Goodwill Value in Divorce: Who Gets the Blue Sky?

By: Erik Gilbertson

Reaching a determination of how marital property will be divided during divorce proceedings can be a difficult task. Several factors, such as when and how an asset was acquired, can have an effect on a court's determination of property division. When ownership of a privately held company is part of a marital property division, further considerations should be given to the goodwill value, or blue sky value, due to its impact on any potential property division. Who gets the blue sky? Before arriving at an answer, several key questions should be asked.

Does blue sky value exist?

In general, a privately held company owned by one or both spouses will be appraised through a business valuation to determine the company's value as part of the marital estate during divorce proceedings. The resulting value of a profitable company can often be broken down into two main categories. The first category is the value of the tangible or "hard" assets in a company, such as cash, accounts receivable, inventory, and equipment. The second category is the value of intangible assets which are often referred to as "blue sky" value. These assets can include a company's brand name, customer base, customer relationships, employee relationships, patents, proprietary technologies or processes. Several factors which create blue sky value will be present in most privately held businesses. However, not every privately held company will have blue sky value. A skilled business appraiser will be able to identify any blue sky value as part of a business valuation.

How much of the blue sky value is personal goodwill and how much is enterprise goodwill?

The blue sky value in a company may include personal goodwill, enterprise goodwill, or a combination of the two. Personal goodwill is derived from the efforts of an owner, and arises from the individual owner making the business inherently more valuable because of personal skills, vision or relationships. Enterprise goodwill arises when the company itself has inherent value due to factors, such as location, workforce, processes, branding or reputation.

In which jurisdiction are the proceedings taking place?

Depending upon the jurisdiction of the divorce proceeding and the determination of whether blue sky value is comprised of personal goodwill or enterprise goodwill, the blue sky value of a company may be entirely excluded or included in the marital estate for purposes of asset division.

Example and Outcomes:

As an example, take a hypothetical divorce between John and Jane Smith. John started Smith, Inc. shortly after being married to Jane, and the Smith's are 50/50 owners of the company. John has worked full time in the company, and Jane worked full time in a career outside of Smith, Inc. A business valuation was conducted to value Smith, Inc. for purposes of the divorce proceedings, and the valuation concluded Smith, Inc. was worth $5 million. The report outlined value for the tangible assets at $3 million and value for the blue sky at $2 million. Furthermore, the report concluded all of the blue sky was considered personal goodwill attributable to John's unique skills and business relationships.

The Smith, Inc. tangible asset value of $3 million will likely be split in a manner similar to the cash, investments and other assets accumulated by the Smith's over the course of their marriage - equally in a community property state or in a manner determined to be fair in equitable distribution states. However, the $2 million of blue sky value could get divided in one of four different ways (statistics courtesy of Business Valuation Resources*):

1. The $2 million of blue sky will be considered marital property and subject to division in a manner similar to the other assets in the marital estate. Approximately one-third of state family law courts currently take this view.
2. The $2 million of blue sky will be considered separate, non-marital property attributable to John, and it will not be included in the marital estate. Approximately one-half of state family law courts currently take this view.
3. The $2 million of blue sky will not be considered marital property of the Smith's at all. Less than 10 percent of state family law courts currently take this view.
4. It is unknown what will happen with the $2 million of blue sky and the Smith's marital estate, because no decision or no clear precedent exists. Less than 10 percent of state family courts currently take this view.

Conclusion

Jurisdictional location and precedent are key considerations in divorce proceedings where a privately held business is subject to an asset division. A business valuation report can help the court determine whether blue sky value exists and the extent to which blue sky value is attributable to personal goodwill, enterprise goodwill or a combination of both. The resulting conclusions will ultimately assist the parties and trier of fact in arriving at a determination of how blue sky value is allocated during a divorce proceeding.

^*Business Valuation Resources, LLC

BVRs Guide to Personal v. Enterprise Goodwill, 5^th Edition (2012)