9031 / What factors are used in determining the intangible value of a small business?
As is typical in small business valuation, the IRS has indicated that the extent to which a business’ value is attributable to intangible value in the form of goodwill must be determined on a case by case basis.1 At its most basic level, the value that exceeds the value of the business’ tangible assets is attributed to its goodwill. Goodwill is determined by deciding how much a purchaser would pay for this excess value, which is the product of intangibles such as reputation and market position (see Q 9030).
Because of the fact-intensive nature of the inquiry, there are no specific factors that must be considered in determining the goodwill of a small business. Often, the value of goodwill will depend upon the business’ earning capacity and projected future earning capacity, but it can also include value attributable to the business’ prestige, whether it owns a trademark or brand name and its record of successful operation over a prolonged period of time.2
A business that derives much of its success from the services provided by its owners, such as a group of doctors or accountants, will often assign significant value to the goodwill generated by the reputations of these professionals. Conversely, if the business is primarily asset-driven, where the physical equipment or structures producing a product may be more important than the personal services of a business owner, goodwill may be assigned a lesser value. However, even in a product-driven business, if the reputation of concrete products produced by the business provides motivation for repeat business, the business’ goodwill should be assigned a higher value.