5 things you need to know about divorce, goodwill and dental practice valuation

What is goodwill and how important is it when preparing a practice valuation for the purpose of divorce?

A quick paraphrase summary of goodwill is as follows: It is that intangible asset that provides the cash flow to the dental practice creating the revenue stream used to provide the net income and value for the owner and dental practice. It typically comprises a large amount of the value of a dental practice.   

What descriptions should be included?

Testimony given at divorce trials, in front of the Internal Revenue in tax court and during negotiations for a transition all provide the insight into what attributes should be included in the goodwill narrative. When the dental practice valuation and the allocation to goodwill have come under attack by advisors to the dentist, those with experience in providing a detailed list of those areas of definition prove invaluable in prevailing with one’s case. Enumerating every point regarding the goodwill categories give an excellent description of what attributes are part of the goodwill apportionment. The support included in determining the value attributed to goodwill and then the resultant personal versus enterprise variances assist in convincing a judge or anyone else why the goodwill value is as presented. The personal goodwill compared to the enterprise, or practice goodwill is extremely important in states where equitable distribution is in effect. 

Related reading: Divorce and the financial toll on the dental practice

What are some of the attributes of goodwill?

When assessing the value of goodwill and then dividing that amount between the dental practice and the personal goodwill, interviewing the personnel in the office(s) including the dentist, is a good starting position. Learning about the dentist’s work ethic, health, personality, age, education and the ability to manage the office staff and interaction with patients is essential. All of these items assist with the composition of the goodwill that is personal to the dentist or available for the spouse in an equitable distribution state. The office location, name of the practice, state of art of the equipment and the comfort of the office are also important items in determining the goodwill value. Comparing the rental paid to the area in which the office is located also assists in the valuation process and in defining what the value of the dental practice is. 

Sometime an inexperienced CPA will inflate certain attributes to reduce taxes. When preparing a dental practice valuation, those inflated categories should be added back to income to normalize the net profit of the practice. When overpaying rent, as an example, to an owner of the dental practice who owns the building, a good evaluator would normalize the income of the practice by adding back the differential between market rent and the overstated rental so the net dental practice value would increase. Explanations regarding tax consequences, like the rental not being subject to payroll tax, do not mean it is correct from a business valuation perspective.  

Continue to page two for more...

Other attributes of goodwill needed to support testimony included in divorce valuations.  

The differences between valuations for divorce regarding goodwill and those prepared for a sale or other purpose are many. The following attributes are some but not necessarily all of them: One of the most important items during divorce proceedings whereby a dentist may be able to retain most of the value in his or her practice is to whom the patients are coming to see.  Is it the dentist or is it someone else in the office? Those who are coming because of the recognition of the attributes of the dentist create an overwhelming percentage of value to the dentist’s personal goodwill and not that of the enterprise.

How the marketing evolves and whether viewed as the dental practice or the dentist also creates allocations to either, based on the format. Who is responsible for the business systems, oversight and management, even with an employee designated as “office manager,” also helps in determining how much goodwill is allocated to the dental practice or to the individual dentist.

Trending article: How Brexit could affect your practice's bottom line

Who assists the dentist in planning before or during the divorce trial?

Planning, structuring the entity of the practice, naming the practice and financial lessons for the dentist are essential items for protecting his or her assets.  A dental CPA with experience in these matters is a good start in assuring financial security.