Key Takeaways

  • Goodwill represents the intangible value of a business, such as customer loyalty and brand reputation, and is a key element in business sale agreements.
  • Goodwill sale contracts can involve personal goodwill, which is linked to the seller’s individual relationships or reputation, especially in service industries.
  • A well-drafted contract should distinguish between corporate and personal goodwill and address tax implications, non-compete clauses, and allocation of purchase price.
  • The buyer typically seeks legal protections through warranties and representations to ensure the goodwill value is valid and transferable.
  • Proper valuation and documentation are critical for both legal and tax purposes during a business sale.
  • Legal and financial professionals should be involved in drafting and executing goodwill sale contracts to ensure enforceability and tax efficiency.

A good will agreement is an agreement between a business and at least one other party, asserting that the business has goodwill, a business asset that outlines the difference between the asking price for a company and its fair market value.

Goodwill Law and Legal Definition

Goodwill is a business asset that can be sold and bought with the business. This marketplace advantage includes customer loyalty and patronage, usually built and developed through continuous interactions with a business over a period of time. When a business owner chooses to sell the company, the goodwill is sold with it, although the value of goodwill is more subjective.

As an attribute of a business, goodwill is something that can be acquired by any owner who maintains a company that is competitive and offers services or goods. Within a sales contract, goodwill can be sold as part of the business. The purchase of a company's goodwill is subject to the same laws as any other type of purchase handled through a contract, according to local contract laws.

Since a contract transfers ownership of a business and that company's goodwill, the person selling the business is legally allowed to compete with the business, unless a non-compete clause is specifically included in the agreement.

Personal vs. Corporate Goodwill

In goodwill sale contracts, it’s essential to differentiate between personal goodwill and corporate goodwill. Personal goodwill refers to the value attributed to the individual seller’s skills, reputation, or relationships with customers or suppliers. This is common in professional services, such as medical or consulting practices. In contrast, corporate goodwill is tied directly to the business entity itself—such as its brand, trade name, or institutional customer base.

The distinction matters because personal goodwill is considered the seller’s individual property, which can impact tax treatment. For example, personal goodwill may be taxed at the capital gains rate, rather than at the higher ordinary income rate typically applied to corporate asset sales.

Valuating Goodwill

The two main methods for valuing the goodwill of a business are:

  • The residuum approach, which calculates the difference between the fair market value of a company's assets and the agreed-upon purchase price of that business
  • The excess profits approach, which presents the value of all projected excess earnings in the future, over the standard earnings for a business that is similar to the one being acquired.

Using the excess profits approach to value a company's goodwill can be imprecise because future earnings are so uncertain.

Additional Definitions

In other words, goodwill is an intangible asset of a business. If a buyer is interested in the business, any amount over the calculated book value of that business would be considered goodwill. Some of the factors that might help one business stand out and become more dominant in its industry include:

  • Marketing
  • Management talent
  • Research
  • Timing

These factors can make the business more appealing to a potential buyer.

When a business owner is able to command a higher price for that business, this is a direct result of goodwill. As the sale is finalized, the new business owner will outline the price paid less the book value of the company as goodwill on any financial documents and statements.

In addition to goodwill, selling a business can involve several other intangible business assets. Examples include:

  • Licensing agreements
  • Trademarks
  • Copyrights
  • Patents

These examples are identifiable, which means it is easier to assign a value to them. Examples of intangible assets include:

  • Brand names
  • Special skills
  • Reputation
  • Market position
  • Operating methods
  • Customer lists
  • Knowledge of innovative technology
  • Location

These factors tend to be factored into the overall goodwill value, although it is difficult to assign an exact dollar amount to each. They do add value because they can help assure a potential buyer that the business will remain successful.

Factors to Consider in Goodwill Sale Contracts

Goodwill sale contracts should include several key components to protect both the buyer and seller. These typically include:

  • Detailed Definitions: Specify what constitutes goodwill in the transaction.
  • Allocation of Purchase Price: Clearly divide the purchase price among tangible assets, identifiable intangibles, and goodwill.
  • Non-Compete Clauses: Restrict the seller from re-entering the same market or soliciting former customers, helping protect the purchased goodwill.
  • Warranties and Representations: The seller may be required to affirm that the goodwill is genuine, transferrable, and not based on any misrepresentations.
  • Tax Clauses: The agreement should clarify how the IRS will treat the goodwill component—particularly distinguishing personal goodwill to potentially secure favorable tax treatment.
  • Transition Assistance: If personal goodwill is involved, the contract may obligate the seller to remain involved for a transitional period to transfer relationships effectively.

These elements ensure the buyer receives the full benefit of the goodwill and that the seller is protected from future disputes.

Business Assets

Goodwill is certainly a valuable asset, but because it is intangible, it is not included on the financial documents of a business. In accounting procedures, a company might assign a value of $1 for goodwill. Although many businesses could be sold for higher values based on their reputations, the goodwill of a business isn't usually valued until the process of acquisition begins. During this process, the price of the business will determine the value of the goodwill. For example, if a business had $100,000 in assets and was purchased for $150,000, the buyer of that business would record a goodwill value of $50,000.

When valuing a business, the first step is assessing how much equity it holds in tangible assets that are easier to value. Examples include:

  • Inventory
  • Real estate
  • Supplies
  • Equipment

After assessing these values, the next step is adding a value for intangible assets. This addition is often referred to as a “blue sky amount” and could include goodwill, non-compete clauses, trade names, and patent rights. In the sales of small businesses, most financial experts recommend keeping the blue sky addition to less than the company's net income in one year. For a public company, the goodwill amount can depend on the current stock conditions. Share prices determine the purchase prices for businesses, so stock prices could jump around during the acquisition process.

Legal Considerations and Drafting Tips

When drafting or reviewing a goodwill sale contract, legal counsel is critical. Specific legal issues may arise, such as:

  • Assignment of Goodwill: Ensure the goodwill described in the contract can be legally assigned to the buyer. Some forms of goodwill (like client relationships) may not transfer automatically without explicit agreements.
  • Good Faith and Fair Value: Courts may scrutinize the transaction to ensure the goodwill valuation was made in good faith and reflects fair market value.
  • Avoiding Double Taxation: In cases where a C corporation is involved, proper classification of personal goodwill can help avoid double taxation by allowing proceeds to be taxed at the shareholder level only.

These contracts should be detailed, customized, and aligned with both local business laws and federal tax codes. Consulting a lawyer with experience in goodwill sale contracts is strongly advised to ensure compliance and strategic advantage.

Frequently Asked Questions

  1. What is a goodwill sale contract?
    A goodwill sale contract is a legal agreement outlining the sale of a business’s intangible value—such as its reputation, brand, and customer relationships—alongside or separate from physical assets.
  2. Why is the distinction between personal and corporate goodwill important?
    This distinction affects tax treatment. Personal goodwill is taxed as a capital gain to the individual, while corporate goodwill can be taxed at the corporate level and again upon distribution to shareholders.
  3. Can goodwill be sold independently from the rest of a business?
    Yes, particularly personal goodwill, though it often requires detailed documentation and sometimes post-sale involvement from the seller to ensure its transferability.
  4. What are common clauses in a goodwill sale contract?
    Typical clauses include purchase price allocation, non-compete agreements, warranties about the quality and validity of goodwill, and transition obligations for the seller.
  5. Do I need a lawyer for a goodwill sale contract?
    Yes. Given the legal and tax complexity, it is highly recommended to consult a lawyer familiar with goodwill sale contracts. You can find experienced attorneys on UpCounsel for this purpose.

If you need help with a good will agreement, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.