What is Personal Goodwill and what is its role in a Asset Purchase Agreement?
After years of experience, a successful business owner has likely built up a reputable image, formed valuable business connections and relationships, and guarded trade secrets. Although it may be hard to believe, when these traits of the owner give a business its value, these traits are are property of the owner and not the business. For example, let’s say Sally grew up in the Girl Scouts. As an adult, she opened a business at a bakery. Never forgetting her experiences as a Girl Scout, she makes it part of her personal mission to help local Girl Scouts learn how to bake. She offers free after-school classes to the Scouts and offers them discounts on her baked goods. Sally has earned the favor and trust of the Girl Scouts and their families, and now everyone in town comes to Sally for their bread, cookies, and cakes because of her personal contribution to the community. Sally is so successful in having created personal business relationships with this community that she could open a new bakery down the street, and her new business would succeed solely because these same customers would seek her out and purchase only her product.
When a business owner decides to sell a business, there are typically two types of sales: sale of stock (or membership interest, in the case of a partnership, sole proprietorship, or LLC) and the sale of assets. When an owner like Sally sells her business as a sale of assets, she can benefit from a significantly reduced tax liability (capital gains tax treatment) by selling her Personal Goodwill in a transaction separate from the business’s asset sale. To ensure the success of this type of transaction, there are a few steps that need to be considered.
First, the assets of the business must be transferred separately from the owner’s Personal Goodwill in a separate agreement. Then, the seller must be able to prove that she “owns” personal goodwill; that is to say, that her personal relationships, reputation, integrity, and business knowledge are of significant value to the performance of the business. Further, there can be no non-compete agreement between the seller and the business for sale. Then, the seller must then draft a separate agreement to personally sell to the buyer her Personal Goodwill. By “selling” Personal Goodwill, the seller is agreeing to transfer the aforementioned relationships, reputation, and knowledge to the buyer help maintain the business’s performance. Finally, a non-compete agreement must be made between the seller and the new business to ensure the existence of Personal Goodwill.
Read a sample Sale of Personal Goodwill Agreement or click here to review other sample legal documents.
If you are selling a business and are seeking favorable tax treatment of your personal goodwill, contact Business Legal Services today to discuss the structure of your sale. We are reachable at (703) 486-0700 and firstname.lastname@example.org!