What Percentage of the Purchase Price should be Allocated to Goodwill?

I see this question frequently, and occasionally I get asked this question from potential buyers. I see claims made by sellers’ advisors that goodwill should be at least 80% of the total purchase price or worse, they suggest that anything lower than 80% will draw the attention of the IRS. This is just plain FALSE!

I hate to break the news to all the folks who believe that there are “standard” percentages that should be used, there aren’t! In fact, I often define goodwill for my buyers as “the difference”. That’s right; goodwill = the difference. Here’s what I mean by that.

Let’s assume you have two practices, each 4 Ops with nearly identical equipment and it’s valued at $150,000. Let’s also assume they’ll have the same allocation to the covenants of $5,000 and the only other remaining assets that need to be allocated are dental supplies and goodwill. Practice A has revenue of $1.5 mil and is selling for $1mil while practice B has revenue of $750k and is selling for $500k. Here’s the proper way to go about allocating the purchase price:

                                                           Practice A                 Practice B

Furniture and equipment                  $150,000 (15%)           $150,000 (30%)

Dental Supplies                                     20,000                          10,000

Covenants                                                5,000                           5,000

Goodwill (the difference)                 825,000 (82.5%)             335,000 (67%)

You’ll note that goodwill is listed last as it should be the last item that is assigned a value. That’s because every other asset above it should be relatively easy to value and after you’ve agreed upon the values of them, the difference goes to goodwill. Furniture and equipment can be appraised, and dental supplies can be estimated based on practice revenues. You might even see allocations for other items like net contract receivables, consulting agreements, leasehold improvements, patient charts, etc. in every case, a value should be assigned to those assets FIRST then the remainder of the purchase price is allocated to goodwill, LAST!

Technically you’ll see the definition of goodwill, an intangible asset, as the excess amount paid for a business over & above its tangible and other asset values. In my world that’s the same as saying “the difference,” it’s that simple. Statistically speaking I would agree that with the “typical” dental practice sale, 75-80% of the allocated purchase price is usually goodwill, but it’s just a statistic, that’s it.

So don’t get sucked into someone else’s world when they tell you “goodwill should be at least 80% of the purchase price of a dental practice” and any other allocation will draw the attention of the IRS. If you hear a seller’s advisor say that then you know they’re NOT being truthful with you and you have to begin to wonder what other statements they’ve made that aren’t truthful.

Written by Tim Lott, CPA, CVA. For more information on our services, please feel free to contact Tim or one of the members of the Dental CPA team by calling 844-DENT CPA or emailing info@dentalcpas.com.