Why divorce makes selling practices so complicated

May 8, 2018

When going through a divorce and a practice valuation, there are a host of issues to contend with.

There are evaluators who merely prepare the same type of dental practice valuation for any purpose. This is not a good idea because a dental practice valuation prepared for something in particular is almost always different than that prepared for another use.

There are many examples that can be given. One that is cause for concern - because of the financial effect on the dentist as well as the emotional drain - is asking whether the dental practice valuation prepared for the purpose of a divorce.

Related article: Why hiring the right experts is critical during divorce proceedings

In a conventional appraisal of a dentist’s office, the major area of value is the goodwill that has been created and that the dentist is selling. This asset has a significant tax benefit to the seller of the practice and the amount allocated to it is normally debated between the buyer and the seller so that the seller gets as much of an allocation as possible on the settlement sheet or in the sales agreement. Let’s look at what the difference between a valuation for a transition and for a divorce looks like.

Compare/contrast

Why should goodwill be the main asset analyzed in the presentation of a dental practice involved in divorce litigation? Why is it so emotionally and financially different than what is involved in the goodwill analysis during a practice transition? Why should the valuation purpose be so extraordinarily different when comparing the divorce valuation to the transition valuation when goodwill is the asset being analyzed?

The transition valuation of a dental practice is typically prepared in order to present the fair market value of a dental practice when both a “buyer and seller are hypothetical, aware of dental practices in general and are under no duress or compulsion to sell or to buy.” This is an indirect quote used in almost every dental practice valuation to identify buyers and sellers.

The goodwill of the dental practice or the dentist may or may not be of critical impact to complete the transition.

Negotiations almost always occur between the buyer and the seller’s advisors to obtain the most favorable tax treatment. During a divorce, there is an emotional component that becomes a factual piece of the entire proceeding of the separation of spouses. The idea of the goodwill being owned by the practice or by the individual dentist is of paramount concern when the preparation of the valuation is for the purpose of a divorce and not for a transition, estate plan or any other purpose that the dental practice evaluator has been retained.

The importance of goodwill

The difference between the dentist’s personal goodwill and this intangible value of the dental practice itself, or the enterprise, determines what is considered marital property and what is owned by the dentist individually and is not part of the estate to be divided. One can imagine the difference if, as an example, the total goodwill of the practice was agreed upon hypothetically at $500,000 and that amount was either deemed as personal goodwill or practice goodwill.

Related article: What effect does divorce have on dental practice values?

Let’s examine the difference in terms of the distribution awarded by a court in each of these extreme instances. Let’s also understand that there is rarely a situation where goodwill is an all-or-nothing extreme in the valuation of goodwill.

 

In the first instance, if all of the goodwill was considered to be a personal asset, that amount would then not be part of the marital estate. The non-dental spouse would receive nothing from the dental practice that was attributed to goodwill. On the other hand, if the entire amount of goodwill were to be considered as practice goodwill, the non-dental spouse would then receive the entire amount of that allocation. We are discussing the economics of the distribution of the assets of the dental practice and not any type of tax allocation. The parties should know that from 70 to 80 percent of the total asset value of a dental practice is typically attributed to goodwill.

How goodwill affects divorce proceedings

For a valuation prepared for the purpose of a divorce, if no goodwill analysis is part of that appraisal, then it falls short of serving the divorcing parties. It also limits the judge or mediator in determining what should go to the non-dental spouse and what the dentist should be allowed to keep as part of the dental practice distribution.

There are key tests when preparing the summary of the valuation for the divorce. Examples include, but are not limited to, to items such as the name of the dental practice - since if the name includes that of the dentist, there is a strong indication that attribute of goodwill should have a strong bias towards the personal goodwill of the dentist. If the dentist’s name and/or picture are prominently displayed on the dental practice website and in almost all of the marketing, that should also give a strong indication of personal goodwill.

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

In states where there is equitable distribution, the personal goodwill of the dentist is not a marital asset. The goodwill allocated to the staff is almost always an enterprise or dental practice asset. That is considered marital property. The location, if there is more than one office, will usually be considered enterprise goodwill and is included in the marital estate. These are just some of the examples of how an allocation supports whether an asset is of a personal goodwill nature or that of the enterprise and therefore a marital asset. Those familiar with valuations of dental practices where the purpose is for a divorce will use testing of the assets to make sure the allocation of the goodwill is accurately presented.