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Goodwill in Sale of Business

Customers or clients may develop personal relationships with a corporation or the stockholders running a business or corporation. These relationships constitute “goodwill.” Courts have defined “goodwill” as simply the “expectation of continued public patronage” of the business or stock being sold (not the patronage of the world at large or general public). See In re Marriage of Foster (1974) 42 Cal. App. 3d 577.

Under California law, any contract where a party is restrained from engaging in a lawful profession, trade, or business of any kind is “void” and unenforceable, absent two narrow exceptions. These types of contracts are referred to as “non-competition agreements.”

Non-competition agreements are only enforceable as follows: (a) where a person sells the goodwill of a business, and (b) where a partner agrees not to compete in anticipation of dissolution of the partnership. This memo deals with the “goodwill” issue under the first exception.

Therefore, in selling a business or their stock in a corporation, the seller may agree not to compete with the buyer in exchange for consideration for such business or stock, which includes their “goodwill.”

There does not have to be a special allocation in the agreements or sale for “goodwill.” Obviously, if set out correctly in writing, there should be no dispute. And yet the parties may also recognize and confirm that goodwill was definitely included in the transaction. In that case, the court will have to analyze all aspects of the transaction. For example, the following factors may indicate the inclusion of goodwill:

  • Sale price that reflects amount “lost” by seller
  • Substantial prior economic investment by seller
  • Payment of fair market value
  • Value over and above aggregate value of tangible assets or property
  • Book value for goodwill

There is no set formula under California law. However, assets less liabilities will not include goodwill. The court will allow the parties to chose their own method in valuing the corporation. Therefore, parties who want to include goodwill as part of the sales price, and want an enforceable non-competition clause, should make sure this is reflected in the purchase agreement.

Article written by:
Neil Klein