A recent divorce case out of Delaware is significant for addressing the treatment of goodwill where the business is a sole proprietorship. The opinion includes important commentary on the only Delaware Supreme Court decision that has broached the issue.
In the instant case, the business was a sole proprietorship through which the husband had worked for decades as an independent contractor for a larger financial services and investment firm. Primarily his work involved financial planning, estate and business succession planning, and executive benefits planning. The husband earned income from selling clients policies that met their financial and strategic needs and maintaining the plans throughout their lifetime. Policy renewals were another earnings source.
Wrong premise: The parties’ BV experts reached very different value conclusions. The husband’s expert found the business was worth $255,000. The wife’s expert arrived at a value of nearly $3.5 million. Goodwill—specifically whether there was enterprise goodwill— was a major area of disagreement. The husband’s expert premised his valuation on the understanding that, under the controlling Delaware case law, there could be no goodwill in a sole proprietorship under any circumstances. This proposition was based on a 1983 decision from the Delaware Supreme Court, E.E.C. v. E.J.C., that deals with goodwill in the context of valuing a law firm owned by a sole practitioner. In E.E.C., the high court noted the parties conceded that “goodwill should be disregarded.”
The court ruling on the present case said there are no other high court decisions giving additional guidance “whether or not it is appropriate to ever include a value for professional good will in such a business.” Many trial court opinions have cited E.E.C. both for the proposition that the capitalization of income approach or the discounted cash flow method are not appropriate methods with which to value a sole proprietorship and that a sole proprietorship has no enterprise goodwill.
The court noted, here, the husband’s business was not a law firm “and the practice and means of generating income are different.”
“The Court does not read EEC as stating that every sole proprietorship in every case has no professional good will,” the court said. Therefore, here, the valuation of the husband’s expert was based on the wrong premise. The court found credible the analysis of the wife’s expert, who assigned 5% of goodwill to the husband (value of a noncompete) and the remainder to the business. The court said both experts agreed that, if the husband could transfer goodwill such that he could transfer to a buyer his client base and stream of income (even 95% of the income), he could obtain about $3.5 million for the business.
The opinion addresses other valuation issues, including how to account for commissions the husband received after separation but on which he worked during the marriage.
A full discussion of A.A. v. B.A., 2020 Del. Fam. Ct. LEXIS 33; 2020 WL 6379355 (Oct. 9, 2020), and the court’s opinion are available to subscribers of BVLaw.
Extra: Check out BVR’s free goodwill chart providing a quick overview of goodwill jurisprudence in the 50 states.