Excess Earnings Method Used to Eliminate Personal Goodwill

By Sylvia Golden, Legal Editor, Business Valuation Update

Burnett v. Burnett, 2012 Ind. App. Unpub. LEXIS 1477 (Nov. 29, 2012)

Personal goodwill was a central issue in this Indiana divorce case—and in the end, the appellate court sided with the wife's expert, stating the lower court’s “extensive findings of fact and conclusions of law” made it easy to discern what portion of the husband's medical practice value was attributable to personal goodwill: “none.”

Previous enforcement of operating agreement supported the wife's expert. The husband was an anesthesiologist in a large practice with 68 partners. The total number of partners had remained fairly stable, with every partner holding an equal ownership interest. However, the practice's operating agreement provided for unequal distributions based on a formula. All of the 32 partners who joined since 2001 paid $100, and those who left received $100 plus a termination benefit.

Actual earnings versus industry standard. Indiana considers only goodwill attributable to the enterprise community property, but the wife's expert eliminated the husband’s personal goodwill from his calculation, using a variation of the excess earnings method.

He found the following factors indicated goodwill that resided in the business:

• The practice was an organization with a formalized structure that required every partner to execute a covenant not to compete;


• The entity, not the individual partners, owned contracts with multiple facilities and its ability to generate revenue did not depend heavily on the personal services that any one partner performed;


• The business’s name did not feature individual partners, and its identity remained unchanged despite the arrival or departure of partners;


• The practice alone determined what partner would provide services at what facility; the husband was able to work at a facility regardless of his personal relationship with patients or surgeons; and


• As a partner in the business, the husband did not need to expend time on nonbillable activities, including finding and scheduling work and billing and collecting for it.

To determine personal goodwill, the expert reviewed industry data from a trade group about the number of billable units that anesthesiologists record annually and the compensation that corresponds with a specific production level. The husband’s billable units for 2009 indicated he was slightly below the 90th percentile in terms of productivity. At the same time, his earnings exceeded those of anesthesiologists at the 90th percentile. The expert used the difference between his actual earnings and the industry standards to capitalize as excess earnings.

As to the calculated value of the husband’s interest, the expert said it applied under different assumptions, including the sale of the practice, the sale of the husband’s interest, and the husband’s remaining a partner or leaving the business. He concluded that the investment value was $337,000 and the fair market value was $253,000.

The trial court agreed with the expert’s methodology and conclusions. The noncompete agreements and the practice’s long-standing exclusive contracts with multiple facilities suggested it would continue to have value even if the husband withdrew. “This,” the court said, “is indicative of enterprise goodwill.” Ultimately, it adopted the appraiser’s lower value and found the business interest was worth $253,000.

The husband challenged the valuation in the state Court of Appeals, claiming the trial court failed to separate personal from enterprise goodwill.

Law supports the idea that transferable value is enterprise goodwill. The law is well settled and requires that “goodwill that is based on the personal attributes of the individual is excluded from the marital estate,” the appellate court said, citing Yoon v. Yoon, 711 N.E.2d 1265 (1999). The value that exists in the patient base and would be transferrable to a buyer who does not bring the same attributes to the business as the individual physician is enterprise value, the court continued.