California Code of Civil Procedure Section 1263.510(b) states "goodwill consists of the benefits that accrue to a business as a result of its location, reputation for dependability, skill or quality and any other circumstances resulting in probable retention of old or acquisition of new patronage." This definition of goodwill came about in 1975 with a revision of California Eminent Domain Law. As a result, California became the first state to recognize, by statute, a compensable goodwill loss.

Goodwill represents the very real ability of a business to generate profits from gross revenue due to advantages, which are primarily intangible in nature, which may not be available to competitors. The expectation of continued patronage, location and general reputation are contributing factors, but the actual value of goodwill is usually measured by an analysis of the income produced by the business and available to the owner of the business.

For years, business appraisers have determined the existence of goodwill using the Excess Earnings Method of valuation, either with historical earnings (valuation related to dissolution) or through a capitalization of future earnings or some other method.

Goodwill of a business is defined by the California Business and Professions Code Section 14100 as "the expectation of continued public patronage." So, if a small, closely held business has no goodwill using the Excess Earnings Method, does this mean that goodwill doesn't exist? The answer is NO. Other methods can be used to determine goodwill such as "Rules of Thumb" or other formulas. Owner's cash flow or the "cost to create" method are also methods to determine the existence of goodwill.

When an analysis of the business shows little or no tangible or intangible value, then the "cost to create" or "in-place" value method cab be used. Raymond Miles defined the "cost to create" method as "the value of an asset or group of assets estimated directly from the cost that was incurred to create or acquire the assets." The "cost to create" method can also be used as a sanity check to corroberate the value of goodwill obtained by other methods such as the "Excess Earnings Method.

When goodwill in closely held businesses is valued pursuant to dissolution proceedings, California Civil Code Section 5118, along with case law, indicate that future earnings after date of separation should not serve as the basis for determining the community interest in that business. (see Marriage of Foster (1974) 42 Cal.App.3d 577, 177 Cal.Rptr. 49, Marriage of King (1983) 150 Cal.App.3d 304, 197 Cal.Rptr.716, Golden v. Golden (1969) 270 Cal.App.2d 401, 75 Cal.Rptr. 735.)

In addition, the standard of value in a marital dissolution is often termed the "marital value" of the investment value of the business in the hands of the individual owner or "in-spouse" who will continueon with the business after the dissolution. This value is contrasted with "Fair Market Value" which values a business as the price that a buyer could reasonably be expected to pay and a seller could reasonably be expected to receive, if the property were exposed for sale on the open market, and both buyer and seller are aware of all the relevant facts surrounding the business with neither the buyer or the seller being compelled to buy or sell.

Another point to remember with the valuation of closely held businesses within the dissolution process in California is that the business is to be valued "as near as practicable to the time of the trial" (Family Code Section 2522), while an exception to the general is that, upon proper notice, a business may be valued at another date between date of separation and date of trial if this date better represents the value for an equal distribution of community property. Case precedence for valuation of closely held businesses at dates other than time of trial include: Marriage of Green (1989) 213 Cal.App.3d, 14 261 Cal.Rptr.2d 411 and Marriage of Stevenson (1993) 20 Cal.app.4the 250,24 Cal.Rptr.2nd 411.

When we perform a valuation of a closely held business for either a dissolution or business litigation, we often begin with the Excess Earnings Method. we also investigate other methods to determine or corroborate valuation. The key question regarding the existence of goodwill is: was goodwill determined using a reasonable method within a certain range that either has case precedence or is routinely used in the valuation of certain industries by valuation professionals.

Example Only
This is a general discussion of this topic which may not be relied upon due to changes in law or valuation theory.