When acquiring a medical practice structured as a C-corporation, the buyer often opts to treat the acquisition as an asset purchase rather than a stock purchase. This approach offers the buyer significant tax depreciation advantages post-transaction. However, this election can result in a capital gain and/or an increased tax liability for the selling shareholder physician(s) which can cause friction within the transaction process. One way in which these interests can be aligned is through the recognition of “personal goodwill” as one of the assets being acquired within the transaction, as this can provide significant tax benefits to the shareholder physician(s), and can help to mitigate some of the incremental tax liabilities that arise from an acquisition of assets.
What is Personal Goodwill?
Personal goodwill is an asset that is specifically attributable to an individual rather than the company. The recognition of personal goodwill requires that at least a portion of the company’s success or failure is dependent solely upon the individual(s) themselves, rather than that of the company.
Personal Goodwill in Medical Practices with Shareholder Physician(s)
Given the nature of medical practices, it is common for personal goodwill to comprise a significant portion of the fair market value (FMV) of the overall medical practice, and therefore purchase consideration. One of the most fundamental questions to ask is whether patients are visiting the practice because of the individual physician(s), or because of the medical practice itself. To the extent that a patient visits the medical practice to see a specific physician, the corresponding income and value generated can be recognized as an asset of the individual (their personal goodwill), rather than a corporate asset.
The same logic applies to referral sources. Where a referral source is referring patients to a medical practice because of an individual physician, rather than the medical practice, the corresponding income and value generated from existing patients who have been referred, as well as future patients yet to be referred, can be recognized as the physician’s personal goodwill.
To the extent a shareholder physician is subject to a non-compete agreement, the terms and restrictions must be reviewed in detail and fully understood to incorporate the pertinent facts into the valuation analysis. For example, if a physician is restricted from competing within a ten-mile radius of the medical practice, the valuation of personal goodwill must exclude any revenues within this area, as the value associated with these revenues is a corporate asset, owned by the corporate entity through the non-compete agreement.
Ultimately, the key question to ask is whether patients visit the medical practice to see a specific physician, or to visit the medical practice itself. Once this question has been answered, the next step is to convert the qualitative factors discussed below into a set of quantified assumptions to be applied to the projected cash flows of the medical practice within a valuation model.
The first step in any valuation of personal goodwill is to conduct interviews with the individual physician(s), as well as employees of the medical practice. The discussions with the shareholder physician(s) should focus on:
- Physician Background
- What is their primary focus – general practitioner, specialist?
- How long have they been practicing in this geographic area?
- How long have they been practicing in this field of medicine?
- What certifications do they hold?
- Have they authored any medical articles?
- What is their personal reputation within the geographic area/field of medicine?
- What are their referral sources for new patients, including an assessment of the relative strength of those relationships?
- What is their age and how long do they expect to continue practicing?
- Patients and Treatment
- What is the duration of their typical patient relationship?
- Does the type of treatment provided create a bond with the patient?
- Do patients come from a wide geographic area to visit the medical practice?
- Does the physician have dedicated staff members?
- Patient Origination
- How do patients typically find their way to the medical practice?
- To what extent is the name of the medical practice a driver in recruiting patients/referral sources?
- Is the physical location of the medical practice a pivotal point in attracting patients?
- Are new patients allocated to physicians based on availability, or specialization/skill?
- Are patients referred from an outside source to the medical practice, or to an individual physician? What drives those outside referrals?
- Do patients visit the medical practice / individual physician due to word of mouth from other patients?
- Are there any marketing campaigns/advertisements that bring in new patients? Are these based on an individual physician’s skills or reputation?
Valuation of Personal Goodwill
Based on the nature of personal goodwill the most common methodology utilized to estimate its FMV is the “with and without method,” a form of the income approach. The with and without method looks to capture the impact of two hypothetical scenarios one in which the shareholder physician(s) remain with the medical practice and the other in which they leave and compete against the medical practice. The appraiser must look to quantify a set of assumptions which should include the proportion of existing patients that would choose to follow the shareholder physician(s) when faced with the hypothetical choice of remaining with the medical practice and seeing an unknown physician, versus moving to a new medical practice in order to continue seeing the physician in question. The appraiser must quantify a similar question for future patients, as well as the various referral sources, while also considering the pattern and longevity of the revenues associated with the patients and the expected profit margins that would be generated on the revenues in this scenario. Ultimately, the value of a shareholder physician’s personal goodwill is directly impacted by the proportion of earnings the physician personally generates, when compared to the medical practice.
Practically speaking, the first step in estimating the FMV of the personal goodwill of a shareholder physician(s) is preparing a discounted cash flow (DCF) analysis utilizing the expected purchase consideration, and consolidated financial projections of the medical practice. This shows the transaction’s implied internal rate of return (IRR). Once this has been calculated, the with and without method must be prepared, with the ‘with’ scenario based upon the projected cash flows of each physician on an individual basis.
When there are multiple shareholder physicians, as is often the case, a with-and-without method must be prepared for each physician, and the sum of the projected cash flows for each physician within the ‘with’ scenarios must be reconciled with the projected consolidated cash flows of the medical practice. This will ensure that the sum of the net present value of the cash flows of the shareholder physicians within the ‘with’ scenarios reconciles with the total estimated purchase consideration for the transaction.
The next step is the preparation of the ‘without’ scenario(s). An adjusted set of projected cash flows must be developed utilizing the various assumptions made for the scenario where the shareholder physician(s) are not associated with the practice and are competing against it within the terms of any applicable non-compete agreements.
The difference in the net present values of the ‘with’ and ‘without’ scenarios represents the percentage of total goodwill that should be recognized as personal goodwill for the respective shareholder physician(s).
An Example of the Benefit of Recognizing Personal Goodwill for a Physician Shareholder
As shown in the below example, the recognition of personal goodwill reduces the effective tax rate and increases the net proceeds to the physician shareholder(s) from the transaction.
| Without Personal Goodwill | With Personal Goodwill | |
|---|---|---|
| Purchase Consideration | $40,000,000 | $40,000,000 |
| FMV of Personal Goodwill | N/A | $30,000,000 |
| Corporate Tax Liability (21% Federal) | 8,400,000 | 2,100,000 (($40.0mm - $30.0mm) x 21%) |
| After-Tax Proceeds | 31,600,000 | 7,900,000 (Corporate) |
| Tax on Personal Goodwill (20% Federal) | N/A | 6,000,000 ($30.0mm x 20%) |
| Dividend Distribution Tax (20% Federal) | 6,320,000 | 1,580,000 |
| Total Tax Liability | 14,720,000 | 9,680,000 |
| Net Proceeds to Shareholder | 25,280,000 | 30,320,000 |
| Effective Tax Rate | 36.80% | 24.20% |
We note that for the purposes of the above example, we have not included the impact of any applicable state and/or local taxes.
Conclusion
Ultimately, recognizing the acquisition of personal goodwill within the purchase of a medical practice provides a significant tax benefit to the shareholder physicians, and helps to align the interests of the seller and the buyer when structuring the transaction as an acquisition of assets. The recognition of personal goodwill as an acquired asset within a transaction should be documented by a robust and comprehensive valuation analysis that supports the recognized value of the personal goodwill.
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© Copyright 2025. The views expressed herein are those of the author(s) and not necessarily the views of Ankura Consulting Group, LLC., its management, its subsidiaries, its affiliates, or its other professionals. Ankura is not a law firm and cannot provide legal advice.
