Understanding and Using the

Goodwill Valuation Report

IRWA Chapter 1
2012 Fall Seminar
October 23, 2012

William W. Thomsen, ASA, CFA, MBA

Thomsen LLC
www.thomsenllc.com

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Understanding and Using the Goodwill
Valuation Report
• Agenda
– When a Goodwill Valuation May be Needed
– Elements of a Goodwill Loss Valuation
– How Goodwill Relates to Other Elements of Value
and Compensation
– Potential Areas of Controversy
– Considerations When Reviewing a Goodwill Loss
Valuation Report

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 When a Goodwill Valuation May be
Needed
• Pre-Condemnation Planning
• Agency Offer and Deposit
• Negotiations
• Trial/Litigation

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 When a Goodwill Valuation May be
Needed
• Pre-Condemnation Planning
– What site to acquire? Agency must identify and evaluate
sites before deciding
– Appraisers may assist in this process
– Preliminary analysis to test for potential goodwill exposure
• Businesses on site?
• Shared facilities parking
• Impact of partial takings
• Inverse condemnation claim exposure
– Complications
• Limited information may be available at this early stage
• Goodwill exposure may be only one factor of many to consider

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 When a Goodwill Valuation May be
Needed
• Agency Offer and Deposit
– Before an Agency can condemn, it must make an
offer based on an appraisal
– The appraisal used to make offer may also be used
to support the pre-condemnation deposit

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 When a Goodwill Valuation May be
Needed
• Negotiations
– An appraisal report (preliminary or formal) may be
used for mediation or settlement purposes
– The appraisal expert may be brought in to explain
findings and opinions
– Appraisal experts from opposing sides may be
brought in to discuss differences and
commonalities – and to possibly arrive at a
mutually agreeable value range

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 When a Goodwill Valuation May be
Needed
• Trial/Litigation
– The formal appraisal is performed in concert with
expert designation and exchange of reports
– The expert is typically deposed after appraisal
exchange
– The expert may testify in court to explain/defend
valuation (goodwill loss) opinions and to rebut
other expert opinions

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Elements of a Goodwill Loss Valuation
• How California Statute Defines Loss of
Goodwill and Compensation
• Calculating Loss of Goodwill
• Implications for Valuation and Compensation

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Elements of a Goodwill Loss Valuation
• How California Statute Defines Loss of
Goodwill and Compensation
– California Code of Civil Procedure Section
1263.510 (b) defines goodwill as:
• the benefits that accrue to a business as a result of its
location, reputation for dependability, skill or quality,
and any other circumstances resulting in probable
retention of old or acquisition of new patronage.

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Elements of a Goodwill Loss Valuation
• How California Statute Defines Loss of Goodwill and
Compensation
– Section 1263.510 (a) of the Code of Civil Procedure states:
• The owner of a business conducted on the property taken, or on
the remainder if the property is part of a larger parcel, shall be
compensated for loss of goodwill if the owner proves all of the
following:
1) The loss is caused by the taking of the property or the injury to the
remainder.
2) The loss cannot reasonably be prevented by a relocation of the
business or by taking steps and adopting procedures that a reasonably
prudent person would take and adopt in preserving the goodwill.
3) Compensation for the loss will not be included in payments under
Section 7262 of the Government Code [No overlap with relocation
benefits].
4) Compensation for the loss will not be duplicated in the compensation
otherwise awarded to the owner.

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Elements of a Goodwill Loss Valuation
• Calculating Loss of Goodwill
– Goodwill Before – Goodwill After (Mitigated) =
Goodwill Change (Loss), where:
• Goodwill Before measures goodwill in the absence of
eminent domain,
• Goodwill After (Mitigated) represents goodwill reduced
by condemnation and the costs of mitigation, and
• Goodwill Change (Loss) is the difference in goodwill
between the “before” and “after” measurements.

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Elements of a Goodwill Loss Valuation
• Calculating Loss of Goodwill
– Causes of goodwill loss:
• Sales decline (lost patronage)
• Increased costs (occupancy/rent, operational/logistic)
• Lower growth
• Higher risk

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Elements of a Goodwill Loss Valuation
• Implications for Valuation and Compensation
– The loss of goodwill is limited by the amount of goodwill
computed in the “before” condition. Need to establish
existence of goodwill (Sobke)
– Compensable goodwill loss must be attributable to the subject
eminent domain action
– In order to be compensated, the business owner must
demonstrate that reasonable efforts were made to preserve
goodwill (mitigation is an essential element of the analysis)
– Avoidable betterment not included in loss
– Compensation for loss of goodwill must not be included in
relocation payments or elsewhere (ex: real property award)

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 How Goodwill Relates to Other
Elements of Value and Compensation
• Components of Business Value
• Goodwill Relationship to Other Components
of Value

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 How Goodwill Relates to Other
Elements of Value and Compensation
Working Capital (Current Assets
less Current Liabilities)

Tangible Assets (Cars and Trucks,

Machinery and Equipment,
Leasehold Improvements) --
Some Movable, Some Not
Other Identified Intangible
Assets (e.g., Liquor License)

Goodwill

Components of Business Enterprise

Value

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 How Goodwill Relates to Other
Elements of Value and Compensation
• FASB ASC Topic 805 identifies the following intangible asset
categories:
– Technology-related (e.g., patents, software, databases, trade secrets);
– Customer-related (e.g., customer lists and related relationships);
– Marketing-related (e.g., trademarks and trade names);
– Contract-related (e.g., licensing agreements, supply contracts); and
– Artistic-related (e.g., pictures, photographs, literary works, a/v
material).
– Assembled workforce
– Goodwill
• “Goodwill” under the eminent domain statute actually
consists of various types of intangible assets
– Understanding this asset composition can help understand how
condemnation may impact goodwill (facts and circumstances driven)

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 How Goodwill Relates to Other
Elements of Value and Compensation
• Components of Business Enterprise Value
– Business Enterprise Value = Working Capital + Tangible
Assets + Identified Intangible Assets + Goodwill
– Goodwill = Business Enterprise Value less Working
Capital, less Tangible Assets, Less Identified Intangible
Assets (Residual Approach)
– Goodwill = Capitalized “Excess Earnings” Above
Required Returns on Working Capital, Tangible Assets,
and Identified Intangible Assets (Excess Earnings
Approach)

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 How Goodwill Relates to Other
Elements of Value and Compensation
• Goodwill Relationship to Other Components of Value
– For a given business enterprise value, a higher value of
working capital, tangible assets, or other identified
intangible assets would imply a lower goodwill value
– Stated otherwise, higher working capital, tangible assets or
other identified intangibles would necessitate a higher
level of “excess earnings” to justify the same level of
goodwill
– Thus, there may be a tradeoff between goodwill and other
allocated components of value – and a possible tradeoff
among award categories. “Efficiency” in tangible asset
utilization rewarded in higher goodwill/intangible value

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 How Goodwill Relates to Other
Elements of Value and Compensation
• Goodwill Relationship to Real Estate
– Value of real estate is typically reflected in the fair market
rent computed for the subject business – separating the
potential award for real property value from goodwill
value
– Other things equal, a higher fair market rent results in a
lower economic earnings for the business, and hence
lower goodwill.
– In most cases, real estate value is positively correlated with
fair market rent. So, a higher real estate appraisal may
imply a lower goodwill value
– However, all things not always equal. High fair market rent
may reflect a superior location that supports higher sales,
profits and business goodwill
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 Potential Areas of Controversy
• Use of Projections and “Hypothetical”
Calculations
• Project Attribution
• Mitigation Assessment
• Accounting for Economic Trends/Cycle

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 Potential Areas of Controversy
• Use of Projections and “Hypothetical” Calculations
– Need to value the actual business conducted on site, not a
hypothetical operation (Mesdaq, Coyne, S&M)
– However, Aklilu decision seemed to turn “hypothetical vs
actual” logic on its head (“cost to create” seemed to
presume existence of goodwill without quantitative proof)
– Any business valuation is necessarily forward-looking, and
may not be reflective of past performance
– Key may be whether the analysis is sufficiently supported,
or whether it would be considered “speculative”

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 Potential Areas of Controversy
• Project Attribution
– How has/will the project impact the business?
– Other factors potentially contributing to company
trends – such as the economic climate,
competition, changes in management and
changes in the marketplace – need to be
separated from project impacts
– Has the project affected the company indirectly by
impacting customers or suppliers?

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 Potential Areas of Controversy
• Mitigation Assessment
– Relocation site search and assessment: has an adequate
effort been made?
– Relocation assistance from the agency: how much benefit?
A data dump from the MLS may be of limited assistance
– Have any betterments resulting from relocation been
taken into account?
– Soft costs of relocation and reconfiguration – such as time
spent by management and potential impact on clients,
suppliers and employees – should be considered
– Is it goodwill mitigation or “reestablishment cost?”

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 Potential Areas of Controversy
• Accounting for Economic/Industry Trends
– Decline in business performance – due to relocation or to
economic and industry trends?
– Was business condemned at the trough of the economic
cycle? If so, has an anticipated recovery been adequately
factored into the valuation analysis? If, on the other hand,
bad times were ahead at the value date, were those
expectations reasonably reflected in the analysis?
– Has economic or industry risk been accounted for in the
analysis to the extent considered appropriate?
– Do comparable company transactions used in the analysis
reflect or have been adjusted to reflect current
expectations?

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 Considerations When Reviewing a
Goodwill Loss Valuation Report
• General Considerations
• Specific Considerations
• Overall Considerations

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 Considerations When Reviewing a
Goodwill Loss Valuation Report
• General Considerations
– Appraiser qualifications
• Credentials and experience)
– Identification of assignment
• Business to be valued, date of value, value definition
– Conformity to accepted professional standards
• USPAP, ASA
– Use of accepted valuation methodologies
• Explanation of why methods used or not used

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 Considerations When Reviewing a
Goodwill Loss Valuation Report
• General Considerations
– Accuracy and adequate disclosure of relevant facts
and assumptions
• Disclosure of hypothetical, critical or extraordinary
assumptions
– Adequate support for assumptions
– Appearance of objectivity/absence of obvious bias
– Demonstrated understanding of company,
industry and economic factors

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 Considerations When Reviewing a
Goodwill Loss Valuation Report
• Specific Considerations
– Adjustments to historical earnings/results
• Normalization, officer compensation, fair market rent,
project-specific
– Use of market data
• Selection of comparable companies, multiples, discount rate
– Mitigation considerations
– “After” condition and project attribution/causation
– “Temporary” vs. “permanent” impacts and
compensability considerations

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 Considerations When Reviewing a
Goodwill Loss Valuation Report
• Overall Considerations
– Does the appraisal accurately reflect the facts and
circumstances?
– Does the appraisal interpret relevant market
evidence and apply them to the facts using
reasonable appraisal techniques?
– Does the appraisal bring together the facts and
analysis to arrive at a credible conclusion?

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 Questions?
William W. Thomsen
Thomsen LLC
www.thomsenllc.com
wthomsen@thomsenllc.com
310-871-6904

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