a right to property — the other spouse’s future earnings — that does not yet exist.”

Identifying Personal Goodwill

One of the more common questions we receive from attorneys trying to understand their client’s/opposing party’s business is how to handle the element of personal goodwill. One can identify personal v. enterprise goodwill by starting to answer some of the following questions:

  • What type of services are being offered in the business?
  • Are specialty licenses/credentials required to service clients?
  • What would happen if the individual left the business?
  • Is there a process in place to fulfill the client services?
  • Is there a workforce in place?
  • Are there multiple locations/offices?
  • What attracts customers to the business?
  • Is the name of the business tied to an individual? (example: Jane Smith’s Accounting Firm v. Raleigh Accounting)

If the answers lead to the determination that personal goodwill exists in the business, the next analysis is to separate out personal and enterprise goodwill. The objective now, as a result of the NCSC decision in Sneed, is to value the business to the exclusion of any value of personal goodwill.

Methods to Calculate Personal Goodwill

There are several methods an appraiser could consider when quantifying (and/or excluding) personal goodwill. Some common methods include the following:

  • With and Without: Considering two valuations of the business — one in which the owner stays in the business, and one in which the owner leaves. The differential implicitly is due to personal goodwill.
  • MUM/Factor Weighting: The Multi-attribute Utility Model utilizes a set of factors, scoring each factor by importance and utility in the business, resulting in a relative overall allocation of goodwill between personal and enterprise elements.
  • Comparability/Market Approach: Reviewing other transactions in the marketplace for similar characteristics as the business being valued, utilizing elements of the underlying transactional data and specific fact pattern of the subject company to control for goodwill allocation.

In each of the methods listed above, it is also important to consider a reasonable compensation analysis in which the appraiser would determine the compensation earned by the individual if he/she was hired by a third party.

Challenges and Recommendations to Avoid Them

Emerging from the Sneed decision, the analysis of personal versus enterprise goodwill in North Carolina equitable distribution cases is more important than ever. Some common challenges for valuation experts include, but are not limited to:

  • Reliable financial data: In small professional practices, the bookkeeping records may be incomplete or inaccurate. Obtaining reliable financial data is imperative before the analyst can perform further valuation modeling.
  • Availability of the owner: Irrespective of who retained the expert, enabling a management interview is a critical component of a valuation, especially in a professional practice where personal goodwill is a component of the valuation. As seen in Sneed, the expert’s attempts to communicate with Plaintiff went unsuccessful, leading to difficulty in obtaining financial information and assistance.
  • Subjectivity of the calculation: There is no single prescribed method for calculating personal goodwill, and the results often depend heavily on the expert’s professional judgment.

For an attorney, navigating the challenges around professional practice should start with obtaining a qualified expert. Retaining an expert early in the matter can assist with preparing appropriate document requests and educating the client on the process and the evolution of the analysis.

Daniel R. Young is a director at Strive Partners, a boutique business valuation and financial forensic firm that primarily assists matters in family law. Daniel is based in Raleigh, NC. You can contact him at [email protected].